Lessons to be learned from Zynga's risk factors
Lessons to be learned from Zynga’s risk factors - Cihan Köseoğlu - Medium
Zynga is a game company everybody loves to hate. People love to hate them, I guess purely for spending way too much time on Farmville. Zynga has a business model of free-to-play games, in which they sell virtual goods that gives you a boost in their games, like coins, lives, whatever.Their games are not really games. Their games are chores. Their games require you to wake up at 4 AM to water your farm and click on tomato seeds to be a Level 493 farmer. This article is not about that.This article ain’t about this.This article is about risk of business.What are Zynga’s risk factors?I have seen this article by Halting Problem, about Zynga’s SF HQ being more valuable than the company itself (I’ve seen the building myself by the way, it’s a beautiful building) and I was really intrigued by the following data mentioned in that article.Multiple sources close to the matter have revealed that Zynga’s headquarters is now assessed at around $540 million. As of close of market today, the company’s market value was around $2 billion. However, due to its reserves of approximately $1.5 billion of cash on hand, analysts estimate that Zynga is actually worth around $500 million. In other words, Zynga’s headquarters is now significantly more valuable than Zynga the company.I was really really intrigued by the fact that Zynga is 75% cash. Anyone who took a finance course would notice that this is really really weird. Cash is not good. Cash is there for you to spend, to grow, to invest, it’s not supposed to sit in the bank. So I went to see the Zynga’s 10K on their website and was further appalled by how they describe their business and the risks, and I was really happy to see that they did not bullshit.Zynga has a lot of this.Core business risksOur business will suffer if we are unable to continue to develop successful games for mobile platforms, successfully monetize mobile games, or successfully forecast mobile launches and/or monetizationOK, this is true and is a normal risk factor in any business. Their core competency is making successful, mobile, social games. If they fail to deliver their core service, they will fail.The below factors are the same as the one above.We must continue to launch, innovate and enhance games that players like and attract and retain a significant number of players in order to grow our revenue and sustain our competitive positionIf our top games do not maintain their popularity, our results of operations could be harmedOur business is intensely competitive and “hit” driven. If we do not deliver “hit” products and services, or if consumers prefer our competitors’ products or services over our own, our operating results could sufferNo matter how many games they have, they will have a hard time replicating the success of Zynga Poker, Farmville, the original one, and CityVille, and maybe Words with Friends.Lesson to be learned: Your core product and/or service always carries the risk of you start being incompetent in what you do.Money money moneyNow comes the good part.Our operating results are volatile and difficult to predict, and our stock price may decline if we fail to meet the expectations of securities analysts or investors.Our bookings, revenue, adjusted EBITDA, player traffic and operating results have fluctuated in the past and could vary significantly from quarter-to-quarter and year-to-year and may fail to match our past performance or the expectations of securities analysts or investors because of a variety of factors, some of which are outside of our control.They are unable to predict their own financials, which is not common in most businesses. A game may be a huge success, or fail irrevocably, and be buried in sand. They must have analysts, covering the competitors in the market, the latest trends in gaming industry, the mobile in general, consumer behavior and such. However your guess is as good as mine, and theirs. They will draft reports on what the latest trends are and what the next game should be like. They may fail to forecast that, and that will result in financial turmoil. This may lead to a fall in the stock price.The company lost about a third of its value in the last 2 years.There is also seasonality in games. Zynga may be making a killing during fall and winter, but may be losing bigly during spring and summer. (EDIT: I predicted this correctly, I found the following in the report afterwards) Gaming industry is a bit like HORECA. I personally think that you should not invest in a winter resort or a beach resort, but to invest in a business hotel in the city center, where seasonality, the risk of weather and many other factors are eliminated.During fiscal year 2015, approximately 23% of our revenue was derived from advertising and other. Advertising budgets are generally highest during the fourth quarter and decline significantly in the first quarter of the following year, which affects the revenues we derive from advertisements and offers in our games. Additionally, we generally experience increases in game downloads and resulting online games revenues in the fourth quarter and first quarter corresponding to increases in smartphone and tablet purchases during the holiday shopping season.What Zynga should be doing is to focus on games like their own Poker, Farmville and Words with Friends, which are less likely to suffer from seasonality and is a good source of stable revenue.I really loved the Zynga logo on these iconsLesson to be learned: If your product/service doesn’t have a reliable sales number and your revenue varies from time to time, TRY HARD to modify/change its business model to have a more stable inflow.Dependency injectionZynga is, in its core, not only a game company, but a mobile and social game company. Which comes down to a lot of business dependencies. Zynga will die miserably without Facebook, Apple and Google. This in fact, is the biggest risk I can think of. Zynga is also very, very afraid of Facebook. And I mean very.A large portion of our business is dependent upon, and our bookings and revenues are derived from, the Facebook platform, and Facebook in many cases has the unilateral ability to interpret its policies and terms and conditions for applications and developers.It’s not unusual for Facebook to change its terms and conditions on the developer side. Take Zynga Poker. Poker is a casino game. In fact, Zynga has exited the sports games category and will invest more in social casino games, as cited in the report. Facebook may kill off Zynga Poker and Hit it Rich (slots) games, simply because they may deem it online gambling, and poof.neverluckyZynga is very aware of this risk and is probably maintaining good relations with Facebook. As I’ve said above, they are very, very afraid.Our business may be harmed if: * Facebook discontinues or limits our access to its platform; * Facebook terminates or seeks to terminate our contractual relationship altogether; * Facebook prohibits us from offering our games on the Facebook platform because it determines that we are a competitor or for other reasons; * Facebook modifies its terms of service or other policies, including fees charged to, or other restrictions on, us or other application developers; * Facebook makes operational changes to its platform that we are not able to adapt to our game offerings; * Facebook changes how the personal information of its users is made available to application developers on the Facebook platform or is able to beshared by users; * Facebook modifies or interprets its terms of service or other policies in a manner that impacts our ability to advertise, either for our games or for thirdparty products or services; * Facebook establishes more favorable relationships with one or more of our competitors; * Facebook platform or purchasing functionality becomes unavailable for a period of time; or * Facebook develops or acquires its own competitive offerings.Similarly, Apple and/or Google may find their social casino business online gambling. You buy in game chips with real money. You can also blackmarket those chips which means a lot of people cash in real money from this. They may change their mind about this being a simple game and ban it citing their terms&conditions.This would mean doom for Zynga. Zynga is heavily dependent in these platforms and losing their connections would mean a huge blow in financials and investors would not be happy.There is also this.We rely on third-party hosting and cloud computing providers, like Amazon Web Services (“AWS”), to operate certain aspects of our business. A significant portion of our game traffic is hosted by a single vendor, and any failure, disruption or significant interruption in our network or hosting and cloud services could adversely impact our operations and harm our business.Imagine if AWS goes poof for a couple of hours, or Amazon deems it unprofitable and announces to shut down. (Just like Facebook did with Parse). Relying on them is an important risk factor. Remember Microsoft Azure had these poof hours in the past, more frequently than others.Necessary cloud computing logoSimilarly but not so similarly, in software development, there is a concept named dependency injection. In most programming languages, there are package manager tools like npm, composer, rubygems, which essentially helps you find and install a little piece of code that you can later use in your project.Let’s think about a piece of code, that many other software projects use, meaning they depend on that piece of code. Now those projects may be depended by other projects. If you were to suddenly remove that piece of code from the package manager database, all projects that depended upon that code would crash.This is exactly what happened about a month ago in node.js world, where a brilliant, fellow Turkish developer had a feud with npm and deleted all his code from their database, causing worldwide mania, because one particular piece of code (just 11 lines of code) was depended by a lot of major frameworks and libraries. Thousands of developers/software companies had their projects crash for hours before the problem was fixed. This incident led to people re-think the dependency patterns in software development world. Azer, the developer in our story, got huge praise and support from everywhere around the world. ❤Lesson to be learned: You should liberate your business dependencies and try to have a stand alone setting if it’s possible. Dependencies carry huge risk.Adapting to change and doing researchIn business, origin of species by means of natural selection holds true. Failing the adapt the surrounding and evolve will result in extinction. Mobile and Internet changes so rapidly, it’s impossible to keep track. Almost every single day I install node.js modules and 100% of the time, some package becomes deprecated already.The social gaming industry, is a fast changing industry. Try to remember the first Farmville, try to remember when Candy Crush Saga first came out. It’s ancient in terms of gaming industry, but it’s merely 5–6 years ago. What game were you hooked on like cocaine last year, and now?TastyZynga acknowledges this fact.The social game industry, through which we derive substantially all of our revenue, is a new and rapidly evolving industry. The growth of the social game industry and the level of demand and market acceptance of our games are subject to a high degree of uncertainty.What they should be doing, and probably are doing, is to have a more than usual number of employees dedicated to market trends and consumer behavior research, competitor research. As mentioned way above in this article, consumer behavior is key in this industry. In any B2C industry, where the sales channel is direct to your customer, you should keep the focus on them because they are where the money is. You should have a team focused on App Store trends, Facebook app trends. Because they are intermediaries in a weird way. If people tend to ‘get’ more free stuff from the App Store and not ‘get’ paid games/apps, you should know that. These are already stuff that Zynga is doing, we don’t even need to talk about this. But it is an important lesson to keep in mind.Lesson to be learned: Even if you are the leader in a monopolistic or duopolistic market, you have to be able to adapt to change in your business surroundings, keep track of your customer behaviors.Risks in AcquisitionsZynga bought a company called NaturalMotion 2 years ago. They are a game company and they have their own engine technology. It does seem like a strategic acquisition, it makes sense.Our acquisition of NaturalMotion was significant, and the anticipated benefits of the acquisition could be impacted by a number of risks specific to NaturalMotion’s business, as well as by risks related to the integration processHowever they are aware of the risks this acquisition brings. They may fail in employee retention, fail to integrate NaturalMotion’s technology into their own, NaturalMotion’s games may fail to be hits.All kinds of specific risks are involved in this acquisition, however, these are all risks that are considered from beforehand and are acceptable risks. No acquisition is without a problem, and these problems can be considered ‘normal’.Remember that Zynga has $1.5 bn in cash. They can buy any mid-size game company or innovation company they want with that much cash. They list one whole page of things that can go wrong in an acquisition so I will not bore you with all of it. I chose two important things in this matter.Industry-specific risksEvaluation mistakesIndustry-specific risks are not mostly about what you acquire, but what your competitors acquire. Social gaming industry is a huge red ocean and it’s beginning to consolidate. Big sharks are eating all the plankton, but big sharks are also being eaten by the old gods. Supercell was acquired by SoftBank (and as of June 21, 2016, Tencent) , King.com was acquired by Activision Blizzard. Zynga will probably be bought in the foreseeable future. Buying non-strategically, simply to prevent your competitors from acquiring, may lead to loss of huge sums of money, a lot people losing their job and eventually to closing down the company. Also a lot of people consolidating around you, but you being left alone may cause you to be eaten cheaply, or worse, they may drive you out of business. Rovio Entertainment, maker of Angry Birds, is dealing with this problem. Their core game just doesn’t sell anymore.GRRRR!!!Evaluation mistakes generally include cultural and business fit problems. If the acquired company is to be merged inside the parent company, a lot of cultural fit problems will arise. If it’s more like an acquihire, and the child company is given some sort of autonomy, and is not merged into the core business, it may be a little better. Either way, this decision is made prior to the acquisition according to the corporate strategy of the acquirer, and it should be done carefully. Cultural fit problems affects not only the acquired company and its employees, but also the parent company employees. A drop in morale is not something you would want.Lesson to be learned: If you are competing in a red ocean industry, you should be careful about your acquisitions and make strategic acquisitions, you should also be aware of what your competitors are doing in terms of M&A activity.Unicorning❤ ❤ ❤I’m not going to dig deep on whether Silicon Valley, tech startups and this whole environment is yet another bubble. However there is another important lesson you need to learn about your financials. It’s not really a risk factor, but an important lesson to learn.We have incurred significant losses since inception, including a net loss of $37 million in 2013, a net loss of $226 million in 2014 and a net loss of $122 million in 2015. As of December 31, 2015, we had an accumulated deficit of $1.3 billion.We have a history of net losses and our revenue, bookings and operating margins may decline. We also may incur substantial net losses in the future and may not achieve profitability.Picking up from the last part about acquisitions, if you are buying a company, you are also buying its debts. It’s not important how Zynga financed itself up until this point, VC money, long-term financing etc. They’ve got an enormous amount of cash, and it’s not clear why they hold so much money at hand and not invest at all. But if they fail to be profitable, more and more people will lose their jobs and eventually Zynga will either be bought for some money or go poof.Lesson to be learned: Whatever your product/service is, make sure it becomes profitable at some point.It’s been a long read, but I hope you enjoyed it. Thanks to Zynga for its no-bullshit stance and for being a good game company. I hope they’ll do well in the future. Cheers and love.Let’s play a game of Risk