Zynga’s 10 Key Challenges Explained

Understanding the challenges Zynga faces is important for everyone to understand. In light of Zynga's S-1 filing, this article elaborates on the 'risk factors' Zynga has identified as it prepares for the public markets.

With Zynga’s S-1 filing and inevitable IPO on the horizon, it’s important to take a critical look at the company before deciding whether to invest or not.  This article elaborates on the ‘risk factors’ Zynga has identified as it prepares for the public markets. More after the jump.

The following are risks and uncertainties for Zynga as listed in its S-1 filings recently. Zynga, like other game developers, is on a quest to capture as miuch of the social and mobile gaming market as possible. In order to do this, they are operating live services for players world wide, including launches of new games and enhancements to existing games like Frontierville. In addition, Zynga has to continue to invest in its technology infrastructure, gain more traction internationally and become stronger on mobile.

1. If we are unable to maintain a good relationship with Facebook, our business will suffer

Zynga’s business heavily depends on Facebook. Deemed ‘frenemies’, the 2 giants are looking to extend their relationship for the foreseeable future. Zynga is expected to account for 10% of Facebook’s revenue, or roughly $400M, if Facebook makes $4B in revenues this year. If Facebook decides to launch its own games or acquires a gaming company (both of which seem unlikely at the moment), or outright bans Zynga games on Facebook, Zynga could suffer.

2. We operate in a new and rapidly changing industry, which makes it difficult to evaluate our business and prospects

Zynga has taken measures to upgrade its analytics and data systems that allows them to capture over 1 Pentabyte of data daily on its games and business. Since the relations are mostly owned by Facebook, Zynga is taking steps to establish its own relations with its players using properties such as Rewardville to inspire loyalty. Zynga also has to stay ahead of the curve and perform better than its competitors or risk losing its employees.

3. We have a new business model and a short operating history, which makes it difficult to evaluate our prospects and future financial results and may increase the risk that we will not be successful

The virtual goods industry is just starting to take off in the west which is Zynga’s primary market. According to the filing there are 38,000 virtual items created every second, with Zynga’s players spending a total of 2 billion minutes on the service daily. The revenue generated from virtual goods trumps all ad revenue. In 2008, online games and virtual good sales comprised $5.3 million of Zynga’s revenue while advertising generated $14.1 million. In 2010, the situation was opposite: Zynga made $574.6 million from virtual goods and its online games and just $22.8 million from advertising.

4. We rely on a small percentage of our players for nearly all of our revenue

It’s no secret that majority of gaming revenue is generated from a small percentage of people also known as whales. These players are the bread and butter for the gaming companies and spend anywhere from $30 to $300 on virtual items. These whales can choose to take their spending elsewhere anytime they feel, so its important to identify and retain these players.

5. A small number of games have generated a majority of our revenue, and we must continue to launch and enhance games that attract and retain a significant number of paying players in order to grow our revenue and sustain our competitive position

Games are risky and operate as hits, they either make it or tank, atleast when you’re not operating the game as a lifestyle business and not worried about missed opportunities. Zynga has been meticulous, though, in taking all its learnings from its previous titles when launching new ones. Zynga’s challenge will lie in figuring out which titles to pursue and which ones to leave behind – a challenge it seems to be tackling head on as it has pushed its Empires & Allies to over 33MMAUs on Facebook.

6. A significant majority of our game traffic is hosted by a single vendor, and any failure or significant interruption in our network could impact our operations and harm our business

Zynga is taking issues of hosting and infrastructure very seriously, aptly pointing out the problems it suffered in the past by over reliance on a single vendor such as AWS, Amazon Web Services. Website disruptions, outages, human errors and other issues can be quite disruptive and cause players to lose interest. Zynga admits that its reliance on third parties for specific elements in the cloud hosting value chain will continue but it will continue to make solid investments in tech. infrastructure moving forward.

7. Security breaches, computer viruses and computer hacking attacks could harm our business and results of operations

We’re all seeing the onslaught of hacker attacks and security exploits becoming more prevalent; the Playstation Network attack being the most notable attack these days. It’ll be imperative for Zynga to make sure its flash games aren’t easily hackable and that its players’ privacy remains properly secured so the playstation saga, where millions of names and credit cards were compromised, doesn’t happen again.

8. If we fail to effectively manage our growth, our business and operating results could be harmed

Over half of Zynga’s employees, 64% to be exact, have been with the company for less than a year. 92% have been with Zynga for less than 2 years. Zynga will continue to invest in attracting the top talent, and has also subjectively been known to ‘dry up’ talent in places around the globe. There is a full fledged talent war taking place and Zynga will have to move fast to attract employees for its mobile efforts before others like Storm8, TinyCo or PocketGems lure them all.

9. Our growth prospects will suffer if we are unable to develop successful games for mobile platforms

Zynga’s limited experience in mobile makes it difficult for them to create a system that, most of the time, delivers results as expected. Zynga has already surpassed their own expectations on Facebook and will need to devise an equally compelling strategy on mobile to yield similar results. Zynga’s most significant acquisition has been NewToy, paying close to $50M for the glorified maker of the popular scrabble-like word game Words with Friends.

Zynga’s latest mobile game, Hanging with Friends, was launched in June 2011 and became the most downloaded game in Apple’s App Store during its first week, according to the filing.

10. Expansion into international markets is important for our growth, and as we expand internationally, we face additional business, political, regulatory, operational, financial and economic risks, any of which could increase our costs and hinder such growth

Localizing for international markets seems to be one of the top most challenging tasks for Zynga. Zynga’s efforts include expansion of their games to attract non-US players, establishment of offices and development studios, and understanding various cultures around the globe to effectively create virtual goods that appeal to those players.

Many challenges lie ahead for Zynga, but the gaming giant is ready to take on the next frontiers in gaming. Many speculate that Zynga’s stock will be a buy and dump ordeal as Zynga’s situation may be more volatile than it seems. Zynga is, however, earning serious money and has over 148MMAUs in over 166 countries. The company has pulled in $235 million in revenue for the first three months of 2011, up more than twice the $100 million it pulled in for the same period a year ago.

Even if Zynga can manage all these challenges, the question of Facebook still remains. What do you anticipate will happen?