Playfish COO: EA Acquisition Validates the Future of Virtual Goods in Social Games

Nearly a month ago, we first reported that gaming giant EA (ERTS) was looking to acquire large social game developer Playfish. Today, the deal was made official: EA is acquiring Playfish for $275 million in cash plus up to $125 million more in earnouts and equity retention bonuses. For those wanting validation of the future of virtual goods-based business models inside social games, your wait may now be over. Free to play social games represent the largest and fastest growing segment of the US virtual goods market, which will top $1 billion this year and will grow to over $1.6 billion next year. Today is a symbolic day in the young history of the social gaming "space." When we started ISG in early 2008, we wondered just how quickly social gaming would grow. Now, it's clear that the whole games industry is taking note. Now that EA has acquired Playfish, the evolution of "social games" across platforms will accelerate even more quickly. We just spoke with Playfish COO Sebastien de Halleux about the deal, the future of virtual goods monetization in social games, and what the acquisition means for the industry. Justin Smith: Congratulations on the announcement. From the beginning, why was EA interested in acquiring Playfish? Sebastien de Halleux: EA has believed since the beginning that social games would be an important part of their future. This is also apparent based on the titles they've released themselves. We've known each other for a long time - our team comes from the game industry. At Playfish we have always strongly believed in IP creation, and this is the kind of approach that resonates very well with EA. The one thing that excites me the most is the combination of really strong IP. We now have access to bring it to the social space now. There are also big cross platform opportunities too - as you know, EA is very strong on the iPhone and other platforms. Why did you decide to sell now, vs waiting for some other option down the road? The space right now is extremely new and a greenfield. All companies are focused on pure growth. But you've heard me say that there will be an S curve around taking care of our audience and building IP. EA gives us more resources to grow right now - more marketing budget to reach new users in new ways - but over the longer term this is the best way to secure the dominant position that we've been aiming for. EA is one of the most formidable players in the world in terms of games overall. How will Playfish be working with EA on its other social gaming efforts? We will drive this as aggressively as we can by using the best IP [EA's] and our experience. It's too early to see what that will look like exactly. Our goal will be to own the social gaming experience over the long term by delivering the highest quality social gaming experience. Does today's acquisition validate the model of social games monetizing through virtual goods? This is the biggest validation this industry has had, and I can guarantee you this transaction would not have happened if there was not some sustainable value. But value is easily confused with maximum revenue in the short term. We want to create the most valuable IP over time. We want to create the Star Wars of social games, or whatever franchise you can think of. Lets face it, there's only so many people on earth, and at some point you move out of hypergrowth and into how well you nurture your audience and take care of them. Every industry has cycles, and as we move there in social gaming, EA is a great fit for that. There have been a lot of people harshly criticizing the idea of virtual goods inside social games, as though players are buying nothing. Let's take a step back. There has been a confusion between the marginal cost of production, $0, and the perceived value. Think about what you buy when you buy a movie ticket - you buy the right to experience some emotions. What do you "have" afterward? Even when you buy a physical flower, you don't have anything very long afterward, but rather you are buying the emotion it creates in the receiver. That is how that good is priced. When you buy a birthday cake, you're not paying for the cake, but the emotion the receiver gets. It's the same with virtual goods. It's a value that's very, very tangible. It's maximized around social emotions and social expression, and often time sensitive like birthdays. Think about the fashion industry - your fashion is a statement about what kind of person you are to your social group. When users decorate their virtual home in games like Pet Society, which sold 8 million pumpkins for Halloween, our users tell us the reason they buy those things is they want their friends to check out their Halloween decorations. But how many friends can go to your real house vs. check out how you've expressed yourself in a game on Facebook or MySpace? So the value of a virtual good can be in some cases higher than that of phyiscal goods. There has been some misunderstanding that most social gaming revenue comes from offers. What role have offers played in the monetization of Playfish games to date, and what role will they play going forward with EA? Yes, there's a bit of a misunderstanding here that needs to be dispelled. For Playfish specifically, the vast majority of our revenue is direct transactional revenue from end users, i.e., not involving an advertiser. The bottom line here is that we are trying to create high quality products, and the ultimate test of quality is do users want to pay for the product. There's no such things as a low value player, there's only low value experiences. There should be a game that appeals to everyone. The potential for direct transaction revenue is very large - there is a lot of room to grow. Myth #2 is that all offers are bad, or that all advertising in general is bad. We have been using offers very conservatively because we believe advertisers have a role to play in social game monetization. There are some types of game play and experiences that can be monetized through advertising in the form of sponsored games, in game advertising, or offers. We have been working with TrialPay on some high quality offers that have meaning to users, for example some items on Valentine's Day. We work with advertisers where there is a very well defined process and value for advertisers and users. We are also working with Super Rewards/Adknowledge because they were the first to enable publishers to fully control quality. We categorically refuse to work with anyone that doesn't give us offer level control. From day one we have scanned every offer from our providers. We had to remove many offers from our system because we believe user protection is very important for the long term. We do believe there is a future for CPA in social games. The industry needs to mature. It's like the early days of internet advertising - it's all about quality control. Ultimately, we need to grow the advertiser base. But it has to be done with the utmost guarantee around quality. I do think the debate over the last couple weeks has been very healthy. Through this the industry can hopefully self regulate and improve, but this is not something we have been involved in. Some people call it the most conservative view, we call it the most long term view around high quality offers. So how would you describe advertising's role in social games in the long run? The long term promise of this industry is to attract a new audience to play games. It's to bridge the gap between the 1.6 billion web users and the 200 million consoles out there. To do that will take the ability to deliver the right game at the right price in the right way. This brings up IP - whether the IP comes from inside the space (like Pet Society or Restaurant City), or outside the space (like in sports, which hasn't happened yet today), this is where there's a lot of excitement about being a part of EA. Now have access to IP to make a lot of new social games to reach large new audiences that may not have been reached by many of the existing games. So what's in it from an advertiser's perspective? You can address friends whether you are a food brand or a car manufacturer - there are ways to augment your brand in experiences that are a good fit for the user. Even with just direct transactions, social games will be a multi-billion dollar industry in just 2-3 years. If we can tap into advertising dollars as well, it will be the first time the games industry has been able to do that, and it could become a meaningful complement to revenues overall. How are you going to increase your marketing efforts now that you have the additional resources from EA? This will require a lot of work. It's hard enough in one country, but it's another thing on a global basis. We will accelerate this, whether it's advertising or IP. There is a big part of the global audience that we've yet to reach. How will the acquisition affect Playfish's product strategy? Particularly cross-platform. I don't think this will affect our product strategy. It will not change our high level process of design. We will be focusing on quality. We are leaders in cross platform social games on the iPhone. EA has 7 of top 10 iPhone titles. Our view is that social games will come to all platforms - everyone has friends, no matter what platforms you are on. No one is better tooled to deliver on that perspective than we are. How will Playfish fit into the EA organizational structure? We will remain operationally independent. Our teams and studios are proceeding according to plans. This will just accelerate our goals to build value in the social gaming space. Users will see very little change - just us being able to execute faster. We will be becoming a part of EA Interactive, along with EA Mobile and Pogo. As you saw from the deal structure, we are all 100% committed. We think this deal is the best way to accelerate our goals for the industry. This is a big event in the history of the social gaming "industry." What's the significance of the acquisition today more broadly? To me, personally, this is just the beginning. The first two years have been about getting started. Everyone, beyond just gamers, has a desire to play with their friends. They were just waiting for the right products, which needed companies with the right business model to create them. With 1 billion people online, there is a huge market here. EA's acquisition validates this space, and shows how big this is about to become. Now, this is going to grow on a really massive scale. Everything that happened before this will be remembered as the early birth stage. Now, things are really going to get interesting. This will become a multi-billion industry over the next couple of years.

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Playfish COO: EA Acquisition Validates the Future of Virtual Goods in Social Games

Justin Smith

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