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.