Team Assignment

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CASE 4 :: ZYNGA: IS THE GAME OVER? C13

In 2017, Zynga not only struggled to remain relevant in the gaming industry but fought to seem attractive to investors. During the previous four years, the company had a new CEO almost every year. In 2013, the founder Mark Pincus stepped down and handed the charge to Don Mattrick, a 15-year employee of Electronic Arts expecting to turn the company around. In April 2015, Don Mattrick left the position, and Pincus returned as CEO for the second time. Just a year later

in March 2016, Zynga announced the replacement of Pincus by the new CEO Frank Gibeau, another 20-year employee of Electronic Arts, again expecting to turn around the company.

Zynga’s lack of consistent leadership has been critical to not formulating an effective turnaround strategy that might have led to progress. Throughout the revolving door of CEO replacements, Zynga has not developed a substan- tially successful new game. Consequently, its revenues have been falling over the past years accompanied by consistent net losses. Though Zynga’s revenue rose by $53 million by the end of 2015, it still posted a net loss of $121 million for the year (see Exhibits 1 and 2). The primary reason for the increase in 2015 revenue was a surge in the number of

CASES

CASE 4 ZYNGA: IS THE GAME OVER?*

* This case was developed by graduate students Eric S. Engelson, Dev Das, Saad Nazir, and Professor Alan B. Eisner, Pace University. Material has been drawn from published sources to be used for class discussion. Copyright © 2017 Alan B. Eisner.

EXHIBIT 1 Zynga Consolidated Income Statements ($ thousands, except per-share, user, and ABPU data)

Year Ended December 31:

2016 2015 2014

Revenue:

Online game $  547,291 $ 590,755 $ 537,619

Advertising and other 194,129 173,962 152,791

Total revenue 741,420 764,717 690,410

Costs and expenses:

Cost of revenue 238,546 235,985 213,570

Research and development 320,300 361,931 396,553

Sales and marketing 183,637 169,573 157,364

General and administrative 92,509 143,284 167,664

Impairment of intangible assets 20,677 – –

Total costs and expenses 855,669 910,773 935,151

Income (loss) from operations (114,249) (146,056) (244,741)

Interest income 3,057 2,568 3,266

Other income (expense), net 6,461 13,306 8,248

Income (loss) before income taxes (104,731) (130,182) (233,227)

Provision for (benefit from) income taxes 3,442 (8,672) (7,327)

Net income (loss) $(108,173) $(121,510) $(225,900)

Net income (loss) per share attributable to common stockholders

Basic $ (0.12) $ (0.13) $ (0.26)

Diluted $ (0.12) $ (0.13) $ (0.26)

Weighted average common shares used to compute net income (loss) per share attributable to common stockholders:

Basic 878,827 913,511 874,509

Diluted 878,827 913,511 874,509

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EXHIBIT 2 Zynga Balance Sheets ($ thousands, except par value)

December 31, 2016

December 31, 2015

Assets

Current assets:

Cash and cash equivalents $ 852,467 $ 742,217

Marketable securities – 245,033

Accounts receivable 77,260 79,610

Income tax receivable 296 5,233

Restricted cash 6,199 209

Other current assets 29,254 39,988

Total current assets 965,476 1,112,290

Goodwill 613,335 657,671

Other intangible assets, net 25,430 64,016

Property and equipment, net 269,439 273,221

Restricted cash 3,050 986

Other long-term assets 29,119 16,446

Total assets $ 1,905,849 $ 2,124,630

Liabilities and stockholders’ equity

Current liabilities:

Accounts payable $ 23,999 $ 29,676

Income tax payable 1,889 –

Other current liabilities 75,754 77,691

Deferred revenue 141,998 128,839

Total current liabilities 243,640 236,206

Deferred revenue 158 204

Deferred tax liabilities 5,791 6,026

Other non-current liabilities 75,596 95,293

Total liabilities 325,185 337,729

Stockholders’ equity:

Common stock, $0.00000625 par value, and additional paid in capital - authorized shares: 2,020,517; shares outstanding: 886,850

shares (Class A, 770,269, Class B, 96,064, Class C, 20,517) as of December 31, 2016 and 903,617 (Class A,

769,533, Class B, 113,567, Class C, 20,517) as of December 31, 2015

3,349,714 3,234,551

Treasury stock – (98,942)

Accumulated other comprehensive income (loss) (128,694) (52,388)

Accumulated deficit (1,640,356) (1,296,320)

Total stockholders’ equity 1,580,664 1,786,901

Total liabilities and stockholders’ equity $ 1,905,849 $ 2,124,630

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CASE 4 :: ZYNGA: IS THE GAME OVER? C15

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mobile users, accounting for 73 percent of the company’s revenue in 2015.1 However, year-over-year decline in reve- nues has been primarily attributable to the innovative prod- uct pipeline, which Mr. Gibeau has tried to turn around by focusing on development of high-quality mobile applica- tions that had helped to shrink the net losses in 2015.

In response to the wildly successful Clash of Clans by SuperCell, Zynga released a new mobile game, Dawn of Titans, at the end of 2016. Dawn of Titans features high- quality graphics and options to play with other users in real time. The 3D strategy game also allows users to create their own fantasy kingdoms and develop strategy to stay ahead of the other players. Prior to the introduction of Dawn of Titans, the company had launched a new version of Zynga Poker, which includes a sophisticated design and feature set that inspires more competition, authenticity, and social connections between players. Zynga also launched NFL Showdown at the beginning of the NFL season with the intention of adding new features based on customer feed- back and play patterns. However, the new product-driven growth was not able to reverse declines in the existing online games.2

Zynga’s Background At the time it incorporated in October 2007, Zynga had become a dominant player in the online gaming field, almost entirely through the use of social media platforms. Located in San Francisco, the company was named by CEO Mark Pincus to pay tribute to his deceased beloved pet bulldog Zynga. Although this might have seemed whimsical, Zynga was actually a quite powerful company. Exemplifying Zynga’s prominence, Facebook was reported to have earned roughly 12 percent of its revenue from the operations of Zynga’s virtual merchandise sales.3

No other direct competitor was close to this revenue. Zynga’s collection of games continued to expand, with more and more success stories emerging. A relative newcomer to the market, its quick success was astonishing. However, Zynga’s impressive financials were possibly at risk because of what some considered questionable decision making. Many of Zynga’s competitors, and even some partners, were displeased with the company’s actions and began to show it in the form of litigation. Agincourt, a plaintiff in a lawsuit brought against Zynga, stated, “Zynga’s remarkable growth has not been driven by its own ingenuity. Rather it has been widely reported that Zynga’s business model is to copy creative ideas and game designs from other game developers and then use its market power to bulldoze the games’ originators.”4 If lawsuits and ethical issues contin- ued to arise for Zynga, its powerful bulldog could start look- ing more like a poodle.

The Products With an abundance of software developers, the ability to create and distribute online games increases by the day, and the demand to play them is equally high. However, while

many people find these online games fun and, better yet, therapeutic, others can’t understand the hype. The best way to understand the sudden infatuation is to view online gam- ing as simply a means of relaxation.

In the movies, at least, large executive offices are often shown with putting greens, dartboards, or even a bar full of alcoholic beverages. These amenities are all meant to serve the same purpose: to relieve stress during a hard day’s work. We’ve all been there and looked for a way to cope. However, few of us have the opportunity to use such things as putting greens to unwind at the workplace. And even if we did, how long could we afford to engage in such an activity before being pulled back to our desks?

Stress reduction at work is one of the many purposes that virtual games fulfill: no need to leave our desks; no need to make others around us aware of our relaxation periods; and, better yet, no need to separate the task of relaxation from sitting at our computers while we work. The ability to play these games on office computers and “relax” now and then as the day goes by makes online gam- ing enticing. This, of course, is just one of many uses for the games. Some people play them after work or at the end of a long day. With the onset of smartphones, people of all ages play these games on the go throughout the day—sitting on the bus, in the waiting room of a doctor’s office, or at the Department of Motor Vehicles. Diverting game play is readily available with the click of a button.

Market Size Compared to other game developers with games present on the Facebook platform, Zynga had once been a dominant force, but by 2016 it failed to surface in the top 5 virtual- gaming rankings (see Exhibits 3 and 4). The King Company appeared to rule with its numerous popular games, includ- ing the billion-dollar Candy Crush Saga.

Zynga’s virtual games provided the opportunity for constant buildup and improvements, offering users virtual goods and services to increase their gaming experience. These items could be purchased using a credit card and were often needed to accomplish fast progressions in the games. These goods were advertised throughout the games and the user was enticed by price cuts for larger purchases.

Zynga’s virtual games could be played both remotely and through social media platforms, most commonly Facebook. Five of Zynga’s games, FarmVille, CityVille, Empire and Allies, CastleVille, and Texas HoldEm Poker, were among the most popular games on Facebook. CityVille had over 100 million active monthly users within months of its release in late 2010.5 On July 1, 2011, Zynga filed with the Securities and Exchange Commission with intention of raising up to $1 billion in its IPO, and its stock began trad- ing on NASDAQ December 16, 2011.6

Of course, Zynga was not the only virtual-gaming com- pany striving for this degree of success. There were and are many others, in what seems to be one of the fastest- growing industries. The capability to create online games

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Toyland, Zoo World, Hero World, and MyCasino. Its most played game, Zoo World, was a free social media applica- tion whereby users tried to build the best zoo they could. The company underwent a phase of major layoffs but con- tinued to work on new and improved games.7

GameHouse, based in Seattle, Washington, was a developer, publisher, and distributor of casual games. GameHouse was acquired by RealNetworks for $14.6 mil- lion cash and about 3.3 million shares of RNWK common stock, which had an estimated value of $21 million at the time.8 Prior to its acquisition, GameHouse generated an impressive amount of revenue through the sale of games on its own website, www.gamehouse.com, and through third-party affiliates and other distributors. GameHouse and RealArcade merged their websites into one portal in an

is widespread. Creativity and innovation are accepted to be the grounds on which competing companies challenge each other. With all competitors after the same audience, the industry is prone to a significant amount of head-butting rivalry.

Background of Competitors RockYou was founded by Lance Tokuda and Jia Shen. Their first product was a slide-show service, crafted to work as an application widget. RockYou was one of the compa- nies invited by Facebook to participate in the F8 event, in which Facebook announced the start of an open platform that would allow third parties to develop and run their own applications on Facebook. RockYou then shifted toward producing more in-depth social application games, such as

EXHIBIT 3 Monthly Users of Facebook Gaming, as of October 2016

Source: Statista 2016.

20 40 60 80 100 120 1400

Candy Crush Saga

Candy Crush Soda Saga

Farm Heroes Saga

8 Ball Poll

Clash of Clans

Criminal Case

Pet Rescue Saga

Subway Surfers

Dragon City

Trivia Crack

38.78

30.53

26.03

24.04

22.2

16.14

12.7

10

Monthly active users in millions 160

149.57

17.47

EXHIBIT 4 Top 5 Virtual-Gaming Developers of 2016

Rank Company 2015 Revenue ($ millions) Key Games

1 Machine Zone $1,000 Game of War, Mobile Strike

2 Supercell 2,300 Clash of Clans, Clash Royale, Boom Beach Hay Day

3 EA Mobile 504 Star Wars Galaxy of Heroes, NFL Madden Mobile, The Simpsons: Tapped Out

4 Mixi 2,000 Monster Strike

5 Com2uS 369 Summoners War

Source: www.pocketgamer.biz, 2016 top developers list.

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Background of the CEO Mark Jonathan Pincus was the entrepreneur behind Zynga. He was also the founder of Freeloader, Inc., Tribe Networks, and Support.com.17 In prior years, Mark was named CEO of the Year in the Crunchies awards,18 as well as Founder of the Year.19 Prior to his entrepreneurial endeavors, Pincus worked in venture capital and financial services for several years. After graduating from Wharton, he went on to obtain his master’s degree from Harvard Business School. Soon after graduating, Pincus launched his first start-up, Freeloader, Inc., a web-based push tech- nology service. Individual, Inc., acquired the company only seven months later for $38 million.20 Pincus later founded his third start-up, Tribe.net, one of the first social networks. Tribe.net focused on partnerships with major, yet local, newspapers and was supported by The Washington Post, Knight Ridder Digital, and Mayfield Fund.21 Unfortunately for him, Pincus’s resume did not impress his competitors, irritated by what they viewed as his questionable business tactics, nor did it dissuade them from making their feelings known via a lengthening laundry list of threats and lawsuits.

Intellectual Property and Ethical Issues Nissan has claimed that its trademarks were used without consent in Zynga’s game Street Racing. Zynga consequently changed the thumbnail images and renamed all the cars that were branded Nissan and Infiniti to “Sindats” and “Fujis.”22 Zynga was criticized on Hacker News as well as other social media sites for filing a patent application involving the abil- ity to obtain virtual currency for cash on gambling and other gaming websites. Many said that the concept was not new and that in fact significant prior art for the concept already existed.23 The unveiling of the game Mafia Wars generated a lawsuit from the creators of Mob Wars. An attorney of the parent company of Mob Wars said that by making Mafia Wars, Zynga “copied virtually every important aspect of the game.”24 The lawsuit was later settled out of court for an amount between $7 million and $9 million.25

California-based web developer SocialApps brought Zynga to court seeking damages for alleged “copyright infringement, violation of trade secrets, breach of written contract, breach of implied-in-fact contract, and breach of confidence.” SocialApps claimed to have entered into an agreement with Zynga, allowing Zynga access to the source code for SocialApps’ Facebook game MyFarm in exchange for an undisclosed compensation. According to the suit, Zynga was given the code, but failed to pay SocialApps. SocialApps claimed that MyFarm’s source code was the foundation of Farmville, as well as many of Zynga’s simi- lar games.26 Following Zynga’s release of the game Hidden Chronicles, Forbes’ Paul Tassi wrote that Zynga “refuses to innovate in any way, and is merely a follower when it comes to ideas and game design.”27

Ethical issues, though less tangible and definable than intellectual property, were equally troubling in assessments

effort to create one massive distribution center. RealArcade delivered its games on a downloadable demo basis, with a 60-minute trial time for most games. When the trial expired, the user needed to purchase the full version to continue playing. Users also had the option of purchasing a mem- bership package for a monthly fee. GameHouse later began offering the full version of many of its games, supported by the sale of in-game advertising.9

EA Playfish, a subsidiary of Electronic Arts, began as Playfish Ltd., a developer of social network games that were free to play. Who Has the Biggest Brain? was the first suc- cess of Playfish Ltd. and was the gateway to the company’s ability to raise funding. The company, like many of its com- petitors, generated revenue by selling virtual goods inside its games. Electronic Arts later acquired Playfish for $400 million. Soon after, Playfish drew approximately 55 million users a month, with over 37 million of those users coming from Facebook.10 Users could purchase “Playfish Cards” at Walmart, Walgreens, and Toys ‘R’ Us stores, at which point they could register on the Playfish website to begin earn- ing “Playfish Cash” that could be used to purchase virtual goods within the games. Playfish announced the change from Playfish Cash to individual cash for all games (except Crazy Planets at that time) and allowed users to trade for the new cash.11

CrowdStar, based in Burlingame, California, was another developer of social games. Founded by Suren Markosian and Jeff Tseng, it ranked fourth for most monthly active users among Facebook applications.12 Its most popular titles were Happy Aquarium and Happy Pets. CrowdStar turned down an offer from Microsoft to acquire the company for more than $200 million.13 The company subsequently raised an additional $23 million and planned on using the money to double its workforce and increase expansion on a global scale. CrowdStar also planned to add about 100 employees, including game developers, server developers, artists, producers, business analysts, and content managers. Peter Relan, CrowdStar’s CEO, said the company needed to raise money to exploit opportunities for global expansion in Japan, China, Eastern Europe, and Brazil.14

Supercell Oy operated as a subsidiary of Tencent Holdings Limited. Supercell Oy, based in Helsinki, Finland, was another successful developer of mobile games with additional office locations in United States, Japan, South Korea, and China.15 The initial hit for the company was its browser game called Gunshine.net. In 2011, the company started developing games for tablets and smartphones, gain- ing worldwide popularity over just a few years. The most popular mobile games developed by Supercell included Clash of Clans, Clash Royale, Boom Beach, and Hay Day, free to download and play. The company had annual rev- enue of about $2 billion, and its strategy game Clash of Clans was a leading competitor of Zynga’s Dawn of Titans. Supercell’s flagship game, Clash of Clans, had approxi- mately 100 million daily users, which posed a big competi- tive challenge for Zynga’s Dawn of Titans.16

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begin creating true one-of-a-kind games—showing its capa- bilities as a leader in the industry rather than a follower? With all eyes on the company, it is certain that it won’t be easy for Zynga to get away with some of its earlier stunts, especially now as a public company. As a public company, Zynga needs to watch its step or prepare to feel the wrath of its shareholders.

ENDNOTES 1. http://www.pocketgamer.biz/list/62773/

top-50-mobile-game-developers-of-2016/entry/48/. 2. Zynga Q4 2014 earnings call transcripts. 3. www.vanityfair.com/business/features/2011/06/

mark-pincus-farmville-201106. 4. http://news.cnet.com/8301-31001_3-20093473-261/

zynga-targeted-in-patent-infringement-lawsuit/. 5. www.appdata.com/apps/facebook/291549705119-cityville. 6. www.reuters.com/article/2011/11/30/

us-zynga-ipo-idUSTRE7AT2FJ20111130. 7. http://techcrunch.com/2010/10/15/

rockyou-rocked-by-layoffs-as-it-switches-focus-to-social-games/. 8. http://investor.realnetworks.com/faq.cfm?faqid=2. 9. www.gamehouse.com/. 10. www.gamasutra.com/view/news/32496/Playfish_Social_Games_

Reaching_55_Million_Monthly_Players.php. 11. www.insidesocialgames.com/2011/04/19/exclusive-playfish-ending-

playfish-cash-going-almost-all-in-on-facebook-credits/. 12. www.appdata.com/devs/30679-crowdstar. 13. www.businessweek.com/news/2010-03-31/crowdstar-said-to-break-off-

talks-to-be-bought-by-microsoft.html. 14. http://venturebeat.com/2011/05/23/

social-game-leader-crowdstar-raises-23m-from-intel-and-time-warner/. 15. http://www.bloomberg.com/research/stocks/private/snapshot.

asp?privcapId=127260687 16. http://www.gamespot.com/articles/100-million-people-play-clash-of-

clans-devs-games-/1100-6435433/ 17. http://company.zynga.com/about/leadership-team/zynga-management. 18. http://venturebeat.com/2010/01/11/crunchies-winners-facebook-bing/. 19. http://techcrunch.com/2011/01/21/

congratulations-crunchies-winners-twitter-takes-best-startup-of-2010/. 20. http://startup2startup.com/2009/06/24/june29-markpincus-zynga/. 21. www.nytimes.com/2007/03/03/technology/03social.

html?pagewanted=1&_r=1&ei=5088&en=f718f182170673a4 &ex=1330578000.

22. http://mafiawars.wikia.com/wiki/Zynga. 23. http://allfacebook.com/zynga-patent-currency_b20985. 24. www.bizjournals.com/sanfrancisco/stories/2009/07/13/story7.html. 25. http://techcrunch.com/2009/09/13/

zynga-settles-mob-wars-litigation-as-it-settles-in-to-playdom-war/. 26. www.joystiq.com/2011/07/18/

lawsuit-filed-against-zynga-over-farmville-source-code/. 27. www.forbes.com/sites/insertcoin/2012/01/06/

zynga-stock-falls-as-second-post-ipo-game-fails-to-impress/. 28. http://blog.games.com/2010/09/08/

zynga-ceo-to-employees-i-dont-f-ing-want-innovation/. 29. http://blogs.sfweekly.com/thesnitch/2011/11/zynga_corporate_culture.

php. 30. www.sfweekly.com/2010-09-08/news/farmvillains/4/. 31. http://forbrukerportalen.no/Artikler/2010/

Facebook_and_Zynga_reported_to_the_Data_Inspectorate.

of Zynga’s operations. A former employee of the company revealed firsthand quotes from CEO Mark Pincus, such as: “You’re not smarter than your competitor. Just copy what they do and do it until you get their numbers.” One contractor said he was presented with freelance work from Zynga related to imitating a competitor’s application and was given precise instructions to “copy that game.”28 Other past employees, even those at the senior level, spoke out about the corrupt ways that Pincus had apparently decided to operate the business. One quoted the banter of employ- ees in the office, “Do Evil,” a twist on the Google motto, “Don’t Be Evil.”29

A former high-level Zynga employee provided an insight into the company’s culture, as regarding any emphasis on creativity and originality. According to the employee, a group of designers brought a new and innovative idea to the table, only to have it turned down by Pincus because of his wariness toward a new idea that didn’t fit the “tried-and- true” mold of other successes.30

Zynga was accused of taking advantage of its end cus- tomers, pertaining to a lack of security and safekeeping of consumer information. The Norwegian Consumer Council filed a complaint against Zynga to the Data Inspectorate concerning breaches of the Data Protection Act. According to the Consumer Council, Zynga’s terms of use “do not offer a clear description of what is being collected in terms of information or what this information is being used for. Nor do they state how long the information is stored for or how it is protected against unauthorized access.” The Consumer Council went even further with its forewarning: “Many of the gravest examples of unreasonable and one- sided terms of use can be found in games providers such as Zynga.”31

Zynga Going Forward Although Zynga game users tend to be pleased with Zynga’s games, many note there seem to be recurring obstacles that limit that pleasure. Many Zynga users complain of lag time while playing the games. Even more complain that when problems arise, Zynga support staff are nowhere to be found. The company has no customer service initiative and forces users to resort to sending their claims through e-mail—which many believed is ignored, or never read. Further, many believe that the company makes it too dif- ficult for users to make real strides in the games without spending ridiculous sums of money. Based on their experi- ences, many users believe that Zynga is all about revenue generation and that everything else comes second.

As Zynga looks to the future, where might its next big hit come from? With all the criticism aimed at Zynga’s past behavior, will the company continue on the path it has become notorious for and reap further accusations of imitating its competitors’ games? Or will Zynga change its approach, gain a reputation for intellectual integrity, and

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