Zynga’s Risky Business

Zynga’s outlook may be rosy on the IPO front, but the company’s scrappy origins may have led it to forge a business model based on a very tenuous relationship with Facebook, which is the company’s greatest strength and vulnerability.

Zynga’s most obvious appeal is its pool of user data, with some 140 million unique visitors. But most of that data has been built through Facebook. “If we are unable to maintain a good relationship with Facebook,” Zynga’s IPO documents read, “our business will suffer.”
Zynga’s status is even more fragile as Facebook faces triple-threat challenges from Google. Google+ looks like its most credible effort in social networking, and it is readying the launch of Google Games.  Facebook, under pressure from Google, might not be willing to nurse Zynga’s rise without demanding more payback than its present 30-70 split on Facebook’s in-game payment system, Zynga’s greatest source of revenue. That split may rise in Facebook’s favor according to Facebook’s whim, and highly dependent Zynga will be obliged to say yes to whatever that percentage may be in order to keep Facebook on friendly terms.
Facebook presently forces applications using its platform to use Facebook credits and charges a 30-percent transaction fee. Add Paypal processing fees per transaction, plus normal operating costs and the potential increased investment in advertising and product development to drive growth in the U.S., on mobile and overseas – all listed as crucial to Zynga’s survival on the company’s filing– and that’s a huge outflow of cash.
That’s OK, because Zynga is wildy popular, with more than half of Facebook users connected to the application, so the potential is huge for consumer revenues if micro-payments take off. At present, Zynga’s percentage of paying customers hovers at 2 percent, about 10 times higher than the average banner ad. That means the long-term future may be rosy if new Zynga registrations and the number of paying customers rises consistently, but Zynga’s growth has slowed considerably over the last two years, with no growth at present. According to some analysts, if Facebook upticks application transaction fees, Zynga’s profits would be reduced to zero (based on profit margins of around 30 percent ) unless it grows swiftly, starting now.
There’s also the question of Zynga’s mobile future. Zynga’s ability to compete in the mobile app world is critical. “Our growth prospects will suffer if we are unable to develop successful games for mobile platforms,” read its IPO filing. Although Zynga recently struck a deal with AT&T to create customized content for Android, the company faces a significant threat on the mobile front. The AT&T and T-Mobile proposed merger will allow the merged operators to manage 99 percent of broadband connections, and Zynga may find itself, according to some analysts, held hostage by its mobile providers just as hopelessly as it is to Facebook.
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