This Is How Zynga Slowly Strangles Itself

Last week, a former Zynga (Nasdaq: ZNGA  ) engineer -- who calls himself mercenary_gamer -- hosted an "IAmA" thread on Reddit, in which he answered questions about the eight months he spent at the company. For the most part the thread confirmed a lot of what we already know about the company's standard operating procedures. However, it did shed a little more light on just how Zynga uses all of that data it collects from players to fine-tune its games. If what mercenary said is true, then the company's data obsession may lead to its downfall.

The $10,000 virtual farm
Zynga collects huge quantities of data, but according to mercenary, it focuses on the habits of the most popular players and those who have spent at least $10,000 on in-game purchases -- also known as "whales." Most of the changes and updates you see to existing games are meant to encourage the big spenders to spend even more.

Mercenary also claimed that the company will sacrifice fun to maximize profits. He recounted an incident in which a game's quality-assurance tester complained that a particular item's low drop rate made the game less fun, so mercenary made an adjustment but was ultimately overruled by the product manager, who changed the game back to the more profitable version.

What's wrong with profitable?
I'm not arguing that video-game companies shouldn't seek profits, or that they shouldn't find new ways of pleasing their existing customers. However, I see two problems with Zynga's strategy. First, the average player and the player willing to spend $10,000 on virtual corn are two very different people. Focusing on the high spender runs the risk of alienating the less obsessive gamers -- which is the larger market. Second, by sacrificing fun, the company also drives away new players long before they begin to consider opening up their wallets.

In short, rather than spur growth, Zynga's strategy actually limits it. You can already see the effects. When the company launches a new game, 90% of the players come directly from an old game, so its audience really isn't growing that much. Eventually, even the company will find the upper limit of what its whales are willing to spend. When that happens, we'll see the company's declining bookings and revenue growth rates shrink even further.

The better way to play
The more I learn about Zynga, the less appealing I find the company. It will ride the Facebook IPO for a while, but eventually the market will turn on it. If you're looking for a better play in video games, I'd go with Activision Blizzard (Nasdaq: ATVI  ) . Although it hasn't entered social gaming yet, the company is also looking to generate more revenue from its players, but it has taken a smarter approach. Its new subscription service, Call of Duty: Elite; the Skylanders figurines; and the real-money auction house launching with Diablo III all add value to the games, but without alienating new players.

You could also take a less direct approach and invest in the booming smartphone and tablet PC markets. The mobile industry's growth potential absolutely dwarfs even the rosiest outlooks for companies like Zynga. If you'd like to learn more and find out about three companies quietly cashing in, then check out our special report, "3 Hidden Winners of the iPhone, iPad, and Android Revolution." The report is completely free, so access it today.

The Motley Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Patrick Martin owns shares of Activision Blizzard. You can follow him on Twitter, where he goes by @TMFpcmart03. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 20, 2012, at 12:05 AM, Mega wrote:

    That's pretty disturbing, I had no idea people were paying $10K on ZNGA games. And it could all be deleted in a millisecond.

  • Report this Comment On February 20, 2012, at 1:52 AM, VolkOseba wrote:

    Basically this confirms what I knew all along... their business is centered around sick people.

  • Report this Comment On February 20, 2012, at 5:46 AM, TheeMadCatte wrote:

    Your link in the article "access it today" points to your local file :

    file:///C:/Users/Patrick/Documents/Dropbox/Fool%20Articles/Updated_version_of_writing_template/3%20Hidden%20Winners%20of%20the%20iPhone,%20iPad,%20and%20Android%20Revolution

    No need to make this comment public, but a fix for that would be nice.

  • Report this Comment On February 20, 2012, at 8:38 AM, pmart wrote:

    TheeMadCatte,

    I have no idea how I managed to mess that up. Thanks for letting me know. You can also click the title of the report. I'll see about getting the link fixed, although since this is a holiday, it might not happen until tomorrow.

    -Patrick

  • Report this Comment On February 20, 2012, at 9:56 AM, foonchip wrote:

    ATVI is the leader in social gaming! Half the reason people still play WoW is because they enjoy the interaction that they have with the friends they've made over the past 7+ years. It may not be what the market views as "social gaming" but I'd say it's a bit more accurate to the term.

    -Foon

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