Source: Google
Google (GOOG 0.56%) (NASDAQ: GOOGL) will no longer attach a "free" label to mobile games that offer in-game purchases, as government regulators crack down on payment security for app stores, which also include competitors Apple (AAPL -0.81%) and Amazon.com (AMZN -1.11%). What do these changes mean for social gaming leaders Zynga (ZNGA) and King Digital Entertainment (KING.DL)?
Europe's app crackdown
The European Commission has waged war against Apple and Google for app store mismanagement, and it wants the companies to take further steps to protect customers against unauthorized charges. Those desired steps include changing the labels on free games if in-app purchases are offered, preventing companies from marketing purchasable content to children, and improving billing transparency, including offering contact information for refunds.
Google's app store change was done to please the European Commission and will launch in September. The Android maker will also take additional steps to meet the rest of the desired changes. European authorities were less impressed with Apple's improvement efforts.
The European Commission last week called out Apple for failing to commit to a rollout timeline for its own proposed app store security changes -- a charge that the company denies. Apple already settled a Federal Trade Commission lawsuit early this year that required $32.5 million in customer refunds.
But while Apple and Google suffer relatively small hits from the regulatory crackdown, social gaming companies Zynga and King Digital Media could lose a chunk of their core business.
Source: King Digital Entertainment
Fall of freemium?
Zynga and King both have business models built around freemium games. Freemium titles are free to download and play, but they offer a variety of in-game purchases to either accelerate or enhance gameplay. Zynga earns most of its revenue from the purchases, with only about 21% of first-quarter revenue coming from ads. King now entirely relies on game purchases, after it did away with advertising last summer.
How could the retraction of the "free" label hurt the game makers? If app stores don't have a clear indication that the in-app purchases in a game are optional, then customers might skip over the King and Zynga titles, thinking they were no longer free to play. Dropping player numbers have plagued both companies, and an overall player loss has led to a drop in monthly unique payers, or players who complete in-game purchases during a given month.
Source: Company filings
The percentage of players who pay to play has remained fairly constant for both companies, with King drawing in 4% of its overall players and Zynga at 2%. Neither company has much room to let those percentages fall.
Despite King's monthly payer advantage, the Candy Crush Saga maker could suffer most from the app store changes if customers flee from its star title, thinking the game now requires in-game purchases. Candy Crush accounted for 67% of King's overall revenue in the first quarter. Zynga doesn't have one title as popular as Candy Crush, but the company acquired a mobile and console game technology company earlier this year and could start stepping away from the social gaming sphere.
Zynga and King might not suffer fatal wounds if the app label changes only apply to European markets. However, a current FTC lawsuit against Amazon could inspire the other app store owners to make similar changes stateside.
Making app payments secure
An FTC lawsuit against Amazon was announced earlier this month regarding the online marketplace's lack of security that allowed children to make unauthorized app purchases. The FTC says the problem has amounted to millions in charges and wants Amazon -- which gets a 30% cut on app sales -- to issue refunds to improperly charged customers.
How were those charges able to happen? Amazon's app marketplace has required a payment method on file to download even free games, but it lacked any type of login requirement starting in late 2011. A fix of sorts was introduced in spring of the next year, but the login was only required for in-app purchases of more than $20, which meant little Johnny or Suzy could still rack up a decent amount of charges while playing an Ice Age game without Mommy or Daddy knowing.
Another update that Amazon rolled out earlier last year required an account login for purchases -- but then left the approval window open for minutes to hours after the original purchase was approved. The FTC says the matter was worsened with Amazon's confusing and often unfruitful app return policies.
Google and Apple might want to avoid ending up in Amazon's position in the future, and changing the U.S. app stores to comply with the European requirements would likely also please the FTC.
Foolish final thoughts
Google and Apple would prove wise to adopt the changes the European Commission requires in both overseas and domestic markets to avoid further regulatory run-ins. The app store changes could impact the earning potential and customer count for the social gaming companies if the in-app purchase notification doesn't specify that the purchases are optional.
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