Opportunities for social gaming companies in mobile and real-money gaming

With over 70M daily active users, Zynga is the global leader of the social gaming industry. Zynga has nearly 6 times as many daily active users as its nearest follower King.com. As a result of its size, Zynga’s financial performance serves as a bellwether for the performance of other social gaming companies. This is why the poor results which Zynga recently announced for the first half of 2012 had an adverse impact extending well beyond the company. Industry analysts who were painting pictures of sunshine and happiness until now have reversed their stance to one of doom and gloom.

However, instead of having a short term memory, we need to remember that the social gaming industry has developed over the last 5 years. It is therefore very unlikely to disappear overnight. In fact the industry faces two big tailwinds in the form of mobile and real-money gaming. Properly pursued, these opportunities will ensure that the industry not only maintains its growth but, more importantly, achieves sustainable profitability.

The first big opportunity for social gaming companies to increase profitability is the transition from browser based games, including those on Facebook, to mobile. In comparison to browser based games, mobile games allow companies to tailor their games based on the user’s location. This not only gives companies the opportunity to improve the gaming experience for users but also makes it possible for advertisers to offer users more targeted location-based ads. This leads to higher click through rates and greater ad revenues from mobile games than from browser based ones.

Mobile games also have greater user engagement than their browser based counterparts because people don’t sit in front of their PC all day but almost always have their smartphone accessible. The ease of performing repeated interactions is a very attractive feature of mobile games.

The combination of an improved location-based gaming experience, more targeted advertising opportunities, and greater user engagement leads to significantly higher monthly average revenue per user (ARPU) for mobile games. Whereas different sources quote monthly ARPU figures ranging from $0.22 to $0.32 for browser based games, these can be as high as $10 to $12 for mobile games. This includes $8 from virtual goods and $2 to $4 from advertising depending on the smartphone operating system.

Social gaming companies have a second big opportunity in real-money gaming. Since social gaming companies largely offer freemium games, they have so far relied on two sources of income: virtual goods and advertising. The flow of cash has been an exclusively one way street with money going from gamers to the company. With the introduction of real-money gaming where users are rewarded for outperforming their peers, gamers will for the first time have the opportunity to earn more than what they pay to play and progress in a game. Since they will only be able to acquire this carrot if they beat other gamers, they will increase their spending on the virtual goods which increase their probability of winning. This is in addition to the upfront payment that can be required to take part in a real-money game. Another way they can increase their chance of winning is by spending more time playing the game, and this will make gamers more attractive targets for advertisers.

There will be legal limits to real-money gaming in those countries that prohibit online gambling. However, there are enough countries where the model can be tested and proven before showing those governments that do prohibit the activity that the stakes involved for most social games are much lower than for traditional casino games. Once the distinction between real-money social gaming and gambling has been established, companies will increase their income from virtual goods and advertising while also having the opportunity to add a new revenue stream in the form of an upfront pay-to-play fee.

As humans we like to play games and compete with each other. This will not easily go away. Social gaming companies addressing these intrinsic motivations have entered a rough patch not because of their poor fundamentals but because extreme hype had simply gotten ahead of great fundamentals. By continuing to meet these intrinsic motivations while innovating in mobile and real-money gaming, social gaming companies will soon refocus attention on their great fundamentals.