Facebook is to Zynga as a Clownfish is to a Sea Anemone?

The days leading up to the highly anticipated Facebook IPO have been met with market excitement.  Comparisons of Facebook to Google and speculation about whether the company is over- or under-valued have been rife for some time.  Facebook has convincingly overcome concerns about negative cash flows and lack of a monetization plan that plagued it in the media a few years ago.  However, concerns about Facebook’s business model seemed to have revivified as investors struggle to identify the company’s bread and butter and more importantly, to understand its relationship with social gaming behemoth, Zynga.

I remember hearing estimates in 2009 that Zynga made up 40% of Facebook’s revenue.  That is why I was taken aback by the market’s surprised reaction when it traded up shares of Zynga upon finding out the company composes 12% of Facebook’s total revenue.

A breakdown of Facebook’s revenues from Zynga shows that Zuckerberg’s company derives its revenue from the gaming company through the sale of virtual goods and other add-on features in games (Payments) and through ads that Zynga buys to cross promote its own games to captive Facebookers (Ads).  Moreover, an increasing proportion of this revenue comes from Payments revenue.

 

In some ways, the Payments model is not very different from the way Apple charges iPhone application developers a cut of the revenues made from the Apple App Store.  Facebook’s cut of Zynga’s Payments revenues is reported to be 30%.  Facebook’s relationship with Zynga deviates from Apple’s relationship with its app developers in at least one key respect—Facebook also reaps ongoing benefits from Zynga’s success in the form of advertising revenue.  The larger Zynga’s customer base grows, the more it is willing to invest in advertising and the more people that fall into the target audience Zynga wants to reach.  Increased advertising by Zynga benefits Facebook.  Additionally, while iPhone app users pay once for an app (say $0.99), Zynga users may keep buying add-ons within the same game (say $0.99 per virtual good).  Finally, while I have not searched Apple’s financials to confirm, I seriously doubt any one app developer makes up 12% of Apple’s app store revenues, let alone 12% of the diversified company’s total revenue.

Thus, Facebook’s near-term future is highly levered to Zynga’s success.  This leverage presents problems in the eyes of some for several reasons.  First, sustaining revenues from gaming alone is not Google-esque.  Google effortlessly fused the worlds of media and technology in a revolutionary way.  It was able to use its technology to appeal to advertisers very broadly.  A dependence on gaming leaves Facebook less diversified, less appealing to advertisers universally, and potentially vulnerable.  This factor doesn’t bother me much because other apps will fit into the Facebook ecosystem as the social networks becomes increasingly ingrained into the way we think about the Internet and computing.  Plus, there is a trend in various sectors to solve problems through gaming anyway.

The bigger problem is a more general business issue.  Dependence on one company can become unhealthy if the equilibrium is rattled.  Right now Facebook and Zynga have symbiotic interests.  Both businesses align well with each other.  However, if Facebook were to decide to invade Zynga’s turf and start competing with the game developer, or if Zynga can successfully create its own network of users outside of the Facebook platform, the relationship won’t be quite as hunky dory.

Some have countered that Facebook has an exclusive arrangement with Zynga whereby Zynga agrees to use Facebook currency and develop certain games only for use on Facebook.   I don’t really see this arrangement mitigating the concern.  Prohibiting development on other social networks is a useless demand since Facebook has won the day as far as general interest social networks go, and gaming is not a fit with other popular social networks such as Twitter, LinkedIn, and foursquare.

More significantly, Zynga has always had a disconnect between its mobile apps and its games on Facebook.  I once tried playing Mafia Wars to get a better idea of what the craze was behind Zynga’s games ahead of an interview with the company.  My profiles on Facebook and the iPhone app could not be synced.  Whether this incompatibility is still an issue with Zynga’s games, I do not know.  However, the recent success of Words With Friends at the very least shows that Zynga is capable of finding success outside of Facebook even with an exclusivity agreement in place.

The fact that the ads portion of Facebook’s revenue from Zynga is decreasing is reassuring, but it still raises issues about Facebook’s ad monetization strategy.  Google found a direct way to relate ads to subjects that directly interests users.  When searching for a person’s profile on Facebook, it is less obvious which ads should pop up than if someone conducts searches about an upcoming vacation on Google.  (This explains why so many people complain about dating advertisements on Facebook.)  The display ads on Facebook are commoditized, and the company’s current advertising strategy is just as shaky as a non-premium online ad network.

These concerns about Facebook’s advertising revenue is not to say the company won’t eventually get it right.  The rich data Facebook collects is highly valuable.  The challenge of utilizing it in a way that doesn’t sound off alarms about privacy remains.  Personally, I thought Beacon was a promising first step, but it was introduced in such a disastrous way that Facebook has been unable to broach the topic again in a privacy-friendly way.

Still, Facebook has to figure out the ad scheme fast.  Other social networks, though not at all threatening in terms of scale, are carving out niches that are more advertiser-friendly.  Pinterest, for example, can make money on ads in a very direct way not too different from Google, and foursquare can capitalize on location-based audiences and local deals.

Utlimately, Facebook is well . . . Facebook.  I don’t think many can imagine life without it, and it is hard to bet against a company with that type of stickiness.  As long as the Facebook-Zynga symbiotic equilibrium does not shift, the fact that 12% of Facebook’s revenues come from Zynga isn’t too troubling.

I’d also note that while I may have painted a rosy picture about Zynga over the medium term, it too has long term concerns, namely the danger of becoming less data-driven/disciplined and more like a media company.  Additionally, while the exclusive arrangement with Facebook might be a pro for the social network, it displays Zynga’s subjugation to Facebook’s terms and power.

In the meantime, I leave it to you to decide which company is the Clownfish and which the Sea Anemone.  For help and more information, see the epic video below.

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Steve Jobs

I first heard the name when watching Pirates of Silicon Valley while in high school.  It was appropriately during a computer programming class.  It was the first time I associated a person with the Macintosh computer I had first used to play Space Invaders as a little kid.  I associated the face of Noah Wyle with Steve Jobs for a very long time.  I didn’t bother rectifying that association in my mind because it seemed as if Apple was a thing of the past.  Why bother?

Fast forward a few years, and I owned an iPod Mini.  Fast forward a few more, and I owned an iPhone 3G.  Fast forward to today, and I am browsing MacBook Airs. . .  It is safe to say I no longer think of a former ER actor when I think of Steve Jobs.

I usually view words like “revolutionized,” “genius,” and “visionary” with disdain for being honorable superlatives that have become mere platitudes.  But with Steve Jobs, they were not only applicable—they may have been understatements.  In the time of ubiquitous behemoth corporations, for one individual to have such a lasting impact on several separate industries and millions (billions?) of people is truly remarkable.  It takes an unbelievable person to exert his will in such a manner.

We all want to say something special at times like this to honor people as special as Steve Jobs.  However, words have the peculiar quality of failing us at these crucial moments.  So, I will just share my feelings.  I am deeply saddened.  Whether through game changing consumer devices or Pixar, Steve Jobs has inspired me to dream big.  Some of the things he made possible were inconceivable, but his propensity to never settle for less than  his vision, compels me to be just as relentless—to “stay hungry, stay foolish.”

Thank you, Steve.  We miss you already.

Apple: Innovator or Hype Machine?

The verdict is still out on whether Apple’s iPad is just an oversized iPod Touch or truly something revolutionary.  At the 0260 Entrepreneur Conference at NYU last week several speakers, including Firstmark Capital’s Larry Lenihan and Union Square Ventures’ Albert Wenger, voiced their enthusiasm for the new device.  I, on the other hand, have been skeptical.  I noticed the recent popularity of netbooks and thought there might be a market for something even less clunky in the same vein.  Of course, the iPhone’s rapid adoption suggested that a touch device could be a great answer.  That is why I applauded Michael Arrington’s original mission with his failed CrunchPad, but after years of unsuccessful tablet gadgets, I started questioning their value.

The iPad, however, has me rethinking things once again.  With now over a million sold, the iPad does present some interesting potential.  I had for a long time been curious about who would win the home media center computing battle—a combination of WinTel, Netflix, Sling Media, Apple, etc.—and the more I think about it, a tablet seems to be a great answer to that dilemma.  Every family room could use a communal computer that looks neat on the coffee table and can plug into the HD TV without too many wires or frills, which the iPad or other tablets can eventually facilitate.  I also realize that on certain trips of shorter duration or of leisure I don’t want to carry my laptop, but I still want more than just what a Kindle-like E-reader can provide.

With all this obvious potential, then, why is it only now that the endless possibilities of tablets are being explored?  Tablets have been around for a while, but only now do we see a conscious effort by electronics providers to push the concept.  There are a slew of competitive offerings on the way.  Perhaps, the new excitement in this category just reinforces Apple’s pivotal role in technological innovation, which was reestablished with the introduction of the iPod.

Apple’s influence in defining electronics categories has spurred innovation.  The iPhone accelerated adoption of smart phones, forcing competitors to work on new handsets and mobile OS’s.  Yet, Apple also operates in a walled garden, meaning its products are self contained, not always playing nice with other software and hardware (lack of Adobe’s Flash being my biggest pet peeve on the iPhone).  The question then is:  does Apple’s dominant role sometimes hamper progress?

MP3’s were already being played on phones as Apple kept releasing newer versions of its ever popular iPod, but the phone and music player all-in-one concept didn’t seem to garner the attention it deserved.  The iPod’s marketing campaigns were just too effective for users to consider alternative MP3 players.  Then, the incredibly sleek design and UI of the iPhone left other smartphone makers playing catch up.  Through its App Store, the iPhone offered some openness as users were treated to games and software produced by third party developers.  Now, however, because the iPhone remains the sleekest handset on the market, users aren’t experiencing a lot of the advantageous aspects of other mobile OS’s such as Android (e.g., multitasking/background processing, open source, notifications).  I worry that Apple will control the potential of mobile devices on their own terms.  For one thing, I look forward to owning a phone some day that projects videos, but there might only be a push to provide this feature if Apple decides to do so.

With this latest iPad rollout, I wonder if the Apple brand has assumed too much power.  Can Apple just put its stamp on any consumer electronic device and succeed?  Is the next step an Apple HD TV that threatens Samsung and Sony?

I am clearly being overly dramatic.  Apple products probably deserve most of their popularity.  If the iPad does indeed reshape the way we think about computing once again, kudos to Apple.  For the time being, I’m not ready to completely buy into the hype just because this tablet has an apple tattoo on its back.

Keep on Chasin’ that Pap– Electronic Currency

After eBay announced earnings recently, there seems to have been renewed buzz about early Internet startup darling, PayPal. And why not? PayPal looks to be eBay’s big source of growth in the next few years, projected to compose about 1/3 of eBay’s revenue by 2011. I have seen tweets and blog posts from venture investors either referencing PayPal’s innovative beginnings or just outright looking for payments processing platforms that could attain similar success.

While PayPal has been a wonderful tool and the go-to currency for online users, it has left food on the table for other hungry startups. As we go electronic and green with regard to paper products, the one paper product that does not seem to be going anywhere is paper currency. While I would assume credit and debit card payments have increased over time, their convenience is not quite ubiquitous, especially when dealing with small business-to-consumer transactions (think about your local city deli’s “no cash” policy) or consumer-to-consumer money transfers. PayPal is indeed the preferred e-commerce currency, but it has thus far fallen short of being the global digital currency.

I have no doubt that PayPal will continue to innovate and try to reach that last mile of digital convenience, but as Josh Kopelman recently noted, the higher risk tolerance of startups versus public companies often serves as a competitive advantage for young companies. I am happy to see friends (at WePay and another in stealth mode) starting bill/payments processing companies to fill apparent gaps in electronic currency.

The most interesting play for me in all this will be mobile. I expect the iPhone to help move things along in mobile payments as it has for everything else mobile. iPhone 3.0’s more extensive Bluetooth support and possible addition of near field communications (NFC) capability in the next hardware upgrade could trigger the growth of mobile payments. Cell phones can then provide the same function as MasterCard PayPass or similar credit cards.

Hopefully in the near future, when you share a cab with a friend, and he says he doesn’t have any cash on him, you can force him to ante up with his cell phone.