Social Gaming

03 May 2011

The social gaming boom and the promise of gamification

As venture capitalists we’re keenly eyeing the social gaming market and the broader impact of gamification on business. Although the social gaming market is maturing, the market leaders are growing at tremendous pace with huge margins. More than ever, capital has become a critical success factor.
Social gaming looks cheap - anyone can make an app, but the winners are spending tremendous sums on advertising to drive traffic, leading to a very profitable user base. Gaming doesn’t just interest us as a sector. Increasingly, we believe that game mechanics will be deployed all around us to drive customer acquisition and loyalty. We’re looking for startups who have figured out the gamification promise.

Not long ago, computer games were associated mainly with geeky male teenagers glued to their screens, firmly in ‘flow’ mode as they blasted monsters to high hell. No longer; today nearly half the world’s online population is playing games. But with a difference: instead of storming the D-Day beaches people are building virtual cities, tending gardens and cooking up a storm. In just over three years a new category of games -social games- has emerged that has rapidly turned the video games market on its head.

In 2007 Facebook opened itself up to third-party developers. This platformisation of the world’s leading social network unleashed a storm of innovation as thousands of developers started creating applications that exploit the power of the social graph. New companies like Zynga and Playfish began cranking out casual games specifically for play on social networks. Who has the Biggest Brain, created by Playfish, became a near instant hit as millions of people played it on a daily basis. And Zynga’s CityVille currently tops the apps ranking with over 90 million monthly active users.

This spectacular growth is easy to understand since the drivers are so profound, and differ so dramatically from the traditional hardcore gaming industry. Typically social games are free, easy to play and they’re built for a platform that itself is growing at a mind boggling rate (as of January 2011, Facebook has more than 600 million active users). Hardcore games, in contrast, aren’t free, often are difficult to play and require an expensive piece of hardware.

From an investors’ perspective such growth drivers always pique interest, but what makes the sector really attractive is the fact that profits are being generated. Social gaming companies earn money primarily from micro-transactions by selling virtual currency and virtual goods. Anywhere between 2-10% of social gamers buy virtual goods, typically spending US$ 1-2 per transaction. Given the phenomenal number of players, this adds up to tidy sums. Already the total virtual goods market is estimated to be worth about $2.2 billion (2009) and is set to grow to $6 billion by 2013. Simultaneously, there is tremendous potential for high margins since the costs of developing and distributing games are relatively low. Whereas in the past you would need millions to develop and distribute a game before knowing whether it would be a hit or miss, now you can develop and test a game for less than $100,000. And you can pick up the pace radically, creating and testing new concepts in fast cycles.

Not surprisingly, investors have taken note. Just three years after its launch Playfish was snapped up by Electronic Arts in a deal reported to be worth nearly $400 million. Disney paid more than $700 million for Playdom in 2010 and market leader Zynga raised more than $500 million to fund its rapid growth. Interestingly, Kleiner Perkins recently launched a $250 million fund for social apps, managed by Bing Gordon, the ex-CEO of Electronic Arts, and supported by Facebook, Zynga, Amazon and others.

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Capital, marketing and data analytics increasingly make the difference

The key question for an investor like Gimv is how to spot the winners, since predictably it has become a crowded market. In our opinion it’s all about management skills and cash. The leading companies all have exceptional management teams, recruited from the ranks of the best and most experienced, and they’re all flush with cash to fund marketing. Whereas the pioneers benefited from a novelty factor and strong viral distribution (gamers notifying and inviting their friends), today’s startups have an almost impossible task standing out from the crowd and need to comply with much more stringent Facebook policies that weaken viral mechanisms. Companies like Zynga clearly are spending copious amounts of money on advertising and have the ability to cross-promote games given their large portfolio of games. As the market matures we expect it to consolidate to about 4-5 large players.

At Gimv we continue to look for investment opportunities in the sector because the potential for high-margin growth definitely exists. However, given the rapid consolidation in the market, we’re specifically interested in companies that have managed to build a reasonable userbase. We’re looking for companies that have a proven ability to create games that people like playing, but need capital to take it to the next level, and that means competing with the likes of Zynga and Electronic Arts.

Whether we’ll find such companies in Europe is open to debate. In our view the local factor hasn’t really played a role, except that games do need to be customized to local languages. Playfish, for example, was headquartered in London but was a global company from day one.

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Mobile and social are coming together

Looking ahead, we will be keeping a close eye on the impact of mobile. It seems clear that social games are going mobile and mobile games are going social. Zynga and Playfish are developing games for smartphone platforms and Rovio Mobile is developing a Facebook version of its popular iPhone game, Angry Birds. With mobile phones set to become the primary internet access device, there should be substantial potential for growth. Clearly investors think so. For example, just in the last year Kleiner Perkins doubled the size of its iFund (focused on mobile apps), Zynga acquired Japanese mobile apps developer Unoh and Electronic Arts acquired Chillingo, publisher of Angry Birds.

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The promise of the game layer

Gaming doesn’t just interest us as a sector. Increasingly, we believe that game mechanics will be deployed all around us. Ecommerce sites such as Groupon are turning buying into a game. Map makers are using gaming mechanics to crowd source data. Schools are experimenting with games to teach toddlers’ language skills. With companies beginning to recognise the power of game mechanics to drive user adoption and loyalty, so an increasing number of gamification platforms are emerging that help businesses employ game elements into their business. Location-based services such as Foursquare and Gowalla give badges and titles to people who visit your location. And SCVNGR wants to build a gaming layer on the world. As Facebook and Twitter consolidate their hold on the social layer, so the gaming layer is being built by a bunch of exciting new startups. At Gimv, we’re watching these trends closely.