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Facebook and Zynga: Sharing Riches Isn't Always Easy
By SHAYNDI RAICE
Wall Street Journal
February 3, 2012
Facebook Inc. Chief Executive Mark Zuckerberg first met Mark Pincus, who later founded Zynga Inc., in 2004. It was the start of what would turn out to be one of Silicon Valley's most symbiotic relationships, a status that is now raising questions for both businesses.
Mr. Pincus was introduced to Mr. Zuckerberg through Facebook's founding president, Sean Parker, who once had been an intern for serial entrepreneur Mr. Pincus at a start-up, according to a person familiar with the matter.
Shortly after that meeting, Mr. Pincus took a small stake in Facebook by investing seed money, said the person.
That personal tie-up between the two CEOs has since spilled over into their companies in a profitable way. Facebook, based in Menlo Park, Calif., derived 12% of last year's $3.71 billion in revenue from Zynga, according to the social network's IPO prospectus released Wednesday.
Meanwhile, Zynga, the San Francisco-based social gaming company that makes many games that are played on Facebook, received 93% of its revenue last year from virtual goods it sells on the social network.
Investors on Thursday sent Zynga's shares 16.8% higher after Facebook revealed just how much revenue comes from taking a cut of Zynga's virtual goods sales.
But while Messrs. Zuckerberg and Pincus—27 years old and 45 years old, respectively—generally view their companies' co-dependency as a positive development, the intertwined relationship has caused tension at times, people familiar with the matter say.
Several years ago, Facebook treated its developers such as Zynga as the enemy, because the developers' viral posts on the social network were considered by many users to be spam.
Last June, Facebook began requiring Zynga to pay 30% of its revenue from the sale of virtual goods on the social network through a payment system called Credits. Zynga had long known Facebook would need to take a cut of its revenue, but there was some disagreement over the size of the fee. In the end, Zynga gave in because of the importance of Facebook to its business, said people familiar with the matter.
During a few months last spring and summer, however, Messrs. Zuckerberg and Pincus met for late-night meetings at Facebook's headquarters or over dinner, said people familiar with the matter.
Although the relationship between senior executives at both Zynga and Facebook was sometimes strained, the two CEOs came to realize that a strong partnership was better than a weak one, said the people.
Mr. Zuckerberg wasn't immediately convinced of the value of social games but came to believe in the medium as Zynga's games became more sophisticated, these people said.
Still, some say Zynga's Facebook habit is a risk. Zynga has moved to diversify its revenue streams by distributing its games directly to users on mobile phones, including its hit game "Words With Friends." Zynga has been growing its mobile business and executives say they want to be present on a variety of platforms.
People familiar with the matter said Zynga isn't consciously trying to lessen its reliance on Facebook, since the company is happy with its partnership.
"In general, Facebook wants to be as open as possible and Zynga needs to be less dependent," said Ben Schachter, a Macquarie Group analyst.
That could become a growing problem for Facebook, which warned in its IPO filing that its financial results could be harmed if "we are unable to successfully maintain this relationship" with Zynga.
Nearly all of its $557 million in payments revenue comes from Zynga. Facebook didn't include in the 12% figure the ads that are displayed on pages generated by Zynga's games.
If the Securities and Exchange Commission requires Facebook to include that information, that could take Facebook's revenue dependence on Zynga even higher.
Jed Williams, an analyst with BIA/Kelsey, said both companies will have to prove they have deeper business roots beyond each other.
That may mean Facebook needs to start allowing application developers the ability to become more viral. Since clamping down on spam after opening itself up to developers in 2007, Facebook developers have complained the social network makes it increasingly difficult for them to build a strong business on the level of Zynga.
Although other game companies like Playdom have had success on Facebook, Zynga's growth remains unmatched.
Write toShayndi Raice at email@example.com