Social Gaming Market Reaches Its Final Stage…and It’s Not Looking Pretty

Editor’s Note: This is a guest post written by Alex St. John, President and CTO of hi5, on the state of the social gaming market.

When Facebook recognized that early social media games were getting a free ride on their network, they shut down the free viral channels these games relied on for audience, started charging market prices for advertising, and demanded a cut of all commerce transactions (see “Facebook Credits”). This changed the economics of social games dramatically. Reaching a large audience easily and for free ceased to be a benefit of developing social media games. In the downloadable casual game business, game developers get a 25%-35% share of the revenue their games generate online when published via channels other than their own. With Facebook charging a 30% premium for Credits and taking an additional cut on advertising, it’s likely that the cost of marketing a social media game is converging on what it costs in the mature downloadable casual game business.

With free virality shut down, social game developers are now forced to compete in the full online game market where a slew of great multiplayer games (such as Club Penguin and Runescape), which interestingly are not called “social media games” because they don’t NEED a social network for distribution, succeed and thrive purely on their viral merits with no investment support or dependence on Facebook for their enormous popularity. This creates a very interesting situation: games that nobody wants to play unless they are inside a social network competing against great viral multiplayer games that monetize and spread more efficiently than social media games once “normal” market pricing for promotion is introduced on Facebook. The only advantage social media games have currently is that the Valley thinks they are “hot” and is willing to invest lots of money in them.

The next stage we’re likely to see is a replay of what happened in the casual game space between 2004-2006 when capital flooded downloadable casual game companies enabling them to buy audience and distribution at prices ABOVE the monetizable value of the games they were selling. Casual game companies went to war, propped up by investment dollars that enabled them to overspend on audience acquisition, which produced the illusion of user and revenue growth even as every customer acquired in this manor returned less revenue than the cost of acquisition. As long as the investment money flowed, casual game publishing seemed to grow, but once the bubble popped in late 2008, it became very clear which companies had built sustainable publishing businesses and which ones had overextended themselves. RealNetworks, once flush with cash from its victory over Microsoft in an anti-trust lawsuit, was apparently the largest and fastest growing casual game publisher, today it is spiraling into decline.

This same cycle is now taking place in social media. When Facebook changed the rules, the early leaders in the space faced two extremely unpleasant realities: 1) Unlike casual gaming, their popular franchises were ineffective at acquiring Facebook audience directly and 2) Paying market rates for audience made their books look a whole lot less pretty. Faced with this challenging circumstance, social game development studios have started taking aggressive steps to remedy their situations, including:

  1. Finding buyers as fast as possible before people realize that their growth and maybe even their businesses are not sustainable
  2. Leveraging the abundant capital available to try to buy their way out of dependence on Facebook by either acquiring their own standing audiences or by acquiring non-Facebook dependant game companies
  3. Overspending on marketing to try to buy audiences to preserve their apparent growth even as their books leak money and their earned audiences decline

What does it mean that Zynga abruptly canceled its deal with MSN to carry Farmville? Probably that they paid a lot for the distribution only to discover that the game did not perform well enough there to justify the expense. Outside of Facebook, Farmville simply can’t hold its own against games like Bejeweled and Scrabble when it comes to monetizing a casual audience, and these games set the market price for advertising on the sites they dominate.

Want to see which games dominate the online economy in a competitive market where distribution doesn’t come for free? Simply check out the front pages of the leading downloadable casual game publishing sites. The minute that Farmville genuinely has superior online economics, it will displace these games. But, until then, it appears that Cubis monetizes best on MSN, and Zynga will lose money by buying its front page position to promote Farmville.

In the end, I believe that “social games” as we know them will be a forgotten internet fad, ultimately consumed by the already mature online market for downloadable and multiplayer games. The only NEW discoveries that remain will be the realization that social networking itself is a new kind of game play, social graphs are an extremely efficient way for games to market themselves and that microcurrency business models blended with advertising are a superior way to monetize online games in general. Everything else will be consumed by the highly competitive and established downloadable and multiplayer online game market. If some of the big names in social media gaming survive, it will be because they leveraged their abundant access to capital to transform themselves away from dependence on Facebook.