Game Changers Capitalize On Constantly Evolving Industry

Key players in the social games industry are reimagining the digital horizon.

by Robert D. Hof

Thomas Duff didn't intend to build a huge criminal enterprise, even an imaginary one. But since joining Mafia Wars, the online game he and about 20 million other people play, he has assembled a mafia of 220 players, many of them his real-life friends. They amass weapons, vehicles, and other virtual goods — often by spending real money on them — so they can rub out other mobsters to climb the game's endless levels. For the past year, he has played 20 minutes a day — OK, 45 minutes, he adds ruefully — because it's a fun way to stay in touch with far-flung friends. “Against my better judgment,” sighs Duff, a software programmer for an insurer in Portland, Ore., “I'll probably keep doing it.”

Thanks to fans like Duff, online games such as Mafia Wars, FarmVille, Tap Tap Revenge, and many more have quickly become a staple of internet activity alongside Google's search engine, Amazon.com's superstore, and Yahoo's portal. They're called social games because people play them with friends on social networks such as Facebook and MySpace, as well as devices such as smartphones. Many of the games were created by companies such as Zynga Game Network Inc. in San Francisco and Tapulous Inc. in Palo Alto that are funded, founded, or managed by Stanford MBAs and other Stanford grads.

On Zynga's FarmVille, the most popular social game, about 100 million players have created virtual farms as they repeatedly click objects on the screen to plant seeds and harvest crops. They don't necessarily compete with friends in real time or compete much at all. But in between calling clients or shuttling the kids around town, nearly 20 million players log in for a few minutes daily to fertilize friends' plots, exchange virtual gifts, and post messages to each other. Tap Tap Revenge, a series of games from Tapulous, allows people to compete with friends to see who can most skillfully tap buttons on their iPhones to the beat of popular songs. More than 35 million people play — enough to persuade Walt Disney Co. on July 1 to pay a reported $35 million to buy the company, cofounded by Andrew Lacy, MBA '05, and Bart Decrem, JD '92.

All this fun and games may look like a colossal waste of time. But by adroitly playing on people's emotional needs, from ego gratification to simple human interaction, social games are becoming a colossal business. With about 1 billion players worldwide, they've captured tens of millions of fans who've never touched a video game, including women and older men. “The key reason social games are so successful is that on Facebook you can connect and play with your friends,” says Haim Mendelson, the GSB's Kleiner Perkins Caufield & Byers Professor of Electronic Business and Commerce, and Management.

Just as important, players are spending big bucks in social games. They're usually free to play, but some people spend 25 cents to a few dollars apiece on virtual strawberry plants, poker chips, submachine guns, and myriad other ephemera. Why? To enhance the game experience and show off their avatar or game status. It's not so different from displaying their real-life status with clothes, watches, or cars — but at far less cost. And while it may seem strange to pay for virtual goods, they're no less real than, say, songs bought on iTunes.

In the United States alone, sales of virtual goods are expected to hit $1.6 billion this year, according to “Inside Virtual Goods: The Future of Social Gaming 2010,” a recent report by consultants Justin Smith, BS Computer Systems Engineering '04, and Charles Hudson, MBA '05, AB Economics and Spanish '00. More than half those revenues will come from social games, the rest from online virtual worlds such as Second Life, IMVU, and Cyworld in Korea. Worldwide, virtual goods are even bigger, by various estimates a $3 billion to $6 billion market, dominated by Chinese companies such as Tencent Holdings.

In fact, Asian internet companies paved the way for social games. That's partly because online activity there always was focused more on social interaction than on e-commerce or information seeking. But rampant software piracy in China, in particular, also meant there was little money to be made selling traditional video games. So game designers chose to make internet games supported by virtual goods. “The only way you can make money is to do them online,” venture capitalist Richard Lim, MBA '88, managing director at GSR Ventures, recently told Stanford Business.

A far cry from classic one-person shoot-'em-up and adventure games played on consoles such as Microsoft's Xbox and Sony's PlayStation, social games borrow elements from two kinds of online games that emerged in the late 1990s. One is casual games such as Solitaire or Tetris, which are simple and quick for individuals to play in spare moments. The other is so-called massively multiplayer online games such as World of Warcraft, in which people create avatars, or animated on-screen representations of themselves, and go on elaborate group adventures. Social games also draw inspiration from the life-simulation personal-computer game The Sims and from virtual worlds where people socialize online using avatars.

It was only about three years ago, when U.S. game designers started adapting parts of those games to be played on fast-growing social networks and Apple's iPhone, that it became apparent social games were on the rise. Game companies spread their offerings like viruses by cleverly hijacking Facebook connections and exploiting social obligations among friends. In Playfish's popular Facebook game Restaurant City, for instance, players run an eatery that “employs” their friends, who must be fed every few hours to prevent them from striking. “Games have become increasingly social,” says Kleiner Perkins partner and Zynga director William “Bing” Gordon, MBA '78.

The addictive appeal of social games has helped create some of the fastest-growing companies in business history. The games can be created cheaply in just a few months, compared with $50 million and several years for some traditional video games. And while social games must be updated constantly, they generate recurring revenue streams. “It's really changing the whole nature of gaming, from a product to a service,” says Zynga general manager Eric Tilenius, MBA '96.

Just three years after Zynga began, for instance, its games are played by more than 230 million people a month, about 52 million every day. Revenues are expected to top $450 million this year, and its staff has more than tripled to nearly 1,000 peo- ple in the past year. A regulatory filing in April implied that the privately held company is valued at $4.6
billion. Kleiner Perkins general partner L. John Doerr recently called Zynga the VC firm's fastest-growing investment ever, placing it ahead of Google, Amazon.com, and Genentech.

The rapid rise of social games has taken even their creators by surprise. Lacy, Tapulous' cofounder and chief operating officer, says he didn't intend to build a games company. When it began in January 2008, he figured an iPhone chat application would be the ticket to riches. But Tap Tap Revenge took off, capturing 1 million players in less than three weeks, and Lacy never looked back. Tap Tap Revenge's social appeal is increasingly key, judging from love notes from fans tacked up on walls at Tapulous' Hamilton Avenue storefront headquarters. One reads: “Your game is great because it gives me a getaway, and I make friends.”

Now, the social gaming game is changing just as rapidly as it emerged, presenting new challenges to leaders and upstarts alike. For one, it's becoming apparent that the larger game makers will win the lion's share of the business. That's partly because the more people who play a game, the more it's likely to draw in those people's friends, in a virtuous cycle. Moreover, companies that run a lot of games can cheaply promote new games to players of existing games.

That last point has become especially critical since late last year, when Facebook suddenly stopped allowing so many public notifications of game activity. Many Facebook members viewed them as spam, the internet equivalent of junk mail. (About 6 million folks became so fed up with messages about friends reaching the next level of a game that they joined a group on Facebook called “I dont [sic] care about your farm, or your fish, or your park, or your mafia!!!”) Facebook's move has made it harder to attract new players and even keep them, so many social games have lost millions of players in recent months.

All that has intensified competitive battles, which have spilled into the courts. In April, Burlingame-based CrowdStar Inc., creator of the popular Facebook game Happy Aquarium, sued WonderHill Inc. of San Francisco, producer of Aquarium Life, for alleged copyright
violation and unfair competition. CrowdStar's suit cited the similarity of its rival's features to its own, including a “distinctive mating dance to a backdrop of hearts and romantic music.”

More often, social-game companies are doing their own mating dances to grab new talent and games to keep growing. Zynga has snapped up six social-game companies in the past year. Mountain View-based Playdom has bought seven since March. As a result, a few companies — Zynga especially, along with Playdom, CrowdStar, and Digital Chocolate — have started to pull away from the pack. That's making it harder for smaller companies to compete and cooling VCs' ardor for funding three Stanford students hoping to create the next FarmVille in their dorm room.

At the same time, the entry of titans such as Disney, Electronic Arts, and Google is rapidly tearing up the playing field. EA bought Playfish for $275 million late last year. In late July, Disney acquired Playdom, whose cofounder is Ling Xiao, MS Computer Science '07, for up to $763 million. Google reportedly invested $150 million into Zynga in July and is believed to be talking with several social gaming companies about participating in a broader social networking service the search giant intends to create. And a company founded by MySpace cofounder and former CEO Chris DeWolfe in March bought Mindjolt Games, a site offering 1,300 casual and social games, with plans to create a global powerhouse in social games.

All those developments are requiring social-game companies of all sizes to craft new business strategies. “The landscape is constantly changing, so you have to adapt to it,” says Electronic Arts founder William M. “Trip” Hawkins, MBA '78, now founder and CEO of mobile and social game creator Digital Chocolate, based in San Mateo. Indeed, social game experts say staying ahead of the competition in social games from here on out will turn on the business skills of MBAs populating many of the companies. In particular, they need to figure out the best combination of game techniques, such as competitions, rewards, and levels of achievement, that gets players hooked and then keeps them coming back. “Analytical rigor is increasingly an important part of social games,” consultant Hudson says.

Zynga, for instance, obsessively analyzes the impact of various game mechanics on player behavior, constantly adjusting the games to get people to play more often, spread the word to friends, or buy virtual goods. It tracks about 40 billion player actions every day and conducts about 1,000 experiments on new features each quarter. “My job is to make sure we add science to the art,” says Ken Rudin, MBA '94, Zynga's general manager for analytics.

As important as that science is to game makers, venture capitalists and entrepreneurs now spy a new opportunity to leverage it: They're borrowing the underlying mechanics of social games, such as rewards and contests, to turbocharge other kinds of online activities. Foursquare Inc., for instance, aimed to offer a service to make it easier for people to explore a city and learn about it from friends. “We needed a motivation for people to check in to places” with their mobile phones, says cofounder Naveen Selvadurai. Adding game mechanics, such as badges and the right to be “mayor” of a cafe or store, did the trick. Now more than 2 million people, doubled from three months earlier, regularly check into their favorite places a total of a million times a day.

In a sense, Foursquare and others are putting a 21st-century spin on such time-tested marketing techniques as frequent flier miles and S&H Green Stamps. Tristan Walker, MBA '10, the company's director of business development, says Foursquare's ability to reach people very close to potential points of sale in the physical world makes the service attractive to brands. “Foursquare can lead consumers to do things,” says Walker, such as buying a Frappuccino at Starbucks, which offers specials on Foursquare, or buy carrots branded as FarmVille at 7-11.

If an event in Menlo Park in June called “Metagaming and the Gamification of Life” is any indication, turning everything online into a game will be one of Silicon Valley's next hot pursuits. More than 150 people, mostly entrepreneurs, showed up as early as 7:15 a.m. to learn how to apply game mechanics to other businesses, then rushed up to panelists afterward with pitches and questions. “The world does not need the next Mafia Wars,” says Reuben Steiger, a games and social media consultant and founder of Virtual Greats, which helps celebrities brand themselves in social networks and virtual worlds. “The opportunity lies in learning the principles of social gaming and applying them to new realms.”

Even to the corporate world. Seriosity Inc., a company cofounded by Byron Reeves, the Paul C. Edwards Professor in the Stanford Department of Communication, is developing a social game for Facebook that will tap into data from people's utility smart meters and give them points for saving energy. “We're using social games to change behavior,” says Reeves, coauthor of the 2009 book Total Engagement: Using Games and Virtual Worlds to Change the Way People Work and Businesses Compete. Some startups are turning work itself into a sort of game. CrowdFlower, founded by CEO Lukas Biewald,
BS Math '03, MS Computer Science '04, is paying about 100,000 people in virtual currency, such as FarmVille cash, for quick tasks such as removing spam comments from a blog.

Social game mechanics hold promise for doing social good as well. Norwest Venture Partners' Tim Chang, MBA '01, is an investor in social-game companies Playdom and ngmoco as well as Lumos Labs Inc., which makes games to improve memory and attention. Chang is looking to fund companies that use game mechanics to address health care problems. For example, consumers who agree to reveal their grocery purchases could get points for buying healthier food and cash them in for health insurance discounts. He's not alone. The Health Games Research program, directed by Debra Lieberman, PHD Communication '86, a communication researcher at the University of California at Santa Barbara, is funding research to create games that motivate players to improve their health habits. “The much bigger market is taking this to real life,” Chang says.

Some skeptics wonder whether there is a limit to how many activities can be made into a game. After all, most people probably prefer to eat a Big Mac than be paid not to, especially in imaginary money. But Gabe Zichermann, author of the 2010 book Game-Based Marketing: Inspire Customer Loyalty Through Rewards, Challenges, and Contests, thinks we've seen only the beginning of the possibilities. “FarmVille and Foursquare have opened people's eyes to the potential for many things in life to be made more fun,” he says.

Former BusinessWeek Silicon Valley bureau chief Robert D. Hof is a writer in Palo Alto.