Tuesday, 26 August 2014

Zynga and King's failure could be Nintendo's opportunity

As a long term Nintendo shareholder and fan, I nearly fell out of my chair the other day when I saw the movement of the share price.  Up more than 4% on 8.18 on the Tokyo stock exchange (though it's subsequently down a bit today as folks take some profit).

The reason: speculation that Nintendo will finally enter the booming mobile games market through its affiliate, The Pokemon Company, by launching a Pokemon game made for Apple's iPad. Though there is no exact date set yet articles appeared in both the WSJ (for those of you who still pay for news) and Bloomberg related to Nintendo's plans.   The Pokemon game in question, a trading card game (TCG), works perfectly for this franchise (since Pokemon is not only a hit TV show but also based on a real world collectable card game in its own right).  More importantly, the TCG mechanic has been tried and proven in Asia by many of Nintendo's would be competitors on mobile like Mobage (part of DeNA), who arguably pioneered the genre with Rage of Bahamut, Blood Brothers and Marvel: War of Heroes in 2012- 2013. Rage of Bahamut was a top selling iOS and Android game for much of 2013 and continues to be among the top 100 here in the United States while Marvel: War of Heroes is ranked #59th on the Apple store currently according to Distimo, an app analytics company, and ranked #21st on Google play.

Nintendo needs a hit and it desperately needs to be on mobile.  To put things in perspective, there were 200 million tablet sold globally last year alone according to IDC.  Compare that to the most successful console of all time: the Playstation 2 which had lifetime unit sales of around 150M units - over 6 years! More importantly, tablets have become gaming machines in their own right.  To gamers who scoff about a tablets capabilities look no farther than games like Infinity Blade, Racing Rivals, Nova 3 to get an idea of what these machines are capable of.  Are they up to the likes of top console games?  Not yet but given the demographics of how people use tablets (11 min average gaming sessions for example) consumers don't expect a console-like experience yet but still happily will spend money for mobile games.  More importantly, companies like Nvidia (NVDA) are now unleashing a new generation of processors (like the K-1) that are even more powerful and consume less power than the chips actually used in the Xbox One or PS4.

The size of the stake is huge and has never been hotter.  The mobile gaming industry is estimated to bring in some $21.7 bln USD in 2014 and could generate as much as $35 bln by 2017 according to figures published by AppLift and Newzoo.

That said, the market has never been more competitive.  Though games like Puzzles and Dragons or Machine Zone's Age of War may bring in several million dollars per day in revenue, development costs, marketing costs and the overall cost of doing business are all on the rise (see the post I did on this recently here and the opportunity it presents for Google).  However, this is where I believe a company like Nintendo has a massive advantage over say a Zynga or a King.com:  They have the brands.  

Pokemon, Zelda, and Mario are all household brands and games that people all over the world of all ages have played and enjoyed.  The impact of brand is essentially reduced marketing costs, pricing power and the ability to extend the brand far beyond its base of users.  For all their early successes, there is a reason Zynga is where it is: nobody would ever care to watch Farmville on Nickleodeon and my kids aren't interested in brushing their teeth with Words with Friends toothpaste.  Though King.com is advertising Bubble Witch Saga heavily on TV, the stories, characters and themes of these games still feel superficial and shallow.  These are essentially casual games designed to reach a very broad user base quickly but with little depth.  The result is that they reach a large base but typically only 1-2% of users monetize and the ARPU (average revenue per user) is much lower compared to games that appeal to mid core or core gamers.  For example Candy Crush is estimated to generate a little over $1M / day from daily active users of more than 7M users which Clash of Clans does roughly the same revenue for 4M users.  

Nintendo is not breaking new ground here.  Activision, another successful gaming company that has been remarkably late to mobile, leveraged their World of Warcraft franchise recently and entered mobile gaming with there Hearthstone franchise.  The game, on iOS only, has done extremely well and is among the top 50 grossing games on the App store in the US.  Coincidentally, it is also a TCG which bodes well for Nintendo's efforts.  

So the three questions investors need to ask themselves when looking at Nintendo are:

1.  Can Nintendo learn mobile faster than Zynga, King and others learn how to build real brands / franchises?

2.  Can Nintendo develop a product roadmap of titles that complements rather than cannibalizes their existing hardware sales?

3.  Can mobile generate meaningful, profitable revenues?

The answer the first question isn't obvious.  For every company that has embraced mobile and succeeded many have not.  EA was successful after acquiring Jamdat, an early pioneer in mobile gaming back in 2006.  However, it still took EA quite a number of years to figure out and launch Free-2-play games (the dominant model of monetization on mobile today).  Like many large gaming companies, EA feared that giving away games for free would damage their franchises and devalue the brands that they stood for.  It wasn't until 2011 that EA embraced F2P in earnest with The Simsons: Tapped out, which proved to be enormously successful for them and still continues to do well in the charts.  Moving from paid games to F2P requires a culture change in most organizations that is often difficult to embrace.  Aside from monetization, there is the mobile form factor, user base and session length the consider.  Mobile screens are smaller and more limited which may explain why Nintendo is choosing to go on iPad first.  More importantly, gaming sessions are far shorter (11 minutes for a tablet session vs. north of 40 mins for a console gaming session).  This means consumers need to be able to "achieve" something that keeps them coming back for more.  Lastly, marketing on mobile is completely different than the traditional CPG model favored by console games publishers.  Acquiring users on mobile and retaining them is a science in itself and top game companies like Supercell, Zynga and others spend vast amounts of money and have large, dedicated teams whose sole purpose is to run and optimize campaigns across dozens of mobile advertising partners like Chartboost, Facebook (FB), Admob (GOOG), Fiksu and others. Running, optimizing and tracking mobile ad campaigns across 80+ different traffic sources requires unique skill sets and people which Nintendo would have to acquire/hire to fully leverage the mobile platform.  

The issue of a solid mobile roadmap seems less risky.  Given the form factor, user base and different consumption habits, I think Nintendo has enough resources and game design chops to come up with unique games that are made for mobile that provide a very different experience from what someone would experience on a DS or a Wii U.  Their experience making portable games for the DS here would be a tremendous asset though sessions on mobile devices are even shorter.  The key here is for them to hire and dedicate resources specifically for mobile.  The biggest problem traditional console game publishers face when moving to mobile is to simply "shoe-horn"  an existing console franchise onto the mobile platform.  A great example of how "not" to do this was Bioware's (a publishing division of EA) adaptation of Knights of the Old Republic (KOTOR) for iPad.  The games' size, controls, graphics and story were all simply copied or "ported" to iPad with little regard for the mobile user / experience.  The result was that though the game initially did nearly 60k in sales on it's first day, sales subsequently crashed once word got out among users that this was essentially an Xbox game from 2005 with little adaptation to mobile.  Other premium console franchises like Deus X and Final Fantasy committed similar mistakes as can be seen below.  

source: Distimo.com App Analytics firm owned by App Annie

Back in 2011, I wrote a piece entitled Could Nintendo Be the Next Nokia.  It doesn't have to be that way but clearly the company is at a crossroads.  It botched the launch of the 3DS (in terms of pricing, lack of titles and misjudging the amount of interest in 3D portable gaming) and subsequently botched the launch of the Wii U as well.  Though 3DS sales have recuperated, after sharp price reductions and the launch of new titlees, and the Wii U's slate of games shows signs of improvement (Super Mario Kart 8 has crossed 1M units sold) the company faces the strategic challenge of not being present on the PC nor on mobile; two key areas of growth (the former being particularly large in China).  Moving its beloved franchises to mobile without cannibalizing DS sales should be a priority.  Nintendo's rabid fan base would no doubt move en masse to mobile to play Zelda, Mario and Pokemon.  Now all Nintendo has to do is provide a great, made-for mobile experience.  

OK great.  But what about the numbers?  Well just bringing Pokemon to iPad won't turn Nintendo around.  Clash of Clans, one of the top grossing games on iOS globally, pulls in roughly $1.2M / day according to Thinkgaming.com  from a daily user base of around 4M players and this revenue is both from iPhone and iPad users.  So if Nintendo were to launch on both devices and also add an Android version (assume the Android game would monetize around 80% of the rate the iOS game does which is consistent with other top games) you might see yearly revenues of roughly $780M.  Less Apple and Google's take you're looking at around $550M (30% distribution costs) less development costs and marketing.  For just one game.  If you also factor in that marketing costs will be far lower than normal given Nintendo's brand strength and that development of a high quality game will likely not exceed $10-15M you're looking at something far more profitable than console equivalents.  Now also keep in mind that mobile development is faster and allows developers to make changes "on-the-fly" and resubmit to Apple and Google.  This means Nintendo could potentially be launching yearly sequels of their major titles and be continuously updating existing games with fresh content (characters, missions, events).  The importance of this is that it essentially de-risks development by turning Nintendo's games business into a games-as-a-service business where games can be improved constantly and always have new content.  This is exactly the model top developers like Zynga, Tencent, CJ&EM (a top korean developer), EA and others use.  

So in conclusion, investors should rejoice regarding the news that the Japanese publisher is finally dipping its toes into the water.  Now lets just see if they can embrace mobile and bring the joy of Mario, Luigi, Zelda and others to the teeming masses of users who have been waiting so long.  Myself included. 

Tuesday, 29 July 2014

Google's Next Opportunity Could Spell Serious Competition for Facebook on Mobile

As I mulled over Google's (GOOG) Q2 earnings a few weeks ago I couldn't help but think that Google is still missing a huge opportunity:  helping more developers get discovered on the Google play store.

Ask any mobile app developer today what their biggest problem is and they will probably say two things:

1.  Make more money on Android
2.  Get their app discovered on the Play store

Apps have become big business for Google.  Android's +Sundar Pichai claimed that it had paid out over $5 billion to developers over the past 12 months.  Some back-of-the-envelope analysis coupled with folks I spoke with estimate that the play store will pull in between 3.5 - 4 billion dollars this year in topline revenue.  Not bad.

Impressive numbers but in reality - Google is still scratching the surface.

When it comes to discovery on Android the solution basically boils down to one thing: Facebook (FB). Every single developer I talk to, including those in our portfolio here at Signia Venture Partners, will tell you that Facebook is the biggest, most important and most expensive source of app installs they have.

The problem with Facebook ads though is that as Facebook's targeting and quality has improved, larger players like King.com (KING), Supercell, Machine Zone, Zynga (ZNGA) and others have gobbled up inventory driving up the cost of installs to levels that simply exceed the Lifetime Value of Users (LTV) for most developers. While the cost per install on Facebook today is somewhere between $3-$4 per install, in September of last year, for example, one of our companies saw CPI go north of $5 which simply wasn't sustainable for their business model.  In fact, according to data released by Superdata, between 2012 to December 2013 the CPI has gone from $1.30 to $4.36; an increase of 288%!

(source: Superdata)

The solution: the industry needs more sources of quality inventory to help bring down prices.  But while some industry watchers think Twitter (TWTR) might have the solution it's actually Google that's sitting on a goldmine: the Play store itself.

Before I joined Google in 2011, I ran marketing for a venture-backed alternative app store called GetJar (acquired this year by Sungy Mobile: GOMO).  GetJar provided an alternative to then Android market by allowing developers to distribute apps to consumers via its mobile web store.  So how did it make money?  Through advertising on the app store itself.  GetJar has an ad-based solution where it allowed developers to bid for actual placement across the store.  Developers could bid for installs by OS, handset and country and a high enough bid coupled with the apps quality score would get them featured in one of several listings either on the home page or across one of the other pages in the store (these appeared in the store as a "sponsored" listings - see below).  If a consumer then clicked on the ad and installed the app, the developer would pay GetJar the value of its bid.

(Source: GetJar homepage on mobile)

The whole model functions much like say... Adwords actually.  So imagine if Google actually added an advertising solution to the play store itself allowing developers to bid for visibility and installs directly on the store front?  What could the economics look like on the revenue side?

For starters, at GetJar about 8% of our downloads were monetizable (back in 2011) - that is we were able to get paid for those installs.  Now GetJar didn't have Google play's scale so lets say Play is only able to sell 4% of their installs. If we assume play downloads are somewhere around 2.9 billion per month (45% more downloads than IOS which is roughly tracking at 2b / month according to Statista) then we're talking about 116M downloads per month.  If we take the median CPI for Android downloads globally according to +Chartboost of around $1.10 then we're talking a high margin ads business worth an additional $1.5B a year in revenue.  Better yet, the cost side of running this business would probably be small for Google.  The existing sales team and ad ops team that currently sells Admob and other mobile search inventory would probably manage this business and 100% of the traffic comes from the store itself (so no traffic acquisition cost (TAC).

More importantly, everybody gains from this.  Developers gain a new, lower cost traffic source for their installs.  Consumers win by discovering new apps / games and other content promoted by the content owners that they might not find otherwise and Google unlocks an additional high growth, high profit revenue stream.

The only possible losers - Facebook (FB), Twitter and nearly every other app install service / ad network out there.  So what is Google waiting for? Well there are a number of reasons why they haven't taken this on.  First, it's a question of focus.  Google has been scaling at an incredible rate and has also been very busy continuously launching new verticals internationally.  Books, Movies and Music continue to expand abroad and this is surely taking up a lot of their resources.  They are also constantly working on improving payments and stability for users which requires resources if they are going to keep users happy.  Second, their could be anti-competitive reasons.  It's well known that over 90% of their business is from games.  These same game developers acquire traffic from many different sources.  Launching an ads business might be good for developers and users but it would negatively affect folks like Chartboost, Fiksu, Twitter and even Facebook.  This could be seen badly by regulators and those affected would likely cry foul.  Finally, there is always going to be the user to keep in mind.  Users might react badly to ads being injected into the store front.  Likewise, they might think Google is using their data to promote certain apps to them which, though it might be welcome by some users, would have privacy zealots running to man the barricades.

So Google must have its reasons for not launching this type of a service to date.  However, given the natural consumer and developer need I think it's more a question of "when" not "if" Google plans to launch a service like this.  The opportunity is simply too obvious to be missed.