“The third quarter of 2012 continued to be challenging and, while many of our games performed to plan, as a whole we did not execute to our satisfaction,” Pincus was quoted in the official press release. The company now expects to report a net loss of between $90 million and $105 million, they noted in the release, which includes an estimated impairment charge of about $85 million related to the purchase of OMGPOP.

Pincus wrote that “While we’re disappointed with these financial results,” Zynga is looking to further expand into more gambling ventures and mobile games to make up for losses. The March acquisition of OMGPOP for $178.5 million, plus another $30 million for employee retention, now looks particularly ill-fated.

Pincus explained why the company has struggled in particular:

There are a few factors contributing to a weaker than expected outlook for Q4.  The reduced performance of some of our live web games is continuing to impact results and we have several new games which are at risk of launching later than expected.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Social third-quarter 2012: analysis and outlook
• Where the next-generation console fits in today’s video game market
• Social 2013: The enterprise strikes back

This sorry situation means that Zynga has been looking to gambling as a lifeline. Reports this week say Zynga spent around $75,000 on lobbyists last quarter in efforts to bring online gambling to California and its CEO, Mark Pincus, recently told investors that the company hoped to enter international gambling markets by the first half of next year.

For Zynga, gambling could be a way to replace revenue lost from the virtual sheep people are no longer buying. The problem, though, is that the company is late to the online poker table.

According to Chris Griffin, CEO of gambling hub Betable, the winners and losers in the internet gambling market are being determined very quickly and Zynga will be hard-pressed to catch up. Griffin points to the mobile launch this week of Big Fish Casino — a game that lets people gamble on their iPhone in places like the U.K. The presence of these rivals mean there could be little left for Zynga.

“Big Fish has a six to nine month head start on Zynga … It’s a false notion that gambling will save them because the valuable players are already locked up and there is loyalty there,” says Griffin, who adds that the current population of Zynga users are unlikely to become overnight gambling fiends.

Griffin has skin in the gambling game so his words should be taken with a grain of salt. Betable, which received a large seed-round of investment this summer (see disclosure below), provides back-end services like payment clearing and legal permits that allow developers like Big Fish to offer gambling in the first place. But that doesn’t mean Griffin is wrong about Zynga.

Even if the game-maker can get gambling up and running, possibly with the help of casino giant Wynn Resorts, it will still need customers. And for now those customers are in the hands of established gambling brands like Poker Stars or the upstarts like Big Fish. To compete in Europe and the U.K., Zynga will have to outspend the incumbents on marketing (impossible) or else offer cheaper rates — leading to the prospect of more revenue but minuscule profit. Meanwhile, Facebook is going its own way with gambling in Europe.

But what about America? Online gambling was illegal until last December when the feds said it could take place in states that pass a law to allow it. This could give Zynga a fresh playing field on home turf.

The problem is that the state by state approval process is a muddle. While bills are inching forward in places like New Jersey, the process is still tied in politics and red tape, meaning it could be years before online gambling is up and running. And even if some states do allow it, only a handful of them have large enough populations to ensure a reliable supply of players at an online poker table. Finally, will American gamblers gravitate to Zynga or, more likely, will they seek out familiar gambling brands like Pokers Stars?

The bottom line is that gambling may be a huge potential revenue stream but that doesn’t mean any of it will go to Zynga.

Disclosure: True Ventures is an investor in Betable and also in the parent company of this blog, Giga Omni Media. Om Malik, founder of Giga Omni Media, is also a venture partner at True. Story and opinions are my own.

(Image by Beto Chagas via Shutterstock)

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Where the next-generation console fits in today’s video game market
• Social 2013: The enterprise strikes back
• Social third-quarter 2012: analysis and outlook

David Ko (left) with Dan Porter, CEO of OMGPOP! Photo courtesy of Zynga.)

When I met with Zynga founder Mark Pincus in March 2012, he was candid enough to admit that like many of the big web giants, he was still trying to figure out the mobile quandary, which he determined was a whole new beast. Fast forward to today and despite its splashy $200 million acquisition of Draw Something parent, OMGPOP, Zynga is still struggling to unlock the mobile mystery. Or at least that is the impression I got after reading this story in The Wall Street Journal.

“We’re going to try different things..I’m not saying everything we do is a home run. ”I always tell people if they say, ‘Oh, there’s a Web division, there’s a mobile division.’ I’m like, ‘No. There’s one division’,..”That division is called Zynga.” [David Ko tells the Wall Street Journal.]

The recent actions undertaken by Zynga such as having chief mobile officer David Ko reporting to CEO Pincus are just papering over the big issue: when you are a web native company and web-based metrics define your decisions and business model, it is hard to think of mobile. Mobile is an entirely different user behavior. Good news: Pincus knows that and unlike others, is not in denial about his company’s mobile challenge.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Social third-quarter 2012: analysis and outlook
• Where the next-generation console fits in today’s video game market
• Social 2013: The enterprise strikes back

But while Zynga CEO Mark Pincus was all smiles on signing the deal, he may be less impressed six weeks on, thanks to an intriguing report from Forbes that indicates a precipitous decline in the game’s user base since the acquisition.

According to figures from AppData.com, the simple and highly-addictive drawing game — which rocketed to 36 million downloads in just a few weeks — has lost around a third of its daily active users in the past month.

So what’s going wrong? There seem to be three major possibilities on the cards.

Technical problems

Lots of players have reported trouble accessing the game over the past few weeks. That seems to be a scaling problem, with the servers struggling to meet the demand of more and more downloads — though the move to shift OMGPOP’s traffic onto Zynga’s “Z-cloud” may also be a culprit, since similar reports are also surfacing about another game, Words With Friends.

For many new and existing players, server issues that mean dropped games or lost moves are an immediate black mark against the game: something that can really hurt in the instant gratification world of mobile entertainment.

Zyngafication

Moving to the Z-cloud meant something else, too: the addition of new features that seem to have soured many players’ relationships with the game. For the most part, this means pushy Facebook and Twitter integration — though the company does seem to have also expanded the number of advertisements, too, taking more money from Doritos, the NHL and others to include brand-related words into the game’s dictionary.

These might not be a turn-off for everyone, but they do seem to have had an impact on some users who feel uncomfortable at the commercial options.

Natural wastage

While Draw Something was an overnight success — spreading virally, zooming up the charts and bringing in a lot of revenue for its makers — many people are saying that they bored of it rapidly. That’s not entirely untypical for a faddish game, and since it has little variation, a pretty limited dictionary and real no long-term stickyness it appears OMGPOP hasn’t done a great deal to boost the game’s longevity.

This sort of wastage is pretty normal for short attention span games, which makes their success all about growth: you have to keep marketing the game to new players and expanding the overall market to compensate for those who switch off.

So who’s fault is this? And is it a real problem, or just a temporary glitch?

Some may argue that this isn’t a big deal for Zynga, since it owns not just Draw Something, but the entire business and team behind it. However, as we wrote at the time, Zynga’s purchase was not really about talent acquisition — while OMGPOP’s team are no doubt smart, they’d produced so many duds that the company didn’t have many rolls of the dice left.

No, for Zynga it was a numbers game: the revenues and user base of Draw Something were interesting, but underneath it all it was really about gaining access to a large, mainstream, purchase-happy audience.

Those users are great targets for Zynga to sell its other games to. And the speed at which Draw Something was growing — it had more than 36 million downloads in just a few weeks — meant that the audience was going to be significant.

Except it’s not. And that’s got to hurt.

If this drop continues — in fact, even if the decline is arrested — it could become a really serious problem for Zynga. After all, it not only shows a lack of judgment from management in buying into a fad when it’s at its very peak, but it also suggests that the company wants to strip mine new assets rather than build them up.

Because while scaling issues and a lack of longevity may be rooted in problems at OMGPOP’s end, the reality is that all these issues have been made worse, not better, by Zynga’s involvement. It’s either failed to support the game fast enough and bring in enough new users, or it’s been actively making it worse for players.

And none of those are good news.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Takeaways from mobile’s second quarter
• Social third-quarter 2012: analysis and outlook
• Hyperlocal: opportunities for publishers and developers

Some numbers from the report and the earnings call struck me as particularly interesting:

$392.2 million: Zynga’s most important revenue metric is one a lot of people might not grok. The bulk of Zynga’s revenue is for virtual goods to use in its games like FarmVille and the new CastleVille. The accounting isn’t as simple as selling something outright. Instead, the company reports it as “bookings” — and those hit $392.2 million in Q1, up 15 percent year over year and 7 percent over the previous quarter.

Actual revenue for the quarter was $321 million. That was up 32 percent over last year but only 3 percent over Q4. Online game revenue hit $292.8 million, up 27 percent year over year but the same 3 percent over last quarter.

$28.2 million: Advertising rose 117 percent year over year, which sounds impressive until you realize that it’s less than $30 million of Zynga’s quarterly revenue and that it, too, was up only 3 percent over the fourth quarter. (Zynga sees a positive in that it is up at all over what is typically the strongest quarter.) Zynga should continue to improve in advertising as it figures out how to best use its games to deliver. As a WWF user, the ads often make me want to pay for the ad-free version, so either way Zynga has a shot at improving ad-related income.

Zynga added reward-based ads to some games in Q1 and plans to expand the concept to more games this quarter. Players can acquire virtual goods by watching ads.

22 million: Zynga’s mobile daily active users nearly doubled in Q1, to more than 22 million compared to 12 million for the previous quarter, thanks largely to Words With Friends, Words With Friends brand extension Scramble with Friends, and Zynga Poker. (Draw Something was only part of the company for 10 days before the quarter ended, so contributed little to Q1.)

Mobile is a trick box for Zynga. It needs mobile for growth but so far mobile users spend less. You need energy to run Cityville but you don’t need to buy letters to play WWF. The rapid growth of mobile draws another important Zynga metric down: average bookings per user or ABPU.

Zynga CEO Mark Pincus talked about the differences between mobile and web with Om recently:

One of the lessons we learned from the FarmVille for iPhone was that web and iOS are entirely different and have different mechanics. That is why we did FarmVille Express. The difference is that on mobile it is a 2-minute session versus a 45-minute session on the computer.

Words for Friends doesn’t do as well on Facebook as it does on the iPhone, because they are a mobile first experience. Our poker game does well on the mobile as well. Even Facebook is trying to figure it (mobile) out, we are all trying to figure it out.

4 million : Zynga introduced its first arcade game, Zynga Slingo. It turned on promotion in late March (sort of like using a portal firehose) and it’s now up to 4 million active daily users.

$180 Million: Post-acquisition comments from Zynga execs, including Pincus, about looking for more deals, gave investors the yips, which in turn helped send shares down from decent double digits to below $9 recently. Pincus used the call to reset expectations, stressing plans to follow the example of Words with Friends by using the new asset to then create more organic growth.

Zynga bought WWF parent Newtoy in late 2010 for $53.3 million, mostly in cash. It’s extended the brand twice, meshing that with in-house games to spur mobile growth. Pincus said WWF has grown more than five times to 14 million daily active users. They hope to do the same with already-more-popular Draw Something and OMGPOP.

As for shopping for more deals, Pincus said when asked directly on the call:

The strategy hasn’t changed since the road show … Our primary focus, the way we’ve built this business, has been organic development and growth of games that have led to a network that we have further leveraged to bring more successful games to market and that’s what you should expect us to continue to do for the bulk of our growth. This product line was the second major product line that we went out and acquired so it was a rare instance for us. … We felt we could organically build more from it but it does not represent a change in strategy.

Macquarie Securities’ Ben Schachter sees potential — and uncertainty:

We continue to like the free-to-play model and the advertising potential inherent in ZNGA’s structural model; however, this is a crowded, competitive space that has few barriers to entry.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Social third-quarter 2012: analysis and outlook
• Where the next-generation console fits in today’s video game market
• Social 2013: The enterprise strikes back

A few weeks ago a sharp comment by me on Twitter about Zynga’s copy-cat games ended up in a meeting with Zynga founder and chief executive officer Mark Pincus. Of course, we chose to disagree on those issues. Regardless, it has taken nearly two weeks for me to get to actually writing about the conversation.

I have known Mark for a long time. The first time we met, he and Sunil Paul were busy running Freeloader. Later, when I relocated to San Francisco, we ran into each other often, for the post-bust Silicon Valley was a very small (and quite bleak) place.

Like many of my age, he has seen the tech economy behave like a yo-yo, where he has oscillated between success and failure. Freeloader was successful, but Tribe never realized its true potential even though it came much earlier than Facebook. He also started Support.com. But it wasn’t up until Facebook opened its platform in 2007 that Zynga actually started on a path to big time.

Our conversation, held against the backdrop of a very noisy Zynga cafeteria (with a sound system blasting Pumped up Kicks), followed two threads. One was about Zynga and the future of social gaming; the other was about how the past decade of success, failure and now mega success with Zynga has changed him as a person.

OM: Mark, so you have seen the ebb-and-flow that is startup life. How have you changed over past decade?

Mark Pincus: I had to go through a lot of change to be successful. For a while I thought it was about control and VC and things like that but I don’t think that the story served me at all. I needed to grow up. I needed to be a CEO and not an entrepreneur and a leader to be followed. My approach involved having to grow up and evolve.

OM: How?

MP: I have had to learn. In fact, I have to be constantly learning. If you don’t learn something new every week, you lose your edge and in the end you lose. You need to be aware of that in order to adapt as a CEO.

With Tribe, I didn’t do that — and I never changed Tribe and that we were an open social network like MySpace, when Facebook was clearly having success with its private, trust-based model. I was not changing. I was just trying harder.

OM: What is the biggest lesson learned of this past decade?

MP: I think the biggest lesson I have learned from the last decade is that to be a good leader, you don’t need to be liked or loved by everyone. I wanted to be liked by everyone. I think if you know what is the right course, you got to go full in, but also be willing to listen to the right input and most importantly listen to your customers.

OM: So what does success look like, say, on the consumer Internet?

MP: The other thing is being in the right place at the right time with the right currency.  That gets you a lot of leverage in the equation. I think when you know what success on the consumer internet) looks like – Google, Facebook, Amazon, Yahoo – you know that is real success. I think you need to have instincts to be right but you also show should be able to use data to prove those instincts.

I think the biggest single change is that I grew up and I want to build a family and career, in that order. (My wife Alison and) I have worked our ass off for last five years and are staying with it, every day. There are so many staging points for the entrepreneurs — highs and lows. You have to stay with it.

OM: Does the current startup environment worry you? I mean we have seen this over-funding environment before and that didn’t end well.

MP: The more things change, the more things remain the same. It looks familiar but in reality things are different. The market opportunity is very different that it was 12 years ago. Today reminds me of the Renaissance. It feels substantial and feels more than just a company. It is happening all around the world. It is awesome.

PART TWO: Future of social games and importance of mobile for Zynga

OM: So what is the biggest challenge for you right now?

MP: My biggest challenge is to deliver on the promise of social gaming. We haven’t yet convinced you (as in me) to play just yet. Social gaming has to get to a level where Facebook has gotten to — you just cannot avoid it. It is a social norm for connections and we want to get there with games. That is what we are doing (with) Word for Friends, so we can get to bigger, broader market and get to more people.

OM: My belief is that Zynga is in competition with not other games but more in competition with Hollywood as both businesses are based on capitalizing on our attention.

MP: [It is] just as television competed with radio! It didn’t replace radio, it just made the radio move over. Our research shows that  Research is that nearly 70 percent of people who are playing social games are also watching television. Our games are played inside a tab and that is a [brand] new behavior. I think we are part of a new category of gaming that is about stealing back lost time like when you are waiting in cabs or in the airport. We are playing these games when we are, say on a boring conference call.

Agreed, that the new business model is less about clicks and more towards engagement and entertainment. I think we have the benefit of being part of the newer trends like mobile. I think the real competition is between mobile and the television. If the smartphone replaces the television, then games are the entertainment. (Related: Zynga and the perils of becoming a platform.)

OM: Tell me more about your mobile plans?

MP: What I want us to do next is be a “poke with a purpose.” You are essentially SMS-ing people and that is carrying a more snack-y game experience. Even more casual games and an even more engaged experience. [Think of an even more atomized version of Words with Friends.] This is more of a different experience that we have now and an experience that is more vertical and more engaged and served up in a tiny container. I think that is the big story here.

OM: From my understanding, you guys are slow to mobile?

MP: One of the lessons we learned from the FarmVille for iPhone was that web and iOS are entirely different and have different mechanics. That is why we did FarmVille Express. The difference is that on mobile it is a 2-minute session versus a 45-minute session on the computer.

Words for Friends doesn’t do as well on Facebook as it does on the iPhone, because they are a mobile first experience. Our poker game does well on the mobile as well. Even Facebook is trying to figure it (mobile) out, we are all trying to figure it out. Instagram and Path are mobile first experiences and are different. I am liking the new Twitter application as well.

OM: From the way I see it, all web services (and not just games) should basically be instant start from the cloud but adapt to the screen they are being accessed. That has to be table stakes. Are you guys thinking along those lines?

MP: Right now we are building back-end technology, so that your game state can be saved and served up in difference screens/devices. The interaction cues will take from the different devices. In other words, you can play a game on a computer and call it up on XBox and you resume from the point you left off, except the game play will now be customized for the Xbox controller.

OM: Thanks, Mark.

.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Facebook’s IPO filing: ideas and implications
• NewNet Q4: Platform mania and social commerce shakeout
• NewNet Q4: Platform mania and social commerce shakeout

The company behind popular Facebook games Farmville and Mafia Wars said in a regulatory filing on Friday that it intends to sell 115 million shares – 14 percent of its common stock – at up to $10 each.

The $7bn price tag will make Zynga the third-largest US gaming firm by market cap, behind World of Warcraft maker Activision (NSDQ: ATVI) Blizzard and Electronic Arts (NSDQ: ERTS). Activision Blizzard was valued at $14.19 billion and Electronic Arts was valued at $7.69 billion when the stock markets closed on Thursday.

Zynga said it has 54 million active users in 175 countries across the world, many of whom play its range of Facebook games including CastleVille, Empires and Allies and Zynga Poker.

Mark Pincus, the Zynga founder and chief executive, will control 36.2 percent of voting stock after the flotation.

This article originally appeared in MediaGuardian.

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Law of large numbers: the issue behind Facebook’s IPO
• Facebook’s IPO filing: ideas and implications
• NewNet Q4: Platform mania and social commerce shakeout

Pincus said three-and-a-half-year-old Zynga has 215 million monthly active users, 33 million of which played its games yesterday. The company has a staff of 1,200, half of them engineers, with 13 games studios in eight locations. It has 20,000 servers not including its heavy use of Amazon Web Services, with 1,000 added per week (more detail on that here).

Pincus projected that the rest of the web will come to look a lot more like Zynga, with advertising only be a small portion of revenue. “As big as ads are, I think what I call the user-pay economy will be much bigger than the advertising economy.” The web should continue to become more app-like, with categories like travel, shopping and health starting to look a lot more like gaming does today.

Zynga is known for making decisions about its product based on metrics, but that also extends to the way Pincus runs the company. He said that every employee at Zynga is treated as a CEO, with goals and metrics they are graded on using the concept of OKRs: one objective and three key results. The company measures its success using its Net Promoter Score (the measure of how likely users say they are to recommend a service) and aggregating daily survey data of customers taken after they go through support.

“We are data junkies,” said Pincus. “We measure everything. We’ve invested incredibly in data warehousing. We capture and track every click in every game every day.”

Related content from GigaOM Pro (subscription req’d):

• How to Measure Social Media Advertising
• The Real Impact of Facebook’s New Approach to Social Gaming
• Multiple Models for Social Media Businesses

You wouldn’t even think of going to Expedia.com to check your flight on an iPhone. It’s too many clicks and too much typing, so Expedia isn’t going to have a relationship with you unless you have that app. It’s not that way on the web but it could be that way.

Pincus said he thinks a proper application economy will require tools that create a consistent social gaming experience as users move between applications on the web. First, an “app bar,” would follow users around, enticing them to navigate back to their games — like the one from Meebo (which is tying up with other social web services through XAuth), the “social games bar” launched today by Heyzap, or the one expected to be launched by Facebook soon. Pincus said such efforts have the added benefit of increased engagement and revenues for publishers and networks who use the bar.

Second, apps need properly tuned user communication channels, Pincus said. These should be open enough to allow apps to grow through reaching out to their users, but closed enough to prevent obtrusive and annoying communication.

Third, an app economy would require universal social feeds that follow users around the web. This would allow users to connect feeds between destinations and activities, for instance sending activity in one game to a narrowcasted group of their friends on a certain network. When Zynga tested narrowcasting, or enabling users to share updates with a certain group of their friends, sharing increased 400 percent, Pincus said.

Because people find more value in games when their friends are playing them, Zynga finds that revenues are a leading indicator of engagement, not trailing. Social games have the capacity to be the most successful long-term gaming franchises in history, he argued, because console and PC games go out of style with their hardware, and traditional MMOs only retain a small portion of users over their life.

Pincus, whose hit game FarmVille has something like 30 million daily active users and has hosted 19 billion virtual gift transfers to date, offered advice for his fellow game developers. In order for a social game to be a hit, he said, there are three requirements: Users have to play with friends, they have to make an investment in the game, and the game should be a form of expression.

Pincus encouraged developers to take what he called “bold beats” — in other words, “giving yourself permission to take an enormous risk with your franchise.” For instance, Mafia Wars started adding new cities, and FarmVille added functional buildings. Both moves were internally thought of as challenges to the core games but were well-received by users. “We don’t want to be on a treadmill where we’re killing ourself to put out new content,” said Pincus. The ides is to test changes that are bold enough, so if they work they make a lasting difference.

So how can social game developers work together in the fiercely competitive space, full of ripoffs, copycats and borderline behavior? “Many of us have tried and failed at ways to share traffic and users,” Pincus said, pointing to past efforts of tool bars and APIs. “I think that where this ought to go is to be the open Xbox Live for the web.”

Pincus left the door open for an outside company to build the connecting tools he proposed. The obvious choice might be Facebook, which didn’t have a speaking role at the conference (they’re busy prepping for f8) but was of course ever-present in conversations about social apps. Pincus said of Facebook, which his company has a very lucrative symbiotic relationship with, “They’re going to have to decide between being the plumbing and the portal. I’m hopeful for all of us that they find the better business model around the plumbing.”

Related content from GigaOM Pro (sub req’d):

How the Next Zynga Could Reinvent Social Gaming

Earlier today, Zynga, a San Francisco-based social games company, raised a whopping $180 million in fresh funding from Digital Sky Technologies (DST), a Russian investment firm that first made a splash with a $200 million investment in Facebook this summer. The Zynga funding was reported in today’s The New York Times.

The company has been using aggressive tactics to bulk up its size and revenues. TechCrunch carried a series of exposés earlier this fall that laid bare the dirty underbelly of the social gaming sector. None of that seems to have impacted Zynga’s ability to raise fresh capital.

The 2-year-old Zynga, which was started by Mark Pincus, is valued between $1.5 billion and $3 billion, reports The New York Times, and is said to have revenues of $250 million. The company has more than 700 full- and part-time employees. It had previously raised $39.5 million from various Silicon Valley investors, including Institutional Venture Partners and Andreessen Horowitz. IVP, according to a report, is rumored to be buying stock from employees looking to sell some of their holdings. DST, I am sure, is betting that Zynga, like Facebook, is going to go public in 2010 and return big profits for the fund.

From what I’ve heard from Silicon Valley sources the maker of games such as Farmville and Mafia Wars is profitable. So this new cash is likely to be used for rolling up other social game makers that don’t have the bulk of Zynga. The company needs to keep getting bigger and distance itself from a growing number of social gaming startups. It also has to worry about Electronic Arts, which recently acquired Playfish for $300 million in stock and cash plus another $100 million in incentives.

The question is: Who is Pincus going to buy? Suggestions, anyone?

Photo courtesy of Lamenta3 via Flickr

Related research and analysis from GigaOM Pro:
Subscriber content. Sign up for a free trial.

• Where the next-generation console fits in today’s video game market
• Social 2013: The enterprise strikes back
• Social third-quarter 2012: analysis and outlook