Zynga vs. Supercell - How One Ascended and the Other Declined

July 12, 2020 Joseph Kim

This analysis is a part of Deconstructor of Fun’s Digest newsletter. You can sign up to the newsletter at the bottom of this text.

Supercell in Decline

Earlier this month, Ilkka Paananen, Supercell’s CEO talked about key learnings from his company on their 10 year anniversary: 10 Learnings from 10 Years.

The lessons are not typical: “hire slowly”, “play the infinite game”, “replace control with trust”, etc.

Many games industry people’s response to Supercell’s approach and accompanying lessons is to consider Supercell as an anomaly. Some even go as far to say that Supercell “got lucky” and that luck enabled them to be this kind of “hippie organization” whose approach would normally not lead to long-term success.

More recently, as Supercell’s revenue and profitability have declined over the past few years, more questions have been raised about Supercell’s approach and even their value as a mobile games company.

Some common refrains:

“If Supercell were a public company, their performance would be unacceptable”
“They should try to be more like Zynga.”
“Tencent got screwed investing in them.”

Zynga in Ascent

Meanwhile, Zynga, a company once left for dead (or at least mediocrity) has been on an incredible ascent fueled by a series of highly accretive acquisitions over the past few years.

Recent Zynga Acquisitions:

* Still Currently Rumored, To Be Confirmed (Edit: Now Confirmed)

Comparing Zynga vs. Supercell: Why?

As one company declines and the other ascends, it’s instructive to consider the differences and similarities in both of these companies.

How has Zynga found recent success and how does this compare with the recent decline of Supercell? Both companies are top 10 mobile game publishers (according to Sensor Tower) and comparing and contrasting the two companies I believe has considerable value in understanding the future direction of mobile gaming.

Until just recently, it would have been inconceivable to even consider Zynga to be spoken in the same breath as Supercell. However, with the acquisition of Peak (again still just a rumor), how close will Zynga get to surpassing Supercell in revenue and even in — the ultimate measure of financial value — free cash flow (FCF)?

Based on simple trend lines, we would expect Zynga to overtake Supercell in FCF generation in the next few years. Below is the graph of historical (2015–2019) and projected (2020–2024) free cash flow of both Zynga and Supercell by linear extrapolation (not necessarily our belief of what will happen) for the two companies. Note: Supercell FCF is estimated (Note 1 below).

Source: WSJ, Supercell Financial Reports

Finally, some interesting questions to consider:

Which company is more valuable?
Do either of these companies have the potential to be the most valuable mobile gaming company in the world?
Who’s approach will succeed in the longer term?

Supercell and Zynga Differences

Strategically and organizationally, both Supercell and Zynga have very different approaches.

Supercell focuses on innovation. They often take existing categories and reinvent them with a specific eye towards simplification.

Clash of Clans drew heavily from Backyard Monsters on social but improved the mechanics for mobile.
Clash Royale drew heavy inspiration from Starcraft Nexus Wars, a PC game, but significantly improved the experience for mobile.
Brawl Stars is Supercell’s attempt at the existing PC MOBA genre for mobile.

In this way, they are very similar to what Blizzard used to be: taking existing gameplay and making it significantly better.

Zynga has from its very beginnings been more about distribution and live ops optimization. They were known for copying games and competing on scale and out-marketing competitors. Even today the new strategy around acquisition is essentially a better execution of competing against scale and incremental improvement.

From a product perspective, the biggest difference between the two companies is really in the focus around a holistic experience (Supercell) vs. a reductionist, specialized focus on small improvements (Zynga).

Hence, a simplified view of the biggest difference between both companies:

Supercell focuses on making big, hit new games
Zynga focuses on growing existing games

Simplified View of Supercell vs. Zynga Strategic Differentiation

Supercell and Zynga Similarities

Despite their differences, you may be surprised that there are core pillars of commonalities between the two companies as well.

Specifically:

Forever Franchises: Focusing on game products that people will play “forever”
Decentralization & Autonomy: Decentralizing authority and giving studios autonomy

Forever Franchises

Supercell popularized the notion now found in almost 90% of new game startup’s investor pitch decks: we build “Games that people will play for years.”

Zynga’s similar notion of “forever franchises” describes quite simply one of the biggest drivers behind F2P mobile gaming success: that live operated titles can continue to generate steady, predictable revenue on a long-term and on-going basis. Poker was Zynga’s first game and they have leveraged that early success, scale, and optimization to develop a portfolio of games that today, unlike other forms of entertainment content, can continue to stack free cash flow over time.

Both companies understanding of and ability to optimize these games on an on-going and long-term “forever” basis are a key area of similarity and competitive advantage.

Decentralization & Autonomy

Supercell was formed with the intent of organizing around a decentralized team structure. In fact, this decentralization is the basis for what the company’s name is intended to imply: a collection of small, independent cells.

Ilkka (Supercell’s CEO) states in his blog post that teams can overrule product decisions for their games and states examples of how that independence had led to success despite doubts from company employees outside of the team.

Interestingly, Zynga has also adopted a similar view with respect to this decentralized approach. Giving autonomy to acquired studios and in fact not running central services like UA from HQ.

Hence, decentralization speaks to a more common theme that likely has spelled disaster for many game publishers who have centralized to date. Specifically, that games require specialized expertise and domain knowledge to achieve success. Therefore, a centralized HQ based team that’s good at “pattern recognition” is essentially useless and that the common wisdom of central management layers can in fact be more harmful than helpful for product success.

Which Company Is More Valuable?

The financial value of a company should be based on evaluating the discounted value of all expected future cash flows from the company set to net present value.

So which company is more valuable? Based on historical performance clearly the answer is Supercell, but the market capitalization (company valuation) is based on historical as well as expectation of future performance. This is where the market seems to be favoring Zynga.

Hence, the big open question for both of these companies really is about the expectation of future cash flows. Will it follow the trend of the past 5 years or is Supercell just overdue for another big hit which will reverse the trend of its revenue and free cash flow performance?

Let’s now look at the current valuation of both of these companies based on public information:

Supercell vs. Zynga Valuation

If the 1.2% acquisition by Tencent for $40M is correct as reported, Supercell may have suffered a significant fall in valuation since the 2016 valuation at $10.2B.

Which game company do you think should be valued more highly?

Let’s get back to this later in this post…

The World’s Most Valuable Mobile Gaming Company

So where do both of these companies sit today compared to the top mobile game publishers in the world? Do either of these companies have a chance at the global crown?

Top 10 Mobile Game Publishers (According to Sensor Tower):

If we were to look just by mobile game revenue for 2019, the top 10 mobile game publishers would include the following list:

Source: Sensor Tower

Above, I show the Q1 2020 market share for the top 10 2019 mobile game publishers according to Sensor Tower.

Assuming Zynga has acquired Peak games, that would add an additional $106.5M in revenue to Zynga giving it a total of $336.5M for Q1 2020 and vault Zynga from 8th place to 4th place (for Q1 2020).

Just to be clear, we should always only care about free cash flow. But just for context and because we don’t have access to all of that information for these publishers, we evaluate in the context of net revenue.

On this basis, Tencent would clearly be the world’s most valuable gaming company. The scale of revenue and the current trend for Supercell would seem to indicate a potentially insurmountable gap between the two companies. Can Supercell 5–6x its revenues?

It’s a bit more believable for Zynga to eventually challenge Tencent if we believe it can continue its growth path. However, to be honest, I don’t think Zynga can grow to the level of Tencent scale.

Hence, a much more realistic goal for both of these companies would be to vie for Western supremacy taking on Playrix, King/Activision, and Playtika. For global domination, the data seems to indicate that without the Chinese market, no mobile gaming company will be able to compete as the world’s most valuable mobile gaming company.

Supercell vs. Zynga Longer-term

Let’s get back to the final question posed when we began this investigation: Who’s approach will succeed in the longer term?

This question should also answer the earlier question of which company should be valued more highly.

Both companies have the distinct advantage of being in an incredibly vibrant industry with massive tailwinds driven by recent surging interest in low cost online entertainment. So no doubt both companies should experience growth and continue to see success in the future.

But on a comparative basis, I believe, despite the trend-line, Supercell will ultimately prevail between the two companies.

Why?

Two trends will drive strategic macro-environmental forces into Supercell’s favor:

The M&A Gravy Train is Over
Scale and Live Ops Will Be Commoditized Over Time

The M&A Gravy Train is Over

All of Zynga’s growth has come on the back of acquisitions. Just to be clear, Zynga have been incredible at M&A and have done a fantastic job in executing a number of deals that have fueled its growth and turnaround.

But how many mid-tier mobile game companies are left? I would argue there just aren’t that many targets left for Zynga to acquire to continue its growth. Further, a strategy dependent on acquiring accretive targets that eventually spring up over time is very risky. There may not be a cultural fit, companies may not agree on a price, and there may not be synergies to justify a combination.

Below is illustrative of the current market dynamics:

What is the longer-term growth story for Zynga without M&A?

Scale and Live Ops Will Be Commoditized Over Time

Performance marketing is getting commoditized, a number of new entrants are beginning to enter the live ops services space, and information leakage is beginning to reveal the secrets behind live ops optimization.

Increasingly, we may see a trend towards the commoditization of live ops over time. Hence, it will become increasingly important for game studios to figure out how to make hit new games, rather than focusing on optimizing and scaling existing games.

Which company would you bet on to come up with the next big hit game?

Conclusion

Now, I won’t say Supercell has fixed it’s problems or that there aren’t underlying issues with the company. On the Deconstructor of Fun podcast, I reported rumors that key leads/designers who were responsible for some of Supercell’s biggest hits have left. If true (to be clear these were rumors only) can we attribute Supercell’s decline to loss of key talent?

However, on a relative basis while I’ll continue to root for both companies, I believe Supercell and not Zynga is setup for longer term success — to be clear, I certainly expect Zynga to keep killing it this year and the next year or two after that. So this comparison is more on a 10-year time horizon.

Finally, I will have to say that on a 50 year basis I don’t think either company is setup for success. In fact, I’d be surprised to see either company around in 2070. Speaking honestly, I just don’t think we have a Jeff Bezos of the games industry, hence there is no Amazon of mobile gaming and probably all of games. Perhaps with Tencent as an exception.

But more on that next week when we look at long term competitive advantage of gaming companies. Stay Tuned!