Sunday, October 7, 2012

Digital Churns: Zynga, Spotify & the Downward Dog

My boss told me some years ago that, if you hang around long enough, every business model will come back either as a bang or a whimper.  His bone of contention was whether a company should be centralized or decentralized.  He gave each type of organization a half-life of about six years until the dreaded consultant came to town and recommended, with great sobriety and cost, the other thing, whatever it happened to be.

I read recently that those launching new businesses should focus much more on the vision and less on the business plan.  I think this advice had its genesis in the Harvard Business Review and was retweeted until it became established wisdom.  It might be time to bring the consultant back to town.

I served as the business development guy at Hachette during the dot com run-up.  Since there were few rules during this prairie fire, I tended to meet with everyone who had invented the next big digital thing.  I soon learned that pets, used clothing, supermarket coupons, and death were the subjects that were getting a lot of attention from the newly formed digital elite.  I had worked at a boutique private equity firm and thought I had enough of a “cunning nose” for new business opportunities, but this was a brand new toy.  I finally decided that for these entrepreneurs to get through the front door, they would have to convince me before a meeting that their Cost of Sales (COS) did not equal or exceed their total revenues by year three.  The foot traffic slowed down to a crawl.  I never got to ask about Average Revenue Per User because it was always somewhere down the road.

The WSJ ran a piece a month ago about Spotify’s plans to launch in Canada (August 22, 2012, “Spotify to Launch in Canada”).   CNET’s Greg Sandoval dug a little deeper into the numbers and asked in his piece, “Is Spotify’s Business Model Broken?”  I have blogged in the past that I thought magazine publishers can learn something from Spotify and still do.  But I was struck by some of the key financial ratios Sandoval focused on with his keen eye and cunning journalistic nose.

Spotify’s Total Revenue for 2011 was $244,539,608; its Cost of Sales for the same period, $238,913,983, or 98% of revenue.  Unlike most of the pet sock folks I met over ten years ago, Spotify has real revenue and plenty of new markets to exploit. But at the end of the day, so to speak, the Cost of Sales and specifically the cost of acquiring new members and, conversely, the Average Revenue Per User (for 2011 at about 5.73 Euros) will tell the tale.  As Sandoval observes, the fly-in-the-ointment might be the royalty payment due even when the offer is free.

Money continues to pour into the venture game; $24.4 billion in 2011.  And at the same time we hear the diurnal lament or prediction that the disruptors of a few years ago will now start taking their place on the disruption stage.  This was certainly the talk, even in the mainstream media, about Facebook after its post-IPO stock price fell.  Forget about Facebook’s one billion users.

Equally interesting was Josh Constine’s October 5, 2012, piece in TechCrunch about “Why Zynga Failed,” a title delivered emphatically in the past tense.  As a kid, I spent enough time on a dairy farm and had no desire to relive my cow-milking blunders with the Farmville fantasy, though I have been tempted to invest my virtual wallet in Emus as a specialty crop.

Constine reminds us that in 2008-2009 Zynga was on top of the world with Facebook as a game portal, CPCs low ($0.27), and hockey-stick growth on the office wall.  He ticks off four reasons for this “failure”: games got too complicated; too many developers, not enough software gamers; CPCs have increased more than 3X since 2009; Facebook got sick of game spam; with Facebook taking a 30% cut, margins got smaller.  Whatever we might think about this prediction, Zynga’s stock has dropped to $2.48 as of this writing from $10 ten months ago.

A writer on the TechCrunch comments page even suggested an official Constine’s Law: “Internet advertising margins are proportional to the size of the user’s screen.”  As these things go, this is high praise, especially for a site that has received criticism by those who think it is too uncritical about tech startups.  Zynga executives might want to read some of these informed comments that charge the company is beginning to look a lot like AOL, MySpace and Blackberry, has based the empire too much on Flash, needs to develop more advanced games, and should bring back the original talent pool.  They might want to ignore those who suggest Zynga’s time had come and gone and management has “screwed the pooch.”

Pets, especially dogs, seem to have a deserved place in digital hierarchy.

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