On EA’s Acquisition of Playfish

I wrote the following brief, high-level news analysis for a multi-industry expert network that I joined earlier this year; figured some of you might like to read it.

EA has just acquired social-network games maker Playfish for $275 million, plus an additional $25 million in equity retention arrangements and up to $100 million in additional cash contingent upon future performance. Playfish is one of the top three game developers in this space, the others being Zynga and Playdom (both privately held.) Zynga is widely rumored to be targeting an IPO within a year, leaving only Playdom as a wild card.

Why would EA pay such a large sum for a company that was only founded in 2007? In fact, one could argue that Playfish doesn’t even possess particularly distinctive IP and that its games are easily cloned (as Zynga demonstrated when it created “Cafe World” — a close copy of Playfish’s hit game “Restaurant City.” Cafe World now has 28 million monthly active users on Facebook, as compared to 18 million for Restaurant City.)

The answer is complicated. On one hand, big video game publishers have a history of overpaying for top development studios. But on the other hand, while social-network games may seem like simple things, they are in fact dramatically different from the video games that publishers like EA have built their businesses around. EA is, in part, acquiring expertise.

The traditional big video game publishers rose to prominence in part because they were capable of funding the development of robust, complex, multi-million dollar video games and in part because of their retail marketing and distribution prowess. In short: they are very good at getting people below the age of 35 to pay $30 to $60 for a boxed game that can be enjoyed alone on the couch or at the desk or with friends online. But social-networking games, by contrast, require a completely different product development and product marketing skill set. These games are free to play and generate revenue via optional microtransactions — they must be designed explicitly for the purpose of driving such transactions, as opposed to traditional games which can simply “be fun to play.” Furthermore, the core gameplay mechanic of any good social-network game must encourage players to invite their friends into the game — again, it cannot simply be “fun.” And of course, there’s no retail shelf to position a social-network game on; instead, developers must rely on non-traditional advertising, on the viral mechanics of their games, and on cross-promotion between online games to drive traffic.

This latter point is critical. The top social-network game developers have become very effective at driving players from their existing games to their new games. This means that they are essentially capable of helping any new title reach a critical mass of players almost immediately, and for “free.” From that point forward, if the game is designed well enough (i.e. if it is highly viral and good at engaging and retaining players), it will succeed.

So why did EA purchase Playfish? Because EA’s game designers are not accustomed to building games that focus mainly on viral design or on monetization via microtransactions. Because EA’s marketing people are not intimately familiar with the techniques necessary to market these non-traditional games to these non-traditional audiences. And because Playfish offers an established network of players that future games can be cross-promoted to. Of course, it certainly doesn’t hurt that Playfish is rumored to already be generating $50 million a year in revenue. Lastly, Playfish was likely the “cheapest” of the three established game developers in this space.

One could certainly argue that it would have been cheaper for EA to spin up one, two, or even three independent studios and charter them with experimenting in the social-network game space (especially if they’d had the foresight to do so two years ago.) Eventually, one studio would have hit on a successful formula, just as Playfish did. And perhaps other major publishers, such as Activision, should be considering such a strategy. But EA’s acquisition of Playfish certainly makes sense… it simply remains to be seen whether they overpaid or not.

4 responses to “On EA’s Acquisition of Playfish

  1. I blogged a short note about this here:

    http://www.kimpallister.com/2009/11/ea-buys-playfish.html

    Yes, in short they bought the IP, the user base, the revenue stream, and the expertise.

    In fact, the structure of the acquisition hints at the above. The earnout is partly to retain talent and partly to make sure they hit the revenue numbers ongoing (which is in turn related to retaining the user base, etc). The stock part of the deal is related to retaining talent.

    As to whether they overpaid or not, we’ll never really know. Whether it turns out to be a successful piece of their business or not is immaterial to whether they overpaid.

  2. Somehow this reminds me of all the people buying AMZN after it gapped up to all-time highs at the peak of a rally driven by government funny-money, you know what I mean? Its like paying a quarter billion to avoid having to do your homework.

  3. All good points. Do you think having EA’s legal expertise and/or working on ironclad IP will change the dynamic for Playfish? Or is this really just a numbers game for active user base?

  4. I’d be surprised if EA didn’t intend to leverage its IP via Playfish, but I’d personally guess that’s a strong secondary reason for the purchase.

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