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).

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:

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:

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:

1. The M&A Gravy Train is Over
2. 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!

Links:

• Ilkka Paananen: 10 Learnings from 10 Years
• Levelup Blog: Making hit new games: The concept big studios are missing
• VentureBeat: How Zynga looks for the right game companies to acquire

The views expressed in this post are my own and do not represent the views of my employer. Even further, this post is just a fun thought experiment expressing a contrarian view to current popular opinion.

Fortnite: The Cultural Phenomenon!

Fortnite is a cultural phenomenon with over 40M downloads on PC and console and bursting out of the gates on mobile. The game has garnered well over 11M installs and reportedly generating up to $1.8M per day on iOS.

Recent press coverage suggests a game that has exploded onto mobile and will only grow bigger:

• Fortnite mobile daily revenue peaks at $1.8m since lifting invite-only requirement
• ‘Fortnite Mobile’ Is Out-Earning ‘Pokémon GO,’ ‘Candy Crush’ And ‘Clash Of Clans’

With all of its current success are we on the brink of a new world order in the mobile App Stores? Will we have a new dominant mobile gaming winner? One that will dominate the AppStore for years to come like Supercell or King?

I don’t think so. Why?

Physics. You can’t fight gravity.

 

 

 

 

 

 

 

While I’m a huge fan of Fortnite on PC and console, I’ve definitely got longer term skepticism at the current level of success on mobile.

Given all of its current success, however, I am definitely in the minority in saying:

• Fortnite on mobile on Unreal (with current device requirements) will flame out. Hence, we should prepare to *eventually* see a major fall off
• While I can certainly see the game do “well”, I do not believe the game sustains over time in the say top 10-25. In other words, I don’t believe Fortnite is a game on the order of Clash of Clans or Candy Crush.

Why am I such a hater? As a professional in the mobile game industry, shouldn’t I be happy for Epic and all of their success? Am I sort of like the old console/PC guys who hated on and doubted F2P games in the early days?

Believers vs. Skeptics

Discussions with my friends in the mobile F2P industry are markedly divided across two camps:

1. Believers: This is 90%+ of the folks I talk to. Those proclaiming a new world order and embracing Fortnite with open arms, these guys shake their heads at me: the grumpy old guy who can’t face the new reality
2. Skeptics: F2P old-schoolers who are totally confused by Fortnite’s success and believe Fortnite will eventually fall out completely of top grossing ranks in the AppStore. 

I’m very fortunate to know people in both of the above camps and benefit from the discussion and debate from both.

While I’m more in the Skeptics camp, I can see the case for why Fortnite is a great game and why BattlePass should not be written off as just “cosmetics monetization”.

Let’s dig in a little more and start with the Skeptics. Why don’t they believe Fortnite is for real? Or at least like me, don’t believe it will sustain as a top 10-25 grossing game long-term? Well, the criticism boils down to the following three primary concerns:

1. 1. Size of Addressable Market: Fortnite currently only runs on high end iPhones with at least 2GB of RAM and running IOS 11. The sheer volume of downloads makes one wonder just how much of the addressable market there is and how much more growth is physically possible.
   2. Monetization: Old school F2P guys like me have never seen cosmetics monetize on mobile except for in Asia/Japan. The monetization in the game for cosmetics is on an order never before seen here in Western markets.
   3. Gameplay: To date, mobile games with high twitch and “micro” controls have not been very successful in the West. Most Western players have consoles and PCs they generally prefer to play high micro types of games on. Hence, MOBAs, ARPGs, and FPS as key game genres on PC/console, because of the high twitch factor, have generally not fared well in Western markets.

So should we believe Fortnite is just a massive phenomenon that has broken through all 3 of these 3 key issues above.

Let’s try and back this up with some data.

1. Size of Addressable Market

I’m just doing back of the envelope math. Happy to have folks out there provide better data points for me.

Let’s try to first determine what the size of the total addressable market for Fortnite is.

Just doing a 5 minute search on the Internet we can arrive at a rough approximation of phones that are capable of running Fortnite as say 600M. Let’s just say it’s “New iPhones” from the data from Deutsche Bank below. Again… back of the envelope.

Breaking this down further, let’s say the addressable demographic who want to play this game are males 18-44 years old. Based on another rough estimation we can say that would be approximately 36.5% x 50% (for males) = approximately 18.25%.

600M iOS phones x 18.25% = approximately 111M phones.

Now let’s say that within that group of males, 18-44 years old, that the percentage of those who would play a fairly hardcore PVP game like Fortnite is say 20% (I think this is pretty generous).

That leaves us with:

• 111M x 20% = approximately 22.2M phones

Ok, so based on media reports we have at least 11-14M installs (as of 4/7/2018). Are we saying we have over 50% of the addressable market already?

Obviously my analysis makes strong assumptions off of very quick and dirty numbers and but I don’t think I’m like an order of magnitude off.

If nothing else, what this should suggest is that at least on iOS we should hit saturation sometime soon given the current rate of installs. Again, assuming I didn’t miss something pretty major.

2. Monetization

I personally have never seen significant monetization contribution from cosmetics for a mobile game in Western markets. Prior to Fortnite, implying anything over $0.20 in LTV I would decry as super aggressive.

Now, I know cosmetics can sell. Given my position in the industry and seeing how games like Phantasy Star Online 2 monetizes, I know in *Asia* it can be a very big deal. There are certainly also mobile games like the DragonQuest game in Japan that monetizes heavily from cosmetics.

But in the West? Hard to believe. But certainly not impossible.

In particular, the way Fortnite monetizes through BattlePass is certainly a significant advance in monetization design for cosmetics. BattlePass isn’t just cosmetics. By having a quest system and progression mechanics baked in as well as XP boost, it meaningfully adds to the gameplay experience. Further, by offering a new Battle Pass every season (around every 2 months), Epic creates a stronger recurring revenue stream.

Rather than regurgitating how BattlePass works here, read this link below:

• Fortnite Season 3 Battle Pass rewards, skins and items explained

So let’s quantify this a bit more. Based on SensorTower data from one of the articles linked above, Fortnite has (as of 4/6/2018):

• $10.5M in net revenue 
• 11M global installs
• That gives us an ARPI (average revenue per install) of roughly $0.95

ARPI generally climbs over time and log fitting ARPI (month by month) can help us get a better idea of long-term LTV in the future. However, since we don’t currently have that data we’d have to guess what the longer term LTV may be.

For F2P games, this ARPI growth (month by month) can be fairly significant, shown below is a real world example for an RPG game which will likely hit at least $22-$23 in LTV.

Let’s say that for Fortnite, the game can continue an increased ARPI trend and that we would even say the game can increase this significantly (for cosmetics) say 3-5x this over time to $3-$5 in overall LTV.

As a traditional, old school F2P game designer I have a hard time believing cosmetics (even with the improved design) can do more than that. Time will prove me right or wrong… let’s see!

This implies that Fortnite should generate (on iOS only) a *lot* but not game changing, AppStore dominating revenue. Certainly, we’ll see another big burst after the launch of Android as well though.

3. Gameplay

In general high twitch, action based games just do not do as well in Western markets as they do in Asia. This has been a truism since the beginning of mobile gaming.

The market, particularly in China however is different. In China, many people (obviously not all) simply do not own a computer at home and don’t have cars. In some ways, their phone is their car. Hence, if you can’t play League of Legends on your home PC you’ll play Arena of Valor on your mobile phone. It’s not the whole market but generally the case.

Certainly, high micro games have been making greater in-roads in Western markets more recently. With games like Mobile Legends Bang Bang, Pixel Gun 3D, and Zombie Hunter Frontier 3 amongst other games breaking the top 100-150 Grossing from time to time. But top 10 is a totally different level. Fortnite is currently the #1 grossing game in the App Stores for the US. This is certainly new territory.

Let’s take a look at the top grossing performers in the high micro categories and see how they stack rank vs. Fortnite:

Key High Micro Game Category	Mobile Game Title	Grossing Position on US AppStore (Based on AppAnnie on 4/7/2018)
Battle Royale	Fortnite	#2
FPS	Pixel Gun 3D	#128
MOBA	Mobile Legends Bang Bang	#226
ARPG	Lineage 2: Revolution	#139

While I believe that high micro games will do increasingly better in Western markets in the future on a genre by genre basis, I don’t think we’re there yet. Based on my read, I think we’re in for a regression to the mean with Fortnite as well for mobile. For this type of game, I believe players will prefer to play on a PC or console vs. mobile and be discouraged by the inability to be as competitive with true cross-play for mobile.

The Rise of Battle Royale

Whatever happens to Fortnite, I am a 200% believer in Battle Royale.

Years ago, I sat next to some young kids at an airport who couldn’t stop talking about a game they were playing called King of the Kill. I asked them about it and they explained the basic concept to me. Once I got home, I immediately bought it. Over the years, I’ve kept an eye on this kind of game with PUBG and now Fortnite. For me, I fully understand this is an important and lasting game category that has survived the test of time and multiple product variations and will continue for the long-term.

I also believe in Battle Royale on mobile. In fact, I believe in Battle Royale as a sustainable, top 5-10 grossing mobile game.

While Epic and Netease have proven that there is massive user demand for a Battle Royale style of game on mobile, both companies have not fully optimized for:

1. Addressable market: Through larger device support
2. Monetization: Stronger F2P monetization (this point is debatable)
3. Gameplay: Through shorter sessions more appropriate for mobile devices and mobile user behavior

In my view, a game company that addresses the above will be the next big winner for this market.

Also keep in mind, Battle Royale doesn’t necessarily have to be FPS. It could be a MOBA, a .io (some of which we’re already seeing from China), sniper, or various other forms of gameplay.

Whatever the form, I submit that we are currently in the MySpace phase of Battle Royale. The Friendster phase (with H1Z1: King of the Kill) is over.

In the end, regardless of how this plays out, what Epic has done with Fortnite has been absolutely fantastic for the end user. They have proven that cosmetics can sell, that a game can be successful without pay to win, and now brought massive attention for the Battle Royale category for mobile.

I’m hoping the big guys pay attention: Supercell, MZ, Glu, Activision Blizzard, Riot, get moving already!

Who will be the next Facebook of Battle Royale?

Context:

Every mobile gaming company has their own system for describing different types of mobile games. In other words, a mobile gaming taxonomy or classification system. Unfortunately, no industry standard exists. Further, I’ve been very unhappy with the current taxonomies developed by the various research firms out there.

As a good friend of mine stated recently to me:

When you have Clash of Clans and Game of War in the same classification category, something is definitely wrong.

To help promote a shared understanding within our industry I’m proposing an “open-source taxonomy” based upon my own understanding of the market. I’d be happy for other companies or research firms to adopt this standard if possible. Further, I’d love to hear feedback and debate how to improve upon the proposed mobile gaming taxonomy below.

Classification Approach:

To build the taxonomy, I relied on 3 primary principles:

1. Gameplay Focus: Focus differentiation of categories based on gameplay instead of systems or other metrics
2. Top-Down High-Level Categories: Build high-level categories top-down using an easy to understand classification approach
3. Bottom-Up Sub-Categories: Build sub-categories/genres using a bottom-up approach based on the actual types of games we find in the marketplace

Gameplay Focus:

At a high-level, I wanted to distinguish categories based on an overriding characteristic. The two characteristics that seemed to make the most sense were either: 1. Gameplay or 2. Systems. I chose to focus on gameplay because we often see similar systems (e.g., Gacha, guild, etc.) mixed in very different kinds of games. However, to the player, I believe they would consider games more different based on the core gameplay itself rather than based on the, for example, monetization system used.

Taking a more specific example: Summoner’s War and Puzzle and Dragon both use Gacha Fusion system design mechanics for character progression but the better classification against those two games would be the core gameplay (Turn based battle vs. Match-3).

Top-Down High-Level:

I picked high-level categories that seemed to make the most logical sense and those I thought easy to understand. I also eliminated some categories I didn’t feel appropriate for mobile or felt dated (e.g., Arcade category vs. Action). Finally, I also picked categories which I believe will be up and coming such as the Party category and Racing.

Bottom-Up Sub-Categories:

In my view, the sub-categories need to be rooted in what actually exists in the market. The audience has already decided what types of games they like with the money they spent. Hence, we develop a sub-categorization focused on making sense of what kinds of products were actually generating revenue.

Further, from a developer perspective, studios will find higher granularity of sub-categories more insightful and actionable. As a specific example, for Shooting and RPG categories you’ll see a much higher level of granularity than from typical research firms out there. I believe developers want to know, for example, the relative success if building a Shooting type game between FPS, TPS, and cover-based shooter games. As another example, we know Match based games are a huge category, but it’s more useful to distinguish between the various types of Match such as match-3, match blast, line matching, or otherwise.

Proposed Mobile Gaming Taxonomy:

So here below is the proposed mobile gaming taxonomy:

You can scroll the spreadsheet above horizontally.

Let me know what you think!