The Social (Gaming) Network

Game developers should thank Facebook for only taking 30% of their revenue when the social network’s credits system of paying for virtual goods becomes its sole currency this July.

Facebook commands an iron fist over its itsy-bitsy “partners” the way the mob used to muscle corner store merchants a century ago. Game developers are still going to happily fork over a fat percentage, however, because they know trying to develop an audience anywhere else is downright laughable. The social network takes a 30% cut when customers make a buy with its credits, and, in taking the payment system throughout its network later this year, Facebook elbows online transaction manager PayPal aside for good.

As Facebook looks to build on the addictive online experience—after all, the site’s ability to engage and retain users is what eventually got its member headcount past a half-billion—the social network’s Disney Dollars approach guarantees continued engagement. You can’t spend them anywhere else. Tangible goods cannot be exchanged for Facebook credits—the virtual payment system is only good for purchasing items within the gaming network. Ever masters of creating the addictive experience, Facebook has set up an expedited system where users can make purchases mid-game, without so much as a pause in play.

Goldman’s $50 billion valuation for the social titan is starting to look a little lowball, all of a sudden. A testament to Facebook’s clout, 22 of the top 25 social games operate through its credits-backed system.

Big strategics already struck deals to build scale in the social gaming space, only furthering the development of Facebook’s currency. Electronic Arts’ $400 million 2009 deal to buy Playfish helped the publicly-listed game developer stretch from the TV-connected console to the Internet, bringing a library of titles online for EA to monetize. The sale also marked a monster exit for Accel Partners, Index Ventures and Stanhope Capital, among Playfish’s backers. It’s going to take a bigger deal for Zynga, however. Reportedly, up to $500 million has been invested in Zynga from VCs including the Union Square Ventures, Foundry Group, Andreessen Horowitz, Tiger Global, Digital Sky Technologies, Softbank Capital and Institutional Venture Partners, even Google. Zynga ought to IPO the same day Facebook does; it’s been along for the ride this long, what’s filing an S-1 to boot?

The pace of M&A in the space will quicken as Facebook’s credits hasten the development of social gaming (to say nothing of what increasingly capable smartphones will do to engage users). Playdom scored a June 2010 round of funding from a group that included New World Ventures, Bessemer Venture Partners and Steamboat Ventures. Within days of those deals, it bought startups Metaplace and Hive7. By late July of last year, Disney, armed with enough characters and copyrights to create a separate social gaming universe, spend $763 million to buy Playdom. Talk about a quick exit for its investors.

Other game developers will invite an increasingly eager VC community to buy smaller stakes. Kabam, earlier this month, scored a Series C $30 million funding round from Redpoint Ventures, Intel Capital and Canaan Partners—more than triple what it had reeled in during its Series A and B outings combined. Others, among them, Appbank and CrowdStar, could still offer opportunities for investors (or, strategics).

But the cat is out of the bag, now that Facebook’s credits will further the pace of growth of the industry via spending on virtual goods. Games played through the network only continue to gain traction with its massive user base.

“Cityville already has over 100 million monthly active users,” said Keith Smith, CEO of digital publisher BigDoor. “Farmville never had that many.”