More Cuts at This Gaming Company

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Zynga (NASDAQ: ZNGA) is undergoing another restructuring effort in an attempt to cut costs. Although the company helped create the social game market, it is increasingly feeling the pinch of competition in what has turned out to be a very fickle sector. Look for Sony and Microsoft to make things worse with new game console releases. Electronic Arts (NASDAQ: EA), meanwhile, looks well positioned to prosper.

Broadening market

Nintendo's (NASDAQOTH: NTDOY.PK) Wii was probably the first game system to court the mass market. Instead of focusing on hard-core games, its innovative motion based controller was used to create family style games. Sales more than tripled between 2006 and 2009.

However, Nintendo stood by and watched as its direct competitors brought out motion controls and, more importantly, as social network-based games stole the social game market. Nintendo's sales fell sharply. The leader in the social space was suddenly Zynga. It had latched onto Facebook as its distribution partner and prospered as that social network's dominance grew.

Moving on

The only problem with the business model was that it relied almost completely on Facebook. That service, while still wildly popular, has seen changes in the way its customers use it. Some have even started to “take breaks.” That's been a problem for Zynga. Worse, there's little barrier to entry when it comes to social network games, so competition has been fierce.

Interestingly, social game demand has proven to be more like fashion trends than hard core games. Hard core gamers will play the same game for months and then eagerly buy the next iteration of the same title. There is, in fact, an element of skill involved in learning how to play such games.

Social games are meant to be simple and mindless. So, customers have no reason to stick around. When they get bored, they just switch to a new free game.

Searching for a cure

Zynga cut 5% of its workforce last year and just announced plans to shed 18% more. The goal is to save money. However, this could be a double edge sword. The company is unprofitable and needs new games to work its way out of the malaise it's in. Cut too many people and that gets harder to do.

It has also broadened its reach into other areas. While its dedicated website hasn't gone over very well, it is working on more mobile content. That's a good move, but one that requires a tough move beyond Facebook. It is also experimenting with gambling style games. If Internet gambling takes off, it could be a nice business for Zynga. Still, the company's shares are too risky for all but the most aggressive turnaround investors.

More competition

Sony and Microsoft are set to launch new gaming consoles toward the end of the year. PlayStation 4 has been targeted at hard-core gamers, but is set to reach into the living room. The living room, meanwhile, is where the Xbox One has been targeted from the start. While both products will still offer the intense game play that hard core gamers want, they are clearly looking to capture more of the casual market, too.

Zynga could find its customers switching to the new hot thing again. While it may not be a lasting shift, it could be long enough to hurt Zynga's chances of a turnaround. The same is true of Nintendo, which is also tied closely to the game market. Investors should probably avoid both companies for now. Microsoft and Sony, meanwhile, have much broader business and new game consoles won't be enough to push needle at either company.

A demand pop

The companies that are most likely to benefit in the social game space are more diversified game makers Electronic Arts and Activision Blizzard. Both companies have been working to get into the social game space and, with new consoles coming out, should see a boost in results as a new round of game buying takes shape.

Of the pair, EA probably has the most upside potential. Sales at the company have declined year-over-year in each of the last four quarters. Meanwhile, it has a solid lineup of games and has been aggressively investing in mobile and casual content, including the purchase of game makers PopCap and Playfish.

While the company is creating casual games, like The Simpsons: Tapped Out, it has also used the mobile and casual arenas to broaden the reach of core titles. For example, Need for Speed and FIFA have both been ported to the space. That should help the company's core titles reach new audiences.

As the new game systems come out, casual gamers will see these now familiar titles and, perhaps, buy the full games as they look to the Xbox and PlayStation to handle more living room duties.

Outside the box

EA's shares have fallen from their highs in the $70s, but have started to turn up recently. If the company's changing makeup works, sales could quickly rebound later this year. That would mean potential upside for investors who get aboard now.

Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's "game over" for this newly public company. Being so closely tied to the world's largest social network can be a blessing and a curse. You can learn everything you need to know about Zynga and whether it's a buy or a sell in our new premium research report. Don't even think about picking up shares before you read what our top analysts have to say about Zynga. Click here to access your copy.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Nintendo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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