Rising Costs Leave Facebook Developers in the Lurch

Small Developers Move to Other Markets As Ad Prices and Revenue Splits Make Environment Tougher

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As Facebook heads toward 700 million users, one thing seems clear: the gold rush for Facebook app developers is over.

Early adopters of the social-game space, such as Zynga, Crowdstar and Playdom -- known in the industry as part of Facebook's "Top 10" -- are still raking in all the users and much of the revenue, but rising ad prices, a cluttered market, and higher transaction fees are forcing smaller players elsewhere, and in many cases off Facebook altogether.

Some in the Facebook app industry go so far as to declare Facebook a closed system for new companies and their products. "For the most part, the window of opportunity for games on Facebook has closed," said Chris Cunningham, CEO of Appssavvy, a firm that pairs marketers with app developers and one that has worked extensively with Facebook. "There was a three-year window for companies entering Facebook, but since Facebook opened their platform in 2007, each year has brought stricter restrictions and requirements that have changed the Facebook app marketplace forever."

Mr. Cunningham said that developers can still enter the fray, but they should also look into other platforms where the opportunity to create a new hit game still exists.

As Facebook enforces stricter and stricter guidelines for developers, some companies are welcoming developers to come and build. Spil Games, one of the largest gaming platforms in Europe, works with 20 developers -- compared with Facebook's hundreds -- but has just opened its own API, so developers can build on the network.

"What we hear is that developers are having a hard time finding the audience on Facebook," said Spil CMO Oscar Diele, who sees 50 million gamers a month. "It's getting more and more difficult to get visibility and grow an audience."

Mr. Diele, who is a competitor to the social-media giant, said he's seeing another trend -- developers skipping Facebook altogether in favor of platforms that are specific to social games. Another huge gaming portal, Bigpoint, with 200 million users, also recently opened its API for producers in hopes of luring developers that might otherwise focus on Facebook.

One of the most-discussed changes in the Facebook ecosystem is the July deadline for all games to transition from using their own currency to Facebook credits, giving up 30% of each transaction to the social network. Analysts say that the 30/70 split is normal for the market, but it will be an increase for many developers and some are scrambling to recoup the loss.

"One possibility is to raise the price of your items to achieve the net you're looking for," said AltEgo CEO Seth Gerson, adding that he expects his company, a relative newcomer to Facebook, to experiment with many ways of increasing revenue on Facebook. "It's easy to try different methodologies on Facebook because it's so easy to collect data."

Mr. Gerson's game, Hollywood Magic, has recently implemented Facebook credits, but he said it's too early to release any meaningful data based on the game. AltEgo has games across several non-Facebook platforms, such as hi5 and Apple's App Store. "The profitability on Facebook depends on how much you're willing to allocate to customer acquisition," Mr. Gerson said. "The real key is how much your marketing costs on Facebook."

When queried on the rising costs for developers, Facebook provided a case study from a successful developer, Digital Chocolate, whose COO Jason Loia said his company has been using Facebook credits for a year. "In essence, you have to treat it like a platform fee as with any other platform and ensure you have optimized your economics accordingly," Mr. Loia said.

Back when Facebook first opened its platform, Facebook inadvertently marketed early games like Zynga's Mafia Wars and Farmville with baked-in viral features, such as auto-posts on the wall updates of the user who was playing the game, and updates to the news feed, which were seen by the user's friends. Those early developers couldn't stop the growth of their user base if they wanted to, and now Zynga is up to 50 million gamers a month. Newer entrants to the Facebook market haven't been as lucky.

"Our problems started in April 2010," said Dallas Snell, co-founder and head of development at Portalarium. "We launched our Port Casino Poker that month and the same month they turned off many of the viral channels." Mr. Snell said he understands that Facebook aimed to eliminate game spam on user walls, but he believes a bit of promotion in exchange for the a free game is not too much to ask. Because of the changes, Portalarium found itself spending more on ads to promote its game.

"It especially hurt those of us in startup phase," Mr. Snell said. "We didn't budget the kind of money that you needed to buy customers on Facebook. Since then, we have been trying to budget that out and the price keeps going up."

Last year, Mr. Snell said he could buy an ad for 15 cents to 20 cents a click, but now, those same ads are costing as much as $2 a click -- and not getting much action. In the first six months of his game release, Mr. Snell said Portalarium spent around $50,000 on Facebook advertising. According to a BAI/Kelsey forecast out this week, social-media advertising revenues may quadruple from $2.1 billion in 2010 to $8.3 billion in 2015, and about one third of that amount belongs to Facebook.

Most of that cash comes from the kind of ads that Mr. Snell buys: display ads. And according to some analysts -- as well as Mr. Snell -- the click-through rate for display ads on Facebook can be very low. "I ran an ad all last week," Mr. Snell said. "I didn't get a single click."

So what is his next move? "We've had to raise more money to allocate a lot more to customer acquisition than we originally planned for," Mr. Snell said, adding that much of the funding is also going to spreading his game outside of Facebook. He's signed on to the hi5 network and has built Port Casino for the iPad, spending some of his newly raised cash on creating apps for the iPhone and Android.

Mr. Snell and Mr. Gerson agree that the mobile market is a great next step for companies like theirs. Indeed, IHS Screen Digest research expects combined revenues from major mobile application stores to leap 77.7% in 2011 to $3.8 billion, with the Apple App Store projected to eat up three-quarters share of the total market. Total download revenue from games and other applications are projected to continue rising in the next few years, jumping to $8.3 billion in 2014.

But of course, the new markets can be just as confounding to developers as Facebook has become. "We have to spread out because it costs so much on Facebook, but it doesn't mean it's easy on the other platforms," Mr. Snell said. "I mean, how do we promote the games on iPad -- how do we compete against the big boys? What's a developer to do? Do we buy ad space somewhere? Advertise in iAds?"

Despite his Facebook concerns, Mr. Snell -- who spends about $1 to get a paying customer on Facebook -- said it appears that he is recouping his costs on the network. "We don't have accurate value projections but the trend so far looks like we are going to earn more than $1 per customer."

And that 's truly the main draw of Facebook -- the sheer number of people who pass through it often guarantees at least a return on your investment, if not a large profit margin. That huge mass of gamers is a constant enticement for developers, who keep launching games despite the fact that the space is more crowded than ever. Even the 30% transaction fee hasn't driven most away, because when your audience is so big, an accidental customer walking into a store can mean more money in the bottom line.

"We're not so worried about the cut because we believe in the volume that Facebook brings," said John Cibulski, creator of top-200 game Bingo Blitz. "Our game is doing well enough so we don't have to worry. We know if someone has Facebook credits for another game and they stumble into Bingo Blitz, then they can use those credits for our game."

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