Is Zynga The Most Profitable Company Ever?

Chickens playing FarmVille

Zynga’s made a $400 million profit on $850 million revenues in 2010, reports the WSJ.

If that’s true, that’s an astounding 47% profit margin.

47%!

By way of comparison, Google‘s profit margin is is 29% and Apple‘s is 28%, and both of those are considered fantastically profitable. Facebook had a profit margin close to 30% as well in 2010. Salesforce and Amazon by contrast, also very respected companies, have profit margins closer to 5%.

In fact, tech companies might not be the best comparison. Hermès, the world's most lauded luxury brand — a company whose business is selling $20,000 handbags — has a profit margin around 30%. When one of your writers was in business school, a professor with extensive experience in the luxury industry told us that Chanel, a private company which doesn't report financials, was rumored to be the most profitable company in Europe with profit margins of 45%.

Again – 47%!

And this after Zynga pays Facebook taxes in the form of advertising to acquire users and 30% of virtual goods sales.

Zynga is either the most profitable company ever – or it's very close to it.

The main reason this kind of profitability is possible is that Zynga sells “virtual goods.” They don’t cost much of anything to make, don’t need to be shipped to shelves, and don’t need any kind of sales force to be sold.

So the real question is: How does Zynga’s virtual goods business work?

The easiest way to understand it is to remember the the videogame arcades of the 1980s.

Back then, arcade games made money by addicting people to simple games (like Pacman), introducing “friction” into these games (by making them harder after each level), and then charging small amounts of money to ease that friction (by allowing gamers to buy “lives.”)

That's what Zynga's social games do – charge people small amounts of money to reduce friction in games they are addicted to. Only, instead of paying another quarter for another life, social gamers buy sub-machine guns in "Mafia Wars," and new farmland in "FarmVille.”

Another big similarity: Arcade games were usually played in a social environment. Zynga games are played on Facebook, a virtual social environment.

If this answer leaves you cold it's probably because you've never actually seen a Facebook game. Or maybe you have looked at Zynga game – say, FishVille – and said to yourself: Really?

We felt much the same way until we decided to suck it up and get addicted to one.

We picked FishVille, an early hit from Zynga. It came out in November 2009 and its simple mechanics best demonstrate how Zynga works.

The object of FishVille is to build a magnificent virtual aquarium, full of spectacular fish and designer decorations. The way you do it is spending fake money to buy small fish for one price, and then, after tending to them for a few hours or days, selling them for more fake money then you paid. Then you use that money to buy more fish. If you want to speed your progress, you buy fake money with real money.

We’d explain more, but it’s really just easier to show you how it works.