It is not surprising that Disney would buy Playdom or Tapulous. What is surprising is that very few of the big media companies are doing very much about the breathtaking disruption in media in general. Others should be following Disney’s lead, and fast. Here’s why.

Media used to be analog, passive, boxed and sold for the purpose of amusement through channels that had limited shelf space (including television).  There was very little technology involved and each medium had a ubiquitous standard like NTSC. Media companies did not need to excel at engineering or technology development, or even creativity, which they could easily outsource. Hence, media business models used to be about using finance and distribution muscle to create chokeholds in the value chain. I even founded and built Electronic Arts on these principles. Disney, more recently, was still thinking this way in the first phase of their Pixar relationship. What Pixar presages is now going to be a pandemic for all media industries.

New media is digital, interactive, virtual and sold through the unlimited shelf space of the Internet. The consumer is no longer limited in their choices to what the distribution powers chose for them. Now, the best business models are about using technology and engineering to create original properties and brands, also known as “IP” (Intellectual Property). We saw this first with the Internet where the big winners have been new technology companies inventing new brands like Facebook.

But even the Internet was a case where there was a dominant platform standard which again allowed media companies to avoid having to become advanced engineering and technology companies. Now, however, consumer platform use is permanently fragmented as consumers roam across various devices, screen sizes and networks. Hence in addition to creating new IP, the other issue will be how to use technology leverage to efficiently cover all devices, screens, platforms and languages around the globe.

Outsourcing is not an option in this case because original IP requires such an advanced level of expertise. You cannot just go to a third-world supplier and tell them to copy what Pixar is doing, but to make up their own original brands. And you also cannot rely on an industry of outside artists because they’ll all use their own software tools and code libraries and you won’t be able to efficiently cover the fragmentation. There is only one solution and that is to become vertically integrated at enough scale and with enough expertise.

Big companies understandably struggle to innovate and would rather wait and “buy in” instead of having to build from scratch. This is unlikely to change, so it pits all the big media companies in competition with each other to acquire the clear industry leaders. At this point, being a leader in digital media basically means being a game company that is competent, at minimum, on both the Internet and the iPhone. I say a game company because we are talking about interactive media and this is not well understood outside the game industry. I say the Internet because that is where digital media is happening now, such as Facebook. And I say the iPhone because it is the first stepping-stone for the mobile Web in the West. And in case you haven’t figured this out yet, the Web on mobile devoces is going to be a much bigger consumer market than the Web on the PC. And it already is in places like Japan where the mobile Web has had time to mature.

So if you are a big media company like Disney, you logically need to cover both Internet games and the iPhone. This is obviously what they are thinking in making the two acquisitions, as Playdom is strong on the Web and Tapulous is strong on the iPhone. Disney faces severe integration problems with their scattered digital media dominion, but I give Disney credit for addressing the issue early. The combined purchase price of Playdom and Tapulous is only about 10% of what they had to spend on Pixar. Disney may face some challenges from being an earlier entrant among the big companies, but they’ll get down the learning curve faster and be in a better position. Their competitor that enters later will be the one that pays ten times more this time around. And given the scarcity of acquisitions that can really solve this problem, some of the late entrants won’t find that there is anything good left to buy.

Google has shown some recent conviction about the business of games. Relative to the Android platform, however, the company has some work to do.  The good news is that Android is ramping up and a lot of devices are selling. Android has the potential to be a platform comparable to Apple’s iOs by 2012.  But as a game platform right now, Android strikes out. It is a well-known fact that the supply of good quality games on Android lags far behind what Facebook and Apple have to offer. Here’s why:

Strike one: Many current devices do not have one-touch payment because they are not integrated with mobile carrier billing systems. This is likely to be addressed comprehensively by 2011.

Strike two:  Conventional games don’t sell on Android because Google has a senseless and lazy policy to ignore what is posted into its app store. Google also allow consumers to try any paid app and then easily return it up to 24 hours later for a full refund. Seriously, when so many other things on the app store are already free and everything else is free for 24 hours, why would anyone pay for a game?

Google defends this policy because it doesn’t want to police the store. I could understand this if Google were a new startup with a small staff incurring startup losses. But we are talking about Google! If Apple and others can pay attention to what is in their app store, surely Google can also do so.  Google has ignored this problem and may remain in denial until 2011, when the widening deficit in their app quality compared with Facebook and Apple should finally motivate the firm to fix the problem.

Strike three: Google does not currently allow competing ad networks on Android, so there are no offer completion networks, which have been a staple of the growth and evolution of engagement and payment with social games. As social games have been the only type of game that can monetize without direct payments, this policy nukes Android for the remainder of the game industry. However,  Google’s recently announced acquisition of Jambool should soon provide at least one in-house offer network alternative.

As long as Google keeps selling devices, Android could be a great game business within two years, but it would blossom much faster if the search engine kingpin becomes more proactive about these issues.

A battle has been unfolding in recent years as immersive 3D games have declined while casual, social and mobile games have arisen. The industry silos that make the immersive console and PC games blamed their slump on the general economy or console cycles. In fairness, their games are amazing and incredible. The trailers for these games make them look like blockbuster movie releases; how could they possibly go into decline? But this part of the industry has been somewhat in denial about a fundamental market shift away from their offerings. And they should not be surprised, as this change is foreshadowed both by disruptive product theory and by media industry history.

Disruption is always accompanied by a major new feature that the traditional industry or customers did not care about. In our case, we are talking about social interaction. Because we are all seeking social value, consumer media interest has shifted to interactive social media, and away from traditionally passive media that only provided personal amusement. But the other factors that often seem to go along with disruption are rising consumer preferences for simplicity and convenience. This often parallels a decline in the fidelity expected by the public. We’ve seen this in the shift from phones and letters to email, and from email to texting. Texting alone is now a global market in excess of $100 billion and a decade ago nobody would have believed it could happen.

It seems that when a market becomes massive, simplicity and convenience are the driving factors and fidelity goes out the window. In the case of texting, SMS was invented purely as a tool for network technicians to test network presence. It was considered to be too clunky to appeal to consumers. But a mobile phone is portable and the convenience of being able to send a short text message from anywhere at anytime was of enough value to tolerate the clunkiness.

Similarly, there was a golden age for films prior to 1950, when to see anything on a screen you had to go to a movie theater. The best you could do at home was to have a radio, which became the most convenient way to get the news or live events. But for immersive entertainment, for a great show, you had to go to the movie theater. And everyone did. And then television came along. The film and radio industries didn’t really get TV, which, like SMS, had a humble beginning. TV was originally intended for civil defense communications. It was many years before the film industry took TV seriously as either a threat or an opportunity, and the dominant radio companies also underestimated TV. The esteemed leader of CBS, Bill Paley, thought so little of TV that he wouldn’t help his own radio stars make TV shows. Lucille Ball was one of his biggest radio stars but had to separately fund her own production company, Desilu, which of course then proved him wrong.

To watch a movie you had to buy a ticket without really knowing what you were going to see. But TV was free, initially using an advertising business model that was later enhanced with monthly subscriptions and what we now call microtransactions. TV became ubiquitous and the movie industry freaked out, rushing numerous gimmicks to market in the 1950s as they saw their growth vanish. In real dollars adjusted for inflation, the movie theater business has been flat since then, while TV grew into an enormous new business.

We are seeing exactly the same thing today with the shift from immersive hardcore games to casual social games. The latter are free with virtual goods microtransactions. And they are on convenient and simple platforms like Facebook and mobile phones. When you see a trailer for a great movie or video game, it is mind-blowing excitement. And there will always be a market for it. And in the case of film, as with video games, the production budgets are always rising and the amazing immersiveness is only going to get better. But the mainstream shifted to TV and now they are shifting to casual social media like Facebook. For blockbuster films and console games, it is a hits business with high costs and high risks. By comparison, it is not so risky to produce a TV episode, a website or a Facebook game. Fewer companies will survive in the challenging blockbuster category but as with TV we will see a great deal of innovation from small new companies in new digital media that has social value.

1.  It’s About the Mobile Web

The principles that have made the World Wide Web such a huge success have to be enabled on mobile networks and devices. This includes innovative and healthy content supply chains, social value, viral spread, viral discovery, free trial, and having a variety of ways to monetize and bill for mobile content. DoCoMo did this right from the beginning of mobile data in Japan in 1999, and today Japan has the highest user penetration, highest user spending on mobile data, and highest spending on mobile content. Far more email in Japan is sent from mobile devices than from desktops. Korea copied the key elements of this model and had similarly great results. In the West, many phone companies ignored DoCoMo and what had been learned from their sister wireline broadband companies, where again today we have consumers spending more on data than on voice because of the Web.

2.  3G Broadbrand Speeds Are a Requirement

To really feel like the Web, 3G is the baseline requirement for network performance. It didn’t happen with 2G.

3.  Touchy Feely: Touchscreen Controls

Another baseline requirement appears to be the better feeling of “flow” that is provided by a touchscreen. Capacitive touchscreens that rely on sensing electricity levels are ideal because they can be more “swipey.” This quality of user experience has obviously caught the imagination of the public.

4.  App Stores with Integrated Billing

A shopping experience like Apple’s App Store that adopts many of the DoCoMo business practices is also a requirement for both the customers and the supply chain.

5.  Virtual Economies Will Lead

For games in particular, we will see a shift from games as a product to games as a service and a shift from paying for the game to free trial with paying for the stuff you need to fully enjoy the game.

6.  Offer Completion Networks

Yes, they need to be cleaned up, but they are an important economic element and they need to migrate to mobile like banner ad networks have.

7.  Content Supply Chain Health

DoCoMo originally paid 91% of content fees to their content publishers and also cultivated support for the innovative and serious professional suppliers who could scale and help drive market growth. Today, companies like Facebook and Apple are actually too laissez faire; they take the app supply chains for granted and overrate the importance of both the big companies and the long tail.

8.  A New Middle Class Must Rise

The supply of Web content or App Store content can divide into three classes: Big companies, the long tail, and an emerging middle class of newer and smaller companies that are doing native development that is innovative and that fits the new mobile medium. The operators of the App Stores need to actively cultivate this new middle class. Ultimately, the long tail will produce some gems and develop some amateurs into professionals. But the long tail must be viewed more as a developmental part of the supply chain, not the key driver. And big companies cannot define or grow a new medium (the Web being Exhibit A). To develop this middle class, the App Store owners need to actively identify, help and support a handful of small companies that have the potential to scale into the future Googles and Facebooks of mobile.

9.  Social Will Go Mobile and Across Platforms

The entire concept of social media that is now dominated by desktop PCs will shift to the mobile side and cross-platform. Why? First, because there are only going to be one to two billion PCs compared to five to six billion mobile devices. Second, because you especially need to be connected 24/7 to obtain social value and this can only come from your mobile device. The shift already happened in Japan – in the West it is merely awaiting the rest of the needs on this list. Finally, when you get to social media as a service in the cloud you will want to connect with friends and other people regardless of what network or device they are coming in from. Companies that are better at covering more platforms will have an advantage.

10.  Social Networks Will Be Mobile Apps but Not Mobile Portals

Facebook is already a potent mobile app, but won’t be the same kind of “destination” that it has becomeo n the PC. Social networks will have to have a shrunken feature set to fit on the mobile side and will compete on a more level playing field with other apps that are entirely crafted with mobility in mind.

There is compelling early evidence of our enormous market potential and how these issues and opportunities are already taking shape. Morgan Stanley analyst Mary Meeker did a great job at the recent Web 2.0 conference of organizing some of the facts and data behind these trends. You can find her slide show at this link, which outlines these exciting topics in full.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

In the old days, big companies could build strategic value by developing control over conventional channels of distribution. When you own the Golden Gate Bridge you can charge any kind of traffic to use your pipeline, but it loses value when everyone discovers how to fly. Browsing and social discovery are now the equivalent of flying, and conventional shelf space is declining as a form of leverage.

Moving to digital networks we still have the value of being on the front page and above the fold. This applies to any website and to mobile app stores. My browser still defaults to Yahoo! because I like to see their rotating news headlines. But I rarely look below the fold and I avoid 99% of the buttons and hotspots on the screen. This is one example of how much less valuable digital real estate is once you move below the fold or just one click away from the home screen. Google represents the newer way of thinking:  Consumers are entering search requests to discover what they are seeking. Google places so little value on conventional shelf space that they choose not to clutter up their home page like Yahoo!

Applying this reasoning to app stores, it means that “featured placement” is not scalable because you can only fit a handful of items on the home page and above the fold. For the industry to get 10 times larger it will depend on virality and social discovery alone because the home page with the mobile web is getting smaller, not larger. Big companies have again enjoyed an advantage in “featured placement,” because in many cases it either goes to established brands or to the highest bidders. So once again the trend is moving this advantage away from big companies. But who gets the advantage? Whoever has the best intellectual property that is worth talking about and sharing socially. And this will happen regardless of the sizes of the companies involved; in fact size may be a disadvantage because big companies are usually slower to adapt and more defensive about protecting old models. Case in point: Why didn’t a large music or video game company recognize the success of Guitar Hero and become the publisher of I am T-Pain?

If featured placement is not scalable, then we need to assess competitive performance based on viral spread and consumer behavior. Apple’s Top Free 100 and Top Paid 100 games provide a good Petri dish and a new form of “shelf space” that is based on the popular vote. To get on this kind of list, the public that is assessing 70,000 apps is voting on which 200 are worth a download. I also want to distinguish between licensed content and self-publishing, because there is no longer the same strategic value in publishing licensed content. This is simply because there is no longer a Golden Gate Bridge to build and own that can be financed through third-party distribution (which was a pillar of how I built EA in the first place). So while we can admire a publisher that is selecting the right third-party stuff to distribute, it is a tactical exercise and won’t create a sustainable strategic position in the value chain.

Self-publishing your own IP is another matter. Any company that can consistently get its apps to rise to the top of a list of 70,000 apps must be doing several things right and is developing brand relevance the way that Yahoo! and Google did in their early days. So let’s have a look and see what we find among these 200 slots of shelf space on the Apple App Store. (Note – this study was done from rankings in early September.)

U.S. VIDEO GAME PUBLISHERS – Aside from Electronic Arts (EA), this sector is relatively inactive and ineffective with only one slot out of 200 (Crash Bandicoot). Companies like THQ have published many iPhone apps, but are currently shut out of these 200 slots.

JAPANESE VIDEO GAME PUBLISHERS – Because mobile has been huge in Japan for some time, many companies are highly active and have made numerous iPhone game releases. But out of these 200 slots, we see Konami with only two and Namco, Capcom and Taito with only one each.

MOBILE GAME COMPANIES – Aside from Digital Chocolate, EA and Gameloft, this group shows poorly, especially in terms of owned, self-published IP: Korean startup Gamevil has two; another Korean leader, Com2Us, has one; Glu has one. Nobody else has any. In terms of licensed brands, Glu has two of those and so does I-Play, but considering that more than 500 licensed brands have been published for mobile this is also a poor showing.

CASUAL WEB GAME PORTALS – The iPhone is perhaps a better fit for casual games? They’ve all been aggressive publishers, but are also poorly represented as a group: PopCap has two; RealArcade and PlayFirst have one each; Big Fish Games, Pogo, Oberon Media and Reflexive have none.

VIRTUAL WORLDS –  None. This probably has more to do with platform constraints.

SOCIAL GAME COMPANIES –  Zynga has two, SGN has one. PlayFish and Playdom and others have none. There are a few iPhone-specific social game startups that have some free games that made the list. Addmired has three, but none of their paid versions made the list. Storm8 has eight free games, but again, no paid games. While that is fantastic in terms of brand development and trial, it is less impressive in terms of monetization and hard to assess the value.

APPLE DEVELOPERS –  Surely within this group of 20,000 “companies” we will find some new leaders. Well, not really. Chillingo has four, but they are all from third-party developers where Chillingo is the distributor, not the IP owner. Firemint and Ngmoco get a lot of buzz, but they have only two each. Backflip Studios has two games for which both the free and paid versions are ranking, so they have four slots.

BIG MEDIA – The music industry partners with Tapulous on two items that made this Top 200, both of which are variants of Tap Tap Revenge. Sony has two slots and Viacom has two, no other big media brands have anything.

Wow. Consider all those video game and software industry sectors that are not dominating the App Store – even when you count an entire sector and all of their games we get maybe 2% of shelf space, and the leaders seem to have no more than 1% each.  Is anybody dominating? Well, yes. See Part 2 of Why It Pays to Self-Publish, Own Your Own Video Game IP, which continues here.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

My prior post analyzed the vote of the public on the App Store and asked the question:  Is anybody dominating? Well, yes. I saved three companies to discuss here.  These are the only companies that have at least 10 of these 200 slots of shelf space and at least five owned self-published intellectual properties (IP) with at least one or more that the public had to buy. It is a special club with perhaps one big surprise.

Electronic Arts – OK, here we go – they have 16 slots out of these 200. A good chunk of this strong performance is relying on regular featured placement by Apple, which of course is not scalable. And 11 of those are brand licenses owned by others such as Hasbro. To continue to perform this well, EA has already invested tens of millions and will have to remain the high bidder for these rights, which will shift significant value to the owners of the brands. I don’t find it surprising that Hasbro brands would do well in the early stages of this new platform, especially with all the featuring. Longer-term, the pendulum will shift to original IP. From that standpoint, EA has five slots out of 200 which are better than anyone listed before because some of them are earning high prices.

Gameloft – Here we have the current leader: Not only does Gameloft match EA with 16 total slots, the company does it with eight slots going to its own IP that reflects the most massive software development investment made by any game company on the iPhone. Gameloft is a big company with more than 4,000 employees that has made a tremendous effort on the iPhone and the results shine through. A whole lot of featured placement from Apple hasn’t hurt.

Oh, there is one more company to look at.  You guessed it, didn’t you?

Digital Chocolate – While we may not have the brands licensed by EA and Gameloft and we may not have thousands of employees, we do join them as one of only three companies with double-digit slots of shelf space. We have eight slots of these 200 that are occupied by our own IP and another two from licenses, so we are the only company other than EA and Gameloft with at least 10 shelf space slots in this survey and we are tied with the #1 leader with eight original, owned, self-published IP items. And the public has elevated Digital Chocolate, not Apple – currently, not a single product from Digital Chocolate is being featured by Apple. And this is hardly an isolated survey or sample: At times we have had as many as six games on the Top Paid 100 at one time, and as many as 11 of the Top Free 100 games. And 75% of the games we have published have charted in the Top Paid 100 at some point. We’re pounding these charts consistently and systematically and despite being much smaller we are in the discussion with EA and Gameloft. We’re also well ahead of the other 20,000 publishers, especially in what counts: IP that we own that the public has decided is relevant, and that is enabling us to develop our own brand awareness and future franchise value.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

It just goes to illustrate the point: The explosive growth of the World Wide Web and mobile phones over the last two decades is too big to be ignored. More and more people across generations are becoming more fluent quicker and quicker on these new devices and platforms. Remember when we used to physically shop in actual stores, watch analog television and phones were attached to the wall by a cord? There was a time when phone booths were so ubiquitous that famous storylines like Superman and Get Smart were built around them.

Well, welcome to the present. TV signals no longer exist. Phone booths are long gone (except in Britain where they are nothing more than red boxes that American tourists photograph). And how’s in-store retail doing? Not so good. Luckily, there’s a whole new digital arena – often on a wireless network – that’s accessible with gadgets that fit in our pockets or can be used in bed. And we feel pretty super and smart about being there.

What has happened is a classic case of product disruption. Video games once served an audience of 100 million hardcore gamers, but in recent years we have seen a cool billion consumers emerge to engage in new digital behaviors including browsing, texting, email, photo sharing, YouTube videos and casual games. Consistent with disruptive theory, consumers came because of a new benefit: Social contact. But with today’s technology, they are consuming more than ever before for the simple reason that these platforms are simple and convenient.

The early adopters used to know and care about their PC operating systems. They would buy and install applications and keep their folders organized. Then they migrated to downloading and installing over the Web, but it turned out that was another “hardcore” behavior and not something the general public easily adopted.

When YouTube was born, numerous video services on the Web already existed, but they required users to download and install a video player they would have to be able to find on their computers later. YouTube simplified the online video world by keeping everything in the browser and not requiring anyone to install or remember anything. Everything users needed was already online waiting for them. When they emailed a video clip, their friend only had to click on it to play and bookmarks made it a snap to use the service again and again.

Simple: Check. Convenient: Check. Viral: Check.  Cha-ching: Check and check.

This simplicity, convenience and “virality” was achieved because the mass market (such as YouTube’s audience) adopted the browser as their fundamental organizing principle for computing. Today, most consumers on a PC do almost everything through their browser. As a result, the browser is the first computing paradigm that will truly reach all of humanity and it wins because it is simpler, more convenient and more viral than other options.

Since entire browsers have been hard to cram onto tiny mobile phone screens, we’ve seen another model emerge: Apps.  DoCoMo invented the app store concept and launched it with iMode in 1999. They have since built an enormous mobile network market in Japan where virtually everyone uses their mobile phone as their computer, 90% of customers are on a 3G network and more email is sent by mobile devices than by PCs.

In Japan, the public is spending as much on mobile data services as they spend on voice. In contrast, just a few years ago mobile voice revenue in the West was 50 times larger than mobile data revenue.

More recently, however, we have seen the meteoric growth of disruptors like Apple and Facebook. While Facebook certainly leveraged the browser wisely, both companies also followed DoCoMo by offering an API for apps and organizing apps into an online retail store with centralized payment methods.

Now, Google is trying to do the same thing with Android, as are others, and Microsoft has an online walled garden with Xbox Live. Sony and Nintendo are also following suit.

This strategy, however, is flawed if it Balkanizes platforms and customers. Fragmentation amongst platforms is not the path we want to take. Roads and analog phones began the same way, but eventually the operators realized that they needed to be “interoperable” as social services, not separate entities.

The same thing then happened with SMS, MMS and email.  All were “walled gardens” until it became obvious that more customers would be happy and the market would be vastly larger if different devices and platforms could communicate with each other through the network cloud and if it could all be simpler for the public to use. Imagine if everyone had to have the same email provider in order to communicate via email. It would be a disaster!

Today a battle is brewing that pits the open Web against the app stores. For social games, it is clear that the browser-based Web approach should win. Consumers will insist on the simplicity and convenience of the browser and they will also prefer the “SaaS” model – “Software as a Service”.

Instead of downloading and installing applications, they will just want the Internet cloud to take care of business. They’ll want to launch their browser, click on their bookmarks and have it all just work. They already have this expectation about voice, SMS, MMS, email, search and other types of browsing, so why not the Web too?

For any kind of social media, the public will want to be able to easily communicate with family members and friends on other networks and devices and once a customer has adopted a service they will expect to have access to it from all of their devices, platforms and networks. This will include “roaming” onto devices and networks they don’t own like hotel and airline set-top boxes, free WiFi hotspots or even someone else’s device.

Companies that are proprietary platforms requiring native development argue that the result is higher quality apps and better customer experiences. Judging from all the garbage you find in many of these app stores, the argument is obviously flawed and not necessarily in the public’s best interest. Insisting on native development means higher costs for developers leading to higher prices for customers. Furthermore, it makes it harder for developers to create technology that can span across an increasing plethora of devices.

Imagine, for example, if recorded music required instruments only made by one company. And if the music could not be played on TV without being a new live recording. And if a film could not be shown on TV without going back on location and re-shooting the entire film with somebody’s proprietary projector that is supposedly “better.”

The way to better quality is to have an enormous market using the SaaS model that embraces open standards. Developers can then focus on making the best quality programs instead of spending time creating several versions for several platforms and the public can vote with their time and money. Let’s not forget that this is how the World Wide Web was built in the first place, and it is under this model that numerous innovations like Google and Facebook have emerged. In addition, the Web also created a huge new market for digital distribution of established media like film, television, news and music.

The network cloud now includes the four fundamental screens of the PC, TV, tablet PC and mobile phone. The first three types of screen are big enough to become browser-based.  The real question comes when taking into account smaller mobile screens.

Ironically, desktop icons were the PC’s “app store” before the browser was invented, and were as obviously superior to MS-DOS as the iPhone is when compared to a Java phone.

But for mass-market consumers, the browser is going to plow the desktop under. And as mobile screens get bigger and mobile browsers get better, the browser will win the fourth screen as well. A browser win is a win for SaaS, a win for developers and a win for the public. You can bet that social games will need more SaaS and that they will get it.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

The hottest market for virtual goods in the West is Facebook, where Zynga blossomed in the last year. Many companies grew last year on Facebook from viral spread, but it made the customer experience on Facebook very “spammy.” And Facebook no doubt did not like the diverting of both the Facebook experience and the spoils of monetization. Hence, we have seen in the last few months a severe dialing back of notifications, invites, bookmarks and other app features on Facebook, the most dramatic of which went into effect on March 1, 2010.

So how’s the social game industry doing in this wake? Not so good: Out of the Top 25 publishers of social games with virtual goods, only two publishers increased their customer bases by at least 1 million customers since March 1 (Playdom and Digital Chocolate). In fact, we were the only two companies that expanded by at least 20%: Most of the others were flat or declined. Several publishers have lost millions of customers, and most of the games have declined in audience size.

The formula last year for social games was viral growth through aggressive spam, but that no longer works. This creates a fundamental need for richer games that are more entertaining and meaningful, that will sincerely motivate players to recruit their friends because they really want to play with them. That, for example, is how the entire fantasy sports industry of more than 30 million players got built. Same with the 40 million Pokémon fans and today’s 6 million active players of Magic: The Gathering, a half-million of which will play in tournaments this year. Going forward, it will be a challenge for many publishers to make games that are really good enough.

The spammy viral spread was also a free marketing department. With no more free ride, growth can only come from an efficient combination of legitimate virality and efficient marketing to help spread the good word. Again, as we look forward, many game companies on Facebook lack the financial resources to do enough advertising and lack the scale to cross-promote well. And even more of them have games that don’t monetize enough to justify the advertising in the first place. Maybe it didn’t matter last year when growth was free, but now it does.

One telling example of this trend is Playfish. They had five of the Top 10 games on Facebook in January of 2009, but it can be seen in hindsight that four of them were not going to monetize because they could not make meaningful use of virtual goods. As Playfish figured this out, they reduced product support and advertising for those four games and they all dropped out of the Top 10 within a year. By contrast, Pet Society had the right characteristics and they were able to grow it like a weed. It got the love, mushroomed in size and remained in the Top 10. As we look at trend data from early 2010, it’s gotten even tougher, and now, not even Pet Society is growing.

They’re not the only ones. Zynga is flat; Crowdstar, RockYou, Slide, Meteor, LOLapps and 6waves are way down. Most of Playdom’s growth is from two hot new games that they are heavily marketing. And these are the guys with cross-promotional scale; on a percentage basis the numbers are much worse for the little guys. At Digital Chocolate we have been pleasantly surprised that we’ve been the fastest-growing developer in recent months because it must be about the games, as we are not doing a lot of marketing yet.  And we look forward to building cross-promotional scale that will make it easier for us.

Meanwhile, the release rate of new games has declined, as has the apparent abandonment rate of industry games that don’t have the right kind of lift-to-drag ratio. I think many companies are now going back to the proverbial drawing board, figuring out how to deal with the new business requirements.

Another issue that is emerging is a spirited game of “Platform Monopoly.” I see a lot of big companies in California that seem to be trying to actually build “Hotel California.” These are guys that already have Boardwalk, but want Park Place, and all the greens, too.

Many platforms have welcomed developers with open arms in recent years, proudly proclaiming offers of Statue of Liberty-caliber freedom and opportunity. Now developers are complaining and beginning to feel like Europeans in the early 1930s, not so sure about the guys that they voted into office and wondering if they should buy the explanations for increasingly suspicious actions. The platform operators don’t seem to realize that consumers are going to soon be demanding a SaaS model (software as a service) for more games and applications. They’re going to want access to their software services from all their devices, platforms, and networks they can get onto. The public is going to want to decide when, where and how they pay and play. They’re not going to be boxed in any more than they would have been with voice, email, browsing, SMS, and MMS, all of which began as platform walled gardens and became interoperable as a result of public demand.

Going forward, spammy isn’t going to cut it. Shallow gameplay isn’t either, or games that don’t monetize. Lack of funding for marketing will be another killer. Walled gardens and dependent on any one platform will be a business liability and a negative for consumers. The industry has a ton of potential but has to overcome these issues. The $7 billion spent on virtual goods in China last year should give us great hope, but let’s not screw it up.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

Magic Mirror on the wall, who’s the fairest one of all? In the world of social gaming, it might be getting easier to tell.

New social games lacking a growing virtual goods economy and unable to easily exceed 100,000 daily players (DAU) on Facebook shouldn’t expect to generate much revenue and will likely struggle to recoup their development costs.

Despite the rising popularity of social games, only 17 new games released in the first half of 2010 have reached these two benchmarks. And, of these 17 games, 15 came from venture-funded companies. Literally hundreds of other companies failed to make this list.

In addition, no single company published more than two of these top-tier games; an achievement shared by Zynga, Playdom, EA, Digital Chocolate and Crowdstar.

One might have expected more out of Zynga than just Treasure Isle and FrontierVille considering their staff size of 760, but Zynga is more focused on building up pre-existing live games like FarmVille and expanding platform coverage beyond Facebook.com.  With their enormous cross-promotional funnel, a new hit for Zynga can be bigger than anyone else’s new hit.

Yet another victim of Facebook’s policy changes, Playdom’s Social City is now in decline; but it was the industry moon rocket of Q1 and is still at scale, joined on this list by the brand-new Verdonia.

Social City’s decline, however, hasn’t stopped Playdom from exploring new paths having acquired two additional publishers that also have games on the list: Bola from Three Melons and Fashion World from MetroGames.

Meanwhile, EA and Playfish have stop-gapped a steep decline with the recent releases of My Empire and FIFA Superstars; Digital Chocolate’s new Millionaire City joins with MMA Pro Fighter to give DC a good one-two punch; and Crowdstar’s Hello City and Zoo Paradise both showed declines in June, but made the list from substantial growth earlier in the year.

Among the remaining five games are the notable Nightclub City from Booyah and Watercooler’s Kingdoms of Camelot.

In addition, if we apply similar criteria to older games we find that only another seven virtual economy social games launched prior to 2010 have sustained at least 65% of their peak audience size (Zynga has three of the seven, led by FarmVille and their poker game; and only one of these seven games, Ninja Saga, is from a smaller independent developer). Most of the hits of 2009 have declined precipitously and, despite the fact that most of them are from large, well-funded companies, they are getting scant marketing support because apparently it is unprofitable to do so.

What does all of this mean? A speedy cleanup of the social game sector is underway, rapidly narrowing the industry to an oligopoly. For starters, making a hit social game is obviously not as easy as it looks. Older versions and policies of Facebook provided such a strong tailwind that nearly anything could sail to greatness. But now it is a legitimate “hits business” like every other form of entertainment.

Facebook’s changes have also shortened product lifecycles and triggered a rapid consolidation phase. The bar is now raised on competitive requirements like capitalization, scale and marketing. In steepest decline are the pure developers that never pretended to meet these requirements.

Many small contenders are now being rolled up by larger developers like Playdom and Zynga while others just fade away. A few will make new hits but for each of those more than 100 will fail.

Shallow games and apps that rely too heavily on spamming Facebook members, games that do not monetize well (since they won’t be able to justify additional investment in either new features or marketing campaigns)  and smaller companies that either cannot or will not attempt to raise capital have also been shown to be vulnerable.

Conversely, while in 2009 the big story was how small developers like Slashkey established new genres like farming, the big story in 2010 is that the strong will get stronger, as evidenced by the high correlation of venture involvement and established scale with the 17 successful new games of 2010 thus far.

With Zynga’s big lead, the consolidation scenario will look like Snow White and the Seven Dwarves.  I think we already have candidates for Grumpy, Happy and Sleepy. At Digital Chocolate, we have been Sneezy at times, but aspire to be Doc and are certainly not Bashful. Industry auditions are now being held for Dopey.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.

1. What’s going to be their Achilles’ heel? Everyone has one.
2. Who’s on the “Flip Side?” No matter how big the hit single, everyone eventually gets tired of it and will play the other song on the flip side of the disc.

Before doubting the Flip Side, consider these B-side songs that became hits and are still going strong today: We Will Rock You (Queen); Maggie May (Rod Stewart); I Will Survive (Gloria Gaynor); Don’t Let Me Down, Day Tripper and I Saw Her Standing There (Beatles). Okay, admit it, which one of those tunes is now running through your head?

Zynga has grown fast, but last year so did Playdom and Crowdstar, and right now so is Digital Chocolate. Nobody has a chokehold on growth. And another thing: We have all been trained to believe that growth turns into market share which turns into control of channels and shelf space. But that is now obsolete thinking when it comes to Web-style digital distribution. The big growth stories from last year don’t have any real control over their customers, the platforms they are on, or the shelf space in the channel. Not only are they unable to use traditional leverage to consolidate their position, but things are evolving rapidly and they have to worry about everything they have slipping through their fingers.

Playdom, Playfish, CrowdStar and others have emerged as strong competitors for the social gaming throne.

The question then becomes as follows: Where’s the real substance? Can game companies evolve out of the shallow, hamster-style games that tax users and depend on the now outdated-Facebook viral techniques? Are they going to become genuinely strong game developers and inventors of great IP (intellectual property) and technology, or just try to keep using scale when others seem to be easily climbing the same mountain towards the same scale? Nobody today has a defensible stranglehold on brand, channels, platforms or customers.

In my opinion, the one game that Zynga publishes that is certain to still be around in ten years is poker. But therein lies the problem; they did not invent poker and it is not their own original IP. They cannot expect to dominate and control consumer demand for poker, and will need to relentlessly defend their position from rival poker games. But at least we know it is a great game that people will always want to play. What Zynga must do is create that experience and value within new IP of their own. FarmVille is their best work, but it’s a glorified form of personalization. Zynga has to paddle as fast as they can to offer new stuff every week to avoid losing customers. Whereas with poker, they merely need to sell more chips again this week. That’s a nice position. Farming is like a hit song, film or video game – it’s such a big deal today that, like Tony Hawk, Grand Theft Auto or Guitar Hero it cannot possibly sustain this big a blip on the public’s radar.

FarmVille alone can’t sustain Zynga’s growth. Which new social gaming companies will emerge to fill the void?

Zynga has to take advantage of their current size advantage and find ways to create their own “pokers.” Meanwhile, the rest of the industry faces the same challenge. We all represent the Flip Side. We’re the alternative to farming and as a group we are getting plenty of traction.

Going forward, I think there will be multiple leaders, including Zynga. Leaders will have to develop competitive advantages beyond simply having a large number of free players, which is not that hard to obtain but is far harder to retain and monetize.

Five key factors going forward will be:

• Access to capital.
• Internal development based on a technology model. Like Pixar, this allows real technology companies to systematically build better games and to cover more platforms and markets. Without it, you are doing too much by hand and are too dependent on someone else’s proprietary tools.
• Organizational scale, otherwise you can’t get to a cross-promotional and financial critical mass.
• IP – clearly companies will need to develop their own intellectual property and brand value that has the depth and stickiness to hang onto customers. This includes product innovation, gameplay depth, brand development and other factors. Some companies lean too hard on brands from other companies or too many outside developers whose IP they won’t own or control, or just are not good at making relevant inventions in the sector, or they know how to build to some industry requirements, but not others. For example, some are viral but don’t retain, some retain but don’t monetize.
• Post 3-1-10 growth: The guys that depended too much on the old Facebook rules need to adapt. Who’s got the right stuff to be a Flip Side hit?

As a cautionary tale, I would observe the rapid rise and fall of the Atari 2600 VCS which peaked in 1982 and enabled the IPO of the first Activision. But both companies were dead in the water within two years and the entire category written off as a hula hoop. Atari withdrew from the category and Activision went into bankruptcy. But a couple of new companies that met the criteria noted above brought innovation to the sector and despite initial skepticism brought about an incredible revival just a few years later. I’m talking about Nintendo and Electronic Arts.

Things will evolve even faster now with the disruption and speed of new platforms and digital media. The Flip Side to Zynga will probably be a group rather than a single company; there should be multiple winners.

Editor’s Note: To read more articles by Trip Hawkins, be sure to check out his OMG blog.