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The Candy Crush King’s Challenge

King Digital Entertainment’s financial and competitive position is more precarious than its critics claim. Can $1B solve for its future?

Though King Digital Entertainment’s 16% first-day-of-trading drop suggests its challenges are generally understood, most of the analysis I’ve seen is either couched in generalities or inaccurate. As such, I wanted to weigh in on the pessimism regarding the company’s future and suggest what, if anything, King’s management can do to survive. Disclosure: I have since initiated a short position on King.

As a category, app-based gaming is a precarious business. Monetization can be challenging, clones are ubiquitous and success can be both fleeting and unpredictable. There’s no better case in point than Zynga. Though King counted 85% more revenue and 33% more Monthly Active Users in Q4 2013 than Zynga did in its prime (Q2 2012), the latter company shows how easy it is for the business of a market leader to implode.


Two years ago, Zynga reigned supreme over the social gaming market. But over a period no longer than five quarters, the company lost an astonishing 2/3rds of its userbase. In Q1 of 2012, the company (infamously) bought OMGPOP for $180M, only to write down the acquisition by 50% six months later. A year after that, it closed the division. The cause? The precipitous fall of Draw Something. The game, which was released in February 2012, was generating a reported $250,000 per day in revenue at the time it was purchased and dominated App Store charts. Draw Something 2, released only a year later, was a sales disaster. Not only had the game been relentlessly cloned by the time of its release, users had largely, but unexpectedly, bored of the game.


When we look at King, there are already signs that its revenue might have peaked. Despite 13% growth in MAUs in Q4, the company’s revenue and EBITDA dropped nearly 10% compared to Q3. Per user revenue fell 14%, meaning that not only did new users spend less than veteran Candy Crushers, the latter group was also reducing its spend. Making matters worse, the company’s games appear to be reaching their saturation point. Its Q4 MAU growth rate was less than 1/7th of its Q2 performance and a third of its most recent quarter’s.


After mobile games have peaked, their decline tends to be rapid – faster than every other type of app, in fact. Multiplayer and social games are particularly hard hit as every lost player reduces a game’s playability or draw. But one-player games aren’t immune: MAU losses diminishes a game’s “watercooler effect” as thus accelerates its exit from pop culture. This poses a serious threat to King, where four of every five dollars comes from its Candy Crush property (and another 85 cents comes from two near-carbon copies, Farm Heroes and Pet Rescue). If users are indeed beginning to tire of Candy Crush – and even if its decline is much longer than the category average – revenues could quickly begin to erode. In King’s Prospectus, the company identified this as their 2nd largest risk factor (behind only mismanagement of the business), stating “(If) we are unable to broaden our portfolio of games or increase gross bookings from those games, we will not be able to maintain or grow our revenue and our financial results could be adversely affected.”


Not only does King need to worry about slowed user growth and highly concentrated revenue, its business is supported by only a fraction of users. Fortunately, King outperforms the Free-to-Play gaming market with 4% of players (16M out of 602M) making in-game purchases, compared to 1.5% of FTP gamers overall. If the distribution of these players’ spending adheres to the industry trends, it is nevertheless possible that only 10% (1.6M) of these players would represent over 50% of King’s revenue ($602M in Q4). Regardless, the loss of key players could easily crumble the Candy Crush kingdom – and surely many high spenders will eventually tire of the saga.

This leaves King in a tough place. As Zynga demonstrated, it’s tough to buy (let alone value) franchises. What’s more, even if you do stumble upon the magic formula for a viral game, there’s little assurance you’ll receive the spoils. After all, Candy Crush is effectively a feature-packed clone of 2001′s Bejeweled. Gabriele Cirulli, creator of current App Store darling 2048, freely admits that the game was a deliberate copy of 1024 (itself a replica of “Threes”), which he created only to test his ability to program from scratch.

Rovio also developed more than 50 games before releasing the Blockbuster Angry Birds. And though the company will be releasing its 12th entry into the Angry Birds franchise this fall, it has yet to establish a second franchise. Rovio success has also been driven by the Angry Birds’ extension into a variety of new gaming genres (RPG, kart racing, puzzling), branded partnerships (Angry Birds Star Wars, Angry Birds Rio) and product categories (cable TV series, soft drinks, toys). Even a playground series is due next year. Though this offers hope to King investors, Angry Birds’ emphasis on character-specific capabilities and personalities likely makes the franchise more extensible than Candy Crush.

Pharmaceuticals and a Three-Point Plan for War

Historically, a dominant gaming company could sustain sales and interest through distribution partnerships and marketing spend. Toys “R” Us, for example, could be paid to promote Game ‘X’ or provide it prime placement in-store and on the shelf. With apps, however, the story is different. Neither Apple nor Google sell slots on the Featured or Editor’s Choice lists – and they don’t need to in order to generate revenue. Digital distribution and relatively inexpensive game development costs also means that capturing user attention and spend will always be hypercompetitive.

In many ways, mobile gaming resembles the pharmaceuticals industry. Only a small portion of a major studio games will become blockbusters and those blockbusters must pay for the many failures. Though product development costs are substantially less in the mobile gaming market, so too are potential revenues. And unlike pharmaceuticals, the underlying engineering of an app is rarely eligible for patent protection. As a result, clones (or ‘generics’) proliferate. In the weeks after Flappy Bird went viral (and in part due to the vacuum caused by its temporary removal), more than a thousand clones were launched by independent developers. According to App Annie, clones Splashy Fish, Fly Birdie and Flappy Wings soared to the #2, #6 and #8 spots on iOS’s game charts February, despite Flappy Bird taking #1.

After its IPO, King now has more than a billion dollars in cash on hand and its current properties will continue to generate cash for the foreseeable future ($600M in Q4 alone). With this, King could mount a three-part defensive.

  • First, it should consider establishing a large team of developers to rapidly clone successful and/or viral properties. The company has demonstrated that it knows how to breathe life into pre-existing game concepts and drive considerable user spend even when free or cheaper alternatives exist. It can also leverage its immense userbase to cross-promote these new titles, bolstering their chance of becoming the leading generic provider – and potentially outshine the original. This strategy would, of course, bring about immense criticism and controversy. Last March, Dan Porter (former OMGPOP CEO and Head of Zynga New York) was forced to resign after he publicly stated that “Zynga is often accused of copying games, which is mostly true.” Though cloning is both rampant and broadly acknowledged, his remarks1 brought unwanted attention to the already-struggling company (which had settled a copyright lawsuit with EA only a month earlier). As a result, King will need to be careful about how closely it copies existing concepts and focus on creating new, additive features and capabilities. 
  • Second, King can afford to aggressively invest in new gaming concepts, as well as license rights to existing intellectual property and brands. Last month, Disney shutdown a substantial portion of its Disney Interactive division due to declining usage and tepid sales of new products. As the (current) market leader in launching and managing mass media mobile entertainment, King would be well positioned to execute upon Disney’s licenses. Unlike Candy Crush, these properties could also be leveraged across a wide variety of game genres and would likely have a much longer lifespan than Candy Crush. Not only would this stabilize revenue, it would also buy time for King to develop its own original characters.
  • Finally, Big Pharma spends an estimated 25% of sales on marketing (though many argue this is either an exagerration or underexaggeration) in order to become a trusted brand and overcome the pricing advantages of its often-generic competitors. King could use its user data to test the effect of broad multimedia ad campaigns (which are likely unaffordable to most mobile developers and studios) that will help them drive adoption and stand out among the hundreds of thousands of games released each year.

Doing this at scale would transform King’s low cost business model (69% gross margins, 44% EBITDA margins) to one with significantly higher costs – meaning investors may see sustained revenue growth but stagnating income. What’s more, this strategy by no means ensures success. Candy Crush’s days will eventually come to end and King may find its next crown jewel – but Damocles sword will always loom.

1. Important to note that Porter claims to have meant this in abstraction, similar to the ways novels often follow same structure and themes.

  • Charlie

    To understand the mind-bending techniques of the old Madison Avenue set, see “Mad Men’s Guide to Persuasion” (