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Zynga's lessons for tech entrepreneurs, investors


(MoneyWatch) When Zynga (ZNGA) announced preliminary financial results for the third quarter yesterday, the news was bad -- between warnings of a loss this quarter and lowered expectations for the year. The stock is currently down more than 17 percent from yesterday, and is at below $3 a share a far cry from the IPO price of $15.

The bad news, though, offers an important lesson for technology entrepreneurs and for investors. A little humility can go a long way to avoiding the danger that hubris presents.

The ugly details

Although CEO Mark Pincus put as upbeat a spin as he could on the financial news that he called "disappointing," it was clear that things were bad, particularly when he wrote of "targeted cost reductions," which often means layoffs in corporate-speak. Here are the reasons why:

  • Mobile games aren't performing as the company had expected. That is particularly bad because Zynga depends on the success of Facebook (FB), and the social network has its own challenges with making money from mobile.
  • Even its mainstay games are underperforming from where the company thought they would be.
  • The company will write off between $85 million and $95 million of what it paid for OMGPOP, maker of the game "Draw Something" that was supposed to bring in new customers and revenue.
  • The current quarter will see a projected loss of between $90 million and $105 million. That means even without the OMGPOP write-off, the company would have lost money.
  • Zynga has significantly lowered its guidance for the entire year by 8 percent to 28 percent, according to Sterne Agee analyst Arvind Bhatia.

However, the biggest problem is not the loss or drop in revenue. It's the fact that management wasn't able to see the issues and either fix or communicate them in advance.

The almighty CEO

Much is expected from the head of a public company. Investors and regulators want transparent insight into how the business is performing. You have to produce growth while acknowledging and addressing the barriers that might keep you from it. And, critically, you must harness the insight and experience of a management team and board of directors, yielding to advice when it makes sense, staying the course to avoid going off track.

Early on, Pincus showed determination and even success. Zynga's annual revenue was reaching $1 billion even before it went public. But when the IPO came, the stock structure was a clue that he might have a little too much faith in himself.

As has become the popular path among many tech companies with recent IPOs, Zynga has multiple classes of stock. Some have greater voting rights than others. Pincus has virtual complete control over the company, so his view has prevailed, even as his strategy has remained largely unchanged.

When someone has all the votes, it can become difficult to hear the concern of others who are also close to the company because, after all, the person in charge doesn't really have to. The lesson for entrepreneurs is to realize that no one is right all the time and that if you structure a company so you are accountable only to yourself, chances are greater that you will ignore warnings from employees and associates that might let you avoid a strategic mistake.

Crossing your fingers isn't an investment strategy

Rolfe Winkler at the Wall Street Journal made a good point that Zynga could become the "first super-voting cautionary tale" among tech companies. When the trend started with Google years ago, investors became accustomed to having no effective voting power when it came to running a company.

And, why should they have cared, so long as the growth was constant, and the revenue and profits strong? But honeymoons don't last forever. For example, investors in News Corp (NEWS) have faced no practical answer to whatever Rupert Murdoch and his family wanted, even during the phone hacking scandals of the company's British newspaper arm.

Zynga is showing how complete control by a founder, even in tech, can be a poor idea, and there are enough other companies facing poor performance under tight control -- Facebook and Groupon (GRPN) come to mind -- that show the problem may not be so isolated.

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