Last week, I had the pleasure of speaking on Eric Goldberg’s panel at the LA Games and Mobile Conference. During the session, I made the assertion that Facebook is the Napster of the games industry. The comment really got people talking, and although I must admit that I spoke off the top of my head, I’ve been trying to find a way of encapsulating the emergent changes to the games industry in a succinct way; I think I’ve found it.

Napster began a profound period of “creative destruction” for the music industry. At its zenith in 2001, tens of millions of people from around the world shared every conceivable song with each other. The total consumption of music skyrocketed, particularly for back catalogue and new releases – the music industry’s primary revenue sources. Within minutes of an album’s release (and often before), it would spread like fire – socially, though not the way we think of it today – from person to person. It reshaped a $40 Billion industry almost overnight. And while opinions differ about the legitimacy of P2P and the current state of music, one thing is for certain: they have yet to recover.

When I apply the Napster-esque threat model to the games industry, it probably seems hyperbolic (again). After all, the games industry continues to grow, innovation is vigorous and most games companies are – at least in theory – paying lip service to the need for increased engagement in social media.

What I mean is not necessarily that Facebook is being used to steal games (though it does that too), but rather that it represents a major structural shift for the industry that will reshape the revenue and consumer landscape in an uncontrolled way. Like most things they don’t teach you in B-School, Social Networks are both a threat and an opportunity. If the games industry doesn’t take control of its destiny, it is likely to suffer.

In true numerological fashion, there are 7 signs of the Facebookalypse. Let’s take a look at them, shall we?

1. User Generated Content Explodes.

P2P moved editorial power in the construction of albums and playlists from the hands of the record labels and placed it in the hands of consumers. While making mixtapes had been popular since the advent of cassettes, the unbundling of content from albums and simple tools for playing music made it more fun and easier than ever before. This was the most powerful User Generated Content (UGC) activity for the average music consumer. Facebook similarly has allowed people to personalize their games in a novel, fun and easy way through the social graph. Friends, photos, events and game assets are now based on real-world social constructs that are derived from and expressed back to the social network. I not only get to play Scrabble, but I can easily figure out which friends also want to play with me, a simple mechanism for keeping score, avatars and chat, and simple integration into my day-to-day life. It’s like a custom version of the game – just for me.

2. Distribution and Revenue Changes.

Napster moved millions of songs into the hands of millions of people that had never purchased a song/album from a given artist. Exciting from a pure distribution standpoint. The downside? No one paid for them. In today’s Facebook world, millions of people play games in Zynga and SGN’s networks every day. In fact, there appear to be more active daily gamers on those networks than any non-Faceboook gaming platform. Of course, an entirely new channel for reaching consumers has been created. And still, no one’s paying.

3. New content creators.

The music industry’s primary strategic competitive advantage was its ability to move product through an arcane and closed distribution channel. P2P networks shattered that cozy collusion, undermining the record labels’ basic market power. In contrast, today’s game publishers trade on their technical (and licensing) know-how, capital and prowess. They hire the best minds in the industry, have unfettered access to the newest technologies and ever-expanding development budgets. As it turns out, however, you can make a multi-million user game for less than $50,000 on Facebook and with a couple of developers that have never made a game before. That’s pretty scary stuff if you tend to think in millions and years when thinking about budgets, isn’t it? Now, it doesn’t mean that traditional game design and production techniques are dead, but it does threaten their economic viability.

4. Consumer Pricing Expectation.

Before Napster, people expected to pay $17.99 for a CD. Today, the market price is $.99/song, $9.99 an album or $10/month for unlimited access (if you’re a paying customer). That’s a huge haircut. On the games side, the massive availability of free social games on Facebook hasn’t appeared to damage game industry yields yet. But there’s no question that I’m not going to pay for Scrabble when there’s Scrabulous – which is also a superior product. And games like Owned and Friends for Sale must be cutting into traditional game play minutes, considering the total length of time they’re being played. So what’s next? The price of games must fall.

5. Incumbents refuse to acknowledge the shift.

In the hundreds of conversations that I’ve had so far about social games and their impact on the mainstream games industry, almost no one is willing to acknowledge the strategic risks emergent in this market shift. I get a lot of "we’re checking it out" and "free doesn’t scale", but I don’t hear much "we’re going to shift our strategy" or "let’s make a whole raft of social games that are really clever". And as of this writing, the games industry still hasn’t even figured out how to structure a publishing deal for socially networked games; this vacuum has placed venture capitalists in the role of game publisher. On the first anniversary of the Facebook platform’s opening, not a single mainstream game publisher is close to making money or the development of a creative ecosystem (their business) .Does the industry expect social media to simply disappear? The parallels with the music business here are obvious.

6. Personnel and Intellectual Capital Shifts.

Ted Cohen = Bing Gordon.

7. Consumers are clearly expressing a preference.

In 2000, my last startup – Trymedia – pioneered the ability to post legitimate content to Napster. We obtained the participation of a very talented artist, Toby Slater, and posted his song to Napster in a free-trial, pay-to-play version. We received a tremendous amount of press for our achievements and were immediately summoned to a half-dozen meetings with key people in the music business. I was asked to speak at myriad conferences, and Trymedia toyed with the idea of entering the DRM for music space, on the back of our simple (and yet unevangelized) premise: record labels would do better to work with P2P platforms and their customers, rather than trying to fight the change in behavior. Fists were pounded on tables and lip service was paid, but little changed in the recording industry’s perspective in the years following Napster’s ascendance. Funnily enough, each conversation I have about games and social networks seems to remind me of that time.

And so, the signs are all around us, but do we heed their call? Even if there’s going to be a big shift, some argue, there will be winners and losers, and companies like EA will simply buy the new teams, products and customers that will position them effectively for the social future. After all, it’s not like the mainline games industry is in imminent financial danger. But strategic shifts of this magnitude are inherently unpredictable. Ignoring the problem or blithely expecting to be able to buy your way out of it is like taking out a mortgage without understanding the rates.

So it seems that while Riccitello fiddles, Liberty City burns. New entrants are muscling in to the game publishers space at record speed. No fewer than a dozen social gaming startups have appeared in the past year. With 18 month operating budgets smaller than the average AAA title, new companies like Zynga, SGN and Serious Business are creating a new competitors to the established order. These companies are relatively easy to squash today, and so expensive to buy in 12 months. Even if Zynga’s not for sale, the games industry is rife with creators just dying to combine the power of the social graph with their game design expertise. What don’t the major gaming companies get?

A little less than 10 years ago, the music business faced its Waterloo in the form of 20 something Shawn Fanning.  The players have changed, but they’re still young:  Mark Zuckerbergsings is a similar (if less legally questionable) song at the age of 23.  Are we on a sinking ship or is it just going sideways?  And where will she come to rest?  

Gabe Zichermann co-founded rmbr in 2007 with a mission to make everything more fun. The company’s products include SMS-based social networking toy rmbrME and a soon-to-be-launched Facebook/OpenSocial application, among others. Gabe is a ten-year games industry veteran, having previously worked for CMP Media on the Game Developers Conference, Gamasutra and Game Developer magazine, as well as helping to launch and guide Trymedia Systems from start to sale as its head of Strategy and Marketing. Now residing in New York City, Gabe frequently muses about why the city that has everything can’t make a good burrito.