It's game time
China's gaming market will soon be the biggest in the world – and its growth is inadvertently being shaped by government policies
China's gaming market is heading toward a showdown. Between 2009 and 2014, the overall global games market is projected to increase from US$77 billion to US$87 billion – the same amount the film industry made in 2009. And with a Pacman-like insatiability, China will eat up more of this growth. According to investment bank Digi-Capital, the country currently accounts for 12% of the global games market, a figure that will rise to a quarter by 2014.
Not everyone will be a champion, however. Traditionally, the games business has been dominated by sales of consoles – including Microsoft's Xbox, Nintendo's Wii and Sony's PS3 – and the titles produced for them. Many console games are major productions with higher levels of investment and profits than studio films: Activision Blizzard's Call of Duty: Black Ops, for example, made US$1 billion worldwide in the first six weeks of its release last year. In the history of cinema, only seven movies have ever made more than US$1 billion.
But in China, console games haven't seen the same success. In the last few years the big growth story has been in online and mobile gaming. Today, the country has more than 76 million online game players – helped by a business model that caters to young players' wallets with low-cost games and cheap add-ons.
Between 2009 and 2014, global sales in the online and mobile games market will rise from US$19 billion to US$44 billion – half of which will come from China, thanks to an ostensible accident of government policy.
The Ministry of Culture banned the production and sale of games consoles and their accessories in China in 2000. The ban's purported intent was to protect the country's youth from wasting time and being exposed to sexual and violent content. But it had an important, inadvertent impact: Chinese gamers and developers were redirected from established console companies, to nascent markets where Chinese companies could not only compete but also thrive.
"[The government ban] inspired local games producers to focus on developing products for the PC market and specifically building games which were online only," said American McGee, founder of Spicy Horse Games, a game development studio based in Shanghai. "If you think about it, actually it was a really nice piece of engineering by the Chinese government. Whether they knew it or not, it gave birth to what is now one of the strongest game economies in the world."
Game developers argue that the government ban was more about protecting domestic firms from foreign competition, than protecting youth from negative influences. That's helped Chinese companies like Tencent, Shanda, Net-Ease and Giant Interactive grow and rank among the world's largest companies in the online games industry.
Across its gaming portfolio, Tencent reaches about 20 million peak concurrent users – meaning that a population slightly less than that of Australia plays its games at the same time.
"China's domestic strength has produced high volume, low average revenue per user (ARPU), cost-efficient games with up to 50% operating margins, enabling significant investment in domestic and foreign markets," said Tim Merel, managing director and founder of Digi-Capital.
Domestic firms have made several major acquisitions this year. Shanda in January purchased flash games advertising company Mochi Media for US$80 million. In February, Tencent purchased a majority stake in US developer Riot Games – which has just one game to its name, League of Legends – for US$400 million. Meanwhile, Tencent is also establishing a US$760 million fund for investing in online, social and mobile games.
Last year, 59.6% of online game revenues in China came from domestic game companies, according to the General Administration of Press and Publication (GAPP). Of the remainder, numerous Japanese and Korean titles have had been well received, as have some American games such as Activision Blizzard's World of Warcraft.
But Merel argued that foreign gaming firms have another level to master before they can see success in China.
"Other countries' games which have been localized by domestic partners in the Chinese market have done extremely well. Similarly, some Chinese games have been localized for other countries' games markets," he said.
"There are significant opportunities for Chinese gaming companies in both directions: investing in and working with foreign companies to enter foreign markets, and acting as strong domestic partners for foreign companies."
Chinese companies' recent forays overseas are evidence of their global ambitions: According to GAPP, China now has 12 online games companies that are listed both in China and abroad. In addition, 82 games developed by 32 Chinese companies are currently being sold in foreign markets.
Besides banning the sale of consoles, China's internet censorship has also benefited local game publishers. Millions are addicted to games played on social networking sites: In 2010, about 50% of the 26 million daily users on Renren.com, a popular social network in China, played SNS (social network software) games.
As social networking websites like Facebook are blocked in China, foreign SNS game developers face a major barrier to competing in the Chinese market. "We believe that foreign companies must work with the strongest Chinese partners to compete in the social games space in China," Merel said. "And this requires foreign companies to bring something to local firms that helps accelerate innovation and commercial growth."
The race ahead
At the same time, the restrictive environment has led some foreign firms to look elsewhere for opportunities. Spicy Horse Games, for example, has decided to put off developing games for local companies even though it's based in China.
McGee said Spicy Horse is the only Western studio to develop "AAA" titles – known as high-quality games with expensive budgets – from start to finish in China. The company recently finished developing a PC and console game for Electronic Arts called Alice: Madness Returns. The two-year project was "a beautiful distraction" from Spicy Horse's core business of creating online games, McGee said.
In addition, the company recently announced a US$3 million deal with Popcap and Vickers Venture Partners to produce about five 3D, free-to-play games over the next two years. Despite how Asian consumers are some of the most profitable users – a higher proportion pay for optional purchases when playing free online games – and that McGee is connected to Chinese publishers, the company plans to promote their games in other markets before China.
"One of the reasons is that Chinese publishers are quite successful with their own games at this point," he said. "To come to them with something that is speculative is difficult because they're doing pretty good on their own. Their attitude is that they don't need outside help."
Spicy Horse also plans to make games that will work on a range of different platforms and payment models, in geographically diverse markets.
"We're going to take a platform and publisher agnostic approach because this is a truly global market," McGee said.
"Because the games are distributed online, you're able to go to places as far-flung as South America, Korea, Europe, North America, Japan – you name it – and there's an operator or a publisher who's willing to partner up and accept the content that you build and run that on your behalf."
Despite the excitement in online and mobile games, there have been signs that the console market may have a resurgence in China. Eedoo, a Beijing-based firm funded by Chinese PC maker Lenovo, is trying to go head-to-head with Microsoft, Nintendo and Sony with its introduction of a new iSec console in the second half of this year. The device, previously called the eBox, uses a 3D depth camera – much like Microsoft's Kinect for Xbox 360.
Produced in a market where consoles are supposedly banned, Eedoo has mostly indicated it will develop exercise games for the iSec. This suggests that it will steer far away from the mature content in console first-person shooters and games made by companies like Rockstar that irk members of the Chinese government.
If and when the iSec does enter the market, it will be harder for China to justify and maintain the ban on similar consoles, like the Wii and the Kinect. "Console games may emerge [in China] thanks to the iSec," said Lisa Cosmas Hanson, managing partner and founder of market research firm Niko Partners in China.
That may be difficult given the momentum behind the shift towards online and mobile games, but the rise of consoles in a market as big and influential as China's could significantly change the future makeup of the global games industry once again.