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Business> Finance
UPDATED: April 13, 2007 NO.16 APR.19, 2007
Prospecting for Internet Gaming Gold in China
Chinese online game portals roll the dice on the future

The total number of online gamers in China is expected to reach a whopping 81 million by 2010, according to Shanghai-based research company iResearch. Revenue in this enormous sector is expected to reach $970 million this year, up 28 percent from $760 in 2005. Chinese Internet game portals, used to making their money on licensed games, are now on the development of their own games. They are also searching for new business models allowing them greater earning potential than what they get now from simply selling gaming hours to gamers.

"Internet gaming is a business that makes money even when you are sleeping," quipped NetEase.com chief William Ding in 2001, commenting on the instant popularity of Internet gaming--the savior of his business. As the biggest online gaming winner last year, NetEase turned to this sector as its saving grace after its stock price dived from $100 to $1 in 2001. By making the game Fantasy Westward Journey available online, they managed to survive a bitterly cold Internet winter.

Internet games became popular in China after a foreign game called MUD--known as "Niba" by Chinese players--spread online in the early 1990s. Chen Tianqiao, founder of China's online gaming giant Shanda Interactive Entertainment, was still in school when he became fascinated with the game. Compared to MUD, Chinese games such as mahjong, poker and chess, appeared simple. Sensing a niche opening, the game hosts--ChinaGames, OurGame and Game ABC--later developed the first leisure game platforms in China.

The year 2001 witnessed massive releases of MMORPG (Massively Multiplayer Online Role-Playing Game) games, represented by the game Legend of Mir. According to official statistics, the Internet gaming market grew by more than 700 percent in 2001. With an average annual profit growth of more than 50 percent across the industry, the number of online gamers was close to a quarter of all Internet users in China.

In a few years, swarms of companies entered the industry, including The9 and Zhengtu. Today, the Internet gaming market in China is vastly different from that of 2001, with margins having been spread thin. Scores of gaming sites have been forced to close due to operational failure. From explosive MMORPG games to leisure games, from licensing to self-development, the Internet gaming industry of today, like the game characters themselves, is full of uncertainty. In the web 2.0 era, how can Internet games improve in style and content? What is the future of Internet gaming?

Licensing vs. self-development

Shanda emerged as the most sonorous name in the online gaming business in 2002, a year after it introduced Legend of Mir. The gaming giant's revenue exceeded 600 million yuan, with net profit exceeding 100 million yuan and daily income topping 1 million yuan. According to IDC, a global market intelligence and advisory firm, Shanda contributed to 60 percent of direct sales in China's Internet gaming industry in 2002, totaling 910 million yuan.

"Shanda owes its success to the licensed Legend of Mir game," said Chen Tianqiao.

Shanda's success enticed local Internet gaming companies into the game licensing business, in hopes of capturing immediate market share and fortunes overnight. NetEase licensed Priston Tale, Asiagame picked 1000 Years, and JoyPark Crossgate. In 2005, Shanghai's The9 Limited secured the game World of Warcraft at a record high price, a climax in the Internet-game licensing business.

According to NetEase's marketing director Li Riqiang, there are two major cooperation models between domestic licensees and developers abroad: profit sharing and sale of regional licenses. By profit sharing, the licensee pays a fixed percentage of income to the developer. "In the second model, the operator buys the game and is free to create derivative gaming products in the specified region without having to pay licensing fees," explained Li.

As the foremost beneficiary of the licensing model, however, Shanda was also the first to encounter problems. In April 2003, ACTOZ Soft, Korean developer of Legend of Mir, unilaterally terminated its partnership with Shanda for various reasons. With this bitter lesson, Shanda found a way out by developing its own game--The World of Legend.

"Shanda would have had no future, but for Chen's vision in self-development," commented Internet analyst Xie Wen. "There was no precedent in the world for a gaming site being entirely supported by its publishing network. In terms of profit distribution, the publisher only takes a portion of the average margin at the end of the industrial chain." Indeed, many licensed games suffered sharp declines in popularity due to unsustainable follow-up development and excessive profit-sharing requirements from game developers abroad, which inevitably made it harder for licensees to make money.

"The days of easy money from game licensing are gone," Li Riqiang said. According to statistics, domestic games accounted for 42 percent of the market, up from 28 percent in the previous year.

"When licensed games prevailed, the market lacked variety," Li analyzed. "Tired of the monster-slaughtering scoring, players found more resonance with domestically developed games that incorporate rich national and cultural connotations, such as NetEase's Westward Journey series and Kingsoft's Swordsman series."

High-stakes leisure gaming

Tencent, an Internet services provider that gained fame for its instant messaging service QQ, created a miracle in Internet gaming. Tencent launched its leisure games on its QQ platform in August 2003. The number of concurrent online gamers exceeded 2 million, or 1.5 times the record high Shanda reached on February 7, 2006. Leisure gaming has gained popularity since then, though Tencent can largely pinpoint its gaming success to its highly integratable instant messaging software.

"We have jobs," a white-collar gamer said. "Obviously, it is impossible for us to stare at the computer screen all day playing MMORPG games." According to the gamer, the purpose of playing Internet games for him and his peers is to relax, and enjoy-play-killing is simply too exhausting.

The popularity of leisure games was a result of customer segmentation of the online gaming market. The compact and concise leisure games cater to gamers who lack time and are looking for relaxation.

According to iResearch, 51 percent of online gamers played leisure games and 53 percent MMORG in 2003. In 2006, an increasing number chose leisure games, accounting for 62 percent of the total and surpassing MMORPG's 55 percent.

"Leisure games, usually turn-based and without the complicated and bloody monster-killing boss system, are easy for beginners and attract more women," explained Yu Kun, editor with an online gaming weekly.

At present, mature leisure games in China focus mainly on music and dance, speed, as well as chess and cards, which account for last year's top three most frequent downloads, Audition, Crazy Racing and Free Style. According to Tencent's forecast, these three categories will remain the focus of Internet leisure gaming in China this year. All leisure Internet games currently on the proving grounds--KO Mahjong, Crossgate and Popland--belong to these three categories.

The secrets of `free'

Shanda made an important decision to offer three highly profitable games for free at the end of 2005, causing a revolution in the gaming operation model. Many insiders believed that Shanda's move undermined the industry's unwritten rules and that it had dug its own grave. While it was true that Shanda saw its revenue and stock price decline after announcing the free offer, revenue gradually rebounded in the first quarter of 2006 and equaled historic highs in the third quarter.

"The three games are not actually free," said Chen Tianqiao, six months into the free offer. "A better interpretation is that Shanda has introduced a new model into the online gaming business. Shanda's transformation is inevitable, as we want to keep pace with the market."

Thanks to Chen's vision and determination, Shanda has transformed itself from a point card seller to a trader of virtual weapons and gadgets players desperately yearn to possess. Sales of point cards used to be the main source of income for traditional game portals, providing the same services to all gamers. The secret of Shanda's new model, however, lies with differentiating players and providing choices. There are diligent players with abundant time, and the richer who, not wanting to struggle through endless monster-killing combat at low levels, spend on gadgets and weapons.

"It's quite fair," commented an insider. "Let the diligent play harder and the rich spend more. This contributes to building an organized and standard transaction platform for the virtual market. "

As many portals joined this transformation, William Ding, the maverick NetEase founder, was not optimistic about the "free model."

"To offer games free, to some extent, equals to 'killing the hen for the egg' in this industry," said Ding. "I'm still relatively opposed to free games." News later provided his supports: Ding's NetEase replaced Shanda as the biggest Internet gaming winner of 2006.

"Biggest winner as it is, who knows if its profitability is sustainable," said a web surfer in response to Ding's comment.

"Who is Shanda's rival, The9, NetEase or some new faces? I think Shanda's greatest rival is itself," said Chen Tianqiao at the third China Game Industry Annual Conference held on January 16-18. So is China's Internet gaming industry. Self-development, a new profit model, and a sense of responsibility are keywords for the industry to pursue continued success.

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