Online gaming giants target China

This article by Eric Jou first appeared in the China Daily on 24 December 2010.

The Chinese video game industry is growing up and changing the face of the gaming world.
"The Asia-Pacific region and Europe should end up taking 90 percent of online and mobile revenue," says Tim Merel, founder of the London-based digital media investment firm Digi-Capital. "If you aren't in China, you aren't anywhere."

The Chinese online and mobile gaming industry is expected to earn more than 28 billion euros in revenue by 2014 and China will account for half of that pie, figures from Digi-Capital show.

China is expected to drive the future of the industry and figures from China game industry analyst Nico Partners also see the market growing by 20 percent a year for the next four years.

Similarly, China's online and mobile gaming market promises an estimated revenue stream of $6 billion (4.56 billion euros) this year and projected revenues of $18 billion by 2014, compared to the $2 billion and projected $3 billion for the United States.

Lured by the huge potential, more European game makers are looking to set up their bases in China.

One of them is European game publishing and developing giant Ubisoft.

The France-based Ubisoft is one of the largest game developers and publishers in the world and is best known for the hit Tom Clancy games, Assassins Creed, and Rayman Raving Rabbids.

Ubisoft set up shop in Shanghai in 1996 and Ubisoft Shanghai has been cranking out game after game for its parent company.

Ubisoft established its Shanghai studio to globalize its workforce, says Corrine Leroy, managing director of Ubisoft Shanghai.

"We came to China for two things. One was to publish our games in Chinese," Leroy says. "Two, we were developing part of the game and some games for the whole market."

Leroy recalls how hard it was for her and Ubisoft to recruit talent during the initial establishment of their Shanghai studio.

"The people were less trained. At that time when we were recruiting artists, we had to train them to use 3d max (an auto desk software). But now when we recruit, even if they are junior, they have already used this kind of software," Leroy says.

"It went from extremely basic because those guys had nowhere to find us, they had no way to get trained in tools in university. But this lasted only two years, and after that, when we recruited people, they were already using the tools that we use in the industry."

The industry has grown on the back of foreign companies such as Ubisoft investing in the Chinese market and training developers. Starting with outsourcing and development for hire, Chinese game developers have begun building their own gaming brands.

But the industry only really took off around the year 2000, amid the South Korean online gaming boom, Leroy says.

Console and offline games also never really boomed in China because of the high prices of consoles were sold, and online games grew through that opening.

"There wasn't really a market to create games for Asia, it grew only because South Korea's government, a little over a decade ago, decided to invest a lot in online gaming," says Richard Tsao, managing director of Ubisoft's Chengdu business.

"Online gaming became very popular in South Korea and then Chinese operators started to see the value of licensing games from South Korea to operate in China, so the online gaming industry in China took off."

Still, the Chinese market faced other barriers. Gaming consoles subsequently became illegal and the only channel to distribute video games was through online operators, which take a huge chunk of the profits.

Foreign developers also have to cooperate with local companies to publish their games and this union usually happens with local Internet giants such as Tencent.

"We have no choice," Tsao says. "If we want to operate games in China, we have to work with Chinese operators."

According to figures from Digi-Capital, Internet penetration within China will be a key factor in the development of the gaming market and many foreign companies are eyeing a piece of the action. Internet penetration in China is currently 29 percent - or 384 million users - and is expected to reach 56 percent or 754 million users by 2014. That includes mobile Internet users. The pie will generate up to $18 billion by 2014, figures from Digi-Capital show.

The Chinese market's emphasis on online gaming is also changing the face of the industry, with piracy less of a major issue, analysts say.

Evolving from just mirroring South Korean online games to producing their own, Chinese companies have helped spur the growth of free-to-play models or f2p, in which game transactions known as micro transactions provide the income to game makers. These micro transactions act as a form of money-making in place of offering a game for free.

"What is happening now is that the government, particularly the Shanghai municipal government, is making it easier for companies to register intellectual property," says Zhang Ming, deputy secretary general of government agency Shanghai Information Services and vice-president of UBM China, which is under the Ireland-based United Business Media (UBM).

"There are a lot of games in the market now that don't care about the piracy, halfway through the game micro transactions offer you opportunities to advance in the game faster or game goods by paying for these with real-world money."

"Game makers can say, 'Go ahead, pirate our games, you are just giving us free publicity, we'll make our money through people playing our free game and purchasing game goods'."

Micro transactions, prominently featured in social network software games such as Farmville and Happy Farm, is a symbol of how ahead China is compared to the West in online gaming, analysts say.

"China is evolving the online gaming market better than any other country in the world," Tsao says. "The West is slowly catching up to the concept of online gaming in general. China has close to a decade more of experience."

Another technological improvement that is growing the video gaming industry is the advent of the Apple App store and the proliferation of smart phones, analysts say.

With the mobile phone gaming market expected to generate half a billion euros this year and close to 1.1 billion euros in the next five years, China is also becoming the home of hundreds of independent game developers working for the mobile market.

Even Rovio, the makers of the runaway hit Angry Birds, has set its sights on the Chinese market. Peter Vesterbacka, who is in charge of business development at Rovio, says it is hard not to see someone playing Angry Birds on the subway in Shanghai. According to Vesterbacka, Angry Birds is only available in China officially via iTunes and Rovio is in talks with operators on bringing the game officially to the Chinese mainland.

This kind of mobile Internet distribution system bypasses the problem of the online operators in China and is proving to be a new form of distribution, resulting in an increase in the number of smaller foreign companies coming to China to create games.

Smaller developers and companies that may not possess the investment capital of big companies also head into China making games with cheap talent and using the new distribution channel created by the iPhone to sell their games back to the West.

Happy Latte is one of such company that operates in China but focuses and sells its products in the West.

"Honestly, we don't even target China as a market, our games were not even available at the beginning in China," says Bjorn Stabell, managing director of Happy Latte.

"We were doing something for RenRen (Chinese social networking service) but we found it not as open as Facebook and the Apple App store."

Despite the seemingly closed market, it all comes down to the possibilities that the Chinese market and industry holds.

Patrik Wilkens, vice-president of sales of Shouji Mobile, a British-owned based in Beijing that deals in localization for foreign companies, sees a bright future for the game industry in China, particularly the mobile market. He cited the prospective plans of companies like Rovio, PopCap and Electronic Arts.

"First of all, the Chinese market is so big, it's very difficult to ignore it. On the mobile side, it's harder to access the Chinese market than to enter the European market," Wilkens says. "But I think the Chinese market, especially with the Android technology on the smart phone side, will grow even bigger. Android is getting cheaper and more affordable and with the whole market shifting right now to smart phones, I'm sure that companies like big ones are coming here. Rovio mobile is coming into the market, Popcap is already in the market and EA is setting up it's own studios in the market."

The increase in the number of Chinese and overseas developers making games in the country also presented opportunities for UBM, which operates the Game Developers Conference (GDC) to set up GDC Shanghai for game makers to get together and trade stories, techniques and lessons on how to make great games.

"What we're hoping for is that everything that UBM can offer regarding game making can be made available for the Chinese market," Zhang Ming from UBM China says.

"The products we can offer to the Chinese developer are very much Chinese oriented."

"Chinese game companies have built strong domestic franchises in the online and mobile game markets and believe that long-term consolidation in the games market will come from China," Merel says.

"Building on their strength in high-growth online and mobile games, Chinese companies may come to dominate the global video games market."

Money Games: Tencent

This article was first published by Games Industry.biz, on Sept 14, 2010, as part of Tim's monthly column 'Money Games'.

As the business of videogames moves ever more into the spotlight, GamesIndustry.biz is pleased to bring you a new monthly column from Tim Merel.  Each month he'll be examining a subject or sector of interest, beginning here with China-based company Tencent - and why it could be the biggest videogames company you might not have heard of.

Who am I?

Let me start by apologising - I used to be a lawyer, then I worked for Rupert Murdoch... and now I'm an investment banker. But - I'm also a software engineer, I write adventure stories, and I play a mean guitar, so life is a balance!

We're starting my monthly column with a profile of the greatest games company you may not know, Tencent. "No!" I hear you cry. "Surely Activision Blizzard, Electronic Arts, Take-Two or Zynga is the greatest?" Well, this all depends on your perspective, and when your perspective happens to be money, things change.

So who is Tencent?

To explain the praise for Tencent, let's start with some data. And again, I apologise; I tend to use a lot of data. For the innumerate, please look away now.

• China has 29 per cent internet penetration, but 382 million users.
• China is forecast to reach 56 per cent internet penetration (754 million users) by 2015.
• Tencent holds dominant or leading stakes in many Chinese online/mobile markets (IM, games, eCommerce, search, mobile services).
• Tencent's Chinese games market share was 20 per cent in 2009, forecast to hit 27 per cent by 2012.
• Tencent's market capitalisation - which is in the order of ¥241 billion ($35 billion) with an enterprise value of 35x 2009 EBITDA in August 2010 - was greater than Activision Blizzard, Electronic Arts, GameStop, Take-Two, THQ, Atari, Game Group and Ubisoft combined.

So what about Sony, Microsoft and Nintendo? Okay, so Tencent is about halfway between Sony and Nintendo's market caps, and nowhere near as large as Microsoft. But (a) we're talking about game software not hardware and (b) Sony and Microsoft do a couple of other things too.  

Tencent's integrated model is where the market is headed

Tencent generates around a 50 per cent operating margin. Online/mobile games (MMO, board & chess, casual/social) generate more than 40 per cent of its revenue. Tencent's business model appears to be migrating from virtual items (higher Average Revenue per User) to subscriptions (short term revenue reduction, but lower volatility), which is a reversal of the trend they started. Expect to see the same thing happening in Western markets in 12-18 months time, which is roughly the lag between China's pioneers and the West's followers. Of great importance, Tencent has an integrated business model with upgrades and privileges across online, mobile and offline (not just games), delivering a significant advantage for customer acquisition, development and retention. It capitalises on enhanced capabilities to cross-promote, upsell and cross-sell. Facebook could learn a lot from them about how to make even more money.

Tencent has some natural advantages which help enormously

I like this first chart a lot, because it contrasts the growth in online/mobile games with the flat console games market, which is great if you're a pure online/mobile company like Tencent.

The next chart helps to clarify things further, forecasting that Asia-Pacific will become the number one market by revenue, with Europe at number two and North America at number three. A very large proportion of Asia's strength comes from China - Tencent's home market - where online/mobile games account for the bulk of revenue.

Whether or not you have faith in the forecasts themselves, directionally they're correct. The videogames market is going online and mobile, with China a large part of those markets. Again, that's great if you're the leading player in online/mobile games in China.

While not going into depth on how Chinese online/mobile videogames business models work, there are a few key elements to note:

• Community focus around the games experience
• Active interaction with gamers to refine both user experience and commercialisation
• Focused commercialisation based around high volume, micro-transaction subscriptions, virtual items and some advertising
• Games as a service, not a product, with multi-year revenue streams, revenue sharing post recoupment of development budgets and continuous, low cost development through game lifecycles post-launch

The charts below help to understand Chinese online game dynamics in general.


Chinese Gross Game Revenue Profile (¥) Example*

Chinese Total Staffing per Game Profile Example*

And what does all of this produce? 49 per cent games revenue growth over the last five quarters, and around seven million peak concurrent users of Tencent's mini casual games alone. Snap your fingers, and more than the population of Ireland are playing a Tencent mini casual game - not 7 million uniques per month, 7 million uniques right now.


Tencent Quarterly Game Revenue (¥ million)

 

Tencent will be in your market soon, if it isn't already


Across the full Tencent games portfolio, you reach around 20 million peak concurrent users, or slightly less than the population of Australia. That's what happens when you're the number one Chinese games company.


Tencent Mini Casual Game Concurrent Users

Chinese Game Company Revenues ($ million)*

 
I was lucky enough to have lunch with Bo Wang from Tencent recently, and it is clear that despite Tencent's advantages the company is actively expanding into new areas. Now annual market growth has cooled to a mere 30 per cent (from 70 per cent-plus), Tencent is looking to leverage its strengths across segments domestically and internationally. But as with all things Tencent, this isn't just talk and it isn't small. There are domestic partnerships:

• China Unicom (fixed line, 3G, operations, "QQ Wallet")
• Hunan TV (talent, animation, online/mobile games)
• China Merchants Bank (financial services)

There are also international partnerships/investments:

• Digital Sky Technologies (Facebook, Zynga, Mail.ru investor)
• Vina Games (Vietnamese online games/internet)
• MIH India Global Internet (licensed software, content & trademarks)
• Naspers (36 per cent Tencent investor) with global reach in high growth markets

All the major videogame, technology and media companies in North America and Europe are both fascinated and slightly nervous about the major Chinese companies entering their home markets. The only advice I can give is to learn from Tencent fast, because these guys mean business and they know what they're doing. It is only a matter of time before they become as strong internationally as they are at home, so watch out!

The UK Government has asked Tim to present his Global Video Games Investment Review to 100 senior executives from videogames companies, media companies and investors at the Shanghai World Expo UK Pavilion on September 28. The session and following meetings with will focus on both Chinese companies and investors investing internationally, and international companies and investors seeking to co-operate with Chinese firms in China.


Sources: PWC, Capital IQ, Credit Suisse, Companies, *presented by Bo Wang at GDC Europe 2010