For an industry that didn’t really exist five years ago, the rise of China’s online gaming market has been nothing short of sensational.
Worth US$627 million in 2005, up 62% year-on-year, the ever-rising number of homes with broadband Internet connections will precipitate further growth.
Credit Suisse believes the market is on course to pass the US$1.7 billion mark by 2010, with the number of online gamers rising from 36.9 million last year to 74.6 million as total Internet users nearly double to reach 213 million.
As a commercial venture, online gaming has everything going for it. Not only does online software remove the piracy problems holding back the software market as a whole, but it operates on a service model with gamers paying according to how much time they spend playing.
Driving growth are the massively multiplayer online role-playing games (MMORPGs), which effectively tap into demand for community activity and entertainment by allowing hundreds of thousands of players to interact in a virtual world. Some games take this to the extreme by giving players the option of marrying one another and even having children – all in the game.
"Online games allow people to make friends, which is quite close to what is happening with instant messenger and portals," said Credit Suisse Internet analyst Wallace Cheung. "A lot of people want to live inside these games."
Game providers can expect to see this growth translate into higher revenues but this doesn’t alter that fact that they are all fighting to survive in an unpredictable industry: much like the movies, you are only as good as your last release.
"Revenues from games that have enjoyed years of strong growth can screech to a halt as aggregate demand evaporates over a period as short as just a quarter or two," a recent Citigroup report noted.
Given the cutthroat nature of the domestic operators – online gaming remains off-limits to foreign firms unless a Chinese group licenses their products – Sage Brennan, managing director of media of China-based tech and telecom research house Pacific Epoch, takes it one step further. "You could say that you’re not even as good as your last game, you’re as good as your next one," he said. "Everything is online and accessible, which means people drop things just as easily as they pick them up."
Nowhere is this better illustrated than in the rollercoaster fortunes of game operators Shanda and The9.
The popularity of Mir 2 powered Shanda to the head of the field in 2004 with 37% of the online gaming market. With Mir 2 now reaching the end of its shelf life and Shanda yet to unearth a new blockbuster, the company’s market share is on course to decline to 16% this year. Meanwhile, World of Warcraft (WoW) has turned The9 from a small-time player into major operator within the space of a year.
But with WoW accounting for more than 90% of The9’s revenues, the inherent danger is that this meteoric rise will be followed by an equally dramatic fall. "It would be dangerous if we only had this game forever," said Zhu Jun, founder and chairman of The9. "If you look at the top MMORPGs in the world right now, we have the licenses for Granadao Espana, Soul of the Ultimate Nation, WoW and then two more in the pipeline."
Shanda has no such luxury. By focusing on its EZ Pod multimedia entertainment platform, critics say the company has taken its eye off the ball and let The9 become "partner of choice" for foreign game developers such as US group Blizzard and South Korea’s Webzen and NCSoft.
Licensing a string of quality games is not the only means of consolidation, though.
Netease stands out as the Chinese operator with the strongest track record for producing MMORPGs in-house. Not only does the company avoid paying expensive licensing fees, but it also retains a degree of control over the release of expansion packs, one of the key methods of breathing new life into a declining game.
Despite the success of 2-D games, there have been delays to latest offerings Datang and Tian Xia, 2.5-D and 3-D respectively.
The question is: if the likes of Netease are struggling to move from 2-D to 3-D products, what does this say about the ability of China’s game developers to take on their Korean and US counterparts?
"It’s still very early days for in-house content," said Pacific Epoch’s Brennan. "The people who are doing it in the US cut their teeth on console games 20 years ago, but China doesn’t have that much experience. Netease is on the ground floor and is ascending the learning curve rapidly."
According to The9’s Zhu, this immaturity in domestic game development means his company will continue to focus on foreign licensing deals.
"We are making preparations [for in-house development] but the time is not right," he said. "We will keep an eye on the Netease’s next two games and, if they are successful, maybe it’s time for China to invest more in developing online games."
However, it is possible to tap the community spirit of online gaming without using the rich graphics of MMORPGs to bring in customers. Tencent has parachuted itself into the top end of the market by using its hugely popular QQ instant messenger service as a games platform.
There are believed to be 184.8 million active QQ accounts. By bringing just a fraction of users to its game services, Tencent will hit pay dirt. The company’s first 2-D MMORPG offering Fantasy QQ proved a smash hit and, with QQ already available on mobile handsets, Tencent has an advantage over competitors as online gaming develops away from the desktop.
But Tencent’s services are underpinned by QQ game zone, which is poised to become China’s largest casual games platform.
Casual games are likely to emerge largely unscathed from regulatory crackdowns on online gaming as measures – such as restrictions on underage players and "fatigue systems", which reduce the rewards available after playing a game for a certain period of time – target the addictive (and, from the operators’ point of view, more lucrative) MMORPGs.
Casual games also offer access to a new and lucrative market. While three-quarters of MMORPG users are male and nearly 50% are aged 20-24, QQ’s gamers are 70% female and half of them fall into the 30-49 age bracket. "It’s a huge population that until recently has been sitting on the sidelines," said Pacific Epoch’s Brennan.
"These women go to Internet cafes to play casual games and chat with their friends – and, just like in the US, it’s the women who make the buying decisions."
In the long term, though, customer retention is key to success and casual games are notorious for not being "sticky". While MMORPGs offer users a new identity in a fantasy world, there are only so many ways to re-package and differentiate Mah Jong.
"Tencent has a large community but they also need good content," said The9’s Zhu. "Look at how Tencent has developed and put it in the reverse direction: if we can consolidate our best games, we can create our own community."