China's Online Gaming Craze

The mainland market for online games is set to surpass $2 billion by the end of the decade and beat out South Korea as king

By his own admission Zhao Songwei, 24, is logging far too many hours these days at a sprawling Internet Café in Shanghai. He spends four or five nights a week immersed in online fantasy and combat games such as The Legend of Mir II—The Three Heroes and World of Warcraft and has been known to go at it in grueling 24-hour stretches. He freely admits he has something of a gaming problem. "I think online games are definitely addictive," he said during a recent Monday morning session.

The Shanghai hotel employee just can't seem to resist the sheer entertainment value and escape from everyday worries that his virtual adventures deliver. At the moment, his current fixation in cyberspace is getting his adopted character in Warcraft (a nasty looking horned creature on a horse with pop-out eyes) some seriously nasty weaponry to go on a killing mission.

Other characters had better watch their backs. "My level in World of Warcraft is 60, the highest in the game," says Zhao, who looks more like a skinny high school student than a predator.

PASSING SOUTH KOREA. Zhao represents an extreme dimension of China's current online gaming craze. Yet make no mistake: Chinese youth are proving to be some of the most committed and driven gamers on the planet. And the stupendous growth of the online, interactive game market in China continues to astound analysts.

The market for fantasy and adventure multiple role-playing games shot up 54%, to $460 million in 2005, and is on track to reach $2.1 billion by the end of the decade, figures research firm IDC. China is expected to surpass tech-happy South Korea next year as Asia's biggest gaming market.

For Chinese Net companies such as Shanda Interactive Entertainment (SNDA), the kingpin of online gaming, and portal companies that also compete in this segment such as NetEase.com (NTES), this market offers huge long-term potential. And the reason seems to go beyond the obvious point about China's sheer market size, though an Internet user base of 120 million (and growing fast) doesn't hurt a bit.

FEROCIOUSLY COMPETITIVE. The quality of Chinese games is fast-improving, and there may be something to the idea that multiple-participant online gaming appeals to the collectivist spirit of mainlanders. "Players have interactive relations and they work together to accomplish missions," says Shanda spokesman Zhuge Hui. "This ensures the demand of online games" in China, he says.

That said, the Chinese online gaming business is ferociously competitive and going through a period of disruptive change. Valuations of Chinese Internet stocks have taken a beating in recent months. The Chinese government and state-run cellular carrier China Mobile are tightening up billing practices and content fees for such things as downloadable games and ringtones. That has cast a pall over the entire Net sector.

On top of that, the business model for online gaming is changing, notes Jun-Fwu Chin, a senior analyst and online gaming specialist with IDC Malaysia. The current trend among online game purveyors is to reduce or entirely eliminate fees to play games to build up a bigger stable of users.

But now companies are hoping to rake in even more revenues by charging for things like weapons and ammo and other virtual goods needed to advance various games. Companies "are switching to a model with revenues generated by the sale of virtual items," he says.

A DISNEY INTEREST. That is probably a smart move long-term, but right now it is costing companies like Shanda dearly. Its first-quarter profits fell 95%, to $1.47 million, as it saw a slide in online subscriptions and increased competition from Chinese rivals such as NetEase.com. Yet Shanda Chairman and founder Chen Tianqiao thinks building up a huge online consumer base will pay off big eventually, not only in the sale of virtual goods but also music and online movies to the legions of gaming fans attracted to its site.

Even so, few would deny the long-term potential of Chinese online gaming—and it is getting noticed in the U.S. In May, Walt Disney's (DIS) Internet unit struck a deal with Shanda to distribute and operate games based on Disney's hottest animated characters.

Meanwhile, a fantasy online game that the National Basketball Assn. rolled out last October called NBA High Scorers' Challenge, in which gamers play the role of a general manager responsible for setting salaries and team rosters, attracted 200,000 registered users at the league's Chinese Web site NBA.com/china, which is powered by Sohu.com.

"It has had an incredible response," says Mark Fischer, vice-president and managing director of NBA China. And a downloadable mobile phone version of the game developed by Shanghai-based Mtone Wireless has also been a hit.

SUPER GROWTH. Yet the real show for Chinese companies is to improve the quality of locally-developed games. Right now, South Korean game developers rule with about a 45% share of the online games in operation in China. Nexon, a Korean online game company, offers games through operators in China, and one called Crazy Arcade BnB (for Bomb and Bubble) which goes under the name Paopaotang in Chinese, has an incredible following of 130 million registered users.

However, Chinese game developers are starting to come on strong with well-designed games of their own. "Some Chinese companies have become pretty competitive," says Calvin Yoo, director in charge of international business development at Nexon, though he thinks the market is growing so fast that Korean game designing outfits will continue to thrive.

Chinese Internet players have a big incentive to develop smash hits of their own, given the $117.4 million in royalty payments the Korean game developers hauled in during 2005 from the mainland. That is why companies like NetEase are pushing hard to generate hits internally.

ON THE PHONE. A good example of that is Westward Journey Online II, which is based on the famous Chinese novel Journey to the West and a film adaptation of that classic tale by Hong Kong actor and film director Stephen Chow Sing Chi. Its visual style draws heavily from traditional Chinese paintings, and is one of the most popular games among those developed inside China. This game has attracted more than 83 million registered users.

Big numbers and huge potential will continue to drive interest in Chinese online gaming. There is serious money to be made by mainland hosting sites and local and foreign game developers. And there will be interesting challenges for a mobile handset-based game when 3G, high-speed telephony arrives in 2007 or 2008. All this will provide more than enough virtual entertainment for hard-core gamers like Zhao.