A good initiation on the sector from the Antonio Tambunan, the new Bear Stearns Analyst covering the China game sector. He knows his stuff; he is a hardcore gamer.
His top pick is Netease, followed by The9. He downgrades Shanda.
Download bearstearnschina_online_games_1207_us.pdf
(Writen on 2005.12.09)
Saturday, September 02, 2006
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.
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.
China moves to zap online game addiction
China on Tuesday introduced an “anti-online game addiction system” intended to protect players from the mental and physical perils of spending too much time in front of computers.
The system, which will encourage players to play less by cutting the benefits they gain in online games, is to be implemented by local internet companies that have signed a code of conduct drawn up by China's press and publications administration.
The move reflects fears about the social impact of popular “multiplayer online role-playing games” which have been blamed for encouraging sloth, truancy and even murder.
An estimated 25m Chinese play online role-playing games. These allow players to interact as characters ranging from warrior heroes to powerful magicians in vast virtual environments.
However, communist groups and newspapers have highlighted reports that many players are addicted to the games.
Under the new standard, up to three hours of play is considered “healthy” - and more than five to be “unhealthy”.
The anti-addiction system cuts in-game benefits to players after three hours. For most games this will mean awarding fewer “experience points” to fantasy characters and reducing the value of virtual goods such as magic weapons that they acquire.
After five hours online, players will be subjected every 15 minutes to the warning: “You have entered unhealthy game time, please go offline immediately to rest. If you do not your health will be damaged and the benefits you can win will be cut to zero.“
Leading games companies have agreed to the system to head off the threat of stricter regulation.
China's online games market is expected to grow 65 per cent to $633m this year, and will be the world's largest by 2006, according to CSFB, the investment bank. .
Such growth has won high valuations for Nasdaq-listed Chinese online games companies such as Shanda Interactive and Netease, which have promised to implement the system by late October.
Why Lenovo-IBM is a tough sell
Two years ago, I got an inside look at operations at Lenovo Group, the Chinese computing giant that is forming a joint venture with IBM to sell PCs worldwide.
Military marching music blared out of loudspeakers that ringed the corporate headquarters. It was 2 p.m., the beginning of the mandatory afternoon exercise break for the assembly line employees. "Here it is," I thought, "the legendary willpower and unity of Chinese organizations." I expected to see employees popping off jumping jacks while wielding soldering guns.
Instead, the workers mingled around a courtyard, smoked cigarettes and in general seemed impervious to the motivational siren songs broadcast by upper management. It warmed my heart--people truly are the same everywhere you go.
Formerly known as Legend, Lenovo has consistently been predicted to become one of the first companies from China to go worldwide. It sells some PCs in Europe, but to date its operations have mostly stayed in China.
The pending deal with IBM will make those global plans will materialize overnight. Under the terms, Lenovo will buy the PC unit, but IBM will lend it its name and make Lenovo a preferred provider. Pulling such a deal off, however, would be fraught with difficulty.
First, let's take a look at the factors in Lenovo's favor. For one thing, the company often behaves more like a Western corporation than an Asian conglomerate, adapting rapidly to changing circumstances.
Founded in 1984 by researchers from the Chinese Academy of Sciences, Legend first existed as a distributor in China of PCs from overseas. It subsequently moved into making PCs, consumer electronics, printers, storage and, more recently, supercomputers. It also has its own retail stores in China.
Lenovo has shown an uncanny ability to extract expertise from its many technological partnerships. It learned how to make PCs from AST Research and Acer, two of its distribution customers. Lenovo subsequently stopped distributing both brands. In 2001, America Online and Lenovo invested $100 million in a joint venture to develop online properties. Lenovo has since bought out AOL's interest at a discount.
Just as importantly, the company knows it can't simply rely on latent nationalism or local low-cost manufacturing to woo customers in China. When it began to lose market share to multinationals like Dell in the first part of the year, Lenovo immediately cut prices.
In addition, technology giants such as Samsung and Acer have paved the way for broad acceptance of manufacturers from Asia.
But here's the snag: Samsung, Sony and Acer sell to consumers and small businesses. IBM sells notebooks and desktops to big companies, and corporate computing doesn't travel easily across borders.
Fujitsu Siemens Computers is the fourth-largest PC maker in the world, but good luck finding any of its products in the United States: The company sells its boxes in Europe and Asia. Samsung bought AST and tried to break into North America a few years back, but the effort floundered.
The problem is that corporate customers want a safe, predictable and fairly inexpensive choice. Selling corporate America on a new technology is like giving your dad the latest fashions at Christmas: Chances are he'll be back in his jogging suit in two weeks. Advanced Micro Devices makes chips that win awards, but they don't end up in business desktops, because the Intel processors the IT managers have tested work just fine.
And IBM customers are the most conservative of the lot. They know they can call Armonk, N.Y., and get answers pronto if something goes wrong. Yes, IBM outsources laptop and desktop manufacturing--but it is Big Blue itself that has to answer for the products.
How comfortable are business customers going to be with a joint venture owned mostly by a company based 10 time zones away? More likely, they'd rather call Round Rock, Texas, home of Dell. In addition, IBM will likely be uneasy about having its brand name of products coming out of a group it does not fully control.
Another problem stems from the nature of joint ventures. They usually don't work. Typically, one company has to become a passive partner (AMD and Fujitsu's flash venture Spansion), or direct competition between partners has to be an extremely remote possibility (EMC and Dell), for a venture to have a chance of success.
IBM and Lenovo are going to have to exchange customer lists and let the one perform a service that it used to do itself. A lot of trust will be required. Remember how people worried whether the Hewlett-Packard culture would mesh with Compaq's. Here, the cultural gulf is a lot wider and, to top it off, the two parties will literally not speak the same language. The new Lenovo will consist of roughly half English speakers and half Mandarin speakers.
As the old saying goes, no one ever got fired for buying IBM. But no one ever got hired for buying Lenovo.
A culture of overwork exacts an extreme price
Thousands of Chinese are literally being worked to death. Huawei, previously seen as a model company, is now a symbol of the overwork phenomenon. One of its star employees, 25-year-old software engineer Hu Xinyu, died suddenly May 28 after nearly a month of overtime work.
At China's biggest telecoms maker, every new employee is issued with a mattress. The reason? So they can grab a nap beneath their desks, day or night, when they succumb to exhaustion from their endless working hours.
The frenetic work habits of the 40,000 employees of Huawei Technologies have become known as the "mattress culture" -- and it's a prime example of the intense pressures that kill up to one million Chinese workers every year.
Until recently, China was proud of its mattress culture. The employees of Huawei were icons of the tireless zeal that transformed China into the "workshop of the world."
Many worked for months without a day off, sleeping in their offices at night so they could keep working as soon as they awoke.
But there is mounting concern about the toll of death and illness from overwork. Experts estimate that 600,000 to one million Chinese workers are dying from it every year.
Huawei, previously seen as a model company, is now a symbol of the overwork phenomenon. One of its star employees, 25-year-old software engineer Hu Xinyu, died suddenly May 28 after nearly a month of overtime work.
He was a former athlete and sports enthusiast, yet he became so exhausted at the company that he often slept at his office instead of going home.
His death has helped ignite a national debate about the culture of excessive work. The Chinese media have documented a growing number of deaths caused by overwork, and Chinese websites and Internet forums have questioned the national economic model.
"Working is important, but it can't be more important than life," one young office worker said in a website debate about Mr. Hu's death.
Almost all sectors of Chinese society, from manual labourers to intellectuals, are prone to overwork. In the past five years, for example, 135 professors and other scholars in Beijing have died prematurely as a result of overwork, according to media reports. Their average age was just 53.
Another report concluded that the life expectancy of intellectuals in Shanghai has dropped by five years in the past decade. And a survey of 2,600 high-tech workers in Beijing found that 84 per cent were unhappy with their excessive workload and nearly 90 per cent were worried about the impact on their health.
"People are starting to look at the human cost of China's phenomenal growth rate," said Robin Munro, research director at China Labour Bulletin, a labour-rights organization based in Hong Kong.
"Many Chinese people are beginning to question whether their society is benefiting from this relentless drive for great-power status. When you have up to a million people dropping dead from overwork, it's a calamitous situation.
"These are the kinds of shocking numbers you might expect from a disease epidemic. It's an awful indictment of the work culture in China and the pressures on ordinary people."
Under Chinese law, he noted, workers are prohibited from working more than 36 hours of overtime a month. Yet this limit is routinely exceeded in most export-oriented manufacturing industries.
"It's the mentality of a slave-labour camp," Mr. Munro said. "The entire work culture is distorted. There's so much emphasis on making money in China, and working extraordinary hours is seen as the way to do it."
Even the state-owned propaganda newspaper, People's Daily, has criticized the amount of overwork, which it blames partly on the rising unemployment rate and the 14 million jobless people in the country.
"With the growing numbers of people ready to take their places, few workers are willing to turn down overtime," the newspaper said in an editorial last month.
One of the most poignant cases was the story of Gan Hongying, a 35-year-old worker in a garment factory in southern China.
Desperate to raise money for her husband and two young children, she worked 22 hours of overtime in a four-day period this spring. She began to complain of dizziness and headaches, and she talked constantly of how she needed to sleep.
On May 30, after more than 54 hours of work over four days, she died suddenly. Her last words to her sister were: "I am so tired. Give me the key to your home, I want to have a rest."
After her death, a local newspaper investigated and found that the garment factory had routinely forced its employees to work overtime.
If the workers failed to finish their orders, the factory gate was sometimes locked to keep them inside, and they were threatened with a loss of pay.
The investigation found that 70 per cent of factories in the Pearl River delta of southern China, where Ms. Gan worked, had required its employees to work more than the legal maximum of overtime every week.
At China's biggest telecoms maker, every new employee is issued with a mattress. The reason? So they can grab a nap beneath their desks, day or night, when they succumb to exhaustion from their endless working hours.
The frenetic work habits of the 40,000 employees of Huawei Technologies have become known as the "mattress culture" -- and it's a prime example of the intense pressures that kill up to one million Chinese workers every year.
Until recently, China was proud of its mattress culture. The employees of Huawei were icons of the tireless zeal that transformed China into the "workshop of the world."
Many worked for months without a day off, sleeping in their offices at night so they could keep working as soon as they awoke.
But there is mounting concern about the toll of death and illness from overwork. Experts estimate that 600,000 to one million Chinese workers are dying from it every year.
Huawei, previously seen as a model company, is now a symbol of the overwork phenomenon. One of its star employees, 25-year-old software engineer Hu Xinyu, died suddenly May 28 after nearly a month of overtime work.
He was a former athlete and sports enthusiast, yet he became so exhausted at the company that he often slept at his office instead of going home.
His death has helped ignite a national debate about the culture of excessive work. The Chinese media have documented a growing number of deaths caused by overwork, and Chinese websites and Internet forums have questioned the national economic model.
"Working is important, but it can't be more important than life," one young office worker said in a website debate about Mr. Hu's death.
Almost all sectors of Chinese society, from manual labourers to intellectuals, are prone to overwork. In the past five years, for example, 135 professors and other scholars in Beijing have died prematurely as a result of overwork, according to media reports. Their average age was just 53.
Another report concluded that the life expectancy of intellectuals in Shanghai has dropped by five years in the past decade. And a survey of 2,600 high-tech workers in Beijing found that 84 per cent were unhappy with their excessive workload and nearly 90 per cent were worried about the impact on their health.
"People are starting to look at the human cost of China's phenomenal growth rate," said Robin Munro, research director at China Labour Bulletin, a labour-rights organization based in Hong Kong.
"Many Chinese people are beginning to question whether their society is benefiting from this relentless drive for great-power status. When you have up to a million people dropping dead from overwork, it's a calamitous situation.
"These are the kinds of shocking numbers you might expect from a disease epidemic. It's an awful indictment of the work culture in China and the pressures on ordinary people."
Under Chinese law, he noted, workers are prohibited from working more than 36 hours of overtime a month. Yet this limit is routinely exceeded in most export-oriented manufacturing industries.
"It's the mentality of a slave-labour camp," Mr. Munro said. "The entire work culture is distorted. There's so much emphasis on making money in China, and working extraordinary hours is seen as the way to do it."
Even the state-owned propaganda newspaper, People's Daily, has criticized the amount of overwork, which it blames partly on the rising unemployment rate and the 14 million jobless people in the country.
"With the growing numbers of people ready to take their places, few workers are willing to turn down overtime," the newspaper said in an editorial last month.
One of the most poignant cases was the story of Gan Hongying, a 35-year-old worker in a garment factory in southern China.
Desperate to raise money for her husband and two young children, she worked 22 hours of overtime in a four-day period this spring. She began to complain of dizziness and headaches, and she talked constantly of how she needed to sleep.
On May 30, after more than 54 hours of work over four days, she died suddenly. Her last words to her sister were: "I am so tired. Give me the key to your home, I want to have a rest."
After her death, a local newspaper investigated and found that the garment factory had routinely forced its employees to work overtime.
If the workers failed to finish their orders, the factory gate was sometimes locked to keep them inside, and they were threatened with a loss of pay.
The investigation found that 70 per cent of factories in the Pearl River delta of southern China, where Ms. Gan worked, had required its employees to work more than the legal maximum of overtime every week.
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