What the Heck’s Going on in China’s Video-Game Market, the Largest in the World?

The Dragon in the Game Room.

By Adam H. Williams, Senior Associate at E911-LBSLBSglobe.com, for WOLF STREET:

The opening of mainland China’s video game market to the world, combined with the rapid adoption of smartphones in China, has helped drive the extraordinary rise in global video game sales of the last decade. China’s gaming-industry revenue soared tenfold from 2008 through 2017. In 2018, China’s 620 million video game players spent about $38 billion on video games, or about 28% of the global market and half the global mobile market, which made China the largest video game market in the world, ahead of the US at $30 billion; and it helped make video games the largest form of entertainment in the world, with $138 billion in revenues, ahead of TV (see our chart of the global growth of video games by category).

In early 2018 something within this market changed, albeit very quietly at first. The government banned all new video game sales for the entire year! Additionally, they began to impose usage restrictions potentially impacting your social credit score.

Major Chinese tech companies have been seriously hurt by these blows. Tencent is ostensibly the largest gaming company in the world, though it may be better-known as the provider of WeChat. Due to the new game bans and usage restrictions, its stock is down about 25% from all-time highs in early 2018. The other major Chinese gaming company, NetEase, has experienced similar woes, with layoffs already announced. Its shares have dropped 35% since the end of 2017. One can only assume smaller operations have been feeling the pain outside of the public eye.

At the end of 2018, the ban lifted and approvals started coming out – but the loss of a year isn’t going to be recouped overnight, particularly since many titles may have lost their luster. Moreover, the approving regulator in February of 2019 asked for companies to stop submitting games for approval, as they had to deal with the backlog the ban generated. This means the ban is effectively back for the time being.

This slowdown/stall in China has pummeled projections for the gaming industry worldwide and shocked the markets. Gaming revenues are now expected to decline in 2019.

Global Impact

The Chinese gaming market is unique in several respects: its size, its culture, its barriers to entry, and the huge role that government plays.

Between 2000 and 2015, all foreign game consoles were banned for official sale, forcing gamers into a deep PC game culture. This culture revolved heavily around netcafes where paying for access was part of the way of life.  When the consoles (Xbox, PlayStation, Nintendo) were finally approved, they proved to be prohibitively expensive and gained little traction.

The rise of the smartphone, however, finally provided an inexpensive and common platform and China’s pent up gaming desire exploded. Most of the video-game growth globally in the last 10 years has been driven by mainland China coming online beyond normal demographic increases and general smartphone market.

Meanwhile, the government maintains tight controls over what is allowed in the market. Spending too much time gaming is seen as a social ill with real repercussions. This approval ban also affects foreign games and associated capital flows.

Quirks of the Chinese market

China requires foreign games to have local partners. Beyond this, all games must receive official approval, and numerous games are banned (not always for clear reasons), or publishers are required to alter the games.

There are also accusations for knockoffs of games. While rarely mentioned in major news, it is a significant part of trade talk discussion – this is a multi-billion dollar issue as players struggle to access the Chinese market while their products are being copied often wholesale as this USCC report notes.

Consumer spending patterns are also wildly different. Pay to Win in China is seen as a legitimate course to “victory,” whereas in nearly all other game cultures it is viewed with deep disdain. It is curious to note that, “micro transactions accounted for 88 percent of PC games spending in 2016,” according to a report by IHS Markit. Similar spending is likely on mobile. In other words, Chinese spending was not on games per se, but on in-game purchases, accounting for the majority of revenue in both the PC and mobile markets.

Chinese players also tend to switch games quickly. A game will become fashionable; urbanites will buy their way to powerful characters to gain face; and then they will quickly move onto the next fashionable game fad.

Many big gaming companies desperately want access to the Chinese market, but they aren’t getting it. Certainly, the government bans and delays haven’t helped, nor has what can be called a “cultural gaming crackdown.”

Why the Crackdown?

So, why the crackdown? Issues of Political Acceptability, Social Order, Good Behavior, Health (particularly eyesight), and Frivolousness are all cited for the approvals ban and obstacles. So the state is limiting game use. Tencent has already implemented in-game controls over playtime and amount of play available to minors, at the request of the Online Games Ethics Committee. The state has set limits on when you can play and how long you can play – children under 12 will be limited to just one hour of play per day, 13-18-year-olds get two hours – and overall there is a ban on play between 9pm and 8am. There is also talk of using facial recognition to help enforce the limits. There is talk that too much play will impact social credit scores.

Furthermore, Authorities have been cracking down on gambling, so if in-game transactions are deemed to be gambling and the practice banned, the sales losses could be even more extreme given the micro-transaction nature of the market.  Interestingly, Chinese laws on things like lootboxes are actually some of the most comprehensive in the world.

Chinese Acquisitions, Market Access, and Global Impact

With the internal market struggling, one item rarely talked about is that major Chinese companies have been quietly purchasing stakes in foreign studios. While not nearly as sensational as Chinese property acquisitions, this acquisition binge is very real yet difficult to understand due to the closed nature of many of these deals. Epic Games for example, the creator of Fortnite, is actually 40% owned by Tencent, making the pain of games like Fortnite not getting approval cut even deeper.

Tencent, in particular, has aggressive efforts to gain international sales. Recently, Epic Games launched its own game-store, and aggressively expanding, offering lower commissions, and (unpopular) exclusive titles.

Unfortunately, Epic has been accused of several privacy scandals, allegations including harvesting PC data and system modification without permission. And Fornite has had several security compromises giving serious concerns of privacy and data protection.  The store itself is not nearly as mature as its main rival Steam, lacking many features.

While obviously more customers are good for business, attempting to buy your way to success doesn’t seem to be going so well. If Chinese Tech companies are forced to liquidate foreign game investments due to capital shortfalls, there could be major ripple effects difficult to anticipate but likely impacting globally.

Of Note: only about 5% of Chinese game profits are by US companies, and only 25% international – 75% of the market is internal. This dovetails to the trade war concerns as outsiders struggle to get a piece of the market which remains mostly closed. This is a big deal, as many major players are going all in on mobile, with hopes to get a piece of the cake, but are not allowed in.

Also of note: No Chinese game has ever made it big outside of China. While some titles have gained limited popularity – usually in limited markets – there has never been a global success.

Looking Ahead

Will China’s love of spending money on mobile games last? Will micro-transactions continue to be popular as incomes become debt-constrained and central authorities limiting playtime? Will Pay-to-Win mechanics be fashionable in a time of tight wallets? With Chinese consumers cutting back their game spending (by choice or by force), plus the de facto ban on new games, the result is likely more financial impact. If the game market worsens, it could easily have global repercussions not just on game market, but even on the Chinese economy overall. By Adam H. Williams, Senior Associate at E911-LBSLBSglobe.com, for WOLF STREET

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