9 Sep 2010 07:44

Online games sector faces challenges and opportunities - analysts

By Nancy Zhang

Shanghai. September 9. INTERFAX-CHINA - Mixed second quarter results this year from China's leading online game operators show a leveling off in the robust growth of the industry that has lasted for over a decade. Not only is the online games industry going through a short-term transition, according to analysts, it is facing a challenging long-term slowdown. Rooted in macro-level changes in China's demographics and consumer environment, these challenges threaten to change the rules of the game. But investors say these changes also contain new growth opportunities.

Of China's six leading online games operators, Perfect World Co. Ltd. has seen its profits drop 25 percent year-on-year in the second quarter, while Giant Interactive Group Inc. recorded a drop of nearly 20 percent year-on-year in the same period. However larger industry players Tencent Holdings Ltd. and NetEase.com Inc. have continued to see revenue from the sector rise substantially year-on-year.

A July Citibank report noted that the mixed results are due to a lack of innovative game releases coupled with regulatory issues, and that the games industry is in a "transitional" period. Relatively simple changes such as more focus on original titles and new monetization models can put growth back on track.

However Zhao Xufeng, an analyst with domestic consulting firm iResearch, is less optimistic.

"The explosive growth of the industry in the past years cannot be replicated in the future due to an unavoidable demographic shift," Zhao said at a press conference in Shanghai last month. "The industry is facing a recession in the next two to four years."

According to Zhao, past growth occurred at a unique time in China's development where a baby boom generation coming out of austerity and deprived of entertainment met the opening-up of the Internet. But as the generation of gamers born in the 1970s enters their 30s, game play will reduce as they face family and work commitments. Future generations of under-30s who are born in the 1980s or 1990s will be much smaller in number due to the one-child policy. They will also have grown up with an increasing array of entertainment choices competing for their attention.

Richard Liu, managing director of investment firm Morningside Ventures, told Interfax that games companies must make fundamental changes to their strategies. In the past it was enough simply to acquire licensing to a good title and then work on expanding distribution channels such as Internet cafes.

"But now, companies have to be a lot more creative - they have to follow the needs of new user segments, follow user behavior and find ways to monetize it," Liu said.

The domination of massively multi-player online role-playing games (MMORPG) in the domestic games market will likely decrease, said Chen Chen, an analyst with domestic investment bank China Renaissance. MMORPGs made up 79 percent of the domestic online game market by revenue in 2009, according to a white paper issued by the Ministry of Culture (MoC).

Instead, Chen foresees the rise of simple Web-based flash games, also known as casual games, that appeal to growing numbers of younger Internet users. By the end of 2009 a third of all Internet users in China were under 19, Interfax previously reported.

According to Liu, Morningside Ventures have made long-term investments in companies like Duowan.com that hosts game forums which aggregate large user bases with a sense of loyalty to the forum.

"In the past we saw loyalty to a particular game such as World of Warcraft (WoW). But increasingly we expect users to form peer groups, such as those in game forums and SNS sites, and be loyal to the group which then move from game to game, always playing with each other."

The importance of the social component in the Chinese online games industry means companies with large user bases, like Tencent, are in the long run likely to come out on top, even over those with innovative content or advanced technology, said Zhao.

The social component also makes business models with low average revenue per user (ARPU) profitable and even sustainable by not over-monetizing users. The crowd has traditionally attracted a few gamers with high ARPU from whom most of the industry's income is derived, Chen told Interfax.

The outlook for the mobile online games sector however is uncertain.

Time spent on entertainment on the move is naturally more fragmented than at a computer, said Zhao. Time spent playing online mobile games in China is also restricted due to price.

A consortium of mobile games developers at the annual online games conference China Joy called for telecom operators to reduce the cost of data packages, stating this as a major obstacle to the development of the industry, Interfax previously reported.

Zhao thinks, however, that the cost of data packages is unlikely to decrease in the near future. Yet lower income groups, such as factory workers in the manufacturing areas of Southern China, tend to use mobile phones for entertainment as they lack access to computers.

Most users therefore can only afford small data subscriptions, giving them less than two hours a day of online gaming time on their mobile devices, according to the previous Interfax report.

"Currently offline income represent around 90 percent of mobile revenue," said Zhao. "Therefore we are not so positive on the growth of online mobile games."