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Upsurge in online gaming in China and the success stories

In the contemporary world, China has attained a niche for online gaming with ‘role playing’ games acing the list of top grossing apps on Android and Apple store within the nation. The country has a netizen population of 700 million and the internet penetration was 51.7% in 2016 (Source: CNNIC Report 2016). This surpassed developed countries such as the US, Japan and UK in terms of gaming revenues. The nation led online gaming industry with revenues crossing 24 billion USD followed by the US and Japan (2016) as seen in the below chart.

This growth in China is conspicuous, especially since the stocks of game developer giants such as Netease Inc., Tencent Holdings, Kingsoft Corp., Changyou.com and Electronic Arts Inc. performed well in the past few years. Their stock prices increased at a CAGR of 30-50% varying from company to company. The nascent stage of web gaming had partially helped the companies to splurge on this opportunity and build a vast empire of the virtual world, which grasped the attention of Chinese netizens. Thus, since the launch of the first graphic game in 1999 there has been no looking back.

The rise in stock prices of the 5 gaming giants in Chinese market from 2008-15 is represented in the below chart.

The number of online gamers in China increased to 446.3 million (2015) from merely 67 million (2008) according to the IBIS World Market Research, indicating that a quarter of nation’s population plays online games. The year 2008 can be attributed as a trigger when China witnessed import restrictions on gaming consoles. Consequently, revenue of Chinese online game operators grew at a whopping rate of 72.2% from 23 (RMB million in 2008) to 143.6 (RMB million in 2015) (Source: Iresearch). Moreover, during this phase there were several changes in the internet and telecom industry such as the rise in the number of internet users, increase in optical networks and 4G, improvement in living standards. This, in turn, raised the demand for on the go entertainment and creative business models for enterprises, this introduced more channels in the industry, and led to the surge in the number of gamers and revenue by nearly 6 times.

The revenue of Chinese online game operators and gamers from 2008-15 can be seen in the following chart.

Furthermore, the analysis on the success stories of the online gaming giants in China (Netease, Kingsoft and Changyou) were perceived by Televisory. The following examination throws light on the common factors such as accelerated revenue growth, the increase in daily active users, more investment in R&D, continuous introduction of new games, successful alliances and healthy EBITDA numbers.

Netease Inc.’s high profitability is mainly attributed to its exponential growth in revenue. The reasons behind the rise in revenue to 3,625.5 (USD million in 2015) from 1,126.3 (USD million in 2011) can be accredited to the following:

  • The company with its large in-house R&D team brought vigorous game additions and built a diverse game portfolio that could reach the broadest possible user base. Comprehensive upgrades proved successful and reignited the interest of existing players. A successful partnership with Blizzard also helped to bring licensed titles in the local market.
  • It was due to the increased traffic of users on its popular web portal, the internet media segment saw an increase in advertisement revenue and effective returns on advertisement budgets.
  • The success of Kaola.com, a cross-border e-commerce platform was launched in 2015.

Netease adopted two different strategies, a diverse revenue stream and a continuous introduction of new games to capture on-going gaming trend. This increased its revenue by more than 5 times. However, there was a fall in the gross margins due to increased direct cost of production and development (contributing 70% of the total cost) for vigorous pumping of new games, this, subsequently, resulted in the decline of EBITDA margins.

The second company is Kingsoft Corp., whose gaming revenue almost quadrupled from 157.7 (USD million in 2011) to 902.5 (USD million in 2015), while its EBITDA margin came down 3 times. A few reasons behind these were:

  • Kingsoft’s all in cloud strategy, solidified its position in the cloud gaming market as they launched 60 new titles in 2014.
  • The high quality intellectual property content owned by the company helped it to maintain proprietary rights.
  • Thirdly, with the formation of Cheetah Mobile App firm in 2014, Kingsoft grew as the second largest internet security software provider.

However, EBITDA margin declined from 2013, when the company invested more in R&D to further develop and protect its cloud-based analytics. Additionally, in the following year, an increase in traffic acquisition cost for accelerating global market expansion also reduced its profits.

The third performer Changyou.com Ltd., a relatively smaller player in this industry managed to increase its revenues from 484.6 (USD million) to 761.6 (USD million). This increase can be attributed to:

  • The success and vast user base of its flagship title TLBB (Tian Long Ba Bu), that still contributes to the majority of its revenue.
  • Secondly, the successful spin-off from Sohu.com to become a separate online gaming entity.

However, the steep fall in profits in 2014 was due to the heavy goodwill impairment in the same year since this was a non-recurring expense, profits rebounded in 2015.

In addition, the domestic and international counterparts of these companies did not have fruitful years. The Chinese companies such as Gigamedia, Kongzhone Corp. and The9 Ltd. were not so successful due to various reasons, for instance, asymmetrical development of product quality and user traffic, inability to innovate or upgrade existing games and failure of famous titles.

The US-based gaming companies such as Zynga Inc. and Glu mobile are still struggling to reduce their losses and improve their margins. The web games have a shorter lifespan and need continuous upgradation or extensive game additions. These companies tried to enter the Chinese market and failed to make fit games for local mainstream preferences. Therefore, western companies attempting to enter the Chinese market need an experienced partner, which understand local practices and users and help in designing games to fit these preferences.

Although the gaming users decreased in 2016, the industry has a lot more growth potential. The success mantra is “Survival of the Divergent”, meaning one must keep evolving with multiple revenue streams from different titles or partnerships or other allied products. While margins above 35% are still high, continued investment in R&D to innovate and maintain the stickiness of users may normalise these margins in future.

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