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What it takes to win in China´s gaming market (2/2)

Major trends on the world’s largest market

· gaming

{{{Daniel Concha Zegarra and Alexander Kremer}}}

The last three years brought disruption and change to China´s gaming industry. Moreover, we look into new challengers that are attempting to get their slice of the pie. Thus, part two of our series is focusing on major trends in the world´s largest gaming market.

As the industry continued to increase in scale and impact, China´s gaming market faced major changes during 2018. While 2019 led to a continuation to pre-crises growth levels, 2020 brought Covid-19 and accelerated growth in the short-term.

The 2018 SAPP updated regulation on new game releases pushed internationalization while Covid-19 led to a rapid acceleration in revenue growth

The last three years found the gaming sector facing disruptive changes in China.

2018: SAPP new regulation on gaming approvals

The 2018 SAPP slow-down on approving new game titles had significant impact on the topline growth of leading gaming companies. Looking at the example of Tencent, we can see how in Q2 2018 the slowdown started to have impact on revenue growth. That lasted for a whole year and Tencent only returned to quarterly revenue growth in Q2 2019.

Figure 1: Annual growth Tencent gaming revenues by quarter in % (Source: Company fillings)

However, in fact, the gaming industry did not go back to the high approval rates of pre-2018 and it became much harder to release new games into the market, requiring much closer cooperation with regulators. Given 9 months data for 2020, we forecast the game approvals for the full year to come in at around 1300-1500, in line with 2019 but still 80% below 2018. We believe that the continued low number of gaming approvals seem to favor the gaming giants.

Figure 2: Annual new game approvals China, by year (Source: SAPP)

Despite their specialization in local games, resourcefulness and acquisitions of foreign assets, China´s gaming giants remain to be highly focused on the rapidly growing local market. However, the 2018 slowdown in the Chinese market made international markets more important.

So far, efforts in internationalization mostly focused on Southeast Asia, the US and UK. Tencent, for example, took PUBG Mobile global. Also, other Chinese strategy games have proven successful overseas, making 56% of revenue in this genre in the US. For example, FunPlus’ real-time strategy game Guns of Glory has been on the top charts for several quarters in the US market. Likewise, Rise of Kingdoms is a mobile MMO real-time strategy game inspired by history. It recorded solid revenue growth this year, making the title to the second-highest-grossing Chinese title in the US in the first three months of 2020. Another example is Genshin Impact developed by miHoYo, which was inspired by The Legend of Zelda: Breath of the Wild. Genshin Impact is a cross platform title released globally just on at the end of August. It is a bigger, more ambitious blend of Zelda’s open world, and a mix of mobile gacha game with co-op play - widely receiving critical acclaim. With more than 5 mn pre-registrations outside of China, it is considered the largest international launch of a Chinese gaming title, ever. During the first week of release, it grossed USD 60 mn and ranked second in global mobile games.

Yet, challenges faced in other verticals – e.g., special characteristics of Chinese market, lack of localization – also leave attempts of Chinese gaming companies so far challenging.

2020: Covid-19 and arrival of ByteDance

Recovering from a disastrous 2018, 2019 was a relatively good year for China´s gaming industry, as major companies returned to growth. However, with 2020 came Covid-19. People stuck at home for long during the times of work-from-home, spent much more time on their smartphones and playing games. This led to incredible results for many gaming companies.

Figure 3: Gaming division revenues growth rate 2019 and Q2 2020 for leading gaming companies in % (Source: Company fillings)

As the aforementioned Figure 2 shows, the three largest gaming companies – Tencent, NetEase, Perfect World – all experienced significant growth acceleration this year. The case of Tencent is especially remarkable, achieving a stunning growth rate of 42% in Q2 2020 which tops the FY2019 growth rate of about 10% easily. Also NetEase went from 16% in FY2019 to 21% in Q2 2020, while Perfect World went from 26% in FY2019 to 48% in Q1 2020. On the contrary, 37 Games experienced a significant slowdown in revenues, possibly driven by their game portfolio lifecycle management.

With revenues, hiring has accelerated as well. However, disruptions have not been rare too, as major events of leagues such as LPL and KPL had to take place online. Also, industry forces continue to push for consolidation, as giants like Tencent and NetEase rapidly strengthen their grip on power with the networks they build for distribution.

The most disruptive force in the Tech right now is ByteDance. Concerning its foray into gaming, ByteDance this year appointed its first dedicated CEO direct-report, Yan Shou. Another senior hire was achieved when in July it announced the arrival of Feng Weihao who previously ran the World Electronic Sports Games (WESG), a gaming championship series organized by Alibaba´s AliSports. Yan´s group by now is estimated to employ more than 1000 people. Furthermore, we currently find 500+ job openings in Chinese and 15 in English language (including with focus on Japan, Southeast Asia, US) on ByteDance´s website. As we have found in our previous analysis, from ByteDance´s point of view, Gaming might be one of its most promising bets to keep the rapid growth going.

ByteDance already maintains a gaming today (今日游戏) tab in the Toutiao app since 2018 and operates the Douyin Games account (抖音游戏) as well, where it also offers gaming mini-programs since 2019. Initially focusing on third-party titles and distribution, in March 2020, it received its first game license for a game called Warrior Girl Parkour. ByteDance in summer then acquired exclusive distribution rights for a game of the popular Naruto series in China. External sources estimate that ByteDance will reach between USD 300-400 mn in non-advertising gaming revenues for 2020 (distribution and self-developed games combined).

A number of major trends are reshaping the industry

After exploding more than 10x within a decade and reaching more than 600 mn users, growth has been slowing in an industry, which, until recently, used to record high double-digits growth rates. Yet, with approvals for new games resuming since 2019 and a rapid acceleration driven by Covid-19 lock-down and work-from-home policies, the industry looks genuinely healthy. Still, a significant change is under way, catalyzed by a number of fresh trends in technology innovations, contents creation and monetization strategies which, when combined, are forcing companies to adjust their game design and operations.

Technology

Artificial intelligence is already an integral part of many games, ranging from bots to streaming moderation. Indeed, progress in artificial intelligence has been making games incrementally smarter and the user experience more and more personalized, but it is not considered a disruptive force.

For long, there have been high expectations on how AR/VR would affect game design. However, so far, from both an hardware and a software perspective, the impact has been limited. In China, this is no different. Furthermore, with the majority of the market in mobile gaming, even the mid-term impact might be more limited.

Cloud-gaming, where processing runs on the cloud rather than on a local device, has been a major force for years. Projects like Google’s Stadia, Amazon Luna and Microsoft’s Project xCloud now show how also international gaming companies pursue this trend. Given the high share of mobile gaming, combined with many lower-end Android devices and expected swift rollout of 5G technology, this trend is in particular relevant for the Chinese market. Indeed, Tencent already in 2019 opened up its cloud-gaming platform START for public testing; it also offers a service called Tencent Instant Play with Intel. Meanwhile, NetEase had teamed up with Huawei to develop a cloud-gaming offering.

Content

In terms of content, there is certainly an ongoing rebalancing between MOBAs, MMORPGs, BR and casual games. Though, this balance is mostly driven by individual titles. Given the nature of game lifecycle management, China´s gaming giants remain under pressure to allow players to come back or launching new successful titles, with the former being the preferred choice. Tencent´s King of Honors was first launched in 2015. League of Legends dates back to 2009. NetEase´s Fantasy Westward Journey dates back to as much as 2001. PUBG Mobile was released in 2017. Considering this, game publishers are already extremely committed to advanced strategies for enriching content with monthly updates and new releases. Yet, many wonder what and when the next big hit will be.

At the same time, China´s gaming giants evaluate which game types to take global. Across the largest economies at least 20% of the top 10 downloads are casual games and this percentage increases to 60% when considering rankings based on revenue. However, the preference for casual games is more predominant in Europe and North America for both downloads and monetization. In South America and Southeast Asia, this genre is more popular in the download rankings than for monetization. More companies are designing and launching new titles focusing on casual games, clearly one trend that has accelerated at least since 2019. On the other hand, it appears that the hype of BR games is following a downward trend.

Monetization

Multi-game subscription packages (monthly subscriptions for a set of games) have become a widely discussed subject in the industry. Western companies have been extremely aggressive and new players such as Apple (Apple Arcade) launched their offerings. However, in China things are slightly different as the vast majority of games are F2P and monetize via IAP, preferable play-to-win and pay-to-win (e.g., battle pass). As a result, the impact of multi-game subscription offerings might be limited.

In the larger scheme of things of the Internet, the video gaming industry stands out as an almost purely digital vertical with little interaction with the real world, requiring strong technical capabilities and smooth user experience to create closed systems of game design, publishing and operations – a true gaming universe, which is already reality in China today.

 

After the 2018 SAPP gaming approval ban, the Chinese gaming market was never the same again. Despite Covid-19 though, overall China´s gaming giants looked stronger than ever before in 1H 2020. What we believe is that ByteDance´s foray into gaming so far looks promising through a combination of game distribution, self-developed titles and a championship event series - a feat many including Alibaba tried to achieve but failed in so far. In terms of major fundamental trends, the innovations under way in technology, content and monetization point towards optimization, rather than disruption. We believe that Genshin Impact might become a new chapter in the international efforts of Chinese gaming companies.

 

All opinions expressed in this essay represent our personal views only.

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