China has one of the most dynamic and unique game markets in the world. Rising from virtual non-existence a decade ago, and surviving a stage when every disk was pirated, the nation has become a force to be reckoned with in online games. Lisa Cosmas Hanson, managing director of Niko Partners, has watched the Chinese online game market for more than a decade. She has seen the rise of publicly traded companies such as Tencent, the launch of popular Western massively multiplayer online games such as World of Warcraft, and the emergence of social networking games. Mobile gaming has exploded with hundreds of Android app stores. And now there’s even a glimmer of hope that the Chinese government will allow the launch of game consoles, particularly if they are education focused. We talked with Cosmas Hanson about this ever-changing market. Here’s an edited transcript of the conversation.

GamesBeat: What kind of games are popular in China? Has the demand for World of Warcraft changed at all?

Hanson: I think World of Warcraft demand has changed slightly on a global scale. I don’t think it’s any more dramatic in China than it is anywhere else in the world. But I don’t have their exact data points. Now, the games that have been popular remain popular. Fantasy Westward Journey is so old now, but it’s still the leading game in the internet cafes. It’s among the leading games on the MMORPG list as well. Riot Games’ League of Legends is a smash success right now. We call that “advanced casual,” so it’s a different list. It has far more hours than Fantasy Westward Journey. It’s a new game. Gamers are attracted to it, and they’ll spend their time and money playing it. I’m sure it’ll be catapulted up towards the top of our advanced casual list when we come up with our top 10 list for home, internet cafe, office, and school use combined. But out of the internet cafes specifically, it’s doing quite well.

GamesBeat: How big is the Chinese game market?

Cosmas Hanson: It’s a harder question to answer than you’d think, because while social network service (SNS) game revenue, which is basically social games just through SNS sites or microblogging sites, started at next to nothing in 2009, it’s rising pretty quickly. But in absolute value, the massively multiplayer online games (MMOGs) still totally dominate. So the SNS game revenue compound annual growth rate is 31.2 percent, and the MMOG rate is only 22 percent, but at the same time, in absolute value it’s so much greater. Overall, it will hit $20 billion by 2016 from $7 billion this year.

GamesBeat: Tell us some of the category numbers.

Cosmas Hanson: The SNS game revenue for 2011 is $753 million US dollars. And in 2016 we think it’ll be $2.9 billion. And then MMOG revenue may be six times that for 2011. In 2016, if the growth rates continue, we will see the total growth rate slowing to only 13 percent from 2016 over 2015, yet MMOGs will still generate $12 billion in 2016.

One thing to say about these numbers is that we always have declining growth because of the law of large numbers and the growth just becomes unsustainable. We keep thinking that it’s got to peak, but then this year, total games revenue was still 46 percent higher than in 2010.

GamesBeat: What does the 2016 figure include?

Cosmas Hanson: That includes MMOG, SNS, and casual games. And so we keep thinking, well, this rate of growth has to come down. The investment community has kind of written off these Chinese online operator stocks, and Chinese operators themselves are looking to international markets for their growth. Yet their domestic market is still growing so much. It’s perplexing that it continues at such a great pace. (By comparison, the U.S. console market fell 42 percent in April.) When we look at what we see for internet users and the rate of usage for online games for internet users, and then behavioral changes between the city tiers, from the big cities of Shanghai and Beijing to some smaller cities further afield, we find the growth. People don’t have a whole lot of entertainment choices. We can see that the usage of games is important. But there are a lot of other choices too. Online video is a very popular thing in China, especially now. It actually outpaced the use of online games as an internet application. We look at all these factors and we try to say, ‘Well, maybe something else is going to come along and knock down the growth rate of online games.’ But we still find that the gamers who are playing continue to spend money, and the gamers who will enter will spend some money in the games, and the revenue just keeps coming.

GamesBeat: What do you see when you compare this to the West or, specifically, to the U.S. market?

Cosmas Hanson: I know that the Chinese PC game market is absolutely critical as a segment of the global market. It’s just so much bigger than people are willing to understand. These U.S.-based and Europe-based companies feel like they’re locked out of the Chinese market, where they can only enter the market with a partner. It is quite difficult to enter, but if you have a hot MMOG, then you can take share away. The problem is you have to get a licensing deal. Then you have to get content approved by the government. You have to jump through lots of hoops and it’s not easy. But it’s worth the payoff once you’re there. It’s definitely worth figuring out what the gamers want and what the government would accept and who the right companies are to partner with in order to have the opportunity, should your development team be as top-notch as you’d hope they are.

GamesBeat: Trion recently succeeded in doing that with its Rift online game?

Cosmas Hanson: Yeah, they did quite a deal with Shanda, and I’m quite hopeful for that game. It’s a type of game that Chinese gamers should like. The only thing that could screw it up is if the companies somehow don’t protect the data. I think that the game itself, assuming that it’s marketed well, and assuming that it hits at a time when gamers are willing to take a few days to try it out, it should be successful. But we saw another game that should have been successful from Korea, Aion. It really was not as successful as it could have been. Some people say there was a lot of hacking and account theft within the game. A lot of operational things didn’t go smoothly. Hopefully that type of thing won’t happen again. It’s rare that it does, but when it does on an AAA title it’s just devastating.

GamesBeat: Speaking of bots, I heard lately that a lot of them have moved into the iPhone downloads business?

Cosmas Hanson: Not just iPhone but Android too. The way people get their games in China is different from here. There are hundreds of stores. I heard a figure of 400 app stores, for legitimate downloads. Plus, phones are jailbroken on purchase. There are all kinds of app stores that you can use, or just places to get illegally downloaded content. So we don’t yet know. We’re publishing a report on mobile games in June. But until we finish the research for that report, we won’t really understand why the gamers are continuing to buy games legally for their phones if they can get almost all of their games illegally. So we’re trying to understand that as well.

GamesBeat: I guess the bots are not just a problem for PC games anymore, then? They’re probably across all of gaming.

Cosmas Hanson: It feels like it’s almost a sport in China, to write some code that will be destructive. But I don’t know any specifics about that occurring in mobile phone games.GamesBeat: The good thing for China seems to be that the growth rate, even though it’s slowing, is still a lot better than the West and the main console market.

Cosmas Hanson: Yeah, I don’t think it’s a regional growth problem. I think it’s a platform growth problem. Now that you can see console quality in online games, these games are disruptive and are becoming far more pervasive and the distribution costs are lower. The operating costs are of course high. I think you’re finding that the platform of PC is so much easier to serve on a global basis than the platforms of consoles. And so maybe consoles are on their way down as a platform. Maybe they’re not.

There’s still a place for them, it seems, and we’re even seeing consoles spring up in China, where they’ve been illegal since 2010. But they’re more playing these for the simple games. So for example there are two separate Lenovo products being launched right now in China for consoles. One is what they call the iSec, and now Eedoo CT510 motion-gaming console. It was just in the news this past week. It supposedly was launched on April 29, with the Kinect-like capability. It’s not quite a clone, but is similar to Kinect. That is a spin-off of Lenovo and the spin-off company is called Eedoo. Their product had been delayed and delayed and it was finally announced that it would launch on April 29 in mainland China for $600. We’ll have to see what’s going on with the regulation of consoles, whether or not the western console makers can enter, and perhaps then with their theatrical-quality games take some share away from the online games.

But at the same time, Lenovo is launching a smart TV with internet connectivity. That’s this month. And within it will be a system-on-chip that works as a console, fully capable of playing 30 console games. I think six are offered for free and then somehow you have to pay for the other ones. I don’t know the full model quite yet. You have to buy a controller to go with the TV, or there’s a free iPhone app available on the Chinese app store that turns your iPhone into a controller for that TV so that you can play those games. And those games are more like a Wii game. It’ll be interesting to see if those games just automatically are approved, or if they have to go through some sort of process, and if gamers are eager to play on their TVs in addition to on their PCs.

So we’ll watch these two different products launch and then we’ll see what the regulators have to say, and meanwhile watch games like Rift enter the market. It could perhaps awaken a whole different segment of gamer. Or, at the same time, they just might get overwhelmed and retreat back to the sanctuary of casual and social games that all the people they know are playing, and have become really popular, just so they can be able to communicate in real life with people that they know about games that they’re all playing.

GamesBeat: China’s social games are $753 million now. It seems like the market is quite a bit smaller there than it is in the U.S., where Zynga alone is a billion-dollar company. What explains that difference between the U.S. social market and the Chinese social market?

Cosmas Hanson: I think some of the games in China don’t all generate revenue. I think that there is so much gameplay already on PC that they are used to playing they way that they’ve been playing over time. We can look at the growth, where in 2009 I think our estimate was that social game market in China was $80 million. And in 2011, two years later, it was approaching $800 million. It’s just really speedy growth. It’s serving to diffuse the attention away from the traditional PC online games and give the gamers something else to play. Also, I think Zynga is probably getting a lot of revenue.

But some of the American major social game developers have to be generating a lot of their revenue from the mobile platform, and in China smartphones and tablets have really only been there about a year. So we’re watching huge growth in the sales, unit sales rates, and you can see Apple’s revenue growing so much just based on the China presence alone. And so I think we need to give the market a little bit of time to have penetration of smartphones and tablets, where these social games are so readily played in the rest of the world, and meanwhile recognize that this tenfold growth has happened just on PC.

GamesBeat: The internet cafes are still going strong over there?

Cosmas Hanson: Yeah, the internet cafes are going strong. We’re collecting monthly data now in internet cafes. What’s interesting about that is, the behavior of the gamer who plays in an internet cafe is different from even that same gamer playing at home. Or quite different from the gamers who would never go to an internet cafe. We see different games emerging as popular from within the internet cafes than in the home. I think gamers who go to internet cafes are playing client-based games. Sometimes web-based games. But they’re not spending a lot of their time in the internet cafes playing social games, unless they don’t have a PC at home. And then they need to go there to play those things.

But those are such short games that they can often play them in an office or a store where there are no customers and things of that nature. You sit down in an I-cafe to play for an extended period of time, and so the social game becomes a kind of interlude rather than a reason to be there.

The internet cafes are still quite important as a channel. They might not generate as much revenue as the home user segment. In fact they don’t, but they cannot be dismissed. Especially as the internet penetration extends to the smaller cities farther away from the great metropolis. The main way for those Chinese citizens to get online is to go to an internet cafe. Many of them could never afford to have a PC at home.

The internet cafe might be losing its luster as a channel in the tier one and tier two cities, or as a primary point of access, but in the smaller cities where the game companies are more frequently sending their field marketing agents to promote games, those internet cafes are still quite important.

GamesBeat: I wonder why they haven’t taken off in the U.S.?

Cosmas Hanson: If there were to be one, it would be marketed as something different. It would be a gaming center. Somebody told me today that for her 10-year-old son, she’s hiring a truck to come to their house and it’s loaded up with game consoles or whatever it is. People just like to congregate to play together, it’s like a roving LAN party. Maybe in that sense, if you could just have a collection of seats with high-speed access and high-end computers and make it more of a party or a tournament or something. In that case I think they could be popular.

But you don’t need an internet cafe when you have such high rates of home PC penetration. No matter where you go in China, people say that they don’t ever need to go to an internet cafe again once they get a home PC. Because the I-cafes can be pretty disgusting. But the people who do continue to go in the tier one or tier two cities, they go, like I said, for different reasons. They go to play different games with their friends, more like a sport or a social outing, and they go to try out new games, they’re being promoted there by the online game operators. Or they go because they just want to escape from, perhaps, a cramped house situation.

GamesBeat: You mentioned that the stock market reception for game companies has changed. How long has that been going on, and what actually has been happening there?

Cosmas Hanson: It just feels like the pulse of investment and buying these shares has slowed down significantly. And the stock prices and the market caps have fallen for these companies. The reasons we’ve found, when asking some of the stock analysts what’s going on, is that they say, ‘Well, the growth in China is going to dry up soon and the online game operators are looking to other countries.’ So for some reason they just think that their primary market is not going to be able to sustain their growth levels. I just think that’s not the case. Maybe I misheard, maybe I don’t understand. But from our data, it shows that things are very rosy there, and that there are plenty of online game operators, there are plenty of publicly traded ones, there are plenty of games.

The market is probably too game-saturated, if anything else. And there are plenty of gamers. I think one of the very interesting and compelling points about the Chinese digital entertainment market in general is that even the online game operators, who had been solely focused on development of and operation of, or in some cases just licensing of and operation of, online games, are now diversifying into mobile games, social games, even online video. All these different entry points for people who have internet access and want to have some digital entertainment on a social level or even a viral video kind of level. At some point these things are all going to merge, there’s going to be this cohesive moment where it doesn’t really matter whether you are developing a hit game or not, so long as whatever you developed is going through the right channel and being right in front of the voracious appetite of the Chinese current gamer audience. It’s probably going to succeed.

And I think that the game companies are trying to hedge their bets and see where all the different avenues of growth might be. They’re watching what happened with social games. They’re seeing the emergence of mobile games. They’re seeing the online video out-seeding online games in one of the government rankings of internet application usage. They’re wondering, ‘Wow, what can we do?’ Well, one thing you can do is put out a hit game like League of Legends and really understand the market and find the right distribution partner and really try to serve a need in a segment where there are lots of games that have been around for just too long. As you can see by some of the data, that game is doing quite well.

GamesBeat: If there is some change in the market cap, do you think the Chinese companies would all come to the U.S. and start buying a lot of the U.S. companies or startups? That’s happened to some degree, but do you think the change in the Chinese stock market will make it more pronounced?

Cosmas Hanson: I don’t think they have any shortage of cash balance. I think they still have enough money to go buy things if they want to. But the more important emigration kind of concept is that, in America, we don’t require foreign companies to share revenue with a domestic company and operate games through a domestic company with domestic-owned servers. We allow companies to just come here, set up shop, and start operating their own games.

On the telecom infrastructure side, I believe that there’s some sort of national security thing that dictates who owns the telecom companies. I don’t get into all of that. But I think that it’s a lot easier for a company to come here and just say, ‘We’re here!’ and try to operate a game. The interesting part of that is that the games that have been just tremendous successes in China may not become tremendous successes here. And that is because the foreign companies have been less welcome, because of the rules and regulations and hoops to jump through to launch their games in China. And also because, historically, a lot of the American game giants have been focusing most of their development efforts on console-based games, and those just haven’t been there in China.

What we see is these Chinese companies have developed into massive companies without any of the opportunity to compete on a global scale, even on their own turf. They are not competing against global giants on their own turf. They’re just competing against themselves. So when they come overseas, they come to America for example, and they think, ‘Wow, we’re the big man on campus.’ They get there and it’s sort of like being in high school and then suddenly you end up at Stanford. You’d better well be a big man on campus or you won’t be anymore at Stanford.

So to watch the whole entry and exposure here, it does sometimes take acquisition of studios that are American-run and American-managed, just so you can have a listening post and understand what gamers are going to want, how the system works, what partnerships you need. All the different steps it takes for any kind of international market expansion effort. Because you have a hit product in your home country, no matter what it is, it might be a toaster oven, it doesn’t matter, you have to understand the market where you’re going, the ways to get in, the methods of access, and the availability for you to make a profit. And all of that is a truth even for foreign companies going to China.

It’s just that the door is smaller, the pathway is narrower, and your margin for failure is bigger. So you need to be more prepared to enter China if you have a hope of succeeding than you do if you’re coming to the US and you have the luxury of maybe throwing spaghetti at the wall. So you see that the Chinese companies are coming here, they are buying studios, and they’re going to other places too, like the Philippines or southeast Asia or Russia. Wherever. There’s a great deal of international expansion and the Chinese government is promoting those companies to develop internationally, expand internationally. I think it’s in their best interest for their domestic success, if they do get this international exposure, but I don’t know what the pace will be for that, or what exact steps they will take for that. But you can be sure that each and every one of those, at least the publicly traded companies, will be making a march to another country, or to more than one, in this year and the years forward.

GamesBeat: Do you see some intersection point where China becomes the biggest game market at some point — and, if so, is it visible yet, as far as which year that might happen?

Cosmas Hanson: I wish I knew the total global online game market revenue. I don’t. But I think that the Chinese PC online game market already makes up at least 50 percent of the global online gaming market. It is the biggest online gaming market.

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[Photo credit: top photo by World of Stock, Derek Brown]