Is a trade battle looming with China over World of Warcraft?

World of Warcraft, one of the most successful fantasy online role-playing games of all time, was recently shut down in China for weeks. On June 7, Activision Blizzard‘s Blizzard Entertainment division changed its Chinese online operator from the9 to NetEase — a transition that could have been executed in a routine manner.

Perhaps it was a botched technical transition that was partly to blame? I am told that is not the case and that the technical transition happened weeks ahead of schedule. The delay in getting the game back up can also be attributed to a content review by the Chinese government. On July 31, NetEase started a limited beta test of the game, as a result of a compromise where the game could operate for free while still under government review. And only in the past week have gamers been allowed back on for free. A full relaunch should be coming in a matter of days. With each passing day, Activision Blizzard is losing a lot of money, since WoW had four million Chinese players who log in to the game at internet cafes with prepaid cards.

Was the delay politically motivated? And should the U.S. government view the matter as an international trade concern? Though a trade war is very unlikely, these questions are gnawing on game industry observers and companies with vested interests in China’s video game market. World of Warcraft’s importance can’t be understated; it’s a billion-dollar franchise and one of the most profitable games in the video game industry, with 11 million subscribers paying money every month to play.

China has already been in the hot seat on trade matters. As the U.S. announced tariffs on Chinese products such as tires, China responded with its own investigation into U.S. exports of chickens and auto parts to China. WoW has been the leading foreign game in China’s online game sector, which has been growing dramatically.

The Chinese online game market will hit revenues of $3.65 billion in 2009, according to market researcher Niko Partners. Since WoW is offline, most of the revenue is going into the pockets of China’s homegrown online game companies. Few other foreign games, with the exception of Shanda’s AION (made by NCSoft of Korea), have generated much revenue.  The question is why was the Chinese government  is so slow to approve the relaunch of WoW by NetEase, a Chinese company?

China’s General Administration of Press and Publications (GAPP) is responsible for granting permits for online games before they can launch. The department within the GAPP that holds that responsibility has grown increasingly powerful as revenue has increased, and some of the Chinese online game operators have publicly listed their stock on foreign exchanges. When Blizzard Entertainment (the division of Activision Blizzard that created WoW) opted to license WoW to NetEase after the initial license for the9 expired in June, it rendered invalid the GAPP permit required to operate the game. Such permits are nontransferable, said Lisa Cosmas Hanson, founder of Niko Partners.

Getting a new permit should have been easy. But when NetEase applied for a new permit, it was denied based on the game’s “unhealthy content.” WoW’s content has not changed over the years, and neither have the GAPP standards for healthy content, so it’s dubious that this is the real cause of the delay.

While the letter of the GAPP law hadn’t changed, the ministry’s focus on detail did. Previously, the GAPP required Blizzard to change undead characters so they were fully fleshed (In Chinese culture, showing visible human bones is taboo). This time, GAPP also asked Blizzard to change icons that depicted severed heads or bones as well.

Chinese game industry regulatory policy is fairly cumbersome, particularly for foreign companies, Cosmas Hanson said. Getting a permit from the GAPP is a hurdle, but, on top of that, any foreign game company in a legal dispute with a domestic game company will have the content approval of their games suspended until the dispute is resolved. There was a legal dispute between the9 and Blizzard, but that has been resolved, so it cannot be the issue. Another policy states that a foreign company may not operate an online game on its own in China; it has to have a Chinese partner and share its revenues with that partner, Cosmas Hanson said. Chinese game companies that operate in the U.S. have no such restriction.

Blizzard has planned the transition for some time. When NetEase and Blizzard formed a joint venture in 2008, their strategy included support and services, but, as recently noted, the plans did not mean that Blizzard would directly control the online game operation of WoW or other future titles. Blizzard has told this to the Chinese government, so it should not be an issue. Maybe the problem was the novelty of the change. Blizzard’s transfer of WoW’s license from the9 to NetEase marked the first time that an online game had moved from one online operator to another. Perhaps the GAPP feels that switching operators would be disruptive to the sector because the practice is discouraged and no one else has done it.

But the question of what really held up the GAPP approval process for WoW still stands. Some industry observers wonder whether the Chinese government was blocking a foreign game in order to limit the leading games to those that are domestically developed, thereby restricting trade of online games. That could possibly trigger some kind of trade battle, if the U.S. government were focused on the problem. Of course, with President Obama prioritizing healthcare, WoW is probably an afterthought.

Admittedly, a Chinese conspiracy against WoW is unlikely and can’t be substantiated (yet), especially since there are other foreign games on the market there. It is still worth watching, since none of those other foreign games generate the same level of revenue as WoW. The thought that the Chinese government would so narrowly protect the interests of its game industry as a whole — as opposed to Chinese game players — comes as no surprise. There are at least two other questionable pieces of Chinese regulatory policy. For instance, it still takes six to 12 months  to obtain a permit to sell a foreign-packaged PC game title in China. That means that pirated copies of the game will saturate the Chinese market before the legitimate copy becomes available for retail purchase. That makes the market very unattractive for foreign game makers.

The other major matter of concern for trade policy is the ban on the sale of game consoles that went into effect in the year 2000.  The stated reason for the ban at the time was that the government wanted to protect Chinese youth from unhealthy activities like playing video games. Then PC online games took off the next year.

In the meantime, the console makers have lost untold amounts of revenue, as has the Chinese government, which has not captured any tax revenue from legalizing the sale of consoles. The Chinese market for PC games has surged to more than 60 million gamers, according to Niko’s estimate. Only a few million Chinese gamers take the risk of playing games on illegally imported game consoles.  Why does China continue to ban consoles when legalizing could generate millions of tax dollars, enable government oversight of game content, and provide choice beyond PC gaming?  Perhaps it is because there are no domestic console makers, and therefore the industry revenue would go entirely to foreign companies. Of course revenue generated by related businesses such as game developers, distributors and operators would go to Chinese companies, but is China blocking fair trade by banning foreign consoles from being sold?

The Entertainment Software Association, the U.S. game industry’s trade group, has been watching for intellectual property violations in China and worldwide on behalf of its membership for years. Companies such as Nintendo have done stellar work at uncovering counterfeiting operations that feed global channels for illegal products, and China is home to many of those operations. Should the office of the U.S. Trade Representative now take a harder look at Chinese regulatory policy for the approval of foreign games and game consoles? It might not result in much action, as there doesn’t seem to be proof that China is intentionally blocking trade or impinging on foreign companies who try to do business there.

But perhaps it is worth investigating what really happened here, even if Blizzard starts charging users for the game again within a matter of days. Are these circumstances unique to World of Warcraft, or could this happen again? Blizzard’s nightmare may be near an end. But Activision Blizzard chief executive Bobby Kotick said that the company wants to take the next Blizzard online title, Starcraft II, to China. And Blizzard has not received approval to launch its World of Warcraft expansion, Wrath of the Lich King, which launched in the rest of the world last year. So the issue will continue. Games know no borders when it comes to pure enjoyment; when they hit artificial barriers, we all lose.