International growth opportunities for Chinese video games companies

This article, written by Tim Merel, first appeared in the China Daily on December 31, 2010 under the title "Global games there for the taking".

The global video games market is growing rapidly, driven by online/mobile games. China has produced some of the world’s best games companies, which are now looking to international markets for additional growth. This offers a significant opportunity, but investing internationally isn't as simple as they might hope. To explain why, let’s start by looking at the global market.

A great market for Chinese games companies

The video games industry is big, getting bigger and changing, rivalling Hollywood in 2009 ($77B video games vs $85B film global revenue). Online and mobile games should grow total video games market size to $87B in the next five years, and take 50% revenue share at $44B (18% CAGR 09-14F). The historically strong pure console sector is flat to down.

Asia Pacific and Europe should take 90% revenue share for online and mobile games (China 49%, Europe 17%, Japan 14%, South Korea 11%). While North America remains important, the dominant market for online and mobile games is and will be China. If you want to be in online and mobile games, if you aren’t in China then you aren’t anywhere.

Online gaming giants target China

This article by Eric Jou first appeared in the China Daily on 24 December 2010.

The Chinese video game industry is growing up and changing the face of the gaming world.
"The Asia-Pacific region and Europe should end up taking 90 percent of online and mobile revenue," says Tim Merel, founder of the London-based digital media investment firm Digi-Capital. "If you aren't in China, you aren't anywhere."

The Chinese online and mobile gaming industry is expected to earn more than 28 billion euros in revenue by 2014 and China will account for half of that pie, figures from Digi-Capital show.

China is expected to drive the future of the industry and figures from China game industry analyst Nico Partners also see the market growing by 20 percent a year for the next four years.

Similarly, China's online and mobile gaming market promises an estimated revenue stream of $6 billion (4.56 billion euros) this year and projected revenues of $18 billion by 2014, compared to the $2 billion and projected $3 billion for the United States.

Lured by the huge potential, more European game makers are looking to set up their bases in China.

One of them is European game publishing and developing giant Ubisoft.

The France-based Ubisoft is one of the largest game developers and publishers in the world and is best known for the hit Tom Clancy games, Assassins Creed, and Rayman Raving Rabbids.

Ubisoft set up shop in Shanghai in 1996 and Ubisoft Shanghai has been cranking out game after game for its parent company.

Ubisoft established its Shanghai studio to globalize its workforce, says Corrine Leroy, managing director of Ubisoft Shanghai.

"We came to China for two things. One was to publish our games in Chinese," Leroy says. "Two, we were developing part of the game and some games for the whole market."

Leroy recalls how hard it was for her and Ubisoft to recruit talent during the initial establishment of their Shanghai studio.

"The people were less trained. At that time when we were recruiting artists, we had to train them to use 3d max (an auto desk software). But now when we recruit, even if they are junior, they have already used this kind of software," Leroy says.

"It went from extremely basic because those guys had nowhere to find us, they had no way to get trained in tools in university. But this lasted only two years, and after that, when we recruited people, they were already using the tools that we use in the industry."

The industry has grown on the back of foreign companies such as Ubisoft investing in the Chinese market and training developers. Starting with outsourcing and development for hire, Chinese game developers have begun building their own gaming brands.

But the industry only really took off around the year 2000, amid the South Korean online gaming boom, Leroy says.

Console and offline games also never really boomed in China because of the high prices of consoles were sold, and online games grew through that opening.

"There wasn't really a market to create games for Asia, it grew only because South Korea's government, a little over a decade ago, decided to invest a lot in online gaming," says Richard Tsao, managing director of Ubisoft's Chengdu business.

"Online gaming became very popular in South Korea and then Chinese operators started to see the value of licensing games from South Korea to operate in China, so the online gaming industry in China took off."

Still, the Chinese market faced other barriers. Gaming consoles subsequently became illegal and the only channel to distribute video games was through online operators, which take a huge chunk of the profits.

Foreign developers also have to cooperate with local companies to publish their games and this union usually happens with local Internet giants such as Tencent.

"We have no choice," Tsao says. "If we want to operate games in China, we have to work with Chinese operators."

According to figures from Digi-Capital, Internet penetration within China will be a key factor in the development of the gaming market and many foreign companies are eyeing a piece of the action. Internet penetration in China is currently 29 percent - or 384 million users - and is expected to reach 56 percent or 754 million users by 2014. That includes mobile Internet users. The pie will generate up to $18 billion by 2014, figures from Digi-Capital show.

The Chinese market's emphasis on online gaming is also changing the face of the industry, with piracy less of a major issue, analysts say.

Evolving from just mirroring South Korean online games to producing their own, Chinese companies have helped spur the growth of free-to-play models or f2p, in which game transactions known as micro transactions provide the income to game makers. These micro transactions act as a form of money-making in place of offering a game for free.

"What is happening now is that the government, particularly the Shanghai municipal government, is making it easier for companies to register intellectual property," says Zhang Ming, deputy secretary general of government agency Shanghai Information Services and vice-president of UBM China, which is under the Ireland-based United Business Media (UBM).

"There are a lot of games in the market now that don't care about the piracy, halfway through the game micro transactions offer you opportunities to advance in the game faster or game goods by paying for these with real-world money."

"Game makers can say, 'Go ahead, pirate our games, you are just giving us free publicity, we'll make our money through people playing our free game and purchasing game goods'."

Micro transactions, prominently featured in social network software games such as Farmville and Happy Farm, is a symbol of how ahead China is compared to the West in online gaming, analysts say.

"China is evolving the online gaming market better than any other country in the world," Tsao says. "The West is slowly catching up to the concept of online gaming in general. China has close to a decade more of experience."

Another technological improvement that is growing the video gaming industry is the advent of the Apple App store and the proliferation of smart phones, analysts say.

With the mobile phone gaming market expected to generate half a billion euros this year and close to 1.1 billion euros in the next five years, China is also becoming the home of hundreds of independent game developers working for the mobile market.

Even Rovio, the makers of the runaway hit Angry Birds, has set its sights on the Chinese market. Peter Vesterbacka, who is in charge of business development at Rovio, says it is hard not to see someone playing Angry Birds on the subway in Shanghai. According to Vesterbacka, Angry Birds is only available in China officially via iTunes and Rovio is in talks with operators on bringing the game officially to the Chinese mainland.

This kind of mobile Internet distribution system bypasses the problem of the online operators in China and is proving to be a new form of distribution, resulting in an increase in the number of smaller foreign companies coming to China to create games.

Smaller developers and companies that may not possess the investment capital of big companies also head into China making games with cheap talent and using the new distribution channel created by the iPhone to sell their games back to the West.

Happy Latte is one of such company that operates in China but focuses and sells its products in the West.

"Honestly, we don't even target China as a market, our games were not even available at the beginning in China," says Bjorn Stabell, managing director of Happy Latte.

"We were doing something for RenRen (Chinese social networking service) but we found it not as open as Facebook and the Apple App store."

Despite the seemingly closed market, it all comes down to the possibilities that the Chinese market and industry holds.

Patrik Wilkens, vice-president of sales of Shouji Mobile, a British-owned based in Beijing that deals in localization for foreign companies, sees a bright future for the game industry in China, particularly the mobile market. He cited the prospective plans of companies like Rovio, PopCap and Electronic Arts.

"First of all, the Chinese market is so big, it's very difficult to ignore it. On the mobile side, it's harder to access the Chinese market than to enter the European market," Wilkens says. "But I think the Chinese market, especially with the Android technology on the smart phone side, will grow even bigger. Android is getting cheaper and more affordable and with the whole market shifting right now to smart phones, I'm sure that companies like big ones are coming here. Rovio mobile is coming into the market, Popcap is already in the market and EA is setting up it's own studios in the market."

The increase in the number of Chinese and overseas developers making games in the country also presented opportunities for UBM, which operates the Game Developers Conference (GDC) to set up GDC Shanghai for game makers to get together and trade stories, techniques and lessons on how to make great games.

"What we're hoping for is that everything that UBM can offer regarding game making can be made available for the Chinese market," Zhang Ming from UBM China says.

"The products we can offer to the Chinese developer are very much Chinese oriented."

"Chinese game companies have built strong domestic franchises in the online and mobile game markets and believe that long-term consolidation in the games market will come from China," Merel says.

"Building on their strength in high-growth online and mobile games, Chinese companies may come to dominate the global video games market."

GDC China: Online Opportunities In The Face Of Stagnating Consoles

This article, written by Christian Nutt, was first published by Gamasutra on December 9, 2010.

Tim Merel, managing director of investment advisory firm Digi-Capital, delved into the present and future of the global game market at a Gamasutra-attended lecture during GDC China in Shanghai earlier this week.
The reason for his talk? "Because investing and growing internationally is very exciting, but isn't necessarily as simple as you might hope."

Trends in The Video Game Market
According to Digi-Capital's research, "online and mobile video games should grow the total video game market size to $87 billion in five years." These games will, at that point, constitute half of the total market revenue; on the other hand, the "console sector is flat to down."

"Asia Pacific and Europe should end up taking 90 percent revenue share of online and mobile," said Merel. Of that slice, half will be China. His conclusion? "If you aren't in China, you aren't anywhere."
The North American market "will remain important, but the dominant market for online and mobile games is and will be China."
"Consumer markets are fragmenting and growing, which is both an opportunity and a challenge," he said.
When it comes to online and mobile games, "There are many ways of playing in this space... all of them require you to execute well. And they all require specific skills and approaches. It's different to the console model almost completely, and the business model is also different."
In his view, the CEOs of the major publishers are not equipped to deviate from the strategy of making multimillion dollar console titles. When budgets are "less than half a million, they can't, and don't know how [to adapt]," said Merel.

Working in the Online and Mobile Space
Mobile and online developers have to be "not one game, hit-driven companies... they have two sorts of portfolios of games... They may have tried 10 games but maybe only three worked. The risk isn't all on one game." Companies should also spread out across platforms to create a "portfolio of distribution" to avert risk.
While Merel calls social games companies like Zynga and Playfish "great businesses," they do have a weakness, in his view: "What keeps them awake at night is their friend Facebook... they are at the mercy of Facebook. They don't have a portfolio of distribution... they have a risk to their business."
"That combination of portfolios is extremely important," said Merel, as is a strategy of "rapid low cost game development... It's about being able to respond on a daily basis."
He described a European farming game which developed a virtual item in the form of a volcano immediately after the Icelandic eruption this spring hit the news, and sold it the next day -- the ash fertilized the farmland, a benefit to players. This bit of game design was "tied to not a pretty game element, but absolutely to how they make money."
As a social game developer, said Merel, you also have "a very, very pragmatic, hard-nosed, objective view of when you cut projects."



What Consoles Can Teach


Though he doesn't see growth in the console industry, he says it's "very valuable in terms of history." In his view, "knowing the mind of the console players is very important."
"If you do the numbers, broadly speaking, you need to sell half a million to 1 million units just to break even, and that's excluding all of your corporate overheads," said Merel. And though "video games rivaled Hollywood in 2009" and were "roughly similar in terms of revenue," he points out that the $60 price point for game titles makes it an unfair comparison.
Worse yet, as all developers and publishers these days know, "failed games can be deadly." Moreover, investing heavily in a title doesn't necessarily imply anything about its potential for success, according to Digi Capital's research.
In the face of these problems, the major console publishers are struggling to invest in the online and mobile markets; unfortunately, said Merel, their weakness is understanding big launches -- but how to do small is very difficult for them.
"They don't know how to operate, distribute, and most importantly market" a mobile game. "Because of the need to do things quickly, fast, small-scale, the major publishers are not driving mobile and online game investment."


Investment In the Video Game Space
Venture capital into video games investment has declined 60 percent since its high point in 2007, Merel said. There's weakness in the VC market thanks to the global financial crisis, but worse yet VCs just don't understand the highly fragmented games market.
"It's a very high-risk market and very tough to play," said Merel. "I've seen very smart, successful VCs make terrible investments." The result? Video game companies of all sorts are struggling to find investors.

And while some new companies have sold for great deals of money, said Merel, "I think the valuations we see today won't last beyond another year. Some of them will pay off as people had hoped, and some of them won't. When some of them don't pay off, the stock market will punish the companies that have done them."

"Investing in a startup is a very high risk game," said Merel, so investing in companies "where they're already generating revenue" -- even if profits are not huge -- is "very exciting... While focusing on the high growth sectors of social and online."

The companies which will attract investment are the ones in which "it's very obvious what the exit path is... Falling in love with a company is dangerous. Investing in a company where you have a good view of who's going to buy them and why, that's the kind of deal you want to do."


One last word of caution to investors: "It's incredibly easy for people to get excited by big deals... buying big because it's big is not a particularly clever thing to do."




Advice on Chinese Partnerships


"Broadly speaking, if you're a strong independent Chinese company growing quickly..." you have a good shot to "exit to major international games, media, private equity company," said Merel. 


Chinese companies will also get a chance to "license successful international IP into China... it is not necessarily a straightforward thing to do. For the right games it's a good business to be in."

He cautioned the audience that "when you go into international markets... unless you have someone who knows the culture and is a native speaker... partnering with someone who you can trust is a very good way to enter."


For foreign companies, he advised them to "work in partnership with leading Chinese companies in the Chinese market, but recognize that your Chinese partners are the strong ones in that relationship. Investing into a great company is never a bad thing to do if you know what you're doing, and can tie it back to your business."


In Merel's view, "Chinese companies bring a lot more to deals than just cash... First is, and most exciting for international companies, is access to Chinese markets. There is so much you can bring to them which they would greatly desire. The quality of people here is extremely impressive... but the costs in terms of staff is not as expensive as in international markets."



International Business Relationships

Doing business globally can present its own challenges, Merel said -- mostly cultural differences. However, "knowledge of potential international partners' motivations is key... if you know what they want and you can give them what they want, you can get whatever you want."

"The most successful acquisitions I have seen [are those] where the appreciation for the culture in both directions exists, and flexibility in both directions exists." On the other hand, if management doesn't understand the culture of the company they've acquired, "the team gets frustrated with the management style, and in two years the earnout ends, and the team leaves and your business is done."

Chinese International Games Investment: Digi-Capital at GDC China (Shanghai)

Digi-Capital’s Tim Merel has been invited to discuss Chinese international games investment opportunities at GDC China in Shanghai on 6^th December http://slidesha.re/fNZ0Sh

Commenting on the session, Merel said, “When I gave the games investment keynote at the Shanghai World Expo earlier in the year http://slidesha.re/dJwTaX, I was impressed by the quality, drive and growth of the Chinese games businesses I met. I have never seen so many people focused on building great companies. What also struck me was the almost universal desire to invest and grow internationally, leveraging their existing strengths.

So I was pleased to be invited back to talk to Chinese companies and investors about international growth and investment opportunities. I believe the future lies in co-operation between East and West, with significant opportunities for Chinese investment and partnership internationally and international investment and partnership within China.”

The session is focused on how Chinese companies can leverage their strength by investing in international games markets, taking a practical approach to the many opportunities and challenges. The presentation includes a comparison of Chinese video games domestic growth and international growth, attractive international video games markets by games industry sector and geography, solutions to the opportunities and challenges for Chinese companies seeking international growth (including international market entry, investment, mergers and acquisitions, partnerships, business relationships / culture, management style, business models and player culture), and practical next steps for strong Chinese companies.

The session will be attended by major and independent video games, digital media, digital services, telecommunications and software companies, institutional, VC and private equity investor, Chairmen, CEOs, CFOs, Corporate Development Directors and Partners.

Tim will also be holding one-on-one meetings with Chinese companies and investors after the conference in Shanghai and Beijing. Companies wishing to contact Tim can reach him at tim.merel @ digi-capital.com