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The Great Wall: Consoles in China

After fourteen years, China has lifted its ban on video game consoles. Microsoft is the first of the major console manufacturers to capitalize on the new market, having recently launched its Xbox One in the region. However, China's gaming culture has undergone a radical shift in the absence of consoles, raising questions about how this segment of the video game industry will fare in China. In our first Shacknews Select, we take a closer look at what led to the ban, how video games in China have flourished in a different way, and the opportunities and perils of jumping into the market.

Behind the Ban

Although video game arcades had become something of an endangered species in the United States and Europe in 2000, they were still thriving in China and other parts of Asia–booming, in fact. However, they were often illegal and poorly managed, which caused people to generally regard them as a threat to the growth and development of their youth. This "threat" prompted several branches of the government, which included the Ministry of Culture, the State Economic and Trade Commission, the Ministry of Public Security, the Ministry of Industry and IT, the Ministry of Foreign Trade and Economic Cooperation, the General Administration of Customs and the State Administration for Industry and Commerce, to band together in a crusade to end the corrosive influence of video game arcades. Many believe that the ban is a result of vocal parents complaining about how video games would waste away the minds of their children, which might also be true enough to fuel a campaign to regulate them.

That year, three months after the PlayStation 2 released in Japan, a bill titled "Feedback regarding the launch of special operation on video game arcades" was proposed and passed. The measure was meant to regulate the operation of arcades, but its wording states:

"..the manufacturing and selling of any electronic gaming equipment plus its parts and accessories headed to China are stopped immediately. No company or individual can partake in the manufacturing and selling of electronic gaming equipment plus its parts and accessories headed to China.

To be clear, the ban had nothing to do with the epidemic of video game addiction that would sweep the nation and prompt the government to set up reformative boot camps. Nor does it share any of the historic and political roots that led to the ban of Japanese consumer products in South Korea, although the outcomes are very similar. China's ban was specifically geared towards protecting its youth from going to dangerous venues and being exposed to unhealthy content. But Chinese gamers would not be suppressed, even as the ban stayed in effect for fourteen years. The result of the ban caused a meteoric rise in PC gaming. Although the ban does include language that prohibits internet cafes from running businesses related to video games, that portion was rarely enforced. As a result, video game revenues in China topped over 13 billion dollars in 2013, with the PC in the lead and a fast growing mobile sector behind it. 

Unsurprisingly, consoles did not figure into the revenue report, but it's not for lack of trying. In 2004, Sony tried to work around the "strictly limited" portion of the ban with a low-scale launch of the PlayStation 2, but it only managed to release it in two out of the five intended cities. Hitting Shanghai and Guangzhou, Sony's official statement referred to the system specifically as "the PlayStation 2 Computer Entertainment System," with the implied emphasis on "computer."

Even with this attempt to distance itself from being a video game console, the PS2 would see a number of different problems, the greatest of which being the China's auditing system. China's government must approve all media content to make sure they fall within strict guidelines, and much of the PS2's library failed to do so. The roadblocks didn't end there. High tariffs on imported foreign products made the PS2 considerably more expensive than ones picked up from the (largely un-policed) black market, which tied in to the country's long standing culture of software piracy. Although the PSP and PlayStation Vita never officially launched in China, they both had a healthy share of knockoff systems (such as the unabashed iReadyGo), and the real ones were quite popular on the black market.

That doesn't mean Sony was ready to give up. In June of 2012, Sony Computer Entertainment opened a headquarters at Guangdong Animation City as part of a government backed initiative in Guangzhou to help strengthen its local animation and gaming industry. A month later, Sony made a surprise appearance at Chinajoy in Shanghai, China's largest video game expo, after skipping it for four years. Around the same time, an outdated PlayStation 3 model quietly passed China's certification process, but was soon withdrawn by Sony after it was discovered.

That leaves Nintendo's brand of iQue consoles as the only success story out of the big three console manufacturers. Partnering with an American entrepreneur Dr. Wei Yen in 2003, Nintendo launched an inexpensive gaming console in China. It was essentially a version of the N64, with the processor built into the controller, and used rewritable cartridges for its games, which also plugged into the controller. In an effort to curb piracy, games could only be downloaded from iQue Depot stores, and each cartridge only had enough memory to hold one game at a time.

The console never really took off due to its inconvenience, but it soon reemerged with a focus on the handheld market. iQue now sells its branded version of the Nintendo 3DS XL, which is popular despite its library being limited to a handful of games mostly developed by Nintendo itself like Mario Kart 7 and Super Mario 3D Land. Nintendo gets a pass because it develops relatively nonviolent games that are free of pornography and consistent with China's regulations and sense of morality. Although other countries might see violent 3DS games, they are conveniently filtered out for China. It might seem like a minor victory, but the iQue is among the few console systems that are openly sold in China. In 2008, Nintendo announced that the Wii would release in China, and the system was certified, but nothing ever became of it. However, similar to what Sony experienced, the console became very popular on the black market. 

The ban on manufacturing arcade machines was lifted in 2009, but the ban on foreign-made video game consoles remained in effect.

In January 2014, after seeing the kind of revenue video games brought in, the Chinese government announced that it would temporarily lift the ban on gaming consoles. However, consoles could only be manufactured and sold in the Shanghai's Free Trade Zone, an area where economic reforms are put to the test. Additionally, games can only be sold after an inspection by China's cultural departments. Nintendo shares leapt by 10% in Tokyo following the announcement, Microsoft added 1%, and Sony remained flat. 

There was a great deal of excitement in the months leading up to September, when the ban was scheduled to lift. Nintendo teased plans to develop a new low-cost console for emerging markets. Microsoft, partnered with Chinese company BesTV, ramped up by ordering 5 million Xbox Ones in preparation for its launch. A hiccup, three days before the Xbox One's anticipated September 23rd launch, caused a six day delay. Finally, on September 29, 2014, the Xbox One launched in China. It garnered 100,000 pre-orders despite a slim lineup of games. No doubt spurred by Microsoft's success, Sony has announced its own plans for launches of PlayStation 4 and Vita. The launch has since been delayed.

The figure of 100,000 units for Xbox One might sound a bit low, but it still far exceeded sales of the console in Japan. Reports speculate that Microsoft is hoping to reach one million sales in the following year. Those might be high expectations, given the hurdles the console still faces. 

Obstacles include high prices that brought other attempts to bring consoles to China down. A base model Xbox One in China currently goes for roughly $500 USD, and that's after a sizable price cut in the region. No one knows how successful an expensive console will be in the long run, especially since China's PC-centric gaming market largely takes place in pay-per-time internet cafes. Then there's the sales model in a country that is famous for pirating software and cheap knock-offs. It's largely for this reason that the most popular PC games in China are free-to-play with microtransactions. 

Don't expect Grand Theft Auto V to be approved anytime soon. Also, the ban suspension is temporary, with no indication of whether or not it will be reinstated. Microsoft, Sony, and Nintendo will have to live with that Sword of Damocles hanging over them.

Then there are other cultural and social concerns. The high population density of China's urban areas means that living spaces tend to be small by American standards. In some cases, really small if console sales ever go beyond the Shanghai Free Trade Zone. That's not exactly an ideal environment for Kinect motion controls or four-player get-togethers. Not to mention China's official recognition of video game addiction, and its ultra-competitive school system. Few parents may want to buy an expensive gaming console for their kid if they still believe that it will rot their minds and lead to decreased academic performance.

Coincidentally, publishers like Ubisoft are experimenting with a different strategy by developing Just Dance Now for mobile platforms, which circumvents many of the hurdles consoles still face and brings the popular series to previously inaccessible markets. Good for Ubisoft, but perhaps not so good for gaming consoles that rely heavily on third party development support for its games library.

Analysts Unsure

As the only console manufacturer to launch after the ban lifted, Microsoft is the de facto bellwether for the industry. Both Nintendo and Sony are surely watching Microsoft's push into the region to help determine if and how they should launch their own standard consoles. However, it raises the inevitable question: just what qualifies as success in China? The country has been a blind spot in the gaming industry for so long, it’s difficult to assess a successful launch, much less its sustained growth.

For example, Microsoft is reported to have sold 100,000 Xbox One units in its first week on the market, and the company aims to sell more than one million within its first year. This appears to easily beat its Japanese launch, which sold only 23,000 units in Japan during launch week and historically struggled during the Xbox 360 era. Despite the boast, analysts are split on just how good that number is.

"I think the 100,000 Xbox One units sold and the growing purchasing power of the Chinese middle class suggests that the market is conducive to--and interested in--dedicated video game consoles," EEDAR's Matthew Diener said. "It’s safe to say that Sony, Microsoft, and Nintendo are well aware of the huge opportunities that exist in China’s predicted $18 billion gaming market.”

Gartner analyst Brian Blau is more hesitant to call the initial figure a success. "100,000 is not great," he said. "If it doesn’t go up from there, it’s terrible. If that’s the starting point and they’re slowly gaining momentum, it’s probably slow but okay."

"Factoring our tariffs, $30MM-$40MM in revenue is significant," said Jesse Divnich of Tilting Point. "Sure, 100,000 units is not the greatest number, but I don't think anyone expected figures higher than that."

Demographics muddy the results. China is one of the largest countries in the world, with an estimated 1.36 billion citizens. That's more than ten times Japan’s latest census data of 128 million. With ten times the audience, and absolutely no console competition, it only makes sense that Microsoft would see a larger number in China than Japan. That doesn’t necessarily mean it is more successful.

China’s heavier sales could also have an element of demographics. Japan has seen a sharp increase in its average age, while China is more evenly distributed. The age range between 20-40 is particularly skewed, as it’s one of the least populated demographics in Japan, and one of the most populated in China. The impact of that difference shouldn’t be understated in a medium primarily aimed at younger players.

However, young players might be hesitant to buy in China for purely financial reasons. As originally reported, a Hong Kong brokerage firm expressed doubts about a viable console market in Japan, after it found that most Chinese gamers earn less than 4,000 yuan ($634 USD) per month. Now that Xbox One has actually launched and been given a price drop, it stands at approximately $500 without Kinect, and $600 with Kinect. Sony will launch its PlayStation 4 at approximately $470. In both cases, a console purchase would account for most if not all of a full month's salary for the majority of the target audience.

“The system is clearly meant for the type of Chinese consumer who has a job at a big company, a salary, to afford a device like this,” said Blau. “That’s not the case for most Chinese consumers, so it’s going to have limited sales in the beginning.”

"There exist a market for home consoles in China, but it is not particularly big. Chinese consumers have a strong preference towards mobile and PC games that utilize the free-to-play business model," Divnich said. "The concept of spending $600 for a dedicated console and then spending an additional $30 for a game is foreign and certainly out of the price range for the majority of Chinese consumers.

"HD consoles will carve out a niche for themselves in China. Getting distribution and access in China for the consoles is definitely a worthwhile and profitable venture, but it will always be a small market compared to PC and mobile for the foreseeable future."

Microsoft does have the advantage, at least so far, of being the only option. Sony's plans to launch in the region came quickly, but Microsoft was the first out of the gate. The first-mover advantage can have a big impact in any region, and China has had a history of it continuing to have ripple effects for years to come.

“In the past, however, the first company into China enjoyed a sizable advantage over its competitors," Diener said. "The obvious example here is Kentucky Fried Chicken, which became the first foreign fast food company in China back in 1987. It’s grown at an unmatched pace thanks to the fact that it became synonymous with the concept of fast food to many Chinese consumers, and it was recently recognized by a BBC-commissioned study as the most powerful Western brand in China--well ahead of McDonald’s, which came in at #7.”

Analysts have also raised concerns about factors that aren't as influential in the United States or Japan. The first has helped shape the face of Chinese video games since the ban took place, and has had the ripple effect of influencing markets here as well. 

“This prevalence of piracy, incidentally, is part of what drove the client-based F2P web game scene in China a decade or so ago," Diener said. "Developers realized that a traditional boxed game would be pirated within 24 hours of being released, and that their sales would plummet as a result. The F2P web game’s business model sidesteps this problem neatly, and keeps players’ money coming in to developers.

"Still, China’s been at the web game market for some time now and there’s a big push from developers--like Linekong – to transition away from web games to focus their development purely on F2P mobile titles. This isn’t a strong point in favor of consoles at face value, but what you can extrapolate from here is that Chinese gaming tastes are changing, and customers are looking for different experiences from the traditional Chinese-developed web game.”

Diener noted that consoles in China will also have to deal head-on with censorship, and that some games have already been held back because of it. 

"As a result of this censorship, you’re seeing a lot of potential system sellers--Destiny, Titanfall, and Call of Duty: Advanced Warfare--absent from the Xbox One’s launch list in China due to their violent content. If console developers and publishers are banking on a release in the PRC, they’re going to have pay close attention to decisions made early in a game’s development and definitely plan with an eye toward China’s history of censorship.”

That may be why the launch line-up was severely slimmed from its original plans. While insiders claimed the launch was set to have 20 games in total, only 10 of them made launch day. Microsoft says it has more than 70 "in the pipeline" for approval, but some more violent ones may not make the cut. 

Huge in China

Even despite these concerns, there's no denying the huge opportunity that awaits console makers by reaching out to China. While console sales remain strong across North America and Europe, the population of China is far too big to ignore, especially given the Chinese government continuing to relax their restrictions on gaming. Millions of people are prepared to discover console gaming for the first time. However, the biggest mistake that Microsoft, Sony, and Nintendo can make is to take the exact approach with China that they do with other territories.

Every culture seems to veer towards different types of games. If the ESA and a recent Wall Street Journal article is any indication, different regions tend to drift towards different genres. Likewise, China has a distinct taste in gaming, one that console makers would be wise to analyze before taking any drastic steps forward.

Arenanet is one major video game developer that took great caution in approaching the Chinese gaming market. Their most-recognized MMORPG, Guild Wars 2, launched in China in May. That wasn't a spur of the moment decision. Rather, the studio analyzed the region carefully, noting a uniquely different taste in games from any other region the developer previously catered to.

"Chinese players are savvy game consumers," said ArenaNet Senior Vice President of Global Business Randall Price. "They educate themselves about the hottest games out there, and they build really strong communities and relationships with their fellow players. However, what Western developers and publishers need to keep in mind is that there are differences in the way they enjoy games. Chinese players often want their games to provide great content direction. They want clarity about how to play, where to go and what to do. Developers should let them know what is in store for them--tell players about the incredible content they’re going to get to play, the epic boss battles coming up and the great rewards they’ll receive. You'll acquire more players with this strategy.

"It's true that Chinese players love online games and MMOs. Their culture is based around Internet cafes and PC games generally, and so that's what they play today. That doesn't mean consoles don't have an opportunity in China. The issues with console games are going to be the price point and the availability of great games. Will the consoles and games be too expensive in China given that players aren't used to paying large amounts to purchase games? Also, with all of the government regulation around bringing foreign games to China, will publishers be able to launch their best franchises there? Consoles will have to get over these hurdles in China to be successful."

Accessible cost is something Microsoft has likely had in mind for several months. In fact, it's easy to make the leap in logic that the eventual Chinese launch is part of the reason the Kinect sensor was eventually sent out to pasture. It isn't just to compete in the Xbox One's current markets, but a cheaper entry point would definitely help court the Chinese user and stand strong against the PlayStation 4 whenever it eventually arrives. China represents a clean slate for console makers. It's a chance to start fresh with a whole new market, but approaching them as if the have the same gaming taste as North America, Europe, or Japan would be folly. That's why research means a lot if any of them are going to succeed.

One thing's for sure, though. If Microsoft, Sony, or Nintendo do succeed in the Chinese market, expect future AAA game development to change in a big way. The simple fact is that there's more money to go around in China and if the user base there grows, so will the influence. Guild Wars 2 is already offering somewhat of a glimpse into what's to come, noting that Chinese players are being taken into account when planning future content.

"For any game company going into China, you need to conduct extensive testing and research with players, and you need to be willing to let the results from those tests influence your development decisions," Price said. "We've certainly done that with Guild Wars 2, making adjustments and conscious decisions based on feedback from Chinese players in an effort to make the game as enjoyable as possible for them. We've now changed the development of the game to focus on global development, taking into account the needs of all of our markets including China in our planning."

However, there's still one area where console makers can falter and that's online infrastructure. With Chinese users dedicated to online gaming experiences, frequent outages will not be tolerated. Stability has grown to be a major weakness for Xbox Live and PlayStation Network over the past few years. If either the Xbox One or PlayStation 4 are to thrive in this new market, it needs to dedicate its resources to keeping their services online more than ever. Issues like the recent PSN and Xbox Live outages can no longer be the norm if any of these companies hope to win over this new audience. Instances like this will simply send Chinese users over to PC, where games like Guild Wars 2, Black Gold, and Age of Wushu are already filling their need for gaming fantasies.

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