As far as online gaming veterans in China go, Shanghai-based The9 Limited knows a thing or two about slaying monsters and dragons. Launched as the country's first virtual community some 10 years ago, the startup morphed into one of China's biggest online gaming companies and listed on Nasdaq in 2004. But keeping a winning streak in MMO — that is, Massively Multiplayer Online — is no small feat. In 2009, theonline game company was dealt a big blow when Californian developer Blizzard ended an agreement with The9 to distribute its phenomenally popular War of Warcraft (WoW) game in China. The9's revenue dropped precipitously as a result, from RMB 1.8 billion in 2008 to RMB 118 million in 2010, and left several class action lawsuits from shareholders in its wake.

The9 — whose founders believed gaming was the ninth art, after painting, sculpture, architecture, literature, music, dance, theater, cinema — has a new action plan. In a country that has flown into first place at the world's largest online gaming market, The9 — like many of its local rivals — has been searching for new product ideas, and revenue models, to lock in million more gamers. The challenge is clear: In this new universe their games need to not only be fun, but also profitable. 

But unlike others, The9 is not content to focus solely on booming China, Its quest for growth is going global, including setting up shop in South Korea, the world's other online gaming hotspot. And in late November, service provider Garena Online Private announced it will pay The9's new subsidiary Red 5 Singapore US$23 million, plus royalties, over six years for the right to distribute its much-anticipated FireFall game across Southeast Asia and Taiwan.

It's a sign of the times, says Eddie Chen, CEO of The9 Interactive. "The whole industry is at a turning point," he states. And it's not just because of fierce competition and a fast-saturating local market. Chen sees online gaming companies scrambling for new business models "It’s very similar to the crisis that hit the music industry when MP3s emerged. Buyers could download music for free and the music industry was not ready for this transition,” he adds. With more than 400 million Internet users, mainland China has the largest online user base in world, of which as much as two-thirds play games online, there's a lot at stake.

Winners vs. Losers

In today's US$24 billion global online gaming world, The9's plight is just one of many examples of how dynamic companies in China need to be to keep pace. According to new forecasts from Ovum, a London-based research firm, sales in digital gaming worldwide — which include games played online as well as on traditional consoles, smartphones and other gadgets — will increase more than 100% between 2011 and 2016, to US$53 billion. Annual revenue from user payments, licensing and development fees and so on in China is a sizable portion of the overall market, and growing, say many experts. According to the latest figures from Analysys International, China's online gaming generated around US$1.5 billion of revenue in the third quarter of last year, a 22.5% year-on-year jump.

And unlike in other tech sectors, the fiercest competition is home-grown. Recently, on, columnist Richard Aioshi quoted Korean game publication This Is Game reported that the top revenue generator in China last year was CrossFire, at US$860 million, with Dungeon & Fighter following in second place at US$464 million. Both are South Korean-developed games released by Tencent, China's largest instant-messaging service, and both say they have hit three million "concurrent users," a popular industry benchmark indicating how many gamers are playing a game simultaneously. By way of comparison, Electronic Arts reported its successful launch of Star Wars: The Old Republic in the U.S. and Europe by logging 350,000 concurrent users in January.

While Tencent dominates the market in China, other Chinese companies in the gaming fray include NetEase, Shanda, Perfect World, Changyou, Giant and The9 — all now boasting Nasdaq listings. Foreign firms, meanwhile, have struggled to break into China. The success of Blizzard's WOW notwithstanding — with China accounting for a big portion of its 10 million active users worldwide — foreign games haven't gained much traction. Some simply get lost in translation while others never make it past watchful regulators, leaving many foreign developers to use the country as a site for outsourcing or offshoring their work rather than a market, according to Aioshi.

But whether local or foreign, online gaming companies in China operate on a gargantuan scale “unimaginable in the Western context,” says Jon Jonasson, chief operating officer of CCP, an Icelandic online games developer and publisher, mostly known for Eve, the global multiplayer hit game set in space. "This kind of scale means that some of Chinese gaming companies are operating at profit margins of up to 70%. For most Western gaming companies, including ours, a profit margin of 30% is considered great,” he says, from CCP's Shanghai office.

It's an even more remarkable achievement given that the tried-and-tested revenue models of older online gaming markets like the U.S. have proven less successful in China. For one thing, most games in China are free to play (F2P) games, rather than purchased with a monthly subscription as is the case in many other countries. One reason why is that "in South Korea and China, gamers are more casual, less hard core," than in, say, Japan or the U.S., Chen says. "If you go to any cyber cafes in China, the gaming atmosphere is totally different. Many players are doing other things — listening to music, talking on the phone, watching television.”

Another reason is that because piracy is rampant, giving away the content free of charge makes a lot of sense. Unlike in the U.S. and elsewhere, "China has never been a console market because of piracy issues," says Chen. "Content has been pushed online so people cannot pirate the software."

But the growing popularity of F2P is increasing the pressure on gaming companies to expand the ways they monetize their games, noted Zhan Ye, president of U.S. consultancy GameVision, in an online presentation. "You have to look at each game feature or design issue from two perspectives — whether or not it's fun and whether or not it will monetize well," he stated. "I call it 'monetization-driven' design.'"

In a monetization-driven universe, the aim is to keep gamers playing a game as long as possible — at least two weeks, he said — so they become attached to their characters and equipment, and friends, they acquire along the way, "then they stay for years." The next step is to encourage them to make small purchases — or micro-transactions — for, say, better weapons, costumes and capabilities to slay enemies and stay ahead of rival gamers.

“The micro-transaction model is more mature in China than in other countries," comments Michael Yuann, founder of Game Concourse, a mobile and social gaming company in Hong Kong. "The population is familiar with the concept. There are many ecosystems to service this model, although admittedly it can be messy,” each Internet service provider has its own payment system and making online credit-card payments is still difficult in China so gamers tend to use prepaid cards that are purchased from the some 200,000 distributors around the country.

Up to 80% of gamers in China, according to most estimates, never pay; but when they do, they pay a lot. What's the secret to finding what gamers will pay for? "Chinese companies have tried thousands of ideas in the past couple of years," constantly changing based on the data they collect, observed Ye. Online gaming companies elsewhere "can learn a lot from them."

In many ways, getting gamers to part with their yuan is not dissimilar to the psychology deployed by casinos to keep gamblers at the roulette wheel or slot machines, he said. According to his estimates, more than 90% of online games in China use features like virtual treasure chests, which randomly contain items to buy, and require virtual keys to unlock them, which are paid for, generating as much as 20% of developers' revenue.

Harvesting the Rewards

The need for monetization has, in large part, been a big reason for the rise of a cottage industry in countries such as China. In particular, enterprises have sprung up across the country selling services like “power leveling,” in which they hire or sell "ready-made" characters to gamers, and “gold farming,” in which they play games to win the virtual rewards on offer on behalf of a gamer, for a fee. Richard Heeks, professor of development informatics at Manchester University, estimated in a 2009 study that 400,000 Asian workers — generally low paid and in sweatshop conditions — were employed in the gold farming business, which generates as much as US$1 billion annually.

A report published in April last year, titled, "Knowledge Map of the Virtual Economy" by the World Bank's Information for Development Program (infoDev), says 25% of all gamers in China buy products in the secondary market, spending nearly US$90 on average every year. Gamers in the U.S. and Europe, meanwhile, spend around US$370 on average every year.

It's an unwanted development in many circles, says CCP's Jonasson. A year ago, CCP noticed that about 3,000 gamers who were regularly logging on from a certain type of proxy server had stopped playing Eve during the seven-day Chinese New Year holiday. Their gaming patterns suggested that they were farmers and CCP disabled their accounts. “People who use farmers ruin the value for the other game players," says Jonasson. "We actively monitor against farmers because it’s a digital form of slavery."

That's not the only thorny issues online gaming companies in China are having to confront. In the last few years, local newspapers have also been awash with deaths of teenagers addicted to online games. However, Kevin Werbach, a Wharton legal studies and business ethics professor, says that some of the debate is unbalanced. “Clearly, there are some extreme cases but addiction is not just limited to online games," he observes. "There are also clear benefits in that many are finding meaningful social system through the games.”

The Endgame

Against that backdrop, China's gaming companies like The9 are forging ahead with new growth strategies, using F2P to compete head to head traditional subscription-based hits, like WoW. “If there is a [high-quality] game of a similar standard that … doesn’t cost anything to play except when you purchase virtual goods or tools, it will be a significant competition to the games where you have to pay US$60 to get started,” asserts The9's Chen.

Others aren't so sure. “The most successful MMOs have an immersive and addictive quality," Werbach says. "So another game at a lower price threshold doesn’t necessary mean that a player will switch.”

But with the release of FireFall, Chen is undaunted. The F2P game, which takes place in the year is 2233 as humanity fights for survival against a race called the Chosen, has pledged to break the mold of online games. Even its rollout is different. Rather than pushing it out the entire game, Red5 is building up anticipation, by releasing FireFall over a number of months as gamers use its combination of PvP (interactive conflict between several players) and PvE, between players and computer-controlled components. As one online critic proclaimed, The9 "has promised an open PvP world, with dynamic world events, vehicles, and more. This’ll lead to a lot of team vs. team action with monsters spawning and wrecking everyone’s day, and more importantly, just lead to PvE that isn’t a complete snore."

There's plenty more ahead that will be keeping China's online gaming executives like Chen awake. Industry observers say the biggest growth driver ahead in China as elsewhere will be "casual" games accessed via mobile apps. Because they are simpler to learn than traditional console and Internet-based games and cheaper to develop, Ovum forecast mobile gaming growth to be twice that of the overall market, with revenues trebling over the five years to 2016 to reach US$17.5 billion.

That explains why there is no shortage of developers in places Shanghai’s Zhangjiang Hi-Tech Park who have an eye on China's 900 million plus mobile device users. That includes Jerry Teng, general manager of Zhongyi Group, who set up his company a year ago. Although he expects the lifecycle of the mobile games is even shorter— two to six months at most — than online games, he's sees bright prospects. “WiFi coverage is expanding. Platforms will be more open," he says. "If we can make RMB 1 million to RMB 2 million profit for each product, we’re on our way.”