China: Free Trade Zone has Silver Lining for Gaming Companies

Last Updated: 17 February 2014
Article by Mark Schaub and David Hong

Most media attention in relation to Shanghai's Free Trade Zone (FTZ) has been in relation to banking sector liberalization and RMB internationalization.

However, personally the writers have felt that some of the greater opportunities in the short to mid- term would be in comparative niches. One such niche is a distinct opportunity for game console manufacturers such as Sony, Microsoft and Nintendo.

China has effectively blocked gaming consoles since 2000. To put this in perspective the PlayStation 2 was released way back in 2000. In 2000 China banned the manufacture and sale of gaming consoles due to the possible adverse effects of violence and explicit content upon China's youth.

However, this fourteen year blanket ban is seeing a slight unraveling as the new FTZ will, uniquely for China, allow console manufacturers to produce games and consoles for China's domestic consumption. Naturally enough, the game manufacturers have not been given a green light to produce anything they want as they will still have to submit products to regulators for approval. Accordingly, do not expect to see a Chinese version of Battlefield 4 coming out of Waigaoqiao but non-controversial games will be able to be sold directly to the China market from the FTZ.

Further, the new regulations will allow for manufacturers in the FTZ to sell gaming consoles to Chinese consumers. Ironically, although gaming consoles have been produced in China for export for years, sales to the domestic market were banned.

Microsoft entered into a $237 million joint venture with BesTV New Media in the FTZ at the end of 2013 to make home entertainment equipment, which could potentially include games and consoles.

The FTZ lifting of the blanket ban will lead many optimists to posit a huge untapped market that gaming console operators like Microsoft and Sony will need to immediately enter. Revenue in the PRC gaming industry grew by 38 per cent year-on-year in 2013 to RMB 83.2 billion. However, this market has been dominated by online computer and smartphone games, with PC games claiming two-thirds of the market in 2013. Due to the ban, gaming consoles have not only been driven to the sidelines but are also comparatively expensive in China.

For reference, on January 8, 2014 a customer on Taobao (China's largest online market) could buy an Xbox 360 for $656 and a Sony PS4 for $566, whilst the same products could be had (with a legal warranty and guarantee) in a US store at $500 and $400 respectively. These prices are hard to swallow for the 70 percent of Chinese gamers who earn less than RMB 4000 per month (or about one PS4).

As expected, hardcore gamers would not be deterred by a simple blanket ban. Even though the product cannot be legally sold in China, does not mean the products are not to be found. Both the predecessors to the new Microsoft and Sony consoles, Xbox 360 and PS3, have been available and sold in China for many years. However, the ban did deter sales to non-hard core gamers and kept a big industry from being even bigger in China.

One reason for optimists to be jaded is that the cost of games for these consoles will be terribly expensive in China compared to other ... options. Authentic games currently cost about USD 60-70 for either consoles, but generally consoles in China have been modified to enable pirated games to be paid. These games can be typically bought for less than a dollar each in China.

It looks like the console market might be getting crowded. Amazon, Google and Apple may also be getting serious about video games as these companies are all rumored to be developing consoles capable of streaming and gaming. Amazon established its gaming arm, Amazon Game Studios, in 2012, and recently acquired game studio, Double Helix Games. Ouya is another new streaming console that is also on the Android operating system.

This Cloud has a Silver Lining (for Gaming companies)

At this year's annual Consumer Electronics Show, PlayStation unveiled its new cloud gaming platform, Playstation Now, which would allow gamers to play older PlayStation titles on a multitude of devices and would not even require a PlayStation console. As much of China's gaming is currently browser or smartphone based, this new platform would be well positioned for the China gaming market.

The expense of gaming consoles and games could be mitigated by the implementation of cloud-based gaming as a subscription based model could be adopted and would provide games at a deep discount due to reduced marketing and packaging costs.

Steam, operated by Valve Corporation, is a similar digital video game distribution system for PC gaming that has demonstrated tremendous success globally and recently entered the China market. Valve entered into an exclusive partnership with Chinese game developer Perfect World in 2012 to allow Perfect World to localize one of its more popular titles, Dota 2, for the China market. Steam was introduced in 2003 and now has over 3000 games available with over 75 million users. It has also developed a community for gamers to interact and communicate with each other, as well as gift games to each other through the platform, especially during Steam sales where games can be discounted by over 90% of its original retail price. As more games became online multiplayer, the cloud model seems to be the future as it allows games to be sold cheaper and better protects against piracy.

The release of PlayStation Now would undoubtedly make console gaming more appealing in a market where the majority of games are bought and played online. Importantly, a major benefit for gaming companies is that pirated games (which are most of them in China) would be sidelined. A Cloud platform that offered a superior gaming experience with additional features would mitigate piracy and incentivize gamers to pay for authentic games.

Cloud based gaming platforms are already proven in China so the business opportunity is both real and now. Many Chinese ecommerce companies, such as Alibaba, have well developed cloud-based gaming platforms. Alibaba's cloud computing subsidiary (Aliyun) was established in September 2009 and has been aggressively expanding its operations. Aliyun currently operates its own Android cloud-based operating system. In 2011, Aliyun formed a strategic alliance with DeNA China, the largest mobile internet company in the world with more than 35 million users and 1800 individual games for smartphones, phones and PCs.

Microsoft has already entered the China cloud market, albeit not in gaming, with its Windows Azure product, which is in cooperation with its partner 21Vianet. A Microsoft's cloud gaming platform may not be far off. As China is obviously a big part of Microsoft's plans as CEO Steve Ballmer suggested that the greater China market should surpass the US in the near future.

The provision of cloud computing services would fall under the PRC Telecommunications Regulations («中华人民共和国电信条例») as value added telecommunication services ("VATS"), which are tightly controlled in China and require a joint venture with a qualified local partner for foreign companies wishing to operate in this sensitive sector (such as Microsoft's partnership with 21Vianet).

The FTZ has more good news for the gaming optimists in relation to VATS. On January 6, 2014, the Ministry of Industry and Information Technology and the Municipal Government of Shanghai released the Opinion on Further Opening-up of Valueadded Telecommunications Services for Foreign Investment in the FTZ. This new regulation will allow foreign ownership of an enterprise engaged in the provision of several categories of VATS to exceed the current 50% maximum placed upon the foreign shareholder.

A foreign enterprise, located in the FTZ, will now be able to operate a wholly foreign-owned enterprise ("WFOE") providing VATS in five distinct categories: i) online application stores; ii) online storage-and-forward services; iii) call centre services; iv) internet access services; and v) multi-party communication services. Furthermore, several other VATS categories will also be liberalized and will allow additional foreign ownership and certain categories that were previously restricted from foreign investment will now allow up to 50% foreign ownership. Crucially entities established in the FTZ will be allowed to provide their services nationwide.

Conclusion

The different threads of new FTZ policies come together to potentially allow for great opportunities to gaming companies. On the one hand the obvious opening is the ability for game console and game manufacturers established in the FTZ to sell their products into China. More subtly the liberalizing of restrictions in the VATS sector may provide far greater opportunity for video game distributors to access the China market. China often embraces new technologies quicker than the West and by putting games on the cloud, the game distributors will be able to better meet consumer demands and taste while also confronting the serious piracy problem as games are stored on the cloud rather than individual devices.

Is this all too good to be true? Time will tell but at present it does seem that the video game sector may well have more to be happy about than many other, more heralded sectors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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