By Sherman So and J. Christopher Westland

Editor’s note:

This article has been adapted from Red Wired: China’s Internet Revolution co-authored by Sherman So and J. Christopher Westland. The to-be-published book is aimed at helping readers gain a firsthand understanding of how the Chinese combined successful components from their Western counterparts with innovation to accommodate the unique characteristics of the Chinese market.

After one of the most popular online games in the world, World of Warcraft launched in China, it stole many users from Shanda. To turn the situation around, Chen Tianqiao, Shanda’s CEO, made a decision that shocked the industry – he was going to offer his games for free.

In the end, Chen’s resolution set a new trend in the industry and raised the popularity of online games in China to another level.

By late 2005, half a year after World of Warcraft entered China, Shanda, the domestic champion in online games, suffered its first substantial decline in revenue and profit. 

Fourth quarter revenue dropped 28 percent from the previous quarter and 16 percent from a year earlier, suffering a huge loss of $66.8 million.  Part of the loss was caused by a $64.6 million investment in Korean game company Actoz. But, even excluding this, Shanda’s profitability dropped a great deal. It made a profit of $32.4 million in the previous quarter and $28 million a year earlier.

In December 2005 to everyone’s surprise, Chen declared that all three of Shanda’s major games – Mir II, Woool, and Magical Land – would be free for its players. They would only be charged if they wanted better game weapons or costumes.

Sales of the three games accounted over an estimated 70 percent of Shanda’s revenue.  And no free massively multiplayer online role-playing game or MMORPG had turned out to be as profitable as a paid game at that time. Most people in the industry saw this as an act of pure desperation – to keep Shanda’s game players from switching to its rivals.

But again, Chen’s bet paid off. It took a tough nine to 12 months for Shanda to adjust to the new model. But after that, revenue rebounded from the bottom at $42.6 million in first quarter of 2006 to $60.3 million in the fourth quarter. Profit also recovered to $30.8 million in the fourth quarter, not much different from Shanda’s earnings before World of Warcraft stole its business.

The Rich Players

The reason was some wealthy players were also enjoying online games. In fact, game players were not only limited to kids and teenagers, but included young adults who had started to earn a living. Many owners of small businesses also enjoy the pastime, as do some office workers.  

Although 43.4 percent of online game players were students, 8.1 percent worked in management, according to a survey by IDC in 2007 (See Table 1). Of the players, 17.9 percent earned more than 2,000 yuan (about $300) a month, and they are considered the middle-income group in China; and 1.5 percent brought in more than 10,000 yuan ($1,500) a month, China’s high income group; while  25.7 percent had a bachelors degrees.

“Shanda’s Mir II and Woool were some of cyber space’s oldest games. They attracted a group of fairly wealthy but not very sophisticated players. World of Warcraft did not suit their taste as it seemed too complicated for them. Many in this segment are factory owners in small cities in China. They loved Mir II and Woool as they have played these games for a long time,” said a former Shanda executive. “For them, spending a few thousand renminbi a month is not a problem.” 

Some people were paying for ‘gold farmers’ – hiring young gamers to play for them and cheating the programs. These suggested that for some game players, they would pay to cheat if they could.

Free games in effect allowed rich players to cheat openly – they can buy better weapons, upgrade their characters faster, become super warriors and kings and queens in the virtual world. For many, such accomplishments (although just in a virtual world) were reward enough for them to spend a few hundred or thousands of renminbi per month.

“More and more game players switched from the status of ‘no money and plenty of time’ to ‘have money but no time’”, said an industry expert explaining the popularity of free games. 

In fact, the success of free model or item-based model in China was not a total surprise. Korea, which led China in online game development by a few years, had already witnessed the popularity of free online games.

Another pioneer in free online games in China was Giant Interactive, founded by Shi Yuzhu. Born in 1962, Shi made his first fortune by developing Chinese software in the 1980s. But when he tried to build the tallest mansion in China in 1998, he almost went bankrupt.

Ground Troop promoters

Shi made a comeback by selling health boosters for the elderly. The product was called Nao Baijin (è„'白é‡') or Brain Platinum in Chinese. The medicine is supposed to make seniors sleep better and live healthier. His marketing tricks did wonders – huge primetime TV advertising and thousands of sales agents who covered every city and town, encouraged millions to line up for Shi’s products, especially as gifts to their elderly parents.

By the time he joined the online game market, it was already packed with strong players like Shanda, Netease, and The9. Shi’s game, ZT Online was nothing special – no fancy graphics or extraordinary storyline. But he had a new tactic under his belt: his game would be free to all players and they would only be charged if they wanted better game weapons or costumes. 

Moreover, Shi used the same promotion tactics for ZT Online as he did with his health boosters. A 2,000-strong army of promoters was sent to Internet cafés in every city and town to encourage players to try the new game. The network reached more than 116,500 Internet cafés. Some 250 liaison offices were set up countrywide to organize the effort.

Each city was divided into different regions, and each region divided into smaller areas. One promoter would be responsible for an area. “Every day, our promoters will pack materials, such as posters and souvenirs of the game into their backpacks and go to the Internet cafés within their area,” said Eric He, Giant’s chief financial officer.

Shi’s promotion worked very well. By May 2007, a year-and-half after its official launch, ZT Online had more than 1 million players during its peak hour. There was only one other game which could achieve the same numbers at the same time –Netease’s Fantasy Westward Journey.

With Shanda’s and Giant’s success, free games soon became the dominant trend in China. Most of the new games launched in 2007 adopted the item-based model. The revenue from such games accounted for 67 percent of the total market income, says IDC.

“The item-based model is helpful in attracting numerous new users to join in the online game world. It has become the new force for the development of China’s online game industry,” said Bryan Yuan, an analyst for market researcher IDC.

The revenue of China’s online gaming market surged 61.5 percent in 2007 to $1.39 billion from a year earlier, partly due to free games, said IDC.
 

Table 1: Income and Occupation distribution of China Online Game Users (2007)

Source: IDC

Table 2: Top Chinese online games

Source: companies