Internet & E-Commerce

CCID Consulting projects the number of China's Internet users will exceed 180 million in 2007. China's online gaming revenues reached 11.35 billion Yuan, up 74.6% over 2006. CCID Consulting now sees a second wave of development, and expects new, more detailed government regulatory policies designed to guide and promote China's online gaming growth.

China's second wave of online gaming IPO activity in 2007 is summarized below. Compared with the first—Shangda (NASDAQ: SNDA) and The9 (NASDAQ: NCTY)—this second wave had companies that were more independent (rather than being subsidiaries) and the listings were spread across different exchanges.

• In July 2007, Perfect World (PWRD, www.wanmei.com), a developer of massively multiplayer online 3D video games, successfully executed its IPO on NASDAQ, raising US $217 million.
• In October 2007, KingSoft (www.kingsoft.com), one of China's first online gaming and, now, software companies, executed its IPO on the Hong Kong Stock Exchange, raising US $99 million.
• In October 2007, ZTgame (www.ztgame.com), known for its racy and sensationalistic online games, filed an IPO application with the New York Stock Exchange, under the name of "Giant Online".
• In November 2007, NetDragon (www.netdragon.us) listed its IPO on the Hong Kong Growth Enterprise Market (GEM).

These activities came in the light of Alibaba.com's November 2007 Hong Kong Stock Exchange IPO. While Alibaba.com is a B2B Internet company and not a gaming one, note that it raised US $1.5 billion, the largest IPO by a Chinese Internet company ever.

However, to sustain growth and realize real profits for the gaming companies, there are three rules to consider:

Rule #1: Traffic is everything.

Traffic does not guarantee revenues and profitability, but it is a necessary foundation. Page rankings, for example, by Alexa and others are important metrics to measure visibility of a website. These and other "mindshare" measures are critical to gaming companies. After all, at least half of all Chinese Internet users have played online games.

To attract traffic, companies will usually offer free online games. For example, relative late-starter ZTgame offers a basic game "ZhengTu" that is free. There are levels, however, and users will be charged for increased features and other props. This stepwise approach to charging has been adopted by other Internet services sectors such as e-payment services.

Flush with cash, many Chinese gaming companies will continue the race to gain traffic. Therefore, the "free" model will flourish, at least in the short term. Traffic, after all, represents potential revenues.

Rule #2: Unbeatable user experience for stickiness.

An online gaming website in China must be able to offer the best user experience to start gaining stickiness from the traffic they have built. Conversely, a poor user experience could be fatal, as Internet user switching costs, as this stage, is zero.

The user experience must not only be graphically and technically impressive, but the game design must also incorporate subtle cultural, economics, and even ethical characteristics that help a game's longevity and popularity. We believe this will be the next level of competition of gaming companies. Another factor is incorporate Web2.0 concepts of interactivity, user control, and community.

Consider learning from other Internet services sectors. For example, Baidu Tieba and Baidu Zhidao improved stickiness to the search engines through Web2.0-like user-communities. Tencent QQ (www.qq.com), one of China's leading IM service providers on the mobile phone, incorporated mobile gaming to increase loyalty to both their IM and gaming offerings.

Rule #3: Separate the wheat from the chaff.

Upon gaining traffic and stickiness, gaming companies in China have to carefully design games in a way that automatically stratify users into groups based on willingness to pay. "Willingness to pay" can either be directly to the gaming company, or to its advertisers. The high-value user is the one with the high willingness to pay.

One type of high-value user will be the ones who appreciate a deeper level of the game to which the user will pay. At the same time, they will be the most demanding; even some part of their personal identity will be tied to the game itself.

Another type of high-value user embodies tangible characteristics attractive to specific advertisers. The challenge will be to design games that flesh out such specific user characteristics. The more clearly identified the user characteristic into large distinct groups, the more compelling the value proposition to the advertiser.

As with many traditional businesses, customers are stratified into groups, often with the high value customers being the smallest, yet most profitable group. Online gaming companies will be no different. Take Tencent QQ for example again: It has 250 million active users in China. But without user stratification (as one reason), Tencent has so far been unable to convert this wide user swath onto their B2B online trading platform.

This critically important step is how revenues can be generates, and actual profits made. Without this rule, it will be difficult for gaming companies to justify their current market valuations.

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Unless otherwise specified, all information provided is sourced from CCID Consulting.

Ó 2008 CCID Consulting Co., Ltd.