How Will China Ending Its Ban On Video Game Consoles Affect The Industry?

Analyst predict a tough road ahead for game companies even if China relaxes its prohibition against consoles.

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How Will China Endings Its Ban On Video Game Consoles Affect The Industry?
The game industry could face a tougher challenge than investors originally predicted when trying to enter the Chinese market.

News broke Monday that a 12-year ban on the sale of video game consoles in China might soon be overturned. A report from the state-run China Daily cited an unnamed source from the Ministry of Culture who said officials are “reviewing the policy and have conducted some surveys and held discussions with other ministries on the possibility of opening up the game console market.”

Gaining access to one-seventh of the world’s population is about as compelling as an untapped market can be. If the lifting of the ban goes forward, game consoles that have become wildly popular in the U.S. Europe, and Japan would be made available to China’s 1.35 billion citizens for the first time.

Investors welcomed the promising news accordingly, pushing up the stock prices of the three major console developers -- Sony (NYSE:SNE), Nintendo (PINK:NTODY) and Microsoft (NASDAQ:MSFT) -- throughout Monday trading.

But investor optimism aside, what does China’s possible détente with the video game industry actually mean for those  companies? So far, game industry executivess have been tight-lipped about the news.

A spokesperson for Nintendo declined to comment directly on the report.

When reached for comment, a spokesperson from PlayStation said: "We recognize that China is a promising market. We will continuously study the possibility but there is no concrete plan at this stage."

While China’s potentially massive customer base is no doubt “promising,” Alicia Yap, a research analyst at Barclays, believes the entrenched cultural position of Internet cafes and online gaming communities will be hard to replace even if consoles were suddenly allowed to be sold in China.

“The community effect and large user interaction of MMO games will be difficult to be replaced by the lack of social/community interaction in console games,” Yap wrote in a report Tuesday. “With the culture difference and the need of user communication within the game, we think the real attractiveness of console games to Chinese users is limited.”

The irony of China possibly ending its ban on gaming consoles in 2013 is that many game industry commentators, such as Eurogamer editor Tom Bramwell, have begun to wonder if consoles have much of a future at all at this point. The U.S. and European game industries, after all, are feeling increasing pressure to adapt their wares to an increasingly mobile-friendly audience and give their content away for free with a business model that Japanese and Chinese Internet companies pioneered.

Video game consoles were first banned in China in 2000 after the government became concerned with the feared physical and psychological harm on the country’s youth; however, that does not mean Chinese people haven’t been able to play video games for the past 12 years. Internet companies like Shanda Games (NASDAQ:GAME), Perfect World (NASDAQ:PWRD), Changyou (NASDAQ:CYOU) and Giant Interactive (NYSE: GA) already reap huge rewards from the micro-transactions pulled in from the PCs set up in Internet cafes throughout the country. Two of China’s most popular Internet companies that offer its customers a variety of online gaming, social media, and e-commerce services -- Tencent Holdings (HKG:0700) and NetEase (NASDAQ: NTES) -- have already established relationships with the U.S. game publisher Activision Blizzard (NASDAQ:ATVI) to help distribute crowd-pleasers like “Call of Duty” to the Chinese. 

In the short term, Yap suggested, console developers will pose little to no threat to these entrenched companies. However, if their entrance into China proves successful among Chinese gamers, "user dilution or distraction away to console and mobile may continue to weigh on investors' concerns about the longer-term growth trajectory of the traditional MMO market" in the country. 

Still, opening the doors to China is no simple task, even for a franchise as popular as “Call of Duty.” Speaking in a rare interview with the Wall Street Journal last July, Activision chief executive Bobby Kotick insisted that the Chinese version of “Call of Duty” was not simply a re-skinned version of the game.

"How you play, what you play, customization of weapons, the types of characters, the equipment you use, the game modes, and the maps are all unique to the Chinese market," Kotick said.

Kotick’s comment highlights a key challenge that any console manufacturer would face in bringing its wares to an unfamiliar audience: cultural differences. Console developers specialize in manufacturing hardware. The actual video game content that players enjoy comes from the software side, which raises an additional question of how well a video game that is popular among Western audiences would penetrate the Chinese market. In the same way Japanese mobile gaming giants like DeNA (TYO: 2432) and GREE (TYO: 3632) are struggling to acclimate American and European customers to their brand of mobile-friendly social games, Sony and Microsoft could have a similarly difficult time convincing Chinese players to pick up the next “Gears of War” or “Halo” title.

“Language and distribution may also be something global console game companies need to consider,” Yap added in her report. “Are they translating the games to the local language themselves? How are they going to distribute the software? And what about piracy issues?”

It’s hard to get clear numbers on the full extent of black market for video games in China today, but gaming forums and websites are full of anecdotal reports of cracked versions of popular games like “Diablo 3” being distributed under fake names to dodge government censors. Console games, meanwhile, can be easily adapted to run on a PC through a virtual console or emulator.

“While it is not officially approved, many Chinese gamers already can purchase pirated copies of game software in the China market currently and this is widely available and gamers already have the choice to play consoles if they want to,” Yap said. “So, by making it official eventually may not have such a big impact in changing gamers' behavior.”

The bigger question here, however, is if the political developments actually mean anything in the short term. The current generation console market, after all, has slowed to a halt as Sony and Microsoft are both expected to release new versions of their flagship consoles later this year. The original report from China Daily, meanwhile, questioned whether or not all seven of the Chinese ministries needed to overturn the ban would actually sign off on it.

Yap said that it could take an additional one to two years for the relaxed regulation “to be formally finalized,” and it would “take a relatively long time for the government to approve it officially.”

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