The Most Recent Stumble
Late last month on December 22nd, 2023, the Chinese Communist Party (CCP) regulators announced new restrictions on video gaming in China that shocked the market and swiftly wiped ~$80b of enterprise value off some of China’s top gaming companies (Bloomberg). The rules included limiting playtime, player spend within games, and a total ban on check in rewards. Tencent had its largest intraday drop since 2008, dropping 12.4% and losing $43.5b in market value. NetEase had a record breaking fall of 24.6% (market cap loss of $14.7b) (CNBC).
The market’s intense reaction caused the CCP to quickly revert the restrictions two days later, which restored some confidence. Furthermore, the head of the National Press and Publication Administration (NPPA), the industry’s governing body that announced the restrictions, was removed from their post (Reuters). Regulators also pushed through approvals for the release of 105 new game titles, the most in a 17 month time period - a positive signal for the industry (Financial Times). Though many of the gaming stocks rebounded slightly, they remain significantly depressed from their pre-December 2023 market caps.
The Stifled Growth of Gaming in China
Though gaming is seeing headwinds and an intensely unfriendly regulatory environment in China, it is still the second largest gaming market in revenue ($44b) behind the US ($46b), and is home to the largest player base (700m people) (Newzoo). The country’s position in the market and impressive growth over the past two decades was achieved through incredibly strong consumer demand and local creativity despite very little support from the government.
“Shanzhai” Consoles: 1970-1990s
China’s CCP has long viewed gaming as a negative influence for the population, describing it as “spiritual pollution” and alleging that it diverts students from their studies. Since opening up to foreign markets in the late 70s and early 80s, China had strict approval requirements for game title releases and maintained a high tax on gaming-related imports. Game consoles were taxed at 130%, which effectively barred foreign gaming companies from taking hold in the country.
Instead, Chinese gamers were driven toward locally produced consoles such as the Xiaobawang, a system sold in 1993 as a tool for learning but could also play NES games. While Chinese parents purchased them for their kids to study, kids found ways to play counterfeit NES games on them. The Xiaobawang, other local consoles, and the counterfeit games they ran were part of the larger category of “Shanzhai”, or counterfeit products in China that copied foreign equivalents yet tailored them to the local market, all under artificial market protections (Game Developer).
As the popularity of gaming grew in China, state media and public sentiment of the entertainment medium grew increasingly negative and eventually led to government crackdowns on the industry (Sarah Laio, University of Texas).
“Wangba” PC Cafes: 2000-2010s
Citing adverse effects on the mental health of its youth, the CCP made the first major crackdown of gaming in China in the year 2000. The CCP banned foreign consoles (though this later lifted in 2015) and censored gaming content (Reuters). Rather than curbing play, the restrictions opened up the market for local internet cafes (wangba) to thrive in the vacuum that the console market left behind. In 2000, an estimated 40k wangba internet cafes existed in China, by 2002 that number more than doubled to 110k (Haiqing Yu, RMIT).
PC gaming took off with imported games like Starcraft II and World of Warcraft, but local PC games also started to be produced, such as Jianxia Qingyuan (Game Developer). In 2000, the Chinese gaming industry is estimated to have been worth ~$210m, by 2005 it was ~$600m (Journal of Technology Management in China), the earliest days of what is now a $44b gaming market in China.
The growth of PC gaming, the purchasing power of Chinese players (high upfront costs made traditional game purchases inaccessible), and the proliferation of copycat games helped spawn online free-to-play games in the region. Online free-to-play games have low barriers to entry (free), are immune to copying as the experience is online with official servers for anyone to join freely, and allow for slowly monetizing users over time (in game purchases). During the mid-to-late 2000s, this monetization mechanic proliferated through Chinese gaming and other markets across the globe. This set the precedent for many of the world’s most successful games today (Garena Free Fire, League of Legends, Fortnite, etc).
However, gaming’s growth in China itself fueled renewed fears of gaming addiction from the government. In 2007, a government report claimed that 6% of teenage internet users played games >40 hours per week. Later that year, the government introduced new regulation that required games to incorporate “anti-addiction software” that required logging in with their national identification, monitor how long underage kids played, and wipe half their in-game currency if sessions surpassed 3 hours (Engadget).
Mobile Explosion: 2000-Today
During the early 2000s, mobile phones started to proliferate and technology progress with smartphones began picking up at increasing rates. In 2007, the iPhone was released, which was a major turning point in the gaming industry. When the iPhone was launched, the global gaming industry was worth ~$42b in aggregate and mobile gaming accounted for very little of the market.
In 2023, the gaming industry is worth ~$184b with mobile making up roughly half of all revenue (Konvoy). The iPhone and the proliferation of smartphones in general over the past 15 years created an incredible boom for the gaming industry globally, but especially in China. Since most Chinese consumers did not have personal computers, mobile smartphones became the main and sole connected technology device for the vast majority of consumers with internet access.
In 2010, the gaming industry was worth $4.9b in China (China Culture); by 2020 that number had risen to $43.1b, driven primarily by mobile gaming. Today, mobile accounts for over 66% of the gaming market in China (Niko Partners).
During the early 2010s, the anti-addiction measures imposed by the government on PC gaming was not enforced on mobile gaming, which further fueled their popularity and growth. However, in 2017, after facing significant public and state media criticism, Tencent began self-imposing similar anti-addiction measures on their Honor of Kings mobile title (CNN). In 2018, multiple government bodies from the Ministry of Culture to the State Administration of Radio and Television all pushed for more stringent regulation on the gaming industry and approvals of new games titles were frozen (Bloomberg).
In one instance, the Ministry of Education called for additional time restrictions on players, which caused a 5% intraday drop in Tencent market value (~$20b) (BBC). Subsequently an "Online Game Ethics Committee'' was set up to review new games for appropriate content and issues related to the renewed concerns of childhood myopia and 2018-2019 saw multiple freezes on new games in China (Polygon).
Increased Scrutiny of Chinese Gaming in 2020s
In late 2019, China announced restrictions that would limit players to 90 minutes of play per day on weekdays and no more than three hours over the weekend (New York Times). By 2021, this was revised to three hours a week in total (Wall Street Journal). The state-owned newspaper, Economic Information Daily, then published a report in August 2021 stating that gaming was a “spiritual opium”, that gaming addiction was on the rise, and called for stricter regulation (Reuters).
The report caused another fall in shares of gaming companies; Tencent market value fell by ~10% (Wall Street Journal). Both Tencent and NetEase shares fell by an additional 8.5% and 11% respectively after they were summoned by regulators for a hearing in September 2021 (CNBC). In the same month, an internal memo was sent to major gaming companies that warned them of things to avoid for game approvals: games that “blurred moral boundaries” where players had the option of being good or bad, games that gave a “revisionist” form of history, or games that appear more Japanese than Chinese (South China Morning Post).
A report in 2022 by the China Game Industry Group Committee (closely associated with the CCP) indicated that measures to curb youth gaming addiction in China had been effective, with over 70% of young people playing under three hours per week (CNBC). Which brings us to the most recent stumble; an $80b destruction in market value and subsequent corrective pullback of those very same regulations by the government.
Takeaways: The CCP has a strong belief that gaming is a negative influence on the Chinese population for a multitude of reasons; they believe it distracts students from studying, that it is an unproductive waste of time, and contributes to myopia. What they do not say outright, but is likely also a contributing factor to their decision, is that gaming opens the door for foreign cultural influence on the population and is a risk to the tightly controlled state surveillance monitoring of Chinese citizens.
Yet it is clear that the CCP realizes they have to tow a fine line between controlling their citizens and enabling their economy to thrive. Actions that curtail gaming have a direct financial impact on many of China’s most prized businesses. We expect Chinese gaming companies to continue to try and serve the local market, but with the restrictions and uncertainty of regulation they will more aggressively setup operations outside of China in places like Southeast Asia (such as Singapore, Vietnam, Malaysia, Philippines) to escape Chinese regulation when possible and to focus their efforts on producing games for foreign markets.
