Episode 5: Gaming and eSports
This episode explores the gaming industry in China. A decade ago, Western gaming companies had no interest to enter China, but times have changed. Today, China is home to the largest gaming company in the world (Tencent) and a dynamic and growing e-sports ecosystem.
What you’re listening to is the 2016 International, the world championship of a computer game called DOTA 2. A Chinese team named Wings won the tournament. Wings won nine million dollars in prize money which set a Guinness World Record for the largest prize in the history of eSports tournaments.
It wasn’t surprising that a Chinese team won the International. Five of the sixteen teams in the tournament were Chinese.
DOTA is a very popular game, with about a half million people playing every day, and the International is the largest of the Major DOTA tournaments. In the 2017/2018 season, there will be nine major tournaments. Each major has a minimum of $1,000,000 in prize money up for grabs.
As I’m writing this there’s a Major happening. It’s the MDL Championship, which is being held in the southern Chinese city of Changsha. Maybe next year’s tournament will be held in the city of Chongqing, where the world’s first stadium dedicated to eSports is being built.
Of the 12 teams in the MDL Championship, 5 are Chinese. There’s only one team from North America, VGJ.Storm.
VGJ.Storm is part of Team VGJ which also includes VGJ Thunder, a Chinese DOTA team. And Team VGJ is owned in part by NBA player and DOTA fanatic, Jeremy Lin.
If nothing I’ve said so far makes sense to you, don’t worry. Nothing really made sense to me when I started researching online gaming in China. But today’s episode is going to both of us up to speed. But brace yourself, because getting “up to speed” with the gaming industry in China, means going really, really fast.
Part 1: History of a Gaming Giant
To understand gaming in China, we have to start with Tencent. Tencent is best known today for being the creator of WeChat, China’s ubiquitous mobile messaging application. It is also the largest gaming company in the world.
The company was founded in Shenzhen in 1998 by Pony Ma and his college classmate Zhang Zhidong. Tencent launched its first application in February of 1999. It was a copy of an Israeli instant messaging application called ICQ. Tencent shamelessly named their product OICQ, until a lawsuit forced them to change the name to QQ. If you remember Aol Instant Messenger, then you have a pretty good idea of what QQ was.
Also, if you remember AOL instant messenger, then you probably also remember that it was free. Of course, that was part of QQ’s appeal, too––Chinese users obviously preferred sending free messages online to sending expensive SMS text messages.
But the free to use model was a problem for Tencent in its early days, because they didn’t have a lot of money. Pony Ma’s salary at his previous job was reportedly 1100 RMB a month, or about $140 US with the exchange rate at the time. And in 1999 they were forced to raise outside funding.
As I mentioned in a previous episode, the fundraising environment for the internet industry in China in 1999 was forgiving. And in Tencent’s case, potential investors were able to point to the success of the Israeli ICQ, which sold to AOL in 1998 for about $300 million. QQ looked attractive by association.
Pony Ma was able to sell two twenty percent stakes in Tencent to investors at IDG and Yingke Hong Kong for around $1.1 million US a piece, enough for a couple years of runway.
So far, this is a pretty typical story of Chinese tech entrepreneurship in the late 90s. But there was a twist in June 2000. With global internet stocks still booming, an American showed up at Tencent headquarters.
That’s David Wallerstein on the guitar performing for Tencent at the Shenzhen Sports Arena in 2014. Wallerstein shreds on the guitar. Today, he’s also Tencent’s Chief eXploration Officer, which basically means that he helps Tencent find overseas companies to invest in.
Back in the year 2000 Wallerstein was working in the investment arm of the South African media conglomerate Naspers. Naspers wanted to invest in China’s internet space, and it was Wallerstein’s job to find promising Chinese tech companies.
Wallerstein wanted to buy Tencent, but Tencent wasn’t interested. Despite the rejection, he stuck around, and developed a working relationship with the Tencent founders. Here’s Wallerstein on the Y-Combinator podcast.
(9:00 in Y-Combinator)
“Even before we signed the deal I was spending a lot of time with the company... it was ‘let’s not worry about these papers and documents”
Anyone who’s ever done any business anywhere recognizes that Wallerstein was putting himself in position to get burned. Tencent could have walked away at any time.
But Naspers caught a break when in late 2000 the global internet bubble popped. Tencent’s investor Yingke got cold feet, and wanted out of the investment. The profitless Tencent was again forced to look for funding.
An article in China Entrepreneur magazine describes the Tencent management team frantically looking for investors. Even though Tencent had Wallerstein and Naspers in their back pocket, Tencent leadership met with executives from Sina, Yahoo China, and Sohu. But the companies all spurned Tencent’s lack of revenue.
But Wallerstein was still around. And in June 2001, Naspers was able to acquire a 33% stake in the company, taking it from Yingke and IDG. Over the years, Naspers invested more, and ended up with about 50% of Tencent.
Tencent became profitable almost immediately after the Naspers acquisition by offering a messaging service that allowed QQ users to send messages between their QQ accounts and their cell phones with SMS. The service cost users a whopping 5 RMB a month, about 60 cents US at the time.
I just want to note here that I think it’s amazing that Tencent, today one of the world’s most valuable companies, earned its first profits offering a service for just 60 cents a month. I’m pretty sure there’s a business lesson there for any aspiring entrepreneurs who are listening.
You might be wondering right now, quite fairly, what does any of this have to do with gaming? After all, that’s what I said today’s show was about, and I haven’t mentioned it yet.
Well, one of the most interesting things about Tencent is that even though today they’re the world’s largest gaming company, online gaming wasn’t on their mind in those first years of the company. It was never really part of the plan.
It is possible that users like to interact so much in these worlds... that they don’t want to use QQ anymore.”
So entering the online gaming space was more of a defensive move for Tencent. And it wasn’t immediately successful.
Wallerstein describes Tencent’s first years in gaming as three or four years of failure. They had modest success with casual games like digital pool or cards that users could play while they chatted in QQ. But Tencent was still primarily a chat company.
At the same time, online gaming in China was beginning to take off. There wasn’t really any domestic game development talent, so Chinese internet companies like Shanda and Netease were bringing foreign games to China, mostly from Korea.
In Wallerstein, Tencent should have had an advantage getting American gaming companies to launch in China, but for the most part, American companies weren’t interested. The Chinese market was still tiny. And for that matter, who was this strange company named Tencent, anyway? They weren’t even on the radar in Silicon Valley.
Of course, Tencent eventually succeeded. Their success began when they brought a Korean game called Crossfire to China in 2008. It was a hit. In fact, it’s still, even a decade later it remains one of the most popular online games in China.
After CrossFire, Tencent’s success exploded. Let me read you a list of some of Tencent’s brands:
Tencent owns Riot Games, the developer of League of Legends.
They have an 84% stake in Supercell, developer of Clash of Clans
40% of Epic Games, developer of Fortnite
5% of BlueHole, developer of Player Unknown’s Battlegrounds
5% of Activision Blizzard, developer of World of Warcraft and Call of Duty
5% of Ubisoft
Basically, Tencent owns at least a little bit of everyone who makes popular games everywhere in the world.
But Tencent has also begun to prove its ability to develop its own games. Most notably, in 2015 Tencent launched a game called Honor of Kings.
OK, so Honor of Kings is not exactly a creative revolution in gaming, Tencent basically just copied League of Legends, a game that they already owned because of their acquisition of Riot Games. But Tencent did put a very important twist on it: Honor of Kings is made to be played on your smart phone.
In the United States, games like of Honor of Kings with complicated gaming dynamics and graphics are usually played on personal computers or consoles like Xbox or Nintendo Switch, but Honor of Kings is mobile first. And that means, everyone in in China with a smartphone––or, just about everyone in China––is a potential user. If you have a smartphone, Honor of Kings is just a free download away.
If you remember the introduction, I said that fewer than one million people per day play Dota 2, a world-famous game with multi-million dollar tournaments.
The most popular game in the United States, League of Legends, has 27 million daily players worldwide.
But Honor of Kings blows them both away. In China, every day, around 80 million people play Honor of Kings. Around 200 million login at least once per month.
Let’s let those numbers sink in for a second. 80 million play Honor of Kings every day. 200 million every month. That’s around 1/7th of the Chinese population.
Remember a few minutes ago when I played that clip of David Wallerstein talking about why Tencent got into video games? They were afraid that games would become so popular that users would rather communicate in virtual worlds than in chat applications. Well, one seventh of China is just about there. And Tencent made it happen.
In order to log in to Honor of Kings, you have to use your WeChat or QQ id. Both apps are of course owned by Tencent, and well over a billion people have WeChat or QQ accounts. Once logged to Honor Kings, you can immediately play the game with any of your active WeChat or QQ friends.
The ubiquity of smartphones in China and Tencent’s integration of chat and gaming has made Honor of Kings the most popular game ever. And by the way, it’s not just popular among men. Over half of Honor of Kings players are women.
The game is so popular that various Chinese government organizations have described it as “a threat to national security” and “a drug.”
In response to the criticism, Tencent has actually implemented time limits for minors who want to play. So if you’re under 12, you get one hour. Under 18, you can play for two.
And I, your humble narrator, can attest to the addictiveness of Honor of Kings. As part of my––*clears throat*––“research”––for this episode, I gave it a try. I’m not really a gamer, though I do occasionally binge game. But Honor of Kings took from me a few precious weeks of my adult life. And I can honestly say that playing it was the most fun I’ve had gaming since I was a boy.
If you want try it, you can download the international version called Arena of Valor. Feel free to add my gamer tag ChinaBytes, and I’ll play a round with you––or maybe we’ll end up playing 37 rounds in a row.
Part 2: A Man Named Uzi
One thing about China that I can’t stop thinking about is how underdeveloped its professional sports leagues are compared to the United States and elsewhere in the world. There’s obviously no professional football or baseball. Basketball is huge, but Chinese people watch the NBA and not its Chinese counterpart, the CBA. Plus, I think that most Chinese people probably give up on being the next Yao Ming after taking their first look at their parents.
So I can’t help but think that if I were a boy in China today, the athlete whom I would admire most might be someone like the 5 foot 6 inch Jian Zihao, better known by his League of Legends gaming ID, Uzi.
Before I get into his story, let me first note that unlike tech billionaires Wang Xing and Zhang Yiming who I talked about in episode 1, Uzi does have a Wikipedia page.
He was born in Hubei in 1997, but his family relocated to Guangdong Province when he was 15. Because of educational bureaucracy Uzi wasn’t able to start school immediately after the move, so he was able to live out a childhood dream of mine: He was stuck at home playing video games every day.
And he was really good at them. It seemed that no matter what video game he played, Uzi beat everyone.
Online games like League of Legends use what’s called an elo rating system to rank players––that’s e–l–o rating. It’s the same kind of system that is used in competitive chess, where your rating rises and falls depending on the scores of whom you beat and who beats you.
Uzi’s rating climbed high enough to catch the attention of Sherry Chen, a former professional League of Legends player turned eSports commentator and today a team manager. Chen introduced Uzi to a League of Legends gaming team called Royal Club. Then, she managed to convince Uzi’s parents to allow the 15 year old to drop out of school to become a professional gamer. Perhaps needless to say, Sherry Chen must be really, really persuasive.
Uzi won his first prize money just a month after joining Royal Club. Two years later, he and his team played in the League of Legends world championship, taking second place, and a prize of a quarter million dollars.
In 2018 he won his first international tournament, netting his team a half million dollars in prize money. The victory makes Uzi arguably the best League of Legends player in the game’s 9 year history and one of the best paid players in eSports. While his annual earnings aren’t public, some estimates I saw put the figure at around $3 million US.
Uzi is just one player of one game in China’s booming eSports industry. In China, there are already around 50,000 people employed in eSports. There are not just professional gamers, but team managers, coaches, event ushers, broadcasters, announcers––basically any kind of position that a traditional sport would have.
And Tencent is at the center of the industry.
In addition to being the owner of China’s most popular games, Tencent is the creator of the LPL, the Tencent League of Legends Pro League. That’s like the CBA, but for League of Legends. Uzi’s team, Royal Never Give Up, won its most recent title.
And I want to make it clear that this eSports league isn’t just an obscure novelty celebrated by a handful of sweaty, basement-dwelling nerds. Here’s Johnson Yeh, who is Head of China eSports at the Tencent subsidiary Riot Games speaking to Bloomberg.
“Total hours watched... 3 billion hours. Most watched... 80 million. It is the most watched sport in China.”
80 million people watched the LPL championship. Just over 100 million people watched this year’s super bowl. And unlike football, where fewer people seem to be interested every year, the trend in eSports is unmistakably upward. Prize money increases every tournament and more and more people watch every year.
Here’s Jeremy Lin, speaking in an interview with his eSports team, TeamVGJ.
If you’re still a skeptic, eSports will be a medal event in the 2022 Asian Games, which is kind of like the Olympics but just for Asia. Of the six esports titles that will be played in the 2022 Asian Games, three are majority owned by Tencent. Those titles are League of Legends, Clash Royale, and Arena of Valor. Remember, Arena of Valor is the International version of Honor of Kings. With 80 million Chinese players, my money’s on China to win the Gold in Arena of Valor.
Part 3: Economics
I think we’ve done a pretty good job of scratching the surface of the gaming industry in China. But there is one critical detail I’ve mostly neglected thus far. And that’s, money.
I’ve mostly described how Tencent spends money in gaming: they acquire foreign companies, develop inhouse games, and sponsor eSports leagues, for example. But how do they make make money?
And that’s an important question, because despite the fact that its most popular apps and games are free to download and use, Tencent is worth over $500 billion dollars.
To put that into perspective, Twitter is worth about 25 billion, Exxon Mobile is worth around 350 billion, and Facebook is right around Tencent’s 500 billion.
You might guess that, based on the similar valuation and what I’ve revealed about Tencent thus far, the obvious answer is that Tencent makes its money using the Facebook model of selling advertisements. With over a billion users, and plenty of user data, WeChat makes intuitive sense as an advertising platform. Likewise, it would be simple enough to place advertisements in a game like Honor of Kings.
But surprisingly, only about one tenth of Tencent’s revenue comes from advertising. So what’s up? Let me play a clip of actor Jack Black, who does a great job of explaining what’s going on during an appearance on Jimmy Fallon’s talkshow:
Yes, a good chunk of Tencent’s 238 billion Renminbi of annual revenue is coming from this kind of in-app purchase. Or as Tencent prefers to call it, “value added services.”
It turns out that Tencent was something of a pioneer of this kind of this kind of in-app purchase. Not long after Tencent introduced their 5 RMB per month SMS to QQ texting service, they introduced a new kind of value-added service.
In QQ’s early days, Tencent users could pay for auspicious usernames and account numbers. Things have evolved since then. Gamers in League of Legends, for example, have to pay to unlock characters. The same is true in Honor of Kings. Like Jack Black’s son, one Chinese girl spent about 100,000 RMB on Honor of Kings, that’s around $15,000 US.
But value added services don’t stop there.
It’s possible that Tencent is also including payment processing as a value-added service. And in that case, maybe Tencent also collected a payment processing fee from the girl’s family. After all, it’s very possible that they’re a family that uses WePay. WePay is Tencent’s mobile payment application, which has become something like China’s Mastercard.
And maybe Tencent also counts its financial services offerings as value added services. In that case, maybe Tencent collected interest on a loan it made to the girl’s family. Because, the purchase of the Honor of Kings equipment may have been financed by a loan from WeBank, which, as you may have guessed, is Tencent’s bank.
I’m going to conclude this episode by just recapping a few of the astonishing things that I learned while researching it.
First, today in 2018 and in the foreseeable future there is nothing weird about seeing a stadium full of sports fans looking at a group of ten people on a stage fingering their cell phones. This is the future of competitive sports. If you don’t like it, feel free to bury your head in the sand, but know that your kids’ favorite professional athletes may well be gamers.
Second, Tencent is a brilliant data point of why you can’t simply say that “Baidu is the Google of China” or “Alibaba is the Amazon of China.” Because if you did, then what’s Tencent? It’s unreasonable to draw a direct comparison between Tencent and any American company. Tencent is like Facebook meets Zynga meets Wells Fargo meets Mastercard meets the NFL.
And third, Facebook meets Zynga meets Wells Fargo meets Mastercard meets the NFL? I don’t really to make of a company that does all that. It sounds like a piece of science fiction. And guess what: Sooner or later, a Tencent product is going to be on your phone or in your home.