Li Xiang × Li Feng: In Waves of Technological Change, Why Is Gaming Usually the First to Make Money? | Li Feng Column

峰瑞资本·February 29, 2024

From a Brief History of Gaming to New Online Game Regulations: Finding Innovation Opportunities in the Industry

This column is drawn from an in-depth conversation between Li Xiang and Feng Shu on the "High Energy" podcast. Li Xiang is the author of the In-Depth Conversations book series and the host of The Torrential Times.

In late 2023, the National Press and Publication Administration released a draft Measures for the Administration of Online Games (Draft for Comments), which included a series of proposed restrictions on online game spending: banning daily login rewards, first-time top-up bonuses, consecutive top-up rewards, and other inducement mechanisms, while requiring all online games to implement user spending caps. The draft sparked heated public debate, and officials from the National Press and Publication Administration stated that further revisions would be made.

In this episode of High Energy, Li Xiang and Feng Shu trace the evolution of the gaming market, examining its patterns and emerging shifts. The conversation begins with China's first wave of online game entrepreneurship, then moves through social games, browser games, and mobile games, before returning to the present moment.

The questions they explore include:

From 2000 to today, what waves has China's gaming industry experienced, and what innovation opportunities emerged from each?
As different game types rose and fell throughout this history, what do these shifts reveal about changing user preferences and market dynamics?
What new changes are happening in gaming now? How are game products adapting to technological transformation and meeting younger generations' demand for immersive experiences?
How will the Draft Measures affect game development and player experience?
How did the "Shanghai Four Little Dragons" succeed without relying on major platforms, and what lessons does this offer startups?
Why is it said that "games both serve as a landing point for AI technology and bear the responsibility of cultural export"?

We've edited portions of their discussion into this article, hoping to offer fresh perspectives. We invite you to continue observing and exploring these topics with us. You can find the full episode on Xiaoyuzhou, Apple Podcasts, or Ximalaya by searching for and subscribing to "High Energy." If you're a founder or professional in the gaming space, we'd love to hear from you.

Giveaway

What innovation opportunities do you see in the gaming industry? By 17:00 on March 7, the five most thoughtful commenters will each receive a FreeS Fund industry research handbook plus a book recommended by Feng Shu.

/ 01 / Early Chinese Online Gaming Evolution: Wealth Creation and Business Model Innovation

Li Feng: Back to gaming — the industry has gone through several cycles.

Li Xiang: I'm not sure about the overall revenue of Chinese gaming companies or the total number of users across all gaming categories.

Li Feng: As of 2023, China's gaming market revenue exceeded 300 billion yuan, with 668 million users. These figures come from the Game Publishing Committee of the China Audio-Video and Digital Publishing Association.

Before the new regulations came out, we were preparing to invest in a game project. After the regulations dropped, we decided to proceed despite internal debate — a decision made right in the eye of the storm. Personally, I don't play games, and I've made very few investments in this space. I'm not your typical hardcore user.

Li Xiang: So you missed out on that wave of gaming company dividends.

Li Feng: Today let's discuss how gaming companies developed, and why we're choosing to invest in one at this particular moment. We'll also talk about the recent gaming regulations.

The gaming industry once produced China's richest person. In the 2004 Hurun IT Rich List, Chen Tianqiao, founder of Shanda Games, topped the list, while Zhu Jun, founder of NCTY, ranked fifth. They were both emblematic figures of China's early internet era.

After the 2001 U.S. dot-com bust, many Chinese entrepreneurs flooded into the internet market. They explored various forms of internet applications, and games became one of the earliest profitable use cases. Most games at the time were imported. In 2001, Shanda licensed The Legend of Mir from South Korea. In 2004, NCTY licensed World of Warcraft. In 2009, NetEase became the exclusive mainland operator for World of Warcraft. After these companies generated enormous wealth, more imported and domestically developed games began competing in parallel in the Chinese market. This was the first wave of internet-driven wealth creation.

Both The Legend of Mir and World of Warcraft were MMORPGs (massively multiplayer online role-playing games). As the gaming pie grew larger, development and gameplay became increasingly complex and refined. Initially, games charged by playtime — the so-called "point card" model. But China innovated on this model. Starting in 2004, Tencent, Shanda, Giant Network, and others announced that some games would be free to play, no longer charging by the hour but instead monetizing through in-game items.

Li Xiang: Right, the so-called free-to-play model.

Li Feng: The emergence of free-to-play had a specific backdrop. In 2005, China's broadband infrastructure underwent a major shift. According to data from the Chinese government website, broadband subscribers reached 37.35 million that year, surpassing dial-up users for the first time. Globally, developed countries accounted for 74% of broadband users, while China represented 17.5% — a relatively leading pace of broadband adoption among developing nations.

This infrastructure change brought massive growth in player numbers and revenue. According to the 2005 China Game Industry Annual Conference, online game users reached 26.34 million by year-end, with 13.51 million paying users — over 30% growth year-over-year. iResearch reported that China's online gaming market grew roughly 50% compared to 2004.

Behind this growth, gaming companies needed substantial capital to build out distribution channels and meet demand from both individual consumers and internet cafés.

This catalyzed a business model innovation: instead of charging by playtime, companies monetized through in-game items. This meant games had to be not just fun, but designed to draw players in and make spending enjoyable — using various methods to immerse users and let them purchase status and prestige. Because companies had to invest heavily in these aspects, the barrier to entry in gaming rose further.

Social Games: Entertainment Transformation in the Web 2.0 Era

Li Feng: After this business model innovation, making PC-client multiplayer games became extremely "heavy."

Li Xiang: R&D investment suddenly skyrocketed.

Li Feng: In these heavyweight games, both operations and player base became critical. If you're a paying player, after spending money, you need enough other players to make you feel your privileges and status in the game.

Li Xiang: There's a popular quip that gaming giants won't tell you: free players are actually a feature provided to paying players.

Li Feng: That's essentially it. So to attract paying players, you need a sufficiently large player base. Looking back, PC-client games already had extremely high barriers to entry — small companies could barely find innovation opportunities in this space.

Li Xiang: They call them AAA titles.

Li Feng: Right, like making a military blockbuster. You go all-in from the start, rather than competing incrementally.

Li Xiang: This might be an industry "conspiracy" — raising barriers means fewer competitors.

Li Feng: Exactly. As we discussed before, historically this approach may have hindered the diffusion of productivity, but it ultimately can't stop innovation, because people always aspire to a better life. If gaming's barriers become so high that they're unfriendly to new users, startups, and innovation, that becomes an obstacle for the entire industry.

Around 2008, another shift occurred in the consumer electronics market. The iPhone had just launched, and the concept of mobile gaming barely existed.

Another development came in 2007, when Facebook opened its platform to drive user growth, making site data available to third-party developers. These developers could create apps integrated with Facebook's core functions. Among all the open applications on Facebook, the most successful and profitable remained games — for instance, Zynga launched social games like "farm stealing" and online poker.

In 2008, open social platforms like Kaixin001 gradually emerged domestically. In 2010, Tencent also opened its platform. In terms of gameplay depth and hardcore appeal, farm stealing couldn't compete with battle or multiplayer RPG games, but it won through simplicity and accessibility.

It's fair to say: whenever new technology emerges, games are always the first to monetize.

Li Xiang: What was the business model for games like farm stealing?

Li Feng: Farm stealing, parking space snatching — these games didn't have much of a monetization model. Zynga abroad mainly profited by selling virtual items to players.

Around 2007, as social games became a trend, many new companies — seeing no opportunity in traditional gaming due to high barriers — pivoted to social game development. Some focused on the domestic market, others targeted both domestic and international markets.

But after all, these games were built on someone else's platform. Facebook later began developing its own social games. Zynga grew from a startup to a publicly traded company with a market cap exceeding $10 billion, then fell back down. The whole cycle involved several years of volatility, but at least Zynga showed the industry new entrepreneurial possibilities.

These social games attracted many people who normally didn't play games. People registered on Kaixin001 just to steal virtual vegetables or grab parking spots.

Li Xiang: It didn't just lower the barrier to making games, but also the barrier to playing them. You could start playing in just a few minutes.

Li Feng: Right. Honestly, these games' social appeal far outweighed their gameplay appeal. Social games, while cultivating a game innovation ecosystem and new player demographics, ultimately didn't produce any enduringly successful companies. For example, when other major platforms launched their own farm stealing games, it severely impacted Kaixin001. Social games flashed by like a fleeting glimpse — though at the time they seemed to offer infinite innovation opportunities.

Following social games came a new wave of browser games. Around the 2008 Beijing Olympics, from 2008 to 2009, China's infrastructure improved rapidly again — broadband speeds and coverage expanded significantly. In 2008, China became the world's largest broadband market; by 2009, Chinese broadband users exceeded 100 million for the first time.

Browser game users grew rapidly. According to TechWeb, by end of 2009, browser game users had surged 60.1% since the start of the year. Some casual social game users began trying browser games like Three Kingdoms Storm, Hot Blood Three Kingdoms, and Seer. The psychological barrier to playing browser games was low — just open a webpage, play, close it. No need to think about downloading clients or registration.

These lightweight browser games contrasted with heavy client-based games. PC-client games had evolved into big-budget, big-production territory with high user barriers — downloading a game client consumed massive hard drive space.

Browser games, including some primarily social ones, even spawned publicly listed companies. Kunlun Tech, developer of Three Kingdoms Storm, was one example.

The Rise of the "Four Little Dragons": Breakthroughs in the Mobile Era

Li Feng: Around 2012, gaming platforms underwent a fundamental transformation. Though the iPhone launched in 2007, smartphones didn't truly penetrate China until roughly 2011 to 2012. By 2012, China had become the world's largest smartphone market, surpassing the U.S.

Li Xiang: Companies like ByteDance were founded right around that time.

Li Feng: Indeed, though the first to profit were still games. After the iPhone appeared, many games began pushing into mobile. Initially these were simple games with novel mechanics — like Angry Birds in 2009 and Fruit Ninja in 2010. Around 2014, NetEase, Tencent, and others began ramping up mobile investments, launching major IP mobile titles like Fantasy Westward Journey and Naruto.

At the time, phone performance was limited, but they offered entirely new interactions and experiences — tactile operations like swiping the screen. The mobile gaming wave spawned many new companies, even new public listings, all starting from lightweight, small-scale games.

As phone performance improved, mobile games gradually became more sophisticated and hardcore. From 2013 to 2017, China's gaming industry saw a new wave of companies emerge — what people now call the "Shanghai Gaming Four Little Dragons" (the new gaming powerhouses miHoYo, Lilith Games, Hypergryph, and Papergames).

I remember about ten years ago, Papergames wanted to partner with Bilibili to promote a game called Nikki's World Tour. The game hadn't launched yet — they only had a working prototype. It was a dress-up game for girls, where players matched stylish outfits.

As someone who didn't really understand games, when they showed me this in 2013, I even wondered whether such a game could really find a market. But the founder had studied in Japan and had deep observations about female-oriented gaming. Moreover, his view was that thanks to the popularity of lightweight mobile games like Angry Birds and Fruit Ninja, the gaming user base had expanded significantly — especially young women, who used iPhones more, and many female users were encountering games through their phones. Therefore, it was necessary to develop more mobile games targeting female users. His reasoning made sense to me, and I approved the investment.

As the user base expanded, more female-friendly games like Mr. Love: Queen's Choice and Tears of Themis appeared in the market, a trend that continues today.

As early as three or four years ago, competition in gaming was already intensifying. miHoYo's Genshin Impact, for instance, cost $100 million to develop, requiring teams of over a thousand people working for two to three years. The characteristic of such games is that by the time they're finished, market conditions and competitive dynamics are full of uncertainty — but without massive investment, you can't even find out the result.

Li Xiang: So when you make a game now, you're betting on market conditions two years out.

Li Feng: In this sense, Genshin Impact may be a landmark product, and an interesting inflection point for the industry.

During the pandemic, with people spending more time at home, gaming received additional momentum. Genshin Impact, along with Honor of Kings and PlayerUnknown's Battlegrounds, performed extremely well during this period. But by then, whether battle games or mobile MMORPGs, the investment required and ultimate uncertainty had become extremely high — like making a blockbuster film, you don't know what you'll get after committing massive funds and resources.

I personally didn't make many gaming investments during this phase, but my impression is that gaming investments and startup numbers may have declined significantly over the past two to three years. The reason is the barrier to entry has become too high — it's difficult to find entirely new innovative genres at such elevated barriers.

When gaming barriers rise to a certain level, historical patterns suggest market shifts typically occur. Because the industry always needs sufficient innovation to attract different types of players, or bring in new ones.

Moreover, these shifts are usually substantial enough that existing large and mega-sized gaming companies can't immediately perceive and adapt to them — creating openings for smaller companies to break through. The PC-to-mobile transition, the client-to-browser transition — these changes were large enough that not all companies could immediately recognize and adapt to them. The computer-to-phone shift, for example, completely changed interaction modes and required far less storage and computing resources. This is roughly where the gaming industry stands now.

Meanwhile, gaming company dynamics are also affected by factors like game publishing licenses. According to statistics from GameLook, The Paper, and other media, China issued 1,075 game licenses in 2023. This was actually relatively high, since 2022 saw only 512, 2021 had 755, and 2020 had 1,405.

Li Xiang: Which year had the suspension?

Li Feng: There wasn't a complete suspension, just a slowdown — like 500-plus, 700-plus. Going further back, 2019 peaked at 1,570.

Though 1,000 licenses is much fewer than 1,500, I suspect that post-Genshin Impact, due to higher barriers, even established gaming companies struggle to simultaneously launch multiple new game product lines.

Considering these factors, the current 1,000 licenses may represent roughly the same market supply level as four or five years ago. Back then there were more gaming companies, more enthusiasm for making new games, and slightly more opportunities — though the industry was already quite "competitive."

So returning to the present: is the gaming industry due for change? And where would change come from?

First, post-pandemic, escape rooms and murder mystery games have become favored entertainment among young people. Young people may prefer these activities because they can become part of the story. This experience surpasses watching films, TV series, or theater. This means today's youth place greater value on immersion, identification, and participation in the narrative.

We've observed that some entertainment projects, particularly web series, were extremely popular on video platforms. About three years ago, interactive dramas even emerged as a new form. At critical plot junctures, users could choose A or B, with different choices leading to different story paths.

Interactive dramas used this mechanism to draw consumers into deeper emotional investment, but the available plot paths were inherently limited. If viewers made frequent choices, production costs would increase enormously. Thus this multi-threaded format only briefly trended. But this tendency showed consumers want to become part of the story, desiring greater identification.

Another change is the metaverse and metaverse gaming. On platforms like Roblox, players can design their own items and scenes within games. But the metaverse wave rose and quickly receded, because the barrier to user participation remained relatively high. Moreover, even if users could create interactive content, without professional skills the results might not be particularly engaging. This still reflected the user desire to participate in content creation.

Another shift is the emergence of large language models, which offer more creative possibilities for plot development at relatively lower cost. Previously requiring massive manual content writing, LLMs can now assist with continuous creation. Of course, this requires a degree of plausibility. Current text-to-image and text-to-video technologies, even when not fully reality-based, can mostly create reasonable content. As long as it's not too absurd, it's generally acceptable.

LLMs have significantly reduced the cost of such creation, especially for multi-threaded storylines and corresponding game scene backgrounds.

So we're observing whether these changes might bring new directions and innovations to gaming.

Returning Games to Being Fun, and to User Volition

Li Feng: Back to the main topic — the recent draft for comments. I have two hats: as a parent, and as an early-stage investor. From the parent perspective, I think limiting games is a good thing. But from the investor perspective, we need to carefully analyze why such policies emerge.

I speculate one motivation behind this draft is to return games to their essence of being fun. It aims to prevent some games from leveraging their backing by major platforms with massive user bases to attract players — which constitutes a form of unfair competition. Sometimes users encounter a game not because it's genuinely fun, but simply because the game reached them through a particular platform.

Another approach, as we discussed earlier, involves operational tactics — relying on inducements, rewards, or other stimulus behaviors to attract players. Perhaps the draft hopes players play because they genuinely want to, not because they're constantly stimulated to log in or induced to top up.

Li Xiang: Like the anti-addiction system.

Li Feng: Right, that was one of the original intentions behind anti-addiction systems. Official meetings have mentioned "establishing the new before abolishing the old." Though in outcome, we can't say the draft is "abolition" — it's more likely about regulating the industry to return to principles of fun and user volition. But from the industry perspective, it may also be seen as a form of "abolition." Meanwhile, issuing 1,000 game licenses could be viewed as "establishment."

Li Xiang: Maybe it's the "slap first, then give candy" approach.

Li Feng: My interpretation is that this policy was originally intended as a "simultaneous abolition and establishment" approach. I think mobile gaming may have reached a point where change is possible. Meanwhile, China's gaming industry bears two additional responsibilities.

First, from the brief history of games, whenever technology and infrastructure transform, the application ecosystem that profits first is usually games. In the current AI wave, gaming will likely be no exception.

Second, games are the vanguard of cultural export right now. Currently, the ratio of domestic to overseas revenue for China's gaming industry is roughly 3:1. According to data from the Game Publishing Committee of the China Audio-Video and Digital Publishing Association, China's gaming industry revenue broke 300 billion yuan in 2023, while gaming export revenue reached $16.366 billion (approximately 117.8 billion yuan). In the current complex international environment, traditional cultural promotion methods may face difficulties, but games may be well-suited for export — alongside short-video apps like TikTok, variety entertainment programs, short dramas, and web novels.

Games, particularly the success of Chinese online gaming companies abroad, in a sense both serve as a landing point for AI technology and bear the responsibility of cultural export.

Therefore, the gaming industry will likely develop along two directions: industry innovation (such as enhancing user immersion) and going global — ideally combining both. If domestic licenses continue to be issued, the gaming industry should be able to continue developing.

Li Xiang: I just recalled there was also a previous round of adjustments targeting short video. During the pandemic, short-video platforms introduced anti-addiction measures too — Douyin and Kuaishou would pop up youth mode reminders at login. Long-video platforms introduced similar measures during the pandemic. From time to time, unexpected things like this can emerge, potentially affecting capital market confidence.

Li Feng: What's interesting to me is that in social entertainment, there's one company in China you can't avoid — Tencent. Previously, gaming companies were more or less influenced by Tencent, either partnering with or being acquired by them. But miHoYo's Genshin Impact and similar games didn't primarily rely on Tencent's platform and heavy paid user acquisition to gain players, yet could independently compete with games from giants. This is partly why people call miHoYo one of the "Shanghai Four Little Dragons."

Li Xiang: NetEase too.

Li Feng: Right, NetEase is another example. They originally promoted games through their 163 email service, having their own channels. But before the "Four Little Dragons," NetEase was almost the sole exception.

Gaming entrepreneurship isn't as vibrant as before, so people don't discuss this as much. But the implicit meaning of "Four Little Dragons" is that even without any exclusive or deep cooperation with giants, you can still become an excellent gaming company — this is where people's hopes lie.

But like almost every industry, giant influence always persists. NetEase's Eggy Party, launched in 2021, had some gameplay innovations and currently shows very strong metrics and financial performance. Tencent's DreamStar, launched in late 2023, was essentially promoted to over a billion WeChat and QQ users.

Finally, as we mentioned, the timing of this draft for comments is quite particular. There may be further developments ahead — let's keep watching.

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