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Adoption of gratis games by the mainland's largest operator signals a market shift that could imperil industry sales

Shanda Interactive Entertainment is making waves in China's US$580 million online game industry after switching a popular title to a 'free-to-play' model - a move that could raise expectations that all games should be free and undermine the business of other operators.

Last week, Shanghai-based Shanda said Legend of Mir II would no longer charge for access to its online world, although the company hoped to continue earning sufficient revenue from the game through the sale of virtual in-game items.

Following the announcement, Shanda's Nasdaq-listed shares fell to new 52-week lows and analysts began trimming their revenue expectations for the company.

'It is a risky move and potentially destructive for the industry,' CLSA analyst Frank Shi said. 'Gamers may develop the perception that games should be free. If they have this mindset, it will be bad news for everybody.'

In all, Shanda plans to offer three free-to-play titles. While making Legend of Mir II gratis has upset Wall Street, industry analysts were not surprised.

The four-year-old title is nearing the end of its shelf life, its users having declined 63 per cent sequentially over the past quarter.

Evolution Securities analyst, Jim Sun, said: 'In order to maintain their user base for future roll-outs, they need to keep existing users and attract new users. But they face the loss of short-term revenues.'

A sense of entitlement may have already seeped into the minds of mainland gamers. Many casual games are free, and a growing number of free multiplayer role-playing games are gaining traction.

The mainland's top-ranked free multiplayer role-playing game is the 2.5D-graphic South Korean import Yulgang, licensed and operated by Beijing-based 17game, a subsidiary of China.com. Yulgang registered 250,000 peak concurrent users at the end of September.

China.com chief executive Albert Lam said: 'We didn't expect the users to grow so fast.' Though he stopped short of calling free-to-play a trend, Mr Lam took a bet on the model because China.com was an industry underdog.

'We needed to be innovative. By giving away free playing time we could grow the base quickly and to compensate for the free playing time, we sell virtual merchandise,' he said.

Bill Bishop, chief executive of Beijing-based game developer Red Mushroom, said business models were shifting from pay-for-play to free play supported by virtual item sales.

Free-to-play has already seen success in South Korea, the mainland's top source for online games and a market from which mainland gamers take their cues.

'[Free-to-play] is a trend in the industry. It's a model that has existed and is now spreading to [multiplayer role-playing games],' he said.

Red Mushroom plans to launch Borderland, a 3D multiplayer role-playing title based on a free-to-play model.

Mr Bishop conceded Shanda's move would cause some pain to other operators. 'In an ideal world, we'd pick fee over free, but free is what the market wants. It's where the market is,' he said.

But while casual games have long been free, it is not clear whether multiplayer role-playing titles can go the same route owing to their larger development costs and other expenses such as product marketing, customer service and server infrastructure.

Yulgang, which entered beta testing in April, has generated US$1.4 million in sales through September.

Legend of Mir II, which had about 233,000 peak concurrent users, took in US$19.1 million for Shanda.

Mr Bishop said the free-to-play model was far from perfect but with some tweaking could prove as lucrative. 'Maybe put advertising in the games. With a large user base, that's another revenue stream,' he said.

But he doubted whether games that were designed to charge users for play could easily be adapted to a free-to-play system.

Also, a title which derives its revenue principally from the sale of virtual items would change the game dynamics, with some gamers opting to buy premiums to give themselves a leg up while others forego them, resulting in play that can be lopsided or unchallenging for either side.

'If balancing isn't done properly, it's no longer interesting to the players. That's happened to a lot of games and it dramatically decreases the lifespan of the game,' he said.

Despite a trend towards free, not every operator is fated for it. Analysts said Shanda's move would pressure second and third-tier companies to follow suit, particularly those in the highly competitive 2D-graphic game space, as the industry prepares for the next generation of 3D games.

Mr Sun said: 'If companies don't offer free service [for 2D] games, they will die. This model will extend their life span for another two to three years.'

For this reason, The9, which operates the hugely popular 3D World of Warcraft in China, will be insulated from the trend.

Another leading game operator, NetEase.com, is also unlikely to give away anything anytime soon, according to the company's online games marketing director Ken Li.

'We have the confidence that ... our products are good enough to convince people to pay for them. Price is not the major reason people leave our games,' Mr Li said. 'If we say our game is free of charge, it doesn't mean they will return.'

Tencent Holdings, whose first multiplayer title QQ Fantasy has hit 660,000 peak concurrent users in beta mode, also had no plans to turn the game into a free-for-all, according to a company official who requested anonymity.

As for Shanda, not everyone is convinced its gamble to sacrifice short-term revenue for greater market share will pay off. Mr Li said Shanda's free-play offer was likely to lure back players who had migrated to illegal, pirate servers and these users were not the best source of revenue.

'People playing on illegal servers like the game, but don't like to pay,' he said.

But Shanda, having reported its first ever quarter-on-quarter revenue decline and losing market share to competitors such as NetEase and The9, appears ready to take a leap of faith.

'Shanda was once upon a time the biggest guy. They set the rules,' Mr Li said.

If the free-to-play gamble pays off, it could see a return to the glory days and once again dictate the rules. But at that point, turning back the clock on free games could be a non-starter.



Shanda prefers free over fee, but rivals not game