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Crouching tiger, hidden dragon: NetEase goes global

Gamers and investors alike have much to expect from NetEase as it explodes onto the global stage.

Credit: NetEase

How do you say Wingardium Leviosa in Chinese?

That is probably not a question Harry Potter fans gave much thought to previously. It may, however, be a question to ponder as NetEase (NASDAQ: NTES) inches forward in its plans to go global.

Started as a relatively low-profile Chinese company, NetEase’s explosion onto the international scene ostensibly came with two announcements in May and June of 2020, when the firm scored rights to develop the mobile games for the Harry Potter and Lord of the Rings franchises respectively. 

While NetEase has a track record for cautious development, the company’s slow creep onto the global scene is one to keep an eye on in the years to come.

NetEase seemingly burst onto the international scene when it scored the rights to develop mobile games for international franchises. Source: Warner Bros and NetEase

A seasoned hand never shows his cards

Ding Lei, NetEase’s CEO, is known in industry circles for being hyper-conservative and cautious. Rumor on the street is that when asked to describe the concept behind his company’s new building in Beijing, Ding Lei proudly said: yin, which means “hidden” in Chinese.

NetEase was listed on the Nasdaq as early as twenty years ago and is considered one of the first generation of Chinese internet giants to do so. The firm’s rise, however, has always been somewhat eclipsed by that of Tencent (HKG: 0700), Baidu (NASDAQ: BIDU), and Alibaba (NYSE: BABA), also popularly known as the BAT triumvirate.

However, NetEases’s new pivot to globalization may just be Ding Lei finally showing his hand, with the goal of taking the world by storm in 2020.

NetEase CEO Ding Lei is a veteran in the Chinese internet market. Source: 36kr

As early as 2009, Cheng Lingfeng, a veteran of the Chinese media industry, described Ding Lei as “the most conservative, the most patient, and the person most likely to live a thousand years in the Chinese Internet industry”.

“He will wait and wait until everyone has killed themselves in battle first, before going in to clean up the battlefield.”

This philosophy is reflected in his letter to his shareholders in 2019, which had the unique quality of being somewhat somnolescent compared to more superlative-laden examples from peer companies.

“We are okay with spending two decades to fine-tune a game or several years to perfect a music app. Our principle is an unwavering belief in proceeding at our own pace, come what may,” Ding Lei mused. “Running a company is not a 100-meter sprint but rather a marathon.”

Ding Lei is known for his reluctance to show an early hand. Source: NetEase Identity website

NetEase’s global pivot may have seemed sudden, but one thing is sure –  it must have been on a slow boil in meeting boardrooms from an early stage.

Keeping in line with the united front, NetEase’s executives have officially shifted gear to promoting its global pivot from 2020 onwards. At its Sixth Annual Product Launch event on May 20 this year, for instance, the firm reemphasized plans to increase its visibility and become a leader in the global online games market.

In official news releases, the company has also made subtle tweaks to its self-description to better reflect its global ambitions. Since November 2019, NetEase has switched from describing itself simply as a “company in China” to a “company based in China, that has been expanding rapidly into other international markets such as Japan and North America in more recent years,” somewhat echoing ByteDance’s ambitions to be seen as a global company “that happens to be Chinese rather than the other way around.”

Coming home to go global

In June 2020, NetEase raised USD 2.7 billion in a secondary listing on the Hong Kong Exchange (HKEX), with its stock price soaring well above its initial price of HKD 127 to HKD 130. This has been the second-largest listing on the HKEX in 2020, after JD.com (NASDAQ: JD).

Ding Lei harked back to cultural principles when explaining the reason behind the domestic listing.

The Hong Kong IPO, he said represents NetEase “returning to a market in which we share a mutual cultural understanding“, closer to the company’s roots, to “further fuel our passion in our business and our users.”

At first glance, one could interpret this as a sign of doubling down on the home market. However, the substance behind this listing suggests the complete opposite. According to NetEase, proceeds from its Hong Kong listing will be used to finance its global expansion plans.

The Hong Kong listing also enables strategic access to global capital, should US-China relations turn sour in the future, with NetEase joining the wave of Chinese companies returning to local capital markets.

NetEase in the limelight recently for its secondary listing. Photo:Shutterstock.com

What makes NetEase different from other Chinese companies seeking cover from US delistings is that it has nearly been bitten before.

In 2001, it was very nearly forcibly delisted from Nasdaq following allegations of fraudulent behavior from its directors. In an eerie coincidence, the company also had to deal with a recession in the wake of the bursting dot-com bubble. Once bitten and twice shy – NetEase was the first Chinese company in 2020 to pursue a secondary listing in Hong Kong, perhaps all too aware of Nasdaq’s power to bring its global ambitions to a screeching halt.

Building a Chinese fortress for survival first

Why NetEase’s global ambitions are interesting is partly because the firm has framed itself as a Chinese game company with a competitive edge in its ability to tailor games to the domestic market.

For instance, its legacy hits, Fantasy Westward Journey and Westward Journey II, are based on one of the Four Great Classics of Chinese literature, Xiyouji. Xiyouji, which stars a monk, pig, monkey, and assorted friends on a jaunt across the greater Asian landmass in pursuit of Sanskrit scriptures, possesses uniquely East Asian historic flavor.

NetEase’s game developers, however, gave it a second life as a swashbuckling MMORG, grossing a staggering USD 6.5 billion in lifetime revenue as of 2019 and searing it into the minds of millennials for posterity.

NetEase leveraged its understanding of Chinese consumers to consolidate its domestic position. Source: NetEase XYQ website

NetEase’s original focus on the Chinese market originated from a pure survival instinct.

“In 1997, the internet business model was advertising, but this crushed in 2000. At the time, I thought that maybe bringing games online would make consumers pay for more games,” explained Ding Lei an interview at the 17th Nikkei Global Management Forum back in 2016.

“So, we learned how to develop online games from Western companies. However, we put more Chinese cultural elements in our games, so even until now, Western and foreign game companies find it very difficult to exist in China…we set up a new standard for games. Chinese players love this style of games but Western companies do not know how to make a game like that…We are very lucky because China is a huge market.”

Baptism of fire in the Japanese market

Growth in earlier stages was largely driven by the growth of new mobile users in China. However, as the Chinese market matured, competition intensified, and gaming quality and variety became become a key differentiator. In addition, challenges from local giants such as Tencent made competition increasingly stiff in the domestic market.

As a consequence, the firm started to think about its international expansion opportunities.

Japan, in particular, was and is a key market for NetEase. After China, it is the second-largest market for mobile games, and despite having less than 70 million mobile gamers, it generates the highest Average Revenue Per User (ARPU), according to SensorTower.

With both China and Japan sharing some East Asian consumer traits, Japan might have been a safe testing ground for NetEase’s first wave of its global go-to-market strategy.

Knives Out struck gold in Japan. Source: NetEase Knives Out website

Rather than being an easy win, however, competition in the local Japanese market is incredibly intense and a true litmus test of NetEase’s inherent gaming quality. In this respect, the company has successfully become somewhat of an anomaly in Japan, as one of the few non-local players with a reputation for developing and publishing quality games.

NetEase’s Knives Out remains one of the top 10 grossing games in Japan even in 2020, three years after its release. Source: App Annie

For instance, NetEase’s self-developed title Knives Out, a mobile battle royale game, struck gold and was the most-downloaded iPhone app in 2018 in Japan. Rather than being a one-time hit, NetEase’s other self-developed games in Japan, such as Identity V, have been largely successful as well.

This trend has largely held steady. In May 2020, NetEase was the top iOS game publisher by revenue in Japan, marking the first time a Chinese company has reached this coveted spot. Successes in its first frontier, therefore, seem to have given it ample encouragement to explore markets outside of East Asia in greater depth.

Back-scratching publishing alliances built a reputation with global players

NetEase’s historic global alliances, in part, arise from its privileged presence in the relatively cloistered Chinese market.

Because international game publishers found it difficult to enter and understand the idiosyncratic Chinese market, big international brands entered into strategic partnerships with NetEase to distribute their own games locally.

In particular, NetEase’s relationship with Blizzard (NASDAQ: ATVI), the creator of legacy gaming hit World of Warcraft (WoW), goes deep. Since 2008, Blizzard has licensed its games to NetEase, opening a portal for the Chinese multitudes to enter the magical world of Azeroth.

NetEase has helped Blizzard make WoW a hit in China. Source: Blizzard website

Locally, World of Warcraft seems to have taken on a bizarre local flavor as well, for better or worse.

In May 2020, a user on Reddit alleged that NetEase’s management in China had led to the game being “damaged”  with, for example, game screens populated with “intrusive” mineral water advertisements and “gold-farming bots damaging the gold economy in WoW.”  The original post has received 10 thousand upvotes so far.

On the other hand, WoW seems to have held its local appeal, with Chinese users estimated to make up at least half of its 5 million users in 2016.  Of unusual note is how, in January 2020, a hashtag referring to a virtual WoW epidemic in 2005 (Corrupted Blood incident) started trending on Weibo, in early 2020, after Chinese users and epidemiologists saw it as a prime model of epidemic spread following the outbreak of COVID-19.

Regardless, the durability of NetEase’s relationship with Blizzard, which has lasted for more than a decade, is perhaps a nod to its overall caliber as a partner, on the balance of things.

In a world where foreign companies’ resentment against Chinese companies for alleged misuse of trade secrets seems to be more common than not — NetEase’s relatively uncomplicated and enduring relationship with Blizzard is quite a feat.

Watershed shift to game development for international markets

For most of its existence, NetEase may have limited its game development activities to the Chinese or at least the East Asian market. Its dalliances with the rest of the world mostly involved publishing activities for large foreign players seeking a partner to publish their games in China.

Its second wave of global strategy, however, involved moving beyond game publishing for foreign brands. Rather, it began building up game development competencies for foreign markets too.

In 2016, when probed over whether his model for Chinese success could be exported overseas, Ding Lei admitted that this would be difficult. “We invested in over 10 game studios in the West, but we are still learning.”

To this end, NetEase adopted a characteristically patient strategy, by very incrementally expanding its research and development (R&D) footprint into further-flung markets to test the waters with local developers.

NetEase seeks to break new ground in international game development. Source: NetEase Rules of Survival website

The company has stepped up its R&D efforts overseas, having made minority investments in New Zealand developer A44, American video game developer Bungie, and French developer Quantic Dream of late. It also opened a studio in Montreal, Canada in 2019, followed by a studio in Japan in 2020.

“Montreal is well known as a hub for western, mainstream PC games, and we want to have people here collaborate with our people in China to create games that can be published globally and have a very broad audience,” explained NetEase regional manager Sun Yu at the opening ceremony of its Montreal office in 2019. “Knowledge of Chinese is not required,” he added, in an attempt to reemphasize NetEase’s interest in truly understanding foreign developer tastes.

In addition, NetEase has effected a palpable shift to thinking about foreign markets not just as ancillary, but equally important to its domestic market.

For instance, in its first-quarter 2020 earnings call, Yang Zhaoxuan, NetEase’s CFO, ventured that “… when [the upcoming Harry Potter game] is ready for launch, whether we will do a global simultaneous launch, or whether we will do overseas launch first, followed by domestic upon the approval…..are [both] possibilities.”

As NetEase rises in global prestige and competes for the same markets as its foreign partners, such strategic partnerships may evolve considerably.

In the near term, however, NetEase’s legacy partnerships seem to be relatively safe, with Blizzard recently renewing its partnership agreement until 2023.

Mobile is crucial for organic globalization

Regardless of how NetEase’s global rise may be perceived to potential competitors, its mobile gaming competencies are now unmistakable, with a laundry list of hits such as Onmyoji.

This is especially fortuitous, given the rise of mobile over other forms of PC or console-based gaming worldwide.

Western gamers are more likely to use PCs or consoles while Asian markets are heavily centered around mobile.

In comparison, China has historically had the largest number of mobile players by far, driven by mobile penetration in its developing years. As of 2019, it had 586 million mobile gamers.

mobile games in china
Mobile gaming is becoming increasingly popular. Photo Source: shutterstock.com

However, the world gaming market seems to be tipping towards mobile growth as a whole: according to Statista, mobile gaming revenue share will grow to 59% of the market in 2021, a huge jump from 2012 when it made up only 18% of the market.

The total spending on mobile gaming was also 2.4 times more than PC/MAC gaming and 2.9 times more than that of home consoles in 2019, according to statistics from App Annie.

NetEase’s experience in designing games to suit the mobile experience may be increasingly valued going forward.

This has not gone unnoticed by global industry players, who recognize both NetEase’s mobile development competencies, and worldwide consumer trends going forward.

Blizzard’s partnership with NetEase has deepened into actual game development, with both companies working together for a mobile take on Diablo Immortal. Diablo Immortal is based on Diablo, which has remained one of the world’s most popular role-playing game (RPG) series even after three iterations.

NetEase will be developing a mobile LOTR game. Source: Warner Bros

In May, Warner Bros also made the earth-shaking announcement that it would be co-operating with NetEase to develop an official mobile game for The Lord of the Rings (LOTR) franchise.

The LOTR franchise was one of the most beloved franchises of all time, and Warner Bros entrusting the intellectual property (IP) of this fan-favorite to NetEase is another rubber stamp for the latter’s credibility. Ironically, one could say that Frodo Baggins’ sojourn into the Chinese industry has long been overdue, as Zhongguo (China) literally translates to the Middle Kingdom in English.

International IP presents huge opportunities and threats

NetEase seems to have its ducks in a row for its global push ahead. According to App Annie, NetEase ranked first among Chinese game publishers in terms of revenue brought in from overseas in August 2019, having ranked in the top three since April 2018.

NetEase’s game development activities have also struck the jackpot with its scoring of Harry Potter and LOTR franchises to announce its true debut into the US and European markets.

The world is waiting for NetEase’s debut. Source: NetEase Harry Potter Magic Awakened website

Response from the western gaming community on Twitter and Reddit to NetEase’s foray into the Harry Potter and LOTR franchises, however, has been mixed.

Like other Chinese companies struggling to throw off the shadow of low-quality “Made in China” associations, or simply facing antagonism from abroad for their nationality, NetEase has received its share of criticism.

On community pages, fans have been skeptical of an “unknown” Chinese company’s ability to do justice to some of their beloved classics. Some have even announced that they would “rather have Activision or EA buy [Warner Bros] rather than some Chinese company.” On the other hand, other forum posts on NetEase’s impending games have been positively feverish with excitement, with users excitedly praising their “new design and [graphics]” based on public previews.

In the midst of a trade war linked to China’s complicated relationship with intellectual property — NetEase’s handling of two of the largest fan favorites of all time will thus be one of its biggest and most delicate trials to date.

But, trade war or not, at the end of the day, a good game is a good game and NetEase has the opportunity to build credibility in one fell swoop abroad.

The question is: Will NetEase pass its most important test?