By Piet Walraven

Nearly 70 per cent of all Chinese netizens are under 30 years old and 20 per cent are under 18. A staggering 39 per cent are still in high school and another 30 per cent of them are students. These demographics combined with the fact that China is still very much a developing country result in an online situation that is not very attractive for advertisers: over 30 per cent of Chinese netizens earn below 500 RMB a month, so they don’t have a lot to spend (even if their parents do).

As a result most business models used by Chinese Internet companies other than portals or search engines are different from models used in the West. While Facebook, MySpace and MSN primarily make their money with advertising, most Chinese web companies have to look for alternative ways of monetizing their services. Unlike netizens in US or Europe, Chinese Internet users are simply not worth enough (yet).

An alternative way of extracting commercial value from the Internet is the ‘digital goods’ business model. Also known as the virtual goods model, the digital goods model generates revenue from micro-transactions. This kind of model was successfully applied by the South Korean Social Network Service (SNS) Cyworld where transactions included upgrades to an avatar’s appearance, gifts, improved game-playing abilities, coins, etc. But Cyworld is a social networking site special to Korean Internet culture and business. How might it translate into the culture of the Chinese market?

Combining Chinese online market characteristics with the adaptation of the digital goods model makes perfect sense for Chinese web companies:

• Economy of scale: China currently has around 253 million Internet users, more than any other country, and this number is still growing. This gives the term economy of scale a new dimension; the digital goods model has already proven itself in South Korea (around 35 million netizens) and one can imagine the potential it has in China.

• Low income: Enabling users to make very small transactions lowers the bar for the majority. At 51.com, one of the most popular Chinese SNS, they explain their microcommerce system as follows: ‘It can be very hard to persuade our advertisers to place ads because our users don’t have too much to spend. To cope with this we offer free services to our customers while we make revenue from the interaction between them’.

For the Chinese massively multiplayer online role-playing game (MMORPG) industry the digital goods model makes even more sense: because of heavy piracy it is nearly impossible to make a profit by selling off-the-shelf games like most gaming companies do in the West. This, combined with the two market characteristics already discussed, made gaming companies in China move from a time-based or off-the-shelf model that was common at that time to a free-to-play business model based on digital goods.

This move seems logical now but back in 2005 it wasn’t. At that time the shares of Shanda Interactive Entertainment – now the biggest MMORPG game operator in China – were falling and their time-based-model did not pay off. The company decided to try something else, something that was truly unique for gaming Chinese companies at the time: a free-to-play business model based on digital goods. At first this seemed a bad decision and the amount of users lowered even further, but in 2007 as the new business structure matured and gamers became comfortable with the new transaction model, it paid off. Revenues grew by 50 per cent and Shanda quickly developed into Chinas biggest gaming company.

Due to market characteristics and user demographics the digital goods business model works for many Chinese web companies. One of these companies is Tencent, an Instant Messaging, Social Networking and Gaming giant that truly excels in making a lot of money with digital goods. Tencent, the operator of the immensely popular QQ, made a total revenue of $442 million in the first half of 2008. Advertising only contributed 12 per cent to this, and the impressive rest was revenue directly made from users. To put it another way: an Internet company operating in a developing low-income market making 88 per cent of its revenues directly from users through a digital goods model might be something that Western companies can learn from.

Sources
+8*, http://www.plus8star.com/
CNNIC, http://www.cnnic.cn/en/

Bio
Pieter-Paul Walraven is a Dutch New Media Master student. For his thesis research on the globalization of Chinese Internet companies he has visited numerous Chinese Internet companies and performed over 30 interviews with experts, government officials, bloggers, VCs, etc. Previously Piet has studied in Hong Kong for six months and has traveled extensively through the Asia-Pacific region with a particular focus on Mainland China. http://pietchinathesis.wordpress.com