Opening new front: THQ kills Nazis, uses free-to-play model to invade Chinese market.

As video game sales stagnate in the United States, publisher THQ Inc. is looking across the Pacific to ramp up business. That means selling in China.

The Agoura Hills-based game company earlier this month rolled out a version of its World War II-themed game "Company of Heroes" in China, where video games sales have been increasing dramatically over the past several years. THQ executives hope they can capitalize on a booming population of Chinese garners as industry growth in the United States slows.

"This is a huge growth market for us, really over the next few years," said Steve Dauterman, THQ's senior vice president of online games, in an interview from his home in Brisbane, Australia. Dauterman, whose office is in Melbourne, heads THQ's operations in the region and helps oversee a 15-person office the company opened in Shanghai two years ago.

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But cracking the Chinese market won't be all fun and games. THQ, like other companies selling in China, faces stringent protectionism and a complex regulatory environment.

The move into China comes as THQ rebounds from a dismal 2008. After seeing its revenue tumble, its stock price dipped to about $2 from a high of $36 in 2007. This year, the company slashed $200 million in expenses and shuttered several studios. Its stock has since climbed back up to $6 and the company reported a slight profit last quarter.

Meanwhile, the recession has cast a pall over the domestic video game market. Year-to-date game sales in the United States have fallen 14 percent compared with last year, according to Port Washington, N.Y., research firm NPD Group.

But game sales in China have so far defied gravity. The online game industry this year there will likely be worth $3.8 billion, up from $2.7 billion in 2008, according to Niko Partners, a San Jose consulting firm that helps video game companies get into China. By comparison, the online game market in the United States was worth $2.5 billion in 2008.

The growth has caught the eye of U.S.-based game publishers, many of which have recently opened offices in Shanghai to blaze market inroads, such as New York-based Take Two Interactive Software Inc. and Redwood City's Electronic Arts Inc.

"It comes down to growth and business opportunities," said Jesse Divnich, an analyst with Electronic Entertainment Design and Research in San Diego. "The whole Asian market has grown substantially over the last several years, much more so than here in North America or in Europe."

Santa Monica-based Activision Blizzard Inc. has perhaps been the most successful U.S. publisher in China, where about 6 million people play its popular "World of Warcraft" game. Activision's revenue from Chinese gamers alone totaled $44 million last year and will likely grow, according to Wedbush Morgan Inc. in downtown Los Angeles.

Chinese challenges

But breaking into China also poses some special challenges to U.S. game companies. The Chinese government has sweeping regulations regarding video games, including requiring foreign publishers to partner with domestic companies. The government also censors sex and violence, and bans content such as Nazi symbols and references to Tibet. Many of its policies are designed to protect local companies and make it more difficult for foreign ones to capture market share.

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"The biggest barrier by far to market entry in China is the regulatory landscape," said Lisa Hanson, managing partner and founder at Niko Partners. "It's complicated, complex and cumbersome."

Also, video game companies can't sell their titles in China the way they do in the United States.

At home, most companies sell games to be played on consoles such as the Xbox 360 and PlayStation 3. That wouldn't work in China, because of widespread piracy. As a result, companies don't sell game software there.

Instead, game companies look to an Internet business model known as "free to play." Publishers offer games to Chinese consumers over the Internet with no charge. Players use their keyboards as game controllers. The companies make money by selling the players "extras" for the games in microtransactions. For example, a player might pay the equivalent of a few dollars to equip their game character with a better weapon or buy virtual currency for use in an online world.

Free-to-play has boomed as more Chinese flock to Internet cafes. But it also has meant that U.S. publishers have had to overhaul their games. THQ spent two years working with Shanghai game company Shanda Interactive Entertainment Ltd. to build an online marketplace for in-game extras for "Company of Heroes."

Dauterman also said THQ had to make some concessions to appease Chinese censors. For instance, because the Chinese government bans reference to Nazis, THQ renamed the German army the "Federation." It also removed Iron Crosses, the symbol of the German army, from tanks, planes and uniforms. But the core game play, Dauterman said, remains the same.

While THQ executives are enthusiastic about the promise of the Chinese market, they are also cautious. The company has fronted no money to develop the game in China; instead, Shanda paid for all the costs. Once Shanda recoups its investment, it will split future revenue with THQ.

Dauterman said THQ hopes to take whatever lessons it gleans from working in China and apply them to future games for that region.

Additionally, the free-to-play model may be imported back to the United States. Some companies are already testing the concept on American consumers.

"Our long-term goal would be to look at this and potentially bring it to the North American market," Dauterman said.

THQ Inc.

Agoura Hills

CEO: Brian Farrell

Employees: 2,000

Market Cap: $386 million

P/E*: N/A

EPS*: $5.94

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By CHARLES PROCTOR Staff Reporter

* Twelve months trailing