China's Social Gaming Leaders Take Aim at the U.S. Market

The controversy surrounding Google's (GOOG) China-based search engine is not the first time a U.S. Internet company has run into obstacles in its attempt to enter the large and lucrative Chinese web market.

"There are a lot of Western sites that are blocked by the Chinese government -- including Facebook, Twitter, YouTube, Google and others," says Justin Smith, a Silicon Valley-based entrepreneur and founder of Inside Network, a market research company.

Some U.S. companies such as Microsoft (MSFT) are trying to play ball with the Chinese in the wake of Google's dispute. In a recent statement, Microsoft said it continues "to offer a global search service, we regularly communicate with governments, including the Chinese, to advocate for free expression, transparency, and the rule of law."

Chinese netizens seeking to get around government censorship of the web do have some resources. One of the most common Internet devices to get information into and out of closed societies are so-called proxy websites. Dr. Paul Bauer, chairman of the I.T. and Electronic Commerce Department at Denver University's Daniels School of Business, notes that proxy servers were used successfully last summer in Iran during the Tehran government's crackdown there.

"The typical approach would be that you and I would turn on our computers and leave them on, set up a server, put a proxy on it, then make it known to people in China," he says. "It will take the Chinese government a while to figure out that all that traffic that is going to your computer is actually going to Google. Once they do, they'll knock you off -- but then somebody else steps up and volunteers."

The Future is Social Gaming, and the Chinese Are Gaining

Geopolitics aside, Smith questions whether investors in China should be looking at traditional Web portals in the first place. The future of information distribution on the Web, he says, is via social networking sites like Facebook and what he calls the "social gaming ecosystem."

According to a recent Nielsen survey, global traffic to social networking sites has skyrocketed over the past three years. The survey notes that, in December 2009, there was an 82% increase in the number of consumers using sites like Facebook and Twitter, compared to December 2008.

"A lot of people are changing their Internet behavior to make their social network much more of their starting point for their Internet day," says Smith. "And there are many sites now who are reporting that social networking sites are sending them more traffic than Google does. So there are some changing dynamics in online behavior, in terms of how people are interacting through social networks instead of portals."

While San Francisco-based Zynga remains the top social gaming site on the web, there's a lot of Chinese competition now entering the U.S. market. Chinese social networking sites like QZone and RenRen are accessed by millions of Chinese web users -- and gaming companies like Shanda, Tencent and Changyou are developing products for a global audience.

And, Smith says, Chinese developers who originally built their games and services for domestic social networks are now eying the American markets. "So while Americans are having trouble moving into China," he says, "Chinese developers are actually moving into the West. For example, some of the more popular games on Facebook are made by Chinese companies. But you don't see very much going in the other direction."

One of the sites Smith co-founded, Inside Facebook, reports that one Chinese gaming company, 6waves, recently raised over $17 million in funding, to be used in part to distribute its games in the U.S. in 2010.

And observers of the Web gaming industry say the sales of "virtual goods" -- the game upgrades, avatars and other online services and features gamers use -- are also on the rise. Data recently released by two industry analysts indicates that nearly two-thirds of all online gamers have purchased virtual goods.

Smith estimates the total virtual goods market in the U.S. will be approximately $1.6 billion this year, compared to around $1 billion in 2009. "The market is growing very quickly," he says, "because of the massive shift of user behavior on to the social networks, and the growth of virtual goods-based business models within that."