The ban was originally introduced due to concerns that video games would impact the mental and physical development of children. But last year, the Chinese government eased restrictions on console manufacturers, allowing them to manufacture devices via joint ventures in the Shanghai Free-Trade Zone. However, companies still had to obtain additional approval for regional sales from regulators, and each console had to be inspected individually.
Despite those hurdles, Microsoft launched the Xbox One in China last September, and Sony's PS4 arrived in March. Unfortunately, neither console has sold particularly well so far. Research firm Niko Partners estimates that only 550,000 units of both consoles combined will be sold in China by the end of 2015, which pales in comparison to the 13 million Xbox Ones and 24 million PS4s which have been sold worldwide so far.
With the ban fully lifted, Microsoft and Sony can now manufacture and ship their consoles anywhere in China, without jumping through hoops in Shanghai. But will that change make a meaningful difference for either company?
Understanding the Chinese gaming market
Last April, research firm EEDAR estimated that there were 517 million gamers in China -- more than the population of the entire United States. China's entire video game industry generated $24.5 billion in revenues last year, according to the China Software Industry Association (CSIA) -- up from a mere $3 billion in 2008. That certainly looks like a massive growth market for Microsoft and Sony, but there are three big issues.
First, it's dominated by online PC gamers, who generated 41% of the industry's operating income during that period. Seventeen percent came from mobile games, while 16% came from web-based games. The dominance of PC and mobile games was directly caused by China's ban on console gaming. The CSIA didn't report how much profit came from consoles, but they generated roughly a fourth of the industry's total revenue. However, that figure reflects sales of all home and handheld consoles, including gray market devices, bootleg consoles, and older imported devices.
Second, software piracy remains rampant in China. According to a BSA report in 2013, 74% of software in China is unlicensed, compared to just 18% in America. Gray and black markets in China, which have sold imported consoles for years, often throw in modchips, pirated software, or hard drives preloaded with games to attract buyers. Since Microsoft and Sony both sell their consoles at either a loss or thin margins, they rely on software sales to make up the difference. Console makers typically keep a $7 cut of a $60 game. Without that cut, the entire business model for console sales crumbles.
Lastly, both consoles are expensive in China. The Xbox One without the Kinect costs about $520 and the PS4 costs $470, while both consoles cost under $400 in the U.S. Both companies attribute that price difference to various taxes, but Chinese gamers can easily buy a decent gaming PC or premium mobile device for the same price.
An uphill battle
Nonetheless, Microsoft and Sony still plan to expand across China. Microsoft is arguably more ambitious. Last year, it partnered with China Telecom, media company BesTV, and e-commerce giant JD.com to launch the Xbox One with ten launch titles.
To attract China's PC gamers, Microsoft partnered with Chinese publisher Perfect World to bring Neverwinter Online, a popular console MMO (massive multiplayer online) title, to the console. Perfect World plans to launch two other exclusive Chinese titles, Celestial Sword and Project X, for the Xbox One. Since the Chinese government has banned Grand Theft Auto V and Call of Duty: Advanced Warfare, two of the most popular games of 2014, Microsoft's partnerships with local companies and Chinese publishers will have to boost its local credibility and appeal.
Sony launched the PS4 with just six launch titles in March. But oddly enough, the console wasn't region-locked like the Xbox One. It can't log in to overseas PSN accounts, but it can play foreign discs and connect to overseas servers. This move enables hardcore gamers to bypass China's laws and buy banned games like Call of Duty: Advanced Warfare on the gray market.
The winner: Sony
In my opinion, Microsoft will likely fall behind Sony in China for two simple reasons -- its higher price tag and its inability to play imported titles. Courting Chinese publishers was a smart move, but cutting off access to some of the top-selling titles of the eighth console generation wasn't.
That's not to say that either console will sell incredibly well in China. The mobile and PC gaming markets there remain incredibly strong, piracy could gobble up software revenues, and premium prices could further reduce their appeal.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.