HONG KONG, March 21 (Reuters) - In a sea change at

China's Tencent ( TCTZF ), an easy-to-play game of cute

characters tackling obstacle courses has taken precedence over

developing a big-budget sophisticated foreign franchise for

smartphones.

Since late last year, the world's largest video games

company has, according to sources, redeployed hundreds of people

from the team developing "Assassin's Creed Jade" for mobile - a

multi-year project with France's Ubisoft.

They are now working on recently launched "DreamStar" -

Tencent's ( TCTZF ) answer to rival NetEase's ( NTES ) hit "Eggy Party"

and the company's most high-profile attempt to date at the

so-called party game genre which offers simple gameplay,

minigames and encourages players to hang out and chat.

As a result, "Assassin's Creed Jade" - an action-adventure

game set in ancient China that has been under development for

mobile for at least four years - will likely be released in 2025

instead of this year, according to three sources familiar with

the matter. They were not authorised to speak to media and

declined to be identified.

The redeployment of resources highlights the trends forcing

a strategic pivot at Tencent ( TCTZF ). Firstly, developing big-name

Western franchises for mobile phones tends to yield thin

margins.

At the same time, rivals have had breakout hits with

ostensibly niche products that offer new takes on gaming such as

as NetEase's ( NTES ) "Eggy Party" and miHoYo's anime-style fantasy game

"Genshin Impact". Moreover, the games were developed in-house so

their profits are all their own.

Tencent ( TCTZF ) had, for years, great success by developing for

smartphones international hits like Activision Blizzard's

shooter game "Call of Duty" and the battle royale game "PUBG" by

South Korea's Krafton.

But such franchise games - called IP (intellectual property)

games - are costly to make. Royalty fees of 15% to 20% of sales

are typical, Apple's ( AAPL ) App Store takes a 30% cut while

marketing and user acquisition expenses can cost another 30% to

40%, the sources said.

After a string of IP game setbacks, Tencent ( TCTZF ) plans to be more

selective.

"We're focusing on fewer bigger budget games. Typically,

we're seeking to make the biggest bets around games that either

iterate on a successful IP ... or games that are iterating

around proven gameplay success within a niche and taking those

to a more mass market," Tencent ( TCTZF ) Chief Strategy Officer James

Mitchell told an earnings call on Wednesday.

Tencent ( TCTZF ) is now also pushing for royalty fees to fall to

under 10% of sales in some negotiations, according to one person

with direct knowledge of the matter.

"That would have been almost unthinkable just a few years

ago. Tencent ( TCTZF ) used to be far more generous," the person said.

Tencent ( TCTZF ) declined to comment on details of its strategic

shift.

SETBACKS AND BAMBOO SHOOTS

On Wednesday, Tencent ( TCTZF ) reported a slight decline in

fourth-quarter gaming sales and also flagged that overall gaming

revenue this quarter would be soft compared with the same period

last year when gaming sales surged as pandemic restrictions were

lifted.

Pony Ma, Tencent's ( TCTZF ) founder and chief executive, has been

blunt that the company's video game division - which last year

generated 180 billion yuan ($25 billion) in sales or around

30%of overall revenue - needs to do better.

Competitors have continued to create new products, "leaving

us feeling we have achieved nothing," he told a stadium of

employees in Shenzhen at the company's annual meeting in

January, according to a separate source with direct knowledge of

the event.

That month, Tencent ( TCTZF ) also launched its "Spring Bamboo Shoots

Project", aiming to incubate in-house games with novel gameplay

and offering budgets of up to 300 million yuan ($42 million) per

game.

While that is much less than budgets of 1 billion yuan for a

major franchise, the initiative signals Tencent ( TCTZF ) is willing to

take more risks on non-conventional game design, the sources

said.

Some major setbacks have only increased the sense of urgency

for change.

Last year, Electronic Arts ( EA ) discontinued "Apex Legends

Mobile", a game developed by Tencent ( TCTZF ), with executives at the

U.S. firm saying it had fallen short of expected quality.

In December, Tencent ( TCTZF ) axed development of a mobile game based

on the "Nier" franchise from Japan's Square Enix ( SQNXF ), in

part because the Chinese firm struggled to find a compelling

monetisation model given its expensive development costs and

franchise rights, sources have said.

"Mobile games studios have learned that IP is not the magic

bullet for user acquisition it once was," says Serkan Toto,

founder of game industry consultancy Kantan Games.

Tencent ( TCTZF ) has also seen a key in-house game bomb. "Undawn", a

zombie apocalypse shooting game that Hollywood star Will Smith

was hired to endorse, flopped spectacularly despite having a

budget of close to 1 billion yuan with more than 300 developers,

according to two of the sources.

In January, almost one year since its launch, "Undawn"

brought in revenue of just around $288,000 on Apple ( AAPL ) devices in

China, according to research firm Appmagic. Globally, the game

made around $1.4 million that month.

Western companies have also started to shift away from

outsourcing mobile game development to Chinese companies like

Tencent ( TCTZF ). Microsoft's ( MSFT ) Activision Blizzard, for example,

has just launched "Call of Duty Warzone Mobile" which will

compete directly with Tencent's ( TCTZF ) "Call of Duty Mobile".

Adding salt to the wound, Tencent's ( TCTZF ) top two games saw

revenue slide during the week-long Lunar New Year holidays in

February. "Honor of Kings" and "PUBG Mobile", which are nine and

seven years old respectively, suffered 7% and 30% drops compared

to the holiday period last year, according to one of the sources

who was briefed on the matter.

($1 = 7.1979 Chinese yuan)