This essay originally appeared in the December 2013 issue of the China Economic Quarterly.
Cognitive dissonance is helpful in trying to understand the Chinese internet. China’s virtual town square remains crowded and rambunctious—even as members of the Public Security Bureau mingle in the throng and grab those who step too far out of line.
By any measure, the Chinese internet is booming: 600m Chinese are online, including approximately 450m using mobile devices, and usage is rapidly expanding from urban to rural areas. The top social media platforms—Sina’s Weibo and Tencent’s WeChat—both have several hundred million users. Billions of dollars are spent annually on online advertising and gaming, and ecommerce may account for close to 10% of total retail sales in 2013. Nearly all this economic activity flows through privately owned companies, including more than 20 firms listed overseas with a combined market capitalization approaching US$300 bn. When Alibaba eventually follows, it will join Tencent, Baidu and Qihoo as one of the most valuable internet companies in the world.
This success comes despite the government’s continued determination to police the internet. A new crackdown against online rumors, specifically targeted at Sina Weibo, started over the summer and has been the harshest so far. Dozens of people have been arrested and the campaign has had a chilling effect on online discussion. Yet most business activity online is unaffected and investors do not seem to care: Sina’s stock has gained nearly 50% since the first signs of the campaign appeared in May. The government recently outlined plans to boost urban broadband penetration to 65% of households by 2015 and sharply raise connection speeds. As with some other foreign technologies, it is clearly determined to harness the economic benefits of the internet while simultaneously controlling its impact on Chinese society.
The Chinese internet is dominated by three firms—Baidu, Alibaba and Tencent—often referred to as the “BATs.” Historically Baidu has owned search, Alibaba has dominated ecommerce and online payments, and Tencent has been the leader in online communications and gaming. Each firm makes billions of dollars a year and has billions of dollars of cash on its balance sheet. Their success contrasts with the failure of foreign internet firms, which are for the most part irrelevant in China. Google, for example, now has a search market share of less than 5%. Their failures stem from a mixture of poor execution, cultural differences, and government discrimination against foreign companies.
The founders of the BATs are held up by officials and state media as champions of the new economy and symbols of innovation and entrepreneurship. President Xi Jinping visited Tencent on his December 2012 tour of Guangdong province, Baidu CEO Robin Li gave a talk at a Politburo study session in September 2013, and Premier Li Keqiang recently praised Alibaba chairman Jack Ma for his work in spurring domestic consumption. This political approval is essential, especially as internet companies begin to expand into heavily regulated sectors like finance. China’s successful internet companies know they must play by the rules to retain their position at the top of the technological tree.
The BATs are also increasingly competing with one another. Traditionally there has been very little internet M&A in China, but over the last year these cash-rich firms realized it is sometimes faster to buy than to build. Tencent made a series of investments designed to enable its QQBuy ecommerce platform to compete with Alibaba. It is also using WeChat, its massively popular mobile messaging and social networking app, to increase the market share of Tenpay, an online payments alternative to Alipay. And Tencent recently paid US$448m for a stake in Sogou, the number three search engine in China. Alibaba is so concerned that Tencent may erode its lead in online payments that it banned Taobao sellers from using WeChat. It also invested US$294m in mapping firm AutoNavi to compete with Baidu’s market-leading online mapping service.
The latest battleground is “internet finance.” Alibaba has led the way, first with a program to make loans to small and medium enterprises (SMEs), and then with a money-market product called Yu’ebao that pays Alipay users higher interest rates on idle cash than traditional savings accounts. Finance is a highly regulated sector, but regulators are supportive of efforts to help SMEs and force state-owned banks to be more responsive to customer needs. Baidu recently launched Baifa, a moneymarket fund that gathered Rmb1 bn of customer money on its first day. Tencent is about to launch a similar product, linked to WeChat, and is reportedly part of a consortium that has applied for a banking license. Perhaps because the opportunity is so large, Tencent and Alibaba have even found space for cooperation. The two companies, along with Ping An Insurance, recently launched an online insurance company.
All about apps
Just as in other markets around the world, the surge in mobile internet usage is both disruptive and a huge opportunity. The explosive mobile growth is driven by the proliferation of Google’s open-source Android mobile operating system, cheap smartphones, and an improving 3G network coverage. This mobile growth is behind much of the increased competition between the BATs as they try both to protect their desktop empires and to expand them. Tencent appears to have the edge in mobile because of WeChat, which the company says has more than 400m users in China. Alibaba made a significant move into mobile when it bought an 18% stake in Sina Weibo for US$586m in May, and it recently launched Laiwang, a WeChat clone. It is also a significant shareholder in the mobile browser firm UCWeb.
Baidu is the dominant mobile search engine, but mobile search is much harder to monetize than conventional desktop search. Baidu is currently at a disadvantage to Tencent and Alibaba because it has failed to build a widely used social media or messaging application. It has splashed significant cash to buy a mobile strategy: in July it paid US$1.9 bn for 91 Wireless, a leading store for mobile applications, with the apparent hope that users will flock to it as a gateway to the mobile internet. But Baidu is at risk of falling behind other BATs as mobile apps increasingly dominate.
The BATs are also trying to expand internationally. Tencent, which has several former Goldman Sachs and Google executives on its manage- ment team, has the most advanced investment and operational strategies for its overseas expansion. Its president, Martin Lau, recently disclosed that it had spent US$2 bn on overseas investments and M&A—including plowing money into top-tier US venture capital funds, enabling it to take a sneak preview of hot new startups. WeChat, with over 200m overseas users, is a credible threat to Facebook in some markets and Tencent has established local WeChat teams in several regions, including North America. It has even signed the Barcelona football star Lionel Messi as its global advertising face. Alibaba has hired experienced American dealmakers for its new US investment team and recently led a US$206m investment in Amazon competitor Shoprunner. Baidu, by contrast, is just starting its international expansion, and so far lacks the global management talent of Tencent and Alibaba.
We demand positive energy!
This explosive commercial growth has been accompanied by increasingly sophisticated government efforts to manage online discourse. Social media, and specifically Weibo, have long been the focus of Beijing’s efforts to direct public opinion online. China’s leaders emphasized the need to strengthen controls at the Third Plenum in November. “While actively popularizing the internet,” the Communist Party declared in its “Decision on Deepening Reform” document, “China will reinforce its overall administration over cyberspace in accordance with the law and accelerate formation of a sound internet management system to ensure national internet and information security.” The government derives tremendous value from monitoring the discussions on social media and understands that its citizens need an outlet. It does not want to kill social media, but it does want it to be better controlled and have more “positive energy.”
We are now in the midst of a new campaign to rein in certain types of activity that is unprecedented in its scope, intensity of official media coverage, number of arrests and impact on Weibo activity. The campaign began in early May when the government declared war on online rumors that “impaired the credibility of online media, disrupted normal communication order, and aroused great aversion among the public.” This new campaign has specifically targeted the “Big Vs” on Sina Weibo—opinion leaders who have millions of followers on their verified accounts (hence the “V”). Big Vs are able to drive discourse and skew propaganda in ways that are anathema to the Party-state’s approach to information control. For example, in the wake of the July 2011 high speed train crash in Wenzhou, actress Yao Chen sent a message to her tens of millions of followers poking holes in an early version of the explanation of the crash. In September, China’s court issued a set of judicial guidelines that include the possibility of arrest for intentionally spreading false information online. Yet, from an investor perspective, the crackdown is more noise than a real concern. Sina even reported that both Weibo activity and advertising revenues rose in July to September, despite the crackdown.
In its attempt to control the message, Beijing has tried to nurture state-owned internet firms but almost all have failed. In the first place, many were late entrants into their respective fields. Separate search engines operated by Xinhua News Agency and People’s Daily Online were recently merged in a last ditch attempt to turn them into a success, but neither had much chance of catching frontrunner Baidu. Private firms have also proved far nimbler and more responsive to user needs than stodgier state-owned competitors. And they typically offer much better compensation, so snap up the best employees. Nevertheless, the central government appears relatively unconcerned, as it believes it can effectively regulate and control the large internet firms without owning them.
More gilded, but just as robust
The BATs are so dominant, so rich and now so aggressive in their domestic M&A efforts that they appear likely to remain the top three Chinese internet firms for a long time to come. Qihoo, which has a significant share of desktop and now smartphone internet usage through its security and anti-virus products, may be the one company that can make inroads against these three. It is not a coincidence that Qihoo has had highly public battles with all of the BATs in the last couple of years.
Back in 2010, when the CEQ last focused on the Chinese internet [see China’s Internet: The Invisible Birdcage. also by me], we concluded that “The government has built a gilded cage around the internet that will prove far more robust than its critics expect.” The cage today is even more gilded than it was in 2011, and it still appears quite robust. China’s new leadership is clear that it will pursue economic reform with-out liberal political reform. It has also repeatedly said it is building a commercially vibrant yet managed internet—an “internet with Chinese characteristics.” There is little reason to believe it will not succeed.
See related: China’s Internet: Investing in Muddy Waters
This essay originally appeared in the December 2013 issue of the China Economic Quarterly.
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