On November 15th, Tencent announced its ninth straight quarter of exceeding analysts’ revenue and profit estimates (70% profit growth over the last year’s quarter). The same goes for Alibaba, another Chinese tech company that has consistently beat analysts’ estimates. But analysts continuously give excuses as to why they miss the mark. They say that it’s because these companies do not publish earnings outlooks. They state that it’s very challenging to measure just how quickly the consumer middle class is growing in China.
So, what exactly is driving this unprecedented growth? Over 50% of Tencent’s revenue comes from games, particularly on phones. It also saw a 48% growth in advertising revenue, primarily through WeChat, China’s largest social media platform with around 1 billion active monthly users.
This party must be a bonanza for US tech firms, right? Wrong. The re-elected president, Xi Jinping, spoke in October at a court attended by Mark Zuckerberg (Facebook CEO), Tim Cook (Apple CEO), and Satya Nadella (Microsoft CEO), as well as other US executives. There, he promised (as he has done in the past) that China will continue to open up economically to foreign corporations. However, Mr. Xi was sure to note that “China will firmly defend its sovereignty, security and developmental interests”.
Although we have seen successful US entrants, take KFC for example, it has been particularly difficult for tech firms to penetrate this market. If it isn’t obvious, the reasoning behind this is because it is a lot easier to influence someone’s thoughts by exposing them to information via technology than it is with a piece of fried chicken (although the Colonel may argue otherwise).
What has this meant for tech firms that have missed the post recession boom? Well, for starters, Facebook has remained mostly blocked in the country. As a result, out of those 1 billion people using WeChat, you can bet that less than 1% of them have ever used Facebook. Think about the billions and billions of ad dollars lost. Apple has also missed out on the explosion of the middle class. Although the iPhone is sold in China, be it personal preferences or price point, Apple has struggled creating a foothold there. As a matter of fact, they’ve lost market share in the last year.
Okay, so US tech companies may have missed the main course of the greatest consumer buying party ever; better late than sorry. But, will their Didi (China’s own Uber) get there in time for the dessert, or will there just so happen to be a roadblock set up by President Xi himself. Unfortunately for tech firms, and perhaps the US economy, it’s starting to look like the latter.
President Xi heralded in what he called a ‘New Era’ for China in his October re-election speech. In this era, Xi stressed that the Communist Party will come first; it is unlikely that they will be any more willing to budge for a Facebook than they have in the past. The risk of faulted censorship is just too great. Chen Zhiwu, the director of the think tank Asia Global Institute and a professor at the University of Hong Kong, states that “Zuckerberg and so forth have many illusions about China. They should understand it’s really different this time.”
Censorship has intensified since Xi took power in 2012. Xi has expanded a block from just the Facebook website to both Instagram and parts of WhatsApp as well. Apple has been forced to remove apps from its Chinese app store that are deemed as an attempt to circumvent censorship. Over the course of the last 40 years, China has demonstrated their economic success. As a result, their primary focus has shifted to political control. Now that they’ve become an economic powerhouse, Xi believes that they can become a true superpower, and that the party’s control is the necessary vehicle to elevate them to the next level. What does this mean for US tech companies as they continue their pursuit into the censorship abyss?
The Chinese government is already pushing tech companies like Tencent and Weibo to give the state at least a 1% stake in them. It is likely that US companies will be forced to accept that they must provide user data and surveillance tools to the party if they are given permission to operate in their state. But, if these companies are allowed entry into China, what exactly can they expect?
The primary difference between the US and Chinese online experience is that while the US allows access to the internet, one in which information is exchanged across borders, the Chinese see more of an ‘intranet’, one that is full of energy across China but more and more separate from the World Wide Web. Now that President Xi has at least another 5 years in power, it is likely that we will only see a strengthening in the firewall between China and the outside world. As we discussed in class, our AI are getting ever smarter. Going forward, China will be able to implement these smarter AI to increase censorship and their tracking of users’ digital footprints. And even though we’re able to download VPNs such as Hola to get around information not available to us but available in other countries, new Chinese regulations have outlawed all VPNs except a few approved by the government itself.
US companies will also notice what you see in the charts above; growth has slowed dramatically. As I mentioned, they have missed the main course. But, because the majority of people have phones with access to internet, the demand for online products and services is greater than ever. This is especially true outside of major cities in countrysides that are currently under served.
R&D spending has exploded in an attempt to differentiate, a result of slowing growth. US companies will see that the market has shifted from one of expansion to one of searching for competitive advantages. This is best seen in Alibaba’s announcement that it will triple R&D spending to more than $15 billion over the next three years. And this is exactly what Mr. Xi wants. As Chinese tech companies get better and better at what they do, the need for US firms to fill a gap continuously disappears. Last year, Xi compared relying on foreign technology to “building a house on other people’s foundation. No matter how big or beautiful it is, it’s not going to last long.”
My opinion is that US tech firms will have a tough time getting a user base in China (if they’re able to get one at all). My bet is that Chinese tech companies will continue to flourish, along with the growing middle class and overall state. Say what you will about President Xi; his economic policy seems to be working.