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- How protectionism helped the Chinese companies?
- Cloning of social networks in China
- Does longevity ensure profitability?
- How competition in China is high despite protectionism?
Summary
The internet and the online content is highly regulated in China. This has limited the entry of the global social networks in the country. The censorship has resulted in protectionism and elimination of the competition for the homegrown companies from international entities. This enabled Chinese social networks to be as profitable as the dominant players globally. However, China is a huge and the most populous nation. Thus, due to its enormous size and population, it has the highest number of internet users in the world and the competition is expected to intensify amid social networking companies in the nation.
China, the land of opportunities for internet based businesses
The internet based businesses such as social media and networking, search engines, web-based emails, etc. are mainly dependent on advertisement revenues and subscription fees from users. Hence, the number of internet users is a key parameter to determine the attractiveness of a country for such businesses. China has 700 million internet users, which is highest in the world. Though India and the United States occupy the 2nd and the 3rd positions, but the number of users in these countries is less than half of China.
China has the highest number of internet users with the highest GDP growth
Internet Users GDP Growth
Thus, coupled with the highest number of users and a high economic growth, China is a huge market for internet based businesses. However, the internet protectionism also known as censorship has kept this market out of the reach of most international internet based software businesses.
Internet protectionism (censorship) in China
China restricts the use of global websites and their applications such as YouTube, Google, Facebook, Twitter, BlogSpot, Instagram, Dropbox, etc. It also justifies censorship as the premise for the heavy regulation of the internet within the nation. There are several reasons that have been cited for the censorship including prevention of leak for sensitive corporate or political data, national security and safeguarding the users from inappropriate content. Thus, if a foreign website or application needs access to the Chinese market, it has to appoint a local partner and transfer the technology with source codes. Although, after these arrangements stringent constraints are imposed on the freedom of speech. Moreover, firms like Twitter, Facebook, YouTube have been accused of allowing their platforms for spreading hate and were held liable for improper censorship of content. However, this censorship is also considered as protectionism in favour of domestic firms.
For instance, in 2010, Google ceased its operations in China after 4 years of existence. Google launched its version in China after adhering to the terms of censorship. However, the company faced hacking among few other foreign companies operating in China. Google maintained that it has confirmed reports of the attacks being aided by the government via the People’s Liberation Army. Google closed the operations and all its traffic was diverted to Baidu (homegrown search engine) by the Chinese government. In this way, the government afflicted a foreign company in the Chinese social media sector. These compulsions directly contributed to the growth of the industry in China.
Cloning of the entire industry segment due to protectionism
The internet protectionism in China has resulted in the introduction and successful operation of most homegrown companies. Secondly, a massive number of the internet users fuel this growth. While the likes of Facebook, Twitter, Google and YouTube are restrained in the mainland, the Chinese entrepreneurs have introduced their own versions of these popular websites. This has resulted in the availability of an almost similar alternative for every popular global social networking site or application.
Social networks in China perform at par with global peers
Televisory examined a set of 7 popular global websites vis-à-vis 5 national websites in China. These websites represent a mix of social networking such as messaging, posts, social gaming, picture sharing and dating. In addition, these companies are at least five-year-old and generate a total revenue equivalent to c. 77% of the global websites (FY 2015).
Additionally, as mentioned above, social networks in China are protected by the way of internet censorship. The ones available are most suited to the regional population as these are in the native language. Although, foreign users are allowed to register on these websites, this may not be counted as an advantage as most content published is regional in nature. On the other hand, protectionism has reduced the competition faced by such companies to a great extent, which has enabled these to remain profitable and flourish.
*Divergent trend in profitability for global companies is visible only in FY 2016 because;
a) LinkedIn has been delisted, thus, lower margins from the company did not average the global trend
b) Tencent (Chinese social network) has increased its opex by 40% Y-O-Y to increase its capacity, which kept the margins under the lid
(Note: Televisory considered only the segment revenue related to the social networking business and allied revenue streams)
*LinkedIn revenue reported only for 3 quarters in FY2016. It was acquired by Microsoft.
Moreover, each one of the above set of global and Chinese companies has one large player dominating the group. For the global set, Facebook contributed nearly 80% of the total revenues (FY 2015). Similarly, in China, Tencent contributed around 96 per cent of the total revenues (FY 2015). Televisory also evaluated the set excluding these companies and removed Renren Inc. from the set of Chinese companies as it has recently announced the possibility of a spin-off, which might result in better operations and different margins.
(Note: The EBITDA margin [ex. Renren and Tencent] was -142.9% in FY2011 due to no revenue in the startup phase)
Interestingly, even the smaller social networks in China have become more profitable than their global peers. These include YY Inc., Tian Ge Interactive and Weibo Corp. Notably, there are a number of global companies (Match group, Snap Inc., etc.) and Chinese companies (Momo Inc., etc.), which could not be included in the analysis owing to unavailability of consistent financials over Televisory’s horizon period. However, two firms, Match Group (USA) and Momo Inc. (China) had almost similar EBITDA of 28-29 percent in FY 2015. Snap Inc. (USA), which floated an IPO in 2016 was deep in red due to start up expenditure in R&D and expansion.
Longevity does not ensure profitability
The general perception is that the companies which survive for a longer period in the industry might be profitable. However, this may not be true. A firm could survive for years due to slow development, low and periodical investments, small innovations in order to be away from troubles or may be the first mover, which had much time but could not monetize the growth in the industry. The following table helps to understand this better.
(N.M.: The companies did not make meaningful revenues and thus, margins were much deep into the loss)
Hence, it can infer that longevity does not necessarily ensure the profitability of a firm. Moko Social Media, which is existent for close to 27 years was in operational losses at least during our horizon period. On the lower end of the spectrum, Tian Ge, with 9 years of operations secured good profitability in the past five years. Furthermore, the profitability of companies in the internet based businesses or more precisely social networking businesses depends on several factors:
- Stage of life cycle of a business
- Incurrence of R&D expenses
- Successful innovations
Thus, only longevity alone cannot ensure the existence of a business at least in this industry. China saw this in practice.
The competition within China
Once touted as the Facebook of China, Renren Inc. is in the market from the year 2005. It attracted a lot of global attention in 2011 when it issued an IPO on the US bourse much before the Facebook went public. However, the company has seen a widening of operational losses each year. In 2011 at its peak the firm had a base of 55 million monthly active users, this dwindled to 10 million from then onward. The user base moved to other identical websites such as Weibo, which started its operations much later (2010). Although the companies are protected from outside competition, there is an intense internal competition in China.
(Note: EBITDA margin for Weibo Corp is not applicable in the year 2011 as the company did not earn any revenue)
The above chart consists of the listed companies for which financials were available for last five years. However, there are numerous unlisted companies which intensified the competition.
The format of social networking differs among companies, for instance, networking through blogging, status updates, photo and video sharing, social gaming, the formation of communities, etc. Though these may not seem to be directly competing with each other, these actually are as they all vie for users’ time. A user spending time on a particular network is a loss of opportunity for other networks. Thus, it can be concluded that although networks in China are protected from global competition the country is the world within, where competition for survival is increasing day by day. Additionally, existing players are facing challenges for growth and thus, gainful innovation is the key to success.
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