Tencent at The Forefront of Chinese Innovation

Michael Gasiorek
Tencent - The Forefront of Chinese Internet

Innovation
Consumer Software/Internet Services Industry
Industry & Environment Analysis

Company Breakdown & Strategic
Michael Gasiorek
December 2013
Tencent | Forefront of China Internet Innovation
Introduction: Scope, Key Services, Business Model, Summary Analysis
From being called a "copy machine" and an "evil empire" ("Tencent
innovation is...") to hailed as China's most promising company (Rabkin) with Asia's
most innovative founder "Pony" Ma ("Asia's Most Innovative"), Tencent has exploded
from a 1998 post-college project by Ma Huateng and Zhang Zhidong to China's
largest internet company with a +USD$100B market cap that places it just behind
Google & Amazon. Tencent thrives in the hypercompetitive Chinese internet market
(Exhibit 1) with the nation's largest social network Qzone, its original QQ chat client
with 798M active users, the newly merged SOSO/Soguo 3rd ranking search engine,
and its new mobile flagship social product WeChat (Annual Report). Supporting
these products, Tencent capitalizes on China's unique pillars of internet services:
online games, ecommerce, and social. President Martin Lau has ambitiously
summarized the services of the company as "MSN web portal plus half of Twitter,
WatsApp, Facebook, and Gmail," (StanfordBusiness), with internal TenPay/QCoin
currency platforms to monetize social & games, and a singular identity login across
multiple services. See Exhibit 2 for an overview of the Tencent core product mix.
While the company has been inspired by creative products out of Silicon
Valley, Tencent's own innovation is on business model, creating the majority of
profits via "value add" (commonly called virtual goods) and margins through realworld ecommerce, rather than advertising (StanfordBusiness, Martin Lau). As a
Chinese company attempting to go global, Tencent battles not only in the
hypercompetitive local market but also the segmented and specialized Western one.
The company holds distinct strengths in scope, scale, and fiscal strength - but to
take on Silicon Valley giants, will have to fight tooth and nail to break into regionally
dominated markets outside of the China internet "safe zone." With strength behind
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a single mobile flagship product, greater emphasis on supporting innovation at
home and abroad, and more robust application of a powerful cash war chest,
Tencent may even give Google a run for its money.
Company History: Brief Strategy & Major Milestones
In summary history, Tencent was started by two Shenzhen University CS
grads as a Chinese "copycat innovation" company: Ma & Zhang localized the ICQ
desktop chat service acquired by AOL as Open ICQ. QQ, as the company was
renamed after an IP suit, quickly gained users but was unable to monetize them
until early venture capital saved the company. With the first value-add QQ business
model, Tencent started the profitable Chinese internet industry. 2003 saw Tencent
enter its most profitable business vertical - online games - as well as build their
advertising business before their 2004 IPO. Tencent launched the majorly disruptive
QZone social network in 2005, and began to merge all services around the single
social login as part of the company's "internet lifestyle strategy."
By 2010, the company had developed a vast portfolio of internal products,
but also
began to see quality 3rd party developers on its fringes. A common
Chinese epitaph about startup success went, "Death, IPO, or Tencent," - the latter
meaning an instant high-grade copy that destroyed the startup (TechCrunchTV,
Pony Ma). With the 2010 launch of the Open Platform, Tencent invited 3rd party
developers to create add-on products for its services in a cohesive, secure, and
monetizable environment that produced $500M in shared revenues in 2013 for
+400 apps. 2011 saw Tencent's Pony Ma win a major bet on mobile - the
restructuring of over 10,000 employees into a mobile-focused division - generating
$4.5B in new revenue, hitting the exciting $100B market cap, and most importantly,
birthing WeChat. Since 1998, the 4M Chinese netizen population has increased 150x
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- and Tecent has been with them almost every step of the way. With WeChat, the
rest of the world is in Tencent's reach (StanfordBusiness, Martin Lau)
Today, Tencent generates $6.26B in revenues from online games, $2.91B &
$2.70B from display/search ads respectively, and $126.3B in gross merchandise
volume from ecommerce (See Exhibits 3 & 4). Profitability is another story. Of its
$601M 2012 earnings, 75% of revenues came from the rapidly growing value-add
market (compared to the relatively saturated advertising segment): 53% from ingame purchases and the remainder from VIP memberships to key services or
unlockable cosmetic items like additional emoticons. Today, Tencent has placed a
major focus additions to its mobile chat platform, and expanded operations in
browser games. It shows the biggest ad revenues from its products in all of China
and supports it with vast eCommerce coverage around the world. The company has
gradually moved into tech investments to improve its product and market
accessibility, and is financially booming (Annual Report).
Industry & Environment: Internet Services, Key Players, Comparative Dynamics

While Tencent operates across multiple verticals including social media,
communication software, ecommerce, and cloud services, the company falls under
the comprehensive umbrella of global software & internet services alongside
conglomerates like Google, Yahoo, Amazon, and Alibaba. This industry "permeates
nearly every aspect of our lives, providing us with fast... inexpensive, and nearly
unbounded access to enormous amounts of constantly updated information and
entertainment ...and a plethora of practical and increasingly important applications.
It also enables us to facilitate communications, relationships, and transactions for
both personal and professional purposes," according to S&P Analyzing Internet
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Companies. IDC anticipates a continuous growth in total unique Internet users to 2.7
billion by 2014 - which will inherently expand the reach of companies like Tencent
and Google to provide products and services not just to larger markets, but ones
with entirely new needs. While the 2001 recession unconventionally limited Internet
industry growth to 4.6%, forward-looking predictions anticipate increased internet
consumption in developing countries as well as increased smartphone proliferation
to fuel new growth to USD$3.22 trillion by 2017. The industry overall has seen a
compound annual growth rate of 4.8% since 2008, with dips during 2008 & 2012.
America accounts for 36.2% of industry revenues, ahead of Asia and Europe at
30.2% and 25.2%, respectively (Global - Software & Services, Marketline). As the
Chinese market becomes more competitive and saturated, Tencent will all the more
need to capitalize on over-the-Wall market opportunities. See Exhibit 1 for a broad 5
forces analysis comparative between Global & Chinese environments.
While the barrier to entry for the industry is low to medium, key players
dominate certain industry segments. While using sophisticated advertising rather
than value-add model to monetize its products, Google is the clearest direct rival to
the wide suite of products Tencent offers. The search giant's mission "is to organize
the worlds information and make it universally accessible and useful" (Google
Company). Google is a key competitor namely for its platform rather than productbased strategy: via services like Chrome, Google+, and Android, Google has built a
product that allows for the incorporation of external products (such as Chrome Apps
and content on the Android app store, called Google Play). Google saw 32% revenue
growth with a 21.50% profit margin on a $354B market cap to Tencent's 54% growth
on 29.13% margins with $107.39B MCAP (Google Finance). In the eCommerce
space, Amazon dominates the West while Alibaba dominates the East. Amazon
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posted breakaway 25% Y/Y revenue growth for 7 years via risky M&A and new lines
of business that paid off to make the business 2nd largest internet company behind
Google (Kessler). Meanwhile, Alibaba continued stock repurchases from Yahoo to the
tune of $4.1B in 2012 ahead of an expected IPO in 2014. No publicly available
financial data currently exists on the company. Finally in the social sphere, Facebook
is Tencent's key international multiplatform rival to QQ/QZone (but sees poor
penetration in China due to internet filtering), while WatsApp - a privately held
company with 350M users compared to WeChat's 236M - represents the biggest
threat to the WeChat mobile messaging platform. With the combined QQ & WeChat
platform, Tencent threatens Facebook with 1,054M users to 1,119M; however,
Tencent is also seeing huge growth (3x from previous year) and a rise in teen users
on mobile, while Facebook is actively losing teens and shows only 18% user growth
Y/Y (Tappin).
In considering the Five Forces analysis, research provided considers the
market players to include any companies offering technology & system integration
services, IT consulting or management, and data or business process outsourcing.
Buyers encompass individuals consuming for personal or corporate use, businesses
and government entities. In the provided exhibits 5-9, the red overlay indicates
researched perceptions of the Chinese market comparative to the global software &
services industry market. Summarily, Tencent operates in a middle-of-the-road
market across all five forces that is influenced heavily by new innovation and
shifting consumer preferences but relatively steady business preferences. The
industry is especially ripe for disruption given lower barriers to entry among niche
entrants by startup entrepreneurs. Rivalry has historically led to successful new
businesses being either outpaced by the increased resources of a major company or
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acquired for purposes of skill employment and market access. Consumers have a
broad range of options, but successful companies utilize network effect, specialized
differentiation, and cross-product integration to raise switching costs of buyers.
Success of the industry has been attributed to innovative small companies serving
specialized markets, large companies with diverse portfolios, and overall growth. As
Tencent represents such a large company, their vulnerability to supplier power is
mitigated through vertical integration into their own development platform, server
racks, and enterprise software.
Buyer power is medium (Exhibit 5) in the global market and typically depends
on the nature of the buyer: individual users typically consume technology services
on a monthly or need basis, while enterprises purchase sometimes long-lasting
contracts which may only be available after a bidding process. The Chinese
industry, especially from a consumer perspective, varies greatly. Collectivist social
mores typically increase importance of brand (and thus treats by oligopolies, in this
case playing to Tencent's favor) while also lowering tendencies to switch. Network
effects are especially powerful in China as in-groups develop around the most
popular consumer tools like chat apps, which are furthermore built around a single
login - much like the Google ecosystem - raising switching costs. China has also
shown a startling aversion to direct payments for software, with some of the world's
highest rates of piracy. In turn, price sensitivity comes with a new expectation: the
product comes free, but is supported through value-add or marketing, the former
which is seeing the most consistent success in the market. Another frequent
occurrence is copying: undifferentiated products litter the consumer-facing market
and attempt to undercut key players on price or marketing offensives, but rarely
posing major threats. In entering foreign markets, Tencent will benefit from the
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hyper-hostile China environment through its revenue model innovation and
competitive core products, but will face entrenched players like Facebook posing
high switching costs. On supplier power, as Tencent is not only able to satisfy its
own hosting needs but has direct access to a wide base of hardware suppliers via
Shenzhen, the company is relatively insulated from supply-side disruption.
Furthermore, the company offers many of these enterprise services for free to users
as a network perk and conversion strategy (such as the 10 terabyte cloud drive),
indicating a strong buffer zone before supplier risks become apparent. An
unconsidered supply-side metric is human resources: the IT industry is built around
highly skilled workers, without whom neither Tencent nor Google could continue to
function successfully. These skilled workers are more proficient in the United States
and Europe, but they are available in larger quantities in South East Asia, leading to
interesting competitive considerations for Tencent's international goals.
The internet & services industry theoretically allows almost any developer to
utilize existing platforms alongside plug-and-play APIs and cheap hosting to create a
competing product. Compared to China, the global industry abides by little internet
regulation and IP is difficult to secure for written code and most use-case processes
- much less protect. The ubiquity of digital devices has made mass distribution a
simple matter, with one overarching caveat: such scale requires building a product
on the platform of another company, immediately surrendering a portion of your
control, splitting profitability, and potentially constraining your capacity to compete
with the players whose services are being used. Market growth globally and in
South East Asia makes the industry very enticing, and considering profitability does
not require large scale with enterprise-focused products (although these require a
far longer sales cycle and have more limited distribution) and even some consumer-
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facing ones, there's a reason why computer science degrees seemingly become
very popular. Weak brands may hold back regionally-focused companies like
Tencent, but ultimately consumer-side apps live and die by network adoption and
delight/ease of use when compared against competitors solving the same problem.
These latter points are at the core of startup culture, but to Tencent's credit, instead
of competing with these small rising players, they have begun to nurture, invest in,
and sometimes acquire them through a slew of international equity-based
investments and their Open Platform. While the volume of substitutes may be high,
their threat is relatively low globally except against established players. Network
effects keep consumers loyal to services that have already engaged their friends
even despite potentially lower costs and diversified features due to one additional
factor: value added services. Tencent has created a negative-feedback trigger for
product switchers who realize sunk costs of moving away from a product for which
they have purchased add-ons. While fundamental prices for these switches may be
from free to free core offerings, the loss of network access and potentially
psychologically challenging switching costs will keep most Chinese users loyal.
Broadly speaking, competition is Tencent's most pressing factor. At home,
fellow internet giant Alibaba has begun to enter various service spaces typically
dominated by Tencent alongside smaller, specialized rivals (such as Sina Weibo and
Baidu). Meanwhile, well-established overseas competition - especially those with
high penetration beyond the United States - will be difficult to dethrone as Tencent
seeks to convert first-time overseas contacts into WeChat users into full social
platform immersion. The company is fighting a war on two fronts, and while the
characteristics of each environment are different due to localized legal, technical,
and economic factors, key factors make industry competition globally grueling. The
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size of competitors, especially within Tencent's ballpark, is one of the largest and
fastest growing across any industry, with established user bases, all-star teams, and
strong capital funding - and all competing in a conglomerated model of internet
services. While companies this large may not be plentiful, the quantity of mid-sized
to small companies competing in similar fields is also large, each serving niche
audiences that may be difficult to convert to Tencent's business mix. The explosive
expansion of some of these small-business services (specifically, in the digitally
dispersed free product category of scalable startups) means a high ease of
expansion may create new competitors overnight. Finally, with Google already
providing a vast suite of services for free monetized by advertising, the race to a
zero-sum game is already on.
The technical environment for the internet industry could hardly be better.
Two major trends are allowing the industry to grow rapidly and reach new users: the
proliferation of high-speed internet access at low costs, and the growth of
smartphone users. While in China the netizen population has expanded 150x since
Tencent's founding, more than 60% of the globe remains unconnected primarily in
Africa, the Middle East, and parts of Asia according to the International
Telecommunications Union. Only 32% of Asia has plugged in (42.3% in China),
compared to 61% of the Americas and 75% of Europe. These numbers speak to
opportunity: when considering an expected growth rate of IP traffic at 3x over the
next 5 years globally, with CAGR of over 30% in Asia, Middle East, and Africa, the
internet market will expand for many years yet. The focus of this consumption also
plays to Tencent's favor: nearly half of all IP traffic will originate from mobile devices
(at 79% CAGR, including tablets at 104% CAGR) by 2017 (Cisco), and over half of
consumed information will be video content, game entertainment, and social.
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Economically, major middle class growth in developing countries isn't just
fueling the boom of Chinese internet companies, but set to dramatically shift the
economic base of the world to Asia (namely China & India) and the Middle East. EY
projects over 40% of consumer spending will originate in developing countries by
2030, with a steady growth rate from its current 18%. With 500M Chinese entering
the middle class in the next decade and as much as 70% of China's whole projected
2030 population earning above US$10 equivalent/day, China and India will make up
over 35% of the world middle class alone. The US will represent 1%, comparatively.
The demographic shifts here are impossible to ignore, and Tencent has already
begun planning around Asia. Marketing efforts are underway in India, and WeChat is
becoming very popular across Eastern continents. While the company now courts
Silicon Valley, their true strength is their tie to the growing world and their
unbreakable hold on the Chinese market. The company's biggest competitors will
soon be originating in India rather than America, meaning regional outreach will
become very important. Social sharing is also becoming a larger cultural
phenomenon among the rising middle class who relish sharing their personal and
national growth, with internet use and smartphone ownership becoming status
symbols.
Finally, noting political and legal factors of China and abroad, Tencent faces
the difficulty in exiting the China bubble to compete on a better-regulated market
with a no-excuses demand for uncensored sharing. Tencent's history of filtration and
blocking to censor provocative speech on Weibo has lost them face in the eyes of
foreign customers, while locals have also shied away from the services after Pony
Ma's claim that False information posted on micro blogs is a touchy issue, for
netizens might believe what they hear." Chinese netizens responded angrily,
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arguing " False information he is referring to is the CCP authorities evildoings
uncovered by civilians Often it is officials who deliberately release rumors and
spread fabricated news. Nevertheless, Tencent has few choices: politically, it enjoys
a favored existence within a protectionist internet environment that has allowed it
to become large rather than be crushed early, receives favorable capital lending,
and is empowered to engage internationally. Should Tencent refuse to comply, they
may face the same fate as Google in being asked simply to leave. This causes great
frustration in overseas users who refuse to submit to filtration, and may be
problematic in converting users to the full Tencent suite (TechCrunch, Pony Ma).
Final thoughts from Martin Lau discuss the differences between the US &
China business environments. Firstly, the US customer is in a state of latent
demand: their needs are highly specialized because generic products are already
plentiful. China is experiencing booming growth on the development of industries
that aren't new, but new for the region. New entrants are therefore even more
difficult to localize because needs are not yet clustered. Secondly, monetization
continues to be tied to value-add across the industry, as advertising sales have
proven difficult to satisfy and require outside business stakeholders. Finally, the
speed of development in China is such that a group of developers can create a new
company (or copy) in the time it takes to have a US board meeting. US operates on
6mo lead times to new competition, but China will have created 100 new
competitors for a seemingly high-potential product on the same day, leaving it all
down to execution.
Financial Analysis - Changes from 2012, Google Comparative
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While competitors across specific verticals were discussed in the Environment
section, the only competitor equivalent to Tencent's product variety and market
potential is Google - and will serve as the main point for comparative financial
benchmarks. To reiterate, Tencent's MCAP has just hit USD$104B to USD$343B,
ranking with Yahoo, eBay, and Amazon (Tappin). Compared to Google, Tencent's IPO
appreciation exceeds 104x compared to 8.5x since IPO. In layman's terms: while
Google is big now, Tencent is growing exponentially faster. As Tencent becomes the
first Chinese company to see major strides in foreign markets, it wouldn't be a
stretch to call Tencent the internet's next big thing, at least from an investment
point of view. 5-year comparative growth trends are available in Exhibit 10.
Looking over the company's year on year performance, Tencent looks robust
after accomplishing a 24% increase in net revenue growth with a 29.13% rise in net
profits during the year. Group averages in revenue growth did not exceed 18%.
Vitally, the majority of growth came from sectors outside of value-add, allowing
Tencent to diversify its revenue streams. Advertising saw 37% growth, joined by
eCommerce at 108% growth. These latest figures show a healthy rebound after
Tencent missed early 2013 earnings estimates by about $200M - the exact amount
placed into WeChat marketing against intensified competition from new mobile
entrant and long-time eCommerce rival Alibaba. The majority of these investments
were on brand-related intangibles like celebrity endorsements. Finally, low
eCommerce sector margins place a drag on operating margins despite representing
a heft GMV. The growth has left Tencent with a sizable cash war chest for
acquisitions, investments, and aggressive product buildouts (Annual Report)
Recapping on comparative assessment to chief rival Google, Tencent is
showing stronger growth on a smaller market cap: $105B to Google's $345B. Net
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profit at Tencent grew by 7.63% more than Google, with over double the REO:
36.5% to Google's 16.61%. The company is offering healthy returns to stakeholders,
among them early-stage investor Nesper of South Africa, which continues to hold
over 30% stake in the company. Tencent's P/E ratio hits an impressive 44.72, while
Google clocks in at a 29.64 ratio. The expansion of the WeChat userbase and
increases in gross margins from in-house games are positive signals for at least the
next half year, but high competition will necessitate increased R&D against
competition which will lower operating profit until WeChat attains greater scale
(S&P).
Company Competencies & Strategy - Product Portfolio, Powerful Brand, Flagship

Platforms
In seeking to improve the quality of life of internet users, Tencent has
established itself as a global leader through a vast product portfolio, a powerful
brand, and a slew of flagship platforms for continuous expansion. These three
strategic components tie together intimately, with strong product offerings helping
establish Tencent as a multi-category leader and strong Chinese brand, encouraging
development and usage of expandable or new platforms like QQ or WeChat.
While the historical perspective gave a summary list of verticals in which
Tencent operates, the company in fact offers dozens of products ranging from
browsers to firewalls to enterprise software in addition to their already-discussed
consumer-facing products. The most major advantage to these offerings is the
development of an ecosystem. With a single login, a user can access games,
business-related content, entertainment, and the files they've uploaded to the
cloud. The convenience of this system encourages frequent use, while the
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development of a fixed identity across multiple services makes the serving of
advertising more targeted. Next, the diverse portfolio eases competitive pressures
by allowing Tencent to have multiple channels of user acquisition and revenue
generation. Finally, the online identity both enables value-add services. Inherent
from the first purchase, but also in strictly free yet consistent use of these
integrated services,
is raised switching cost. Few users would prefer a service
requiring a second login when Tencent is already able to offer the service. By
continuing to diversify, Tencent is also able to continue seeking new talent and
attract new users in niches, making for both resource acquisition and customer
expansion.
These products represent key intellectual property resources that have
become leading in the industry. Starting in 1998, Tencent has grown its role in the
lives of Chinese users and now represents one of China's top brands, and is China's
most valuable listed technology brand. The company was ranked 21st on the WPPMillward Brown brand list in 2013 even before its recent success with international
expansion of WeChat. The brand has been so powerful that Tencent's penguin
mascot has been leased out to manufacturers and merchandisers for the creation of
plush toys, suitcases, and more - which sell very well, and provide Tencent with a
new source of revenue. The company has also aligned itself with established
celebrities across multiple regions (South America, US, India, China) in order to
promote its WeChat product, further strengthening and localizing its brand.
Just as awards for innovation have helped Tencent turn around claims about
its copy culture, a strong brand goes far beyond glitz. While brand icon leasing is a
true measurable expression of brand equity, its greatest value is intangible: in more
easily aligning trust with new product launches, in retaining customers who believe
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in the mission and projects of the company, in helping Tencent remain an
"aspirational" company that attracts young developers with ambition, and which
provides a stronger launching ground for international entry.
Framed in the context of generic business strategies, Tencent has a stated

strategy of high-quality differentiation alongside a low-cost or zero-cost end-user
price. The products the company creates aim to solve specific issues (firewallintegrated web browser), engage users socially (QZone), or provide top-quality
entertainment (considering League of Legends investments and internally-produced
games by top talent). These products are then made available at no cost to the
user, instead being supported by add-value and advertising outlets. Tencent is a
powerfully innovative company on both product and business model, allowing them
to win on both differentiation and cost savings simultaneously. The brand has been
valued at $34B, close to Wal-Mart (Reuters). The recognition has also allowed
Tencent to become an investor of choice for successful startups looking to tackle
China, which in turn empowers innovation within Tencent. In a country where
marketing did not exist until a few decades ago, Tencent has risen above the pack
to support its products, employees, and investments with powerful recognition and
a clear mission statement (Exhibit 11). Above all, considering the human resource
competitive nature of the technology industry, this strong brand equity will attract
the best, most creative employees, allowing Tencent to stay ahead of the pack.
Tencent is not just in the business of building games and everyday services,
but platforms on which to continue building new features and spinoffs as well as
create value-add revenue generators. While examples exist in QZone and QQ,
Tencent's newest mobile play is most relevant and their biggest advantage as a
Western-bound
Chinese
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company. WeChat is becoming Tencent's flagship
international product: between May-September 2013, the company hasn't just hit
236M active users (tripling its previous year 85M, and out of 600M downloads), but
doubled its overseas users to 100M. Blowing past localized copies of Facebook &
Twitter (Ren Ren & Sina Weibo, respectively) that have flourished namely due to lack
of international competition, WeChat is instead taking on the global market and
already seeing success in SE Asia, the Middle East, Australia, and parts of Africa &
Europe (Stanford Business, David Wallerstein). In the US, adoption has been slower
due to integrated free messaging from BBM & iMessage as well as packaged phone
plans that include unlimited messaging, which reduce WeChat's cost-save value
proposition (StanfordBusiness, Martin Lau).
Great opportunities exist for maximizing WeChat internationally. Due to global
popularity and usage among all social groups from youth to senior professionals,
frequent travelers (author included) are beginning to leverage free international
texting through WeChat to keep in touch with friends & business contacts crossregionally. This allows WeChat to spread in the most effective manner possible: as a
standard-bearer and through word of mouth via influencers. Tencent has begun
leveraging this strategy: they've brought on stars from the NBA, soccer, and
Bollywood to become not just spokespeople, but users with whom anyone can (try
to) interact and follow.
Ultimately, the winning mobile chat app will be the one that reaches the tipping
point to become a standard; however, considering the demand for business &
connection with China, WeChat may not need to become the standard too far from
home. If the majority of the non-Western world population begin relying on WeChat
for business & connectivity, lesser players (be they regionally saturated or not) will
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be forced to adapt. As demographics shift to the creation of the great Asian middle
class during 2020 onwards, WeChat will inevitably end up in the hands of the
developed world. Tencent continues to develop WeChat using an iterative lean
approach - creating the features for the product as they are demanded by users - as
they aim for 300M active users during early next 2014.
Tencent's platform approach is not constrained to simply their products, but
includes their process. The Open Cloud platform has been a major boon to Tencent's
image and revenue stream by allowing 3rd party developers to create add-on
products to improve Tencent's services for a share of earned profits. Tencent wins by
being able to channel external creativity to attract and retain users, and developers
receive the power of the development platform. By creating an environment that is
secure, easy to use, provides wide distribution, and allows the monetization process
to be quick and painless for the developer removes all friction from the experience,
resulting in over $400M in shared profits thus far. This Open Cloud has incredible
potential should Tencent wish to crowdsource more development outside of the
company, especially in the gaming space. The service also allows Tencent to
discover skilled developers for hire or full-team acquisition, creating a strong
internal funnel. While still small compared to some of Tencent's other initiatives, the
Open Cloud must be considered one of their strongest achievements from an
innovation re-branding standpoint, a human resource acquisition funnel, a product
improvement strategy, and a diversified and scalable revenue stream.
Strategic Recommendations - International Expansion & Fostering Innovation

While the company has been financially successful and has come to dominate
major Asian markets with WeChat, Tencent still struggles with a strategy for truly
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becoming a global business. Over 85% of revenues continue to be generated within
China, and despite highly successful managers with international accreditation, the
company has little experience in performing outside of the "China internet." While
long-term projections show Asia is to quickly become the world focal point of the
middle class, Tencent needs less the customer base of the United States, and more
so the talent and innovation. To continue being an ambitious and growing
technology company, Tencent just incubate ideas by skilled engineers, be they
internal or external to the company. This will not only help Tencent establish a
strong international reputation for being an excellent company to work for in terms
of being challenging and interesting, but will contribute directly to their bottom line
by way of new product or new 3rd part add-on pack for an existing property. While
other strategic threats and opportunities exist, these two synergistic points will
most meaningfully align Tencent with future growth on an international scale. See
Exhibit 12 for full SWOT breakdown.
China has followed the traditional trend of foreign market entry: firstly, in
manufacturing, then in the service sector. In the creation economy, with a currency
of ideas and passionate skilled workers, Tencent must hire, acquire, and invest in
inspiring young companies to gain local market stake. The company has already
begun investing in companies (See Exhibit 13) that align with is mission: gaming
companies like Plain Vanilla, social & photo networks like Origami Labs, and
existing-product differentiations like SOGOU. These investments, however, reflect
the careful, long-term orientation of a company with a fraction of the resources
Tencent currently possesses. 10-15% investments also bring little in way of
mentorship & resources without an adjoining support program, leaving promising
startups to ultimately defend for themselves or risk getting copied. To truly
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capitalize on new market entries, Tencent should apply its capital more aggressively
into markets it is looking to dominate, acquiring 2-3 impactful & synergistic
companies in order to create network effects and begin pulling in users to its other
offerings. These companies should build around specific verticals like gaming with
low switching costs on complimentary goods like XFire chat, Kamcord, and Curse.
Making inroads into a small niche within developed markets will allow the company
to begin building early adopters who will ultimately be the foot soldiers for
spreading the use of WeChat. With nearly $2B in liquid assets, Tencent should be
able to find 2-3 small to mid-sized startups that are already scaling up and would be
powerful local ambassadors for the brand - again, in very specific and specialized
niches rather than on a mass market scale. Were Tencent to invest too heavily or
too broadly, they may open themselves up to vulnerabilities in asset agility against
major competitors or into an ineffectual investment that does not pave the way for
future Tencent product adoption.
Tencent should also leverage its Open Platform and the international nature
of 3rd party development to encourage involvement by coders outside of China. The
platform has thus far been very successful: Tencent & developers are both getting
paid, and new innovations are seeing the market by way of Tencent. Undertaking
developer challenges around the world for its WeChat platform in places where it is
on the cusp of the "standardization" tipping point will help push WeChat over the
edge in influential circles of developers. These events would function like typical
"Hackathons," with a set time to sole a specific problem or develop a useful add-on
in exchange for attractive prizes. Tencent would be increasing its brand recognition,
helping foster young entrepreneurs, and potentially discovering new ambassadors
for its leadership.
Michael Gasiorek
December 2013
While considering Westward expansion, Tencent should also continue to focus
heavily on the world besides America. Entering this saturated market does not
suggest itself to be especially more profitable despite being incredibly difficult, and
may be an expression of hubris more than of wise investing. Tencent has been
seeing incredible growth in South America, Europe, the Middle East, Australia, and
South East Asia. These regions will be able to collectively export more soft power
than the United States, converting American users by way of global standard. These
actions should be taken alongside, not instead of, a focus on American growth,
which should continue to receive marketing support. Wherever Tencent focuses its
energy, it may be leaving its home market open to new competition from
companies like Alibaba, and must be careful to watch both fronts.
To foster both innovation and expansion, Tencent should overall focus on
becoming a platform - not product - company as wage expectations begin to exceed
cost savings in China. By exporting content creation to 3rd parties, often partially
controlled, Tencent can focus on its core competency of creating scalable methods
of connectivity, delivery, and working on large, brave innovations rather than hit-ormiss games. Competition in online gaming has begun to fragment the vertical
further, with users moving from software games to web and mobile, creating further
demand for R&D that will not be sustainable in the long term. With a focus on
mobile in the last year, game publishing has become a profitable outlet to generate
high-margin returns, but will require the adoption of outsource development on the
well-established Tencent Open Platform. The first targets for outsourced creation lie
in vertically specialized markets that do not benefit from Tencent's scale, but rather
on external specialization in a particular vertical, namely eCommerce, games, and
video. All are growing dramatically, but require an entirely different skillset than
Michael Gasiorek
December 2013
what is core to Tencent's current team. The company should continue working with
its select partners on the gaming front while seeking to buy influential control in
others, while also seeking companies skilled at producing video content and others
skilled in product design and eCommerce optimization. If this process is rushed and
lacks due diligence, the move may greatly reduce short-term
earnings - and if
companies are picked incorrectly, may not promise quality returns.

Tencent should also look to continue innovating on and diversifying its
business model, most temptingly into just this 3rd party work. The company
currently receives over 75% of its profits from value-added service which, while
doing well in China, may not transfer easily to Europe and the US. Improvements
have been made since 2011 when the value-add segment generated 92% of
revenues, but by adding a new focus on licensing and profit-sharing, Tencent stands
to reduce this dependency.
Tencent has been able to be a one-stop-shop for all things internet services,
but if it is to begin competing against Silicon Valley companies, it must focus.
Tencent runs a powerful R&D branch, has a network of skilled developers, and is
growing rapidly outside of China. However, incredible product overlap that exists for
purely historical reasons, conservative use of funds in an environment that
demands aggressive expansion, and laser-focused intentions on American conquest
despite lack of product-market fit continue to be troubling. By focusing on building a
strong, innovative presence in markets in higher demand for Tencent products and
establishing WeChat as the global standard - especially among students and
business people who will convert other users - Tencent will be able to focus on new
business while experiencing steady growth over time. The opening of the QQ
account system as planned (StanfordBusiness, Martin Lau) will allow greater social
Michael Gasiorek
December 2013
integration among apps and addons, but it is only with Tencent's direction towards
content pillars (again, video, games, and ecommerce) that the right types of
proficiencies can be outsourced. Greater robustness with reserve capital should not
open Tencent up to vulnerabilities in China with due diligence on competitive
analysis. The company is in a strong financial, strategic, and actionable position and with time, may become the Google of China yet.
Appendix
Exhibit 1 - Industry Environment, Porter 5 Forces Analysis
Source: MarketLine Industry Profile, "Global Software & Services"
Software Industry
Global vs. China
5 Forces Model
Exhibit 2 - Tencent Product Mix & Monthly Active Users (MAU)

Source: Stanford Business, Martin Lau, President of Tencent (via YouTube)
Michael Gasiorek
December 2013
Online Game revenues
Exhibit 3 - Tencent Revenue Model

trump Display & Search
Source: Stanford Business, Martin Lau, President of Tencent (via
YouTube)
ads
combined in China.
"Will obviously change,"
-Lau
eCommerce revenues
high, profit only 15% (Exb
Exhibit 4 - Tencent Business & Profit Model

Source: Stanford Business, Martin Lau, President of Tencent (via YouTube)
Michael Gasiorek
December 2013
Exhibit 5 - Industry Environment, Buyer Power

Source:
MarketLine
Industry
Profile,
"Global
Software &
Services"
Exhibit 6 - Industry Environment, Supplier Power
Michael Gasiorek
December 2013
Exhibit 7 - Industry Environment, New Entrants

Exhibit 8 - Industry Environment, Substitutes

Michael Gasiorek
December 2013
Exhibit 9 - Industry Environment, Competition

Exhibit 10 - Economic Environment, China: total income by band 2010 and 2020
(annual income, thousands of people)
Source: EY, Middle class growth in emerging markets
Michael Gasiorek
December 2013
Exhibit 10 - Growth Rates of Chief Players (China & US) in Internet Services
Industry
Source: Google Finance, December 1st 2013
Tencent
(OTCMKTS:TCTZF)
sweeps rivals in 5y
growth,
Tencent MCAP
Exhibit 11 - Tencent Value Statement

Source: StanfordBusiness, Martin Lau, President of Tencent
Michael Gasiorek
December 2013
Exhibit 12 - SWOT Analysis

Source: Original
Michael Gasiorek
December 2013
Established brand and relative

market dominance.
Diverse portolio of products and
services.
Robust, growing financials with
high quantities of reserve capital.
Well-managed, effective, large
workforce.
Flagship platforms on mobile &
S
O
for Powerful
developers.
demographic/economic
trends in favor of
Asian/MidEast middle
class growth.
High internet &
smartphone proliferation.
Asian advertising &
ecommerce growth.
Regionally constrained with

low international expansion
experience.
Poor out-of-Asia branding,
stigma attached to early
"copy culture"
Heavily leveraged revenues
on value added services.
Battle on two fronts: retain
W
Asia share while growing
TChinese legal & political
USA.
internet and equity

regulations.
Security threats on
Chinese internet.
Threat of foreign entreants
or startups into own
market segment.
Exhibit 13 - Tencent CrunchBase Startup Investments

Source: CrunchBase, Tencent
Michael Gasiorek
December 2013
Works Cited
Michael Gasiorek
December 2013
Asia's Most Innovative. (Oct 2013). Today Online. Retrieved from
http://www.todayonline.com/world/asia/asias-most-innovative
Bossong-Martines, E. (October 2013). Industry Surveys - Computers: Consumer
Services & The
Internet. Standard & Poor's Industry Surveys. Retrieved from
Standard & Poor's NetAdvantage.
Chen, L. (Nov 2013). Tencent jumps after boosting online game sales. Retrieved
from Mail & Guardian,
web.
Cisco. (May 2013). Cisco Visual Networking Index: Forecast and Methodology, 20122017. White Paper. Retrieved from
http://www.cisco.com/en/US/solutions/collateral/ns341/ns525/ns537/ns705/ns827/w
hite_pap
er_c11-481360.pdf
Karklins-Marchay, A. (2013). Entering the global middle class: Middle class growth in
emerging markets.
EY. Retrieved from
http://www.ey.com/GL/en/Issues/Driving-growth/Middle-class-growth-in- emergingmarkets---Entering-the-global-middle-class
Google Company. (2013). Google.com. Retrieved from
http://www.google.com/about/company/
Google Finance: Stock market quotes, news, currency conversions & more. Google.
Retrieved November
30 from http://www.google.com/finance
MarketLine. (Oct 2013). Global - Software & Services. [industry profile]. Retrieved
from MarketLine
Advantage database.
MarketLine. (Dec 2012). Tencent Holdings Limited. [company profile]. Retrieved
from MarketLine
Advantage database.
MarketLine. (Dec 2012). Tencent Holdings Limited, Tencent's rise to dominance in
the Chinese Internet
Industry. [case study]. Retrieved from MarketLine
Advantage database.
Ren, Shuli. (Nov 2013). Game Publishing Gives Tencent The War Chest To Be
Aggressive In Video, ECommerce. Emerging Markets Daily. Barron's.
Kessler, S. (Oct 2013). Industry Surveys, Computers: Consumer Services & The
Internet. [industry profile].
Standard & Poor's Capital IQ. Retrieved from S&P
database.
Stanford Business. (Dec 2012). David Wallerstein: Tencent's Business Model Pushes
Customer
Engagement. Retrieved from http://www.youtube.com/watch?
v=aMh6Dn6mCNI
Michael Gasiorek
December 2013
Stanford Business. (Oct 2013). Martin Lau, President of Tencent: Our Mission is to
Enhance People's Quality of Life. Retrieved from http://www.youtube.com/watch?
v=ZJ_X3HdhLhA
Rabkin, A. (Feb 2013). MOST INNOVATIVE COMPANIES 2013 - 16, Tencent.
FastCompany. Retrieved from
http://www.fastcompany.com/most-innovativecompanies/2013/tencent
Reuters. (Dec 2013). China's Tencent brand valued at $34 bln, close to Wal-Mart.
Retrieved from
http://www.reuters.com/article/2013/12/03/china-brandsidUSL4N0JH1TA20131203
Tappin, S. (Nov 2013). Who Has 1 Billion Users and is About to Overtake Facebook?
LinkedIn. Retrieved
from
http://www.linkedin.com/today/post/article/20131104184701-13518874-who-has1bn- users-is-about-to-overtake-facebook
TechCrunchTV. (Oct 2011). Opening Remarks by TechCrunch and Fireside chat with
Pony Ma (Tencent),
with Sarah Lacy. Retrieved from
http://www.ustream.tv/recorded/18222196
Tencent Holdings. (2012). Annual Report 2012. Retrieved from
http://www.tencent.com/enus/content/ir/rp/2012/attachments/201202.pdf
Tencent innovation is copied out of it [Translated from Mandarin]. (Apr 2007). Kee
Media Network.
Retrieved from http://translate.google.com/translate?
js=n&prev=_t&hl=en&ie=UTF- 8&layout=2&eotf=1&sl=zhCN&tl=en&u=http%3A
%2F%2Fnews.xinhuanet.com%2Fzgjx%2F200704%2F13%2Fcontent_5973072.htm
Whatley, H. (2013). Chinese companies and their quest for globalization. ICIBIT
Journal.

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Tencent at The Forefront of Chinese Innovation

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Michael Gasiorek

Tencent - The Forefront of Chinese Internet

Industry & Environment Analysis

began to see quality 3rd party developers on its fringes. A common

Industry & Environment: Internet Services, Key Players, Comparative Dynamics

Financial Analysis - Changes from 2012, Google Comparative

Company Competencies & Strategy - Product Portfolio, Powerful Brand, Flagship

is raised switching cost. Few users would prefer a service

Framed in the context of generic business strategies, Tencent has a stated

Strategic Recommendations - International Expansion & Fostering Innovation

companies are picked incorrectly, may not promise quality returns.

Exhibit 2 - Tencent Product Mix & Monthly Active Users (MAU)

Online Game revenues

Exhibit 3 - Tencent Revenue Model

Exhibit 4 - Tencent Business & Profit Model

Exhibit 5 - Industry Environment, Buyer Power

Exhibit 6 - Industry Environment, Supplier Power

Source: MarketLine Industry Profile, "Global Software & Services"

Exhibit 7 - Industry Environment, New Entrants

Exhibit 8 - Industry Environment, Substitutes

Exhibit 9 - Industry Environment, Competition

Exhibit 11 - Tencent Value Statement

Exhibit 12 - SWOT Analysis

Established brand and relative

Regionally constrained with

internet and equity

Exhibit 13 - Tencent CrunchBase Startup Investments

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