Features

Tencent: March of the Penguins


It’s hot and crowded in the Shatang Internet Café in the southern coastal city of Shenzhen, where some 300 young factory workers sit amid flickering lights and discarded cigarette packs. At one computer, Zhou Qingqing chats with her boyfriend about 600 miles away in Zhejiang province using QQ, the popular instant messaging software.

She interrupts the conversation to play an online game called QQ Dancer, maneuvering a fashionably dressed avatar to the beat of a catchy Chinese pop song. “This is the only game I know how to play,” she says. “It’s easy.”

Across the smoky room, not far from one of the No Smoking signs, Yan Huan also has QQ open on two screens, mainly to accrue the loyalty points that come from spending time on the service. The more points, the higher the level. The higher the level, the better the icons on your home screen. Huan has attained two smiley faces. “It means nothing,” he says, then brags that his level is several times higher than his girlfriend’s. His favorite game is QQ Speed, in which he races a go-cart through a dense urban landscape, zipping past other characters controlled by players around the country.

Zhou and Yan are both in their own digital worlds, yet like almost everyone else in the cafe, they’re mostly engaged with the products of a single company: Tencent. Guo Zhenquan, deputy manager of China Internet Cafe Holdings, which has 55 outlets in Shenzhen, walks from row to row, pointing out all the customers using Tencent’s QQ service. They’re chatting, gaming, watching movies, and topping up their prepaid mobile phones. “Every computer has somebody on QQ,” he says.

Tencent is the Internet Goliath you’ve either never heard of or know little about. Yet 674 million Chinese actively use its QQ service, and hundreds of millions more are familiar with its cute cartoon mascot, a winking, scarf-wearing penguin that has helped make Tencent one of the most recognized brands in the country. With 11,400 employees and more than $3 billion in revenue in 2010, it’s become the largest—and, by its competitors, most criticized—Internet company in China. Now Tencent’s ambitions are expanding into the U.S. and elsewhere. Flush with cash, it’s making investments, acquiring startups, and forcing Western companies to consider whether it’s friend or foe. “If you are a Silicon Valley guy and you don’t have Tencent on your radar, you have to be deaf, dumb, and blind,” says Michael J. Moritz, the renowned venture capitalist who backed Google (GOOG) and PayPal (EBAY). “I am full of admiration for the characters at the helm of that company. They are extraordinarily thirsty and aggressive.”

Tencent was founded in 1998 by four geeky college classmates and a friend from Shenzhen who devised a Chinese version of the pioneering instant messaging service ICQ. Led by the zoomorphically nicknamed “Pony” Ma Huateng (ma is Mandarin for “horse”), the founders adapted their chat software for mobile phones and watched as it became the primary communication tool for a generation of young Chinese. Along with chat and games, the company’s stable of products now includes a virtual currency called Q Coins, a search engine, an e-commerce marketplace, and two social networks, pengyou.com and the youth-oriented Qzone, which collectively have more than 500 million members. Tencent also recently hatched a Twitter-like service known as Tencent Weibo (pronounced way-baw), which is used by some 200 million people in China and is keeping pace with a competing service from rival portal Sina.com (SINA). The publicly traded company has a $48 billion market value. Last year it had $1.2 billion in profit, the bulk of that from selling free-to-make bits and bytes like virtual clothes and racing car decals that allow its young users to represent themselves online.

At least some U.S. companies are choosing to join forces with Tencent. In February, Groupon announced it would counter the proliferating number of Chinese daily deal sites by co-investing in a Beijing startup along with Tencent and others. On July 26, game maker Zynga said it would bring its online game CityVille to China via Tencent’s QQ network. Tencent actually has an indirect relationship with both of those companies: Last year it invested $300 million in Digital Sky Technologies, the Russian venture capital firm that has invested in Zynga, Groupon, Facebook, and Twitter. Tencent looms especially large for Facebook. Mark Zuckerberg is looking for a way to enter the world’s largest Internet market, according to two people familiar with Facebook’s plans. Chinese Internet users, particularly young ones, may not want to shift their allegiance away from Pony Ma. “If Facebook goes into China,” says Hugo Shong, of the venture firm IDG Capital Partners, who backed Tencent in its early years, “it will have to think about how to compete against Tencent.”

 

Yet Tencent’s rise has not been frictionless. Among the dozens of rivals, partners, and analysts Bloomberg Businessweek interviewed for this article, a common concern about Tencent is its dominance of the Chinese Internet. Its products may resemble elements of AOL, Yahoo! (YHOO), Facebook, and Twitter, but in reputation, at least, the company evokes the specter of the Bill Gates-led Microsoft (MSFT) of the ’90s. “Tencent is a copycat,” Charles Zhang, chief executive of Sohu.com (SOHU), which operates a rival Web portal and video game service, said in an interview last year. “It’s a company that doesn’t create anything.”

Stephen Bell, a Shanghai-based partner at Trinity Ventures, a venture capital firm, says he hears this all the time: “In the U.S., students think, ‘If I build something good, Google will buy me.’ In China they think, ‘If I build something good, Tencent will copy me.’ ”

A story last year in the prominent technology magazine China ComputerWorld captured that sentiment. The article charged that Tencent was never the first to “eat crab”—a localism that means “try new things”—but “looks for a space in a mature market to shove its way in.” The magazine cover featured the Tencent penguin, stabbed and bleeding, along with a headline that included a profanity that translates roughly as “Tencent has sexual relations with dogs.” Tencent complained and threatened legal action over the depiction of its trademark; the magazine apologized.

Tencent has been intensely private, even mysterious to many followers of the Chinese Internet industry. The company’s executives grant few interviews. Amid the criticism and an increased level of competition from new Chinese social networks and microblogging sites, Tencent has signaled that it wants to be more open and accessible to third-party developers and journalists. After months of requests from Bloomberg Businessweek, the company agreed to host a reporter in Shenzhen, a coastal city of 10 million people across the bay from Hong Kong.

The headquarters is nestled amid the skyscrapers of Shenzhen. The tall, tapered building so resembles an electric razor that some employees jokingly call it Gillette Tower. Tencent takes the Chinese tradition of a post-lunch naptime seriously: Office lights are dimmed between noon and two, and most of its twentysomething employees put their heads on their desks or lie down on foldout cots. If anyone’s too noisy, security asks them to keep it down. Like Pony Ma, employees give themselves English nicknames—Thunder, Fruity, Neo—and use those handles on the company’s internal instant messaging system.

In a top-floor conference room with dramatic views of the city, Ma addresses the most persistent question around Tencent: Why doesn’t it innovate? “I think that’s unfair,” he says. Most Internet inventions, he notes, spring from Silicon Valley, with its high concentration of experienced entrepreneurs and engineers. The focus of Tencent, like most other tech companies in Asia and Europe, is on what he calls “micro-innovation”—adding small details that localize a service and make it relevant. He also rejects the idea that Tencent directly copies the work of other companies. “Just because we enter a space, that’s not to say we plagiarize your features and code,” he says. “Look at Microsoft, Google, and Facebook. They have all entered many sectors, and actually in many of those sectors, they weren’t as early as Tencent.”

 

Ma is the ninth-richest man in China, according to Forbes, with a fortune estimated at $4.4 billion. He wears glasses and an open-collar dress shirt and combs his hair somewhat messily across his broad forehead. He speaks quietly and with gathering confidence, but he’s famous for being shy. His public profile in China is much lower than that of Robin Li, the handsome co-founder of Baidu (BIDU), and Jack Ma (no relation), Alibaba Group’s pugnacious CEO who has gone multiple rounds in a high-profile fight with Yahoo, one of his largest shareholders.

Within his company, though, Pony Ma is hardly demure. Former colleagues say he’s a micromanager who will send e-mails to product heads about the location of a single button on a new service. When it comes to the media spotlight, though, he typically begs off, saying public speaking isn’t his style. Keeping a low profile “is a personality issue. It’s not a choice, I don’t have those abilities,” he says, speaking in Mandarin but punctuating his phrases with occasional English. The reticence, he says, is a trait common to people from China’s Guangdong province: “In the south, you do your own thing. You talk through your product.”

Ma was born in October 1971 and grew up in modest circumstances. He spent his childhood on Hainan, an island off the south coast, and as a teenager moved with his parents and sister to Shenzhen, where his father got a job as a manager of a port and his mother worked in the accounting office of a local company.

Ma graduated from Shenzhen University in 1993 with a bachelor’s degree in computer science, then worked on a paging network for China Motion. He caught only glimpses of the Internet via slow, expensive dialup connections to local bulletin boards. In 1996 the company sent him to the U.S. for training at Harris (HRS), a telecom equipment company in Melbourne, Fla. It was there that Ma got his first unfettered look at the Web, which was exploding with new technologies—including a chat service called ICQ.

ICQ was created in Israel by four recent college graduates who wanted to replicate the Unix-based chat tools of the early Internet on personal computers. Introduced in 1996, it was free to download and spread rapidly. It had 3 million users by the end of 1997, mostly in the U.S. and Europe.

AOL bought ICQ in 1998 for $407 million, an astonishing figure at the time. For Pony Ma, the deal suggested there was tremendous opportunity on the Internet. With financial support from his mother and help from four friends, Ma quit his job and set out to devise an instant messenger tailored for the Chinese market. He barely disguised his intentions to appropriate the Israeli company’s idea, naming his startup OICQ.

The plan was to create an Internet service whose messages were accessible via pagers, and then to sell the software to a larger company for a quick payday. Four companies sniffed at the prototype, including Ma’s old employer China Motion and Tom.com, a company controlled by Hong Kong billionaire Li Ka-shing. They either didn’t believe in the service or were unwilling to pay enough to acquire it, so Ma and his friends were stuck developing OICQ themselves. “It just ended up in our hands,” he says.

People who visited the startup back then remember a group of young engineers working in cramped offices—not in Shenzhen’s booming downtown district but in a mixed-use residential and commercial neighborhood. There was only a freight elevator that stopped on every floor; employees and visitors usually took the stairs. Ma’s English was terrible, so everything had to be translated for American visitors. “They were not so internationalized at that time,” says Anthony Zhao, a partner at Zhong Lun Law Firm in Shanghai, who worked with the company as it was getting started. “They didn’t have overseas exposure, education, or working experience.”

Ma and his friends had one advantage: “They had a manic focus,” recalls Paul Hsiao, a partner at Silicon Valley VC firm New Enterprise Associates. “They would lock themselves in a room and work around the clock to tackle problems. They had a fear that someone else could do it faster than they could.” The founders crammed group messaging, online dating, and other features into their chat software and outmaneuvered Chinese rivals with similarly uninventive names such as PICQ and CICQ.

By late 1999, Ma had 100,000 users and the attention of AOL, which demanded that the startup change its name. His father helped him register the name Tengxun, which translates into “galloping message.” For foreigners, Ma went with the easier-to-pronounce Tencent, and the messaging service itself was ultimately renamed QQ.

Investors were not easy to come by, at least initially. Shenzhen was known for manufacturing, not software. Desperate for cash, Ma raised $2.2 million in seed capital from PCCW, an investment firm run by one of Li Ka-shing’s sons, and IDG, one of the first Western VC firms in China. By 2001, Ma’s cash situation was dire again. Ultimately, both firms agreed to sell their stake to the South African media group Naspers. The terms were $32 million for a 47 percent share in Tencent. Naspers’s investment is now worth more than $16 billion, making it one of the most profitable private equity investments of all time. Shong of IDG, who can console himself with a blockbuster return on his stake in Baidu, says that selling his piece of Tencent was the biggest mistake of his career.

With Naspers onboard, Ma was free to address another looming threat: Microsoft. QQ’s entertainment-oriented messaging service appealed to young people. Microsoft, which introduced a Mandarin version of its MSN Messenger service in the late 1990s, had locked up a more professional user base. “The pressure on us from MSN was really great,” Ma says. “People were saying sooner or later we were going to die.” Tencent set out to build services that Microsoft, without a significant force of local engineers, probably wouldn’t or couldn’t match.

Tencent again borrowed ideas from other companies. It took a virtual goods model from early Korean social networks such as Cyworld, which allowed users to express themselves by dressing up their avatars, and copied Chinese Web pioneers such as Sina.com and Sohu.com with a Web portal, QQ.com, that was densely populated with links to news, music, and video. Microsoft executives who worked in China at the time charge that Tencent also freely copied features from MSN Messenger, right down to the light blue background of the chat software. They also acknowledge that they underestimated the size of the market and the willingness of young Chinese Internet users to spend money accessorizing their avatars. “I don’t think anyone [at Microsoft] really took the time to understand what the culture was and what would be big there,” says Friedbert Wall, a general manager for Microsoft in China from 2005 to 2009. “We were really U.S.-centric and thought, we’ll just do it and everyone will accept it. But it doesn’t actually work that way.”

Tencent went public in 2004 on the Hong Kong Stock Exchange, raising $200 million. Pony Ma and his four co-founders became millionaires. Ma says he doesn’t recall celebrating. He may have been preoccupied with other matters. Around the time of the IPO, the young tycoon began chatting over QQ with a woman in Beijing; she didn’t know who he was, since Ma didn’t use his real name. The two eventually married. A Tencent spokeswoman won’t comment on Ma’s wife or the couple’s children.

Since the IPO, Tencent’s stock has jumped more than 5,000 percent. Games are a big reason. They also offer a good example of why many competitors, analysts, and Internet observers continue to argue about whether Tencent is a company uniquely tuned in to the needs of Chinese Internet users—or a ruthless force that steals and profits from the creativity of its competitors.

 

Tencent first added casual games such as chess to QQ.com in 2004, then watched as upstarts Shanda Interactive Entertainment (SNDA) and NetEase.com (NTES) imported more immersive games from developers in South Korea and the U.S. The Chinese market, those companies proved, was uniquely receptive to free games that offered players the option of paying small amounts of money for virtual goods, since years of rampant piracy had undermined the retail trade in shrink-wrapped games.

The company decided to enter the game market seriously in 2007, led in part by Martin Lau, a former Goldman Sachs (GS) banker who joined Tencent in 2005 and is now its president. Tencent scoured South Korea for new game properties, licensed and adapted them for Chinese users, and linked them to its massively popular QQ service. By 2008 users of QQ chat software could, with a few clicks, call up a shoot-’em-up called Cross Fire or a fantasy role-playing game called Dungeon & Fighter, both developed by South Korean companies.

Tencent licenses those games and splits the virtual goods revenue with their creators. A farm simulation game called QQ Farm, like Zynga’s FarmVille in the U.S., is a version of a game called Happy Farm by the Chinese game maker Five Minutes. Some of Tencent’s other popular games, though, were built in-house, and they aren’t exactly unique. The racing game QQ Speed closely resembles KartRacer, created by South Korea’s Nexon.

Adapting free online games for the Chinese market and linking them to ubiquitous QQ chat software proved to be a killer formula. The company’s gaming revenue vaulted past that of NetEase and Shanda, and Tencent now has four of the five most popular games in Chinese Internet cafes, according to Goyoo, which provides an Internet portal service to more than 30,000 cafes around the country. QQ’s users, accustomed to paying for virtual goods, have made the games massively profitable. Players can use their virtual Q Coins to buy everything from body armor in Cross Fire to healing potions in Dungeon & Fighter.

Steve Gray, a veteran of Electronic Arts (ERTS) who moved to Shanghai in 2009 to run Tencent’s game production division, acknowledges that inventing from scratch is not the company’s strength. “Tencent is not really a first mover,” he says. “You can say that we sort of follow a lot of stuff. We’re cautious.” He believes Tencent innovates in another way: publicizing its games to a mass audience, bringing out incremental features customers want—and supporting millions of gamers online at the same time. A year ago, QQ Speed had 700,000 players concurrently at peak times. Gray says the company fiercely marketed the game with giveaways like (real) automobiles, and managed to triple the number of players in a year. Now 2.3 million Chinese play QQ Speed during peak hours. “I’d say the secret sauce of Tencent is in its customer service and operations,” he says. “You can have millions of people playing the same game, and it works.”

Benjamin Joffe, a consultant who studies the Asian technology market, has a name for this kind of commercial mimicry: innovation arbitrage. He says Tencent, like many other tech companies, finds things that work abroad, strips them of their native cultural components, and adapts them to the local market. Like Zynga in the U.S., Tencent is a “fast follower, because there is little upside in taking big risks to innovate dramatically.”

 

Tencent understands that it needs a reputation makeover. In the last year it has reached out to game makers, promising to be more open and work with them to bring their games to QQ’s network. The exact meaning of such “openness” is hotly debated in Chinese Internet circles. In the U.S., for example, anyone can create a program for Apple (AAPL)’s App store, as long as they follow Apple’s published guidelines. Tencent has guarded its network much more closely than that, carefully selecting and vetting which applications it will feature—and which it will simply copy in-house. Executives tend to cite security reasons and the need to protect their users’ financial information from hackers and malware. Julian Ma, a general manager of Tencent’s strategy development department (and no relation to Pony), promises the company will be a friendlier, more inclusive partner. “We will be quite cautious about competing with third-party developers,” he says. “If there is a conflict of short-term interest, we will put the partners first.”

Recent events may have forced Tencent to play nicer. Last fall the company, which bundles antivirus software into QQ, was drawn into a public spat with Beijing security software maker Qihoo 360, with both sides accusing the other of anticompetitive behavior and spying on users. The Chinese government rebuked Tencent and Qihoo—the Minister of Information Technology called both “immoral” and “irresponsible”—but not before users were spooked and both companies were widely criticized in the local media. One former Tencent employee, who does not want to be named because he plans to do business with Tencent, says the intensity of the criticism was a wake-up call that forced Pony Ma and his colleagues to recognize they needed to do a better job courting favor with other Chinese high-tech companies.

Tencent also probably fears that a new wave of more open social networks may lure users away from QQ. Renren, a Facebook-like service, has tens of millions of active members and is flush with cash after raising $743 million in an IPO in April. Another threat isSina.com’s microblogging service, Sina Weibo. Sina’s offering launched in 2009 and now has 140 million members. In terms of the richness of its features, Sina’s Weibo has surpassed Twitter, the company it imitated. Users can comment directly on each other’s posts and more easily integrate photographs and video. You can tell how nervous Tencent is by how aggressively it pushes its own product: It has lined up celebrities to join and use its service, including Chicago Bulls superstar point guard Derrick Rose. Tencent’s Weibo now has more members, though Sina’s regularly gets more posts.

The Chinese Internet market is growing so quickly that Tencent doesn’t necessarily need to expand abroad. Still, Pony Ma continues to attempt to become one of the first Chinese Internet CEOs to make it big outside his native country. In 2006 the company experimented with localized versions of QQ in Japan and the U.S., and packaged its games into the instant messaging software of its old rival, AOL. “The products weren’t competitive and those markets were already dominated by big U.S. companies,” Ma says.

Tencent subsequently decided to concentrate its global ambitions in online games. It has a small development team in a high-priced office building in downtown Palo Alto, Calif.; the second-floor office is marked by a small, photocopied picture of its penguin mascot taped to a window. Employees there develop social games for Facebook, published under the name Ice Break Games. In February, Tencent also paid $400 million to acquire a majority share of a Los Angeles-based gaming studio, Riot Games, and is adapting its online fantasy game League of Legends for the Chinese market. Brandon Beck, Riot’s 29-year-old CEO, says that since the acquisition, Tencent has basically left the company alone because it understands the importance of preserving entrepreneurial energy in a startup.

Tencent and its executives may finally be learning from their past. At the company’s holiday party last December, Pony Ma performed magic tricks and grabbed the microphone to sing Silent Night and Jingle Bells in English. It was another sign that he’s trying to open up to people, both inside and outside the company. In early July at a Tencent conference in Beijing for software developers, Martin Lau, Tencent’s president, declared that the “theme of the day is openness.” Later, Pony Ma took the stage to do the thing he hates: public speaking. Cooperating with other companies, he explained, is now part of Tencent’s core strategy. Even a dominating force such as Tencent has to rely on partners to create content in the era of iPhone apps and Facebook games.

“We have to do this,” Ma says back at headquarters in Shenzhen. “We can’t develop all that content, all those applications.” As for the criticism, he says he’s not letting it get to him. He doesn’t have any hobbies, though every couple of days he gets a little time to play games like Cross Fire, Tencent’s popular first-person shooter. “The important thing isn’t to look at the level,” he says. Shooting things up online “is a way to reduce stress.” And although he’d never say so, apparently he’s quite good at it.

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Einhorn is Asia regional editor in Bloomberg Businessweek’s Hong Kong bureau. Follow him on Twitter @BruceEinhorn.
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Stone is a senior writer for Bloomberg Businessweek in San Francisco. He is the author of The Everything Store: Jeff Bezos and the Age of Amazon (Little, Brown; October 2013). Follow him on Twitter @BradStone.

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