Bloomberg News

How a Free Chat App Ate Into Profits of China's Communist Party

April 24, 2013

China's Inner Conflict Over Innovation

Chinese take photos with their mobile devices at the Mercedes-Benz China Fashion Week in Beijing. Photographer: Feng Li/Getty Images

For more than 60 years, China's telecommunications market has really only had one player: The Communist Party.

The nation's three carriers are all state-run and have competed among themselves with no private companies allowed -- until two years ago. That's when the country's largest Internet company, Tencent Holdings, began offering consumers a free instant-messaging app for smartphones called WeChat.

Today, it has more than 300 million users, and the popularity of Tencent's application is eating into the profit of China Mobile, the country's largest carrier. Revenue for text messaging -- its most profitable business -- fell 4.8 percent to 44.2 billion yuan last year, according to CEO Li Yue, who said sales "slipped due to substitution by Internet businesses." (In its latest earnings, China Mobile reported its weakest profit growth in three quarters.)

Hard as it may be to believe, what began as a free little chat app is now posing the biggest challenge yet to the 1.3 trillion yuan ($210 billion) state-run telecom industry. And WeChat's success highlights China's conflicting objectives. On one hand, the government wants to maintain control of the market. On the other, the country's leaders are pushing for innovation to make the nation an "economic heavyweight," as China President Xi Jinping called for last month.

A Bit of History

This awkward position is forcing the question: Is the Communist Party willing to lose in order to win?

It has before. For decades, China has been reforming its economy by opening it up to the outside world, a move to deliberately weaken state control over many industries and dismantle bit by bit the legacy of Maoism. Through it all, however, the nation has retained firm control over telecom, which it saw as a strategic industry that needed to be tightly regulated.

But in a world that's gone mobile, the government's reins on that market are being tugged on by the innovation of private companies such as Tencent. WeChat made news again this week when Chinese in the earthquake-hit province of Sichuan resorted to the app to communicate with friends and family as overloaded phone networks failed.

Although it wasn't the first to create an instant messaging app, Tencent took the idea, made it better and pushed mass adoption of its product, similar to what Google did with search.

Tencent's approach to giving away its product for free in order to attract a lot of users, and figuring out later how to make money from it, is straight out of Silicon Valley's playbook. It's a strategy that's also a totally alien concept to China's state-owned carriers, which can't understand why they should cede a proven money-maker like texts to a product Tencent gives away, said HSBC analyst Tucker Grinnan.

"China Mobile is losing a very high-margin service and Tencent is adding a zero-margin business," said Grinnan, who estimates the EBITDA margin for China Mobile on a text message is greater than 60 percent. "To China Mobile, Tencent is not a rational competitor."

Despite what's at stake, the public statements from both sides aren't outwardly acrimonious.

"Today's environment is very different from the past," China Mobile's Li said in an interview after the company announced 2012 financial results last month. "Today, you have companies like Tencent."

Meanwhile, Tencent said it believes it "can develop collaborative and mutually beneficial relationships" with the carriers, Jerry Huang, a director of investor relations at Tencent, said in an e-mail earlier this month. He said the company generates data plan subscriptions for telecom carriers.

Fear of What It Will Become

However, the surge in traffic from WeChat doesn't boost carriers' sales proportionally.

While China Mobile's wireless data volume almost tripled last year to 1.04 trillion megabytes, sales only rose by half (54 percent). Unlike traditional texts, where the carrier charges the user per message, WeChat and other messaging apps ride on top of a user's Internet connection, where the services received are not related to the telecom operators.

"The telcos will be fearful of becoming 'dumb pipes,' providing the infrastructure for other companies to provide the innovative services that customers want," said Neil Juggins, an analyst at JI Asia Research Ltd.

Disruptive technology typically comes at a major cost to a market's incumbents. It becomes a lot dicier when the incumbent is the People's Republic of China.

This story was first published in Bloomberg's Global Tech Today newsletter. To get an early jump on the top tech news from around the world, sign up for the free weekday report.

To contact Bloomberg News staff for this story: Edmond Lococo in Beijing at elococo@bloomberg.net


The Good Business Issue
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus