BAT vs FAANG: The battle for digital dominance

Facebook, Apple, Amazon, Netflix and Google would love to get access to China’s 1.4 billion population, but protectionist regulation has made that almost impossible.

Instead, their prospective positions in the world’s second biggest economy have been taken by homegrown equivalents: Baidu, Alibaba and Tencent. The three tech firms dominate the digital and social categories in China – and are starting to rub up against FAANG in international markets.

Alibaba – China’s Amazon
While it’s important to be cautious about direct comparisons between US and Chinese brands, most analysts agree that the nearest thing to online retail platform Amazon in China is Alibaba.

In 2017, the company reported revenues of over $40 billion, up 58% year on year, and it expects 2018 to be similar. In May, Alibaba CFO Maggie Wu said she expects “revenue growth above 60%, reflecting our confidence in our core business as well as positive momentum in new businesses.”

Aaron Kessler, Analyst at Raymond James, says Alibaba controls 70% of the Chinese e-commerce market, adding: “We expect continued robust China e-commerce growth with Alibaba as the biggest winner.”

While China accounts for most of Alibaba’s revenues, Co-founder and Executive Chairman Jack Ma has made no secret of his ambition to internationalise the company, which is why Alibaba signed up as a premium partner of world soccer governing body FIFA in 2015.

“We expect continued robust China e-commerce growth with Alibaba as the biggest winner.” Aaron Kessler, Raymond James

On the retail front, Alibaba has already made serious inroads into Southeast Asia and is starting to butt heads with Amazon in markets such as India and Australia (which it views as strategic priorities). It has earmarked $15 billion for international growth over the next five years.

Alibaba’s retail leadership in China is enabling it to make similar technological advances to Amazon. In 2017, it launched Tmall Genie – an equivalent to voice-controlled personal assistant Amazon Echo. In the first four months after launch it shifted around 1 million units.

Like Amazon, Alibaba also has its own cloud computing division Alibaba Cloud. Currently worth around $2 billion a year in revenues, Alibaba Cloud has been targeting EMEA in the last two years. Again, the fact that Alibaba Cloud is a presenting partner of FIFA’s Club World Cup is an indication that the firm has ambitions to expand globally.

Echoing Amazon’s Prime Video service, the company is also a significant presence in China’s content streaming business via its Youku platform. Although it is third in size to iQiyi and Tencent (more below), the fact that it has 325 million active users makes it a significant player.

In summer 2018, it partnered with public broadcaster China Central Television (CCTV) to stream the FIFA World Cup. In return for a fee of $250 million, it generated an audience of approximately 180 million across the tournament, with 24 million viewing the tournament final.

Youku is also investing in original Chinese content to bolster both its subscription and advertising OTT ambitions. Examples include entertainment show The Street Dance Of China and drama series Day and Night (which has been licensed to Netflix for the rest of the world).

In recent years, Youku has acquired many international shows for its platform, but at MIPTV 2018 Yang Weidong, President of Youku and Alibaba Media & Entertainment Group, also outlined the platform’s ambition to co-produce. He said: “International experience and production quality is still more advanced than our local production teams. We’ll catch up, but global players can help us improve our production quality, through cooperation. So we are starting to explore the possibility to co-produce variety shows, drama and animation.”

Commenting on China’s streaming landscape, Yang Weidong added: “Five years ago, we were maybe one of 10 players in China, for online-video streaming. Last year, there were six major players. And now we are three major players. So it’s very competitive… and the content has become more and more expensive… because of the three rivals.”

While Youku seems unlikely to develop as a global streaming platform, it is worth noting Alibaba’s massive ongoing investment in Hollywood, headlined by the acquisition of stakes in Steven Spielberg’s Amblin Entertainment and Dalian Wanda’s film division. In total, Alibaba is expected to have invested around $7.2 billion in entertainment content over the three-year period 2017-2019.

Baidu – China’s answer to Google
Baidu is China’s answer to search giant Google. For the first quarter of 2018, it generated revenues of $3.33 billion, up 31% year on year and ahead of analyst expectations. These results follow a couple of slightly sticky years when Baidu was forced to reorganise internally to comply with new government regulations on online advertising. The company currently makes around 80% of its revenue from online ads, and has an active online marketing base of around 475,000 customers.

The company has narrowed its investment in non-core businesses but still invests heavily in search and AI. It is also the majority shareholder in China’s leading streaming platform iQiyi, which it spun off in March.

At first glance, Baidu-iQiyi might seem to mirror Google-YouTube, but most analysts tend to characterise iQiyi as ‘China’s Netflix’.

To understand why requires a little bit of historical context. Put simply, iQiyi was initially launched as an AVOD service at a time when the Chinese market showed little willingness to support a subscription-based TV business (circa 2008).

“International experience and production quality is still more advanced than our local production teams. We’ll catch up.” Yang Weidong, Alibaba

But in mid-2015, iQiyi began a concerted drive to convert its users into subscribers. So in a sense it has gone from being a quasi-YouTube service to a quasi-Netflix service with the main difference being that YouTube is mostly shortform and UGC whereas iQiyi has been centred on longform programming.

Google has tentatively explored the idea of a paid-for YouTube service but never really been willing to undermine its existing ad revenue-based model. In the meantime, Netflix, which was born as a subscription-based DVD rental service, quickly filled the SVOD gap in the market (thus explaining the divergence between US/international and China).

Today, you can see iQiyi’s progression in the fact that it has almost 1 billion users in total of which around 67 million are paying subscribers.

As referenced above, 10-year old iQiyi was spun-off in March 2018 in an initial public offering that raised $2.25 billion. The IPO document at the time said iQiyi had 61 million subscribers so it has managed to put on around 6 million subs since then.

Its results for Q3 2018 show that quarterly revenues have risen by 51% year on year to around $1 billion. In addition to streaming subscription revenues, Goldman Sachs has attributed this rapid rise to upside from the company’s growing content library, traffic from short-form video platform Nadou and mobile gaming revenue from recently acquired Skymoon.

Not to be overlooked either are the ad revenues it generates from its non-paying users – which are similar in scale to its subscriber revenues (so maybe it is best, in the final analysis, to think of iQiyi as a kind of YouTube-Netflix hybrid operating a ‘freemium’ business model).

For the first quarter of 2018, Baidu spent around $669 million on content for the iQiyi service and all the indications are that this level of investment will keep going up (similar to Netflix). In June, for example, iQiyi announced the expansion of its paid subscription model beyond premium movies, drama and in-house content to genres such as animation and documentaries.

With popular series including The Rap Of China, the prevailing view among analysts is that iQiyi is ahead of its rivals in terms of production. Also worth noting is that iQiyi has an exclusive licensing deal with Netflix that covers animation, documentaries and hit series such as Stranger Things.

Chris Dong, Research Director at IDC China, said in a recent report that fierce rivalry in the mainland’s online video market “has led many platforms to use exclusive content as a competitive strategy”. Like Netflix, iQiyi has seen a large number of its users shift to mobile. Recent statistics put the platform’s monthly active users on mobile at 442 million.

In terms of international expansion, it’s important to stayed focused on Baidu-level developments. The company has invested heavily in artificial intelligence/machine learning technology with a view to the global market. It also has a portfolio of apps that are in heavy use in India, Brazil and Southeast Asia.

The company is also a global leader in self-driving vehicles – possibly even ahead of Google. It has developed a self-driving bus that is expected to launch on Japanese roads in 2019.

Tencent – mobile to games to streaming
The US/China comparison breaks down when it comes to the third of China’s mega-companies, Tencent. Launched in 1998, Tencent initially based its business around mobile messenging, but its real success has been down to its ability to pivot in the direction of fast-growing businesses.

Today, it is one of the world’s leading gaming firms with investments in Riot Games, Epic Games, Kingsoft and Activision Blizzard among others. It also has its own in-house gaming division.

In addition, Tencent is the biggest rival to iQiyi in China’s streaming space and has stakes in search engine Sogou and ecommerce business JD.com. It has a stake in Snapchat and owns Chinese social messaging service WeChat. With WeChat user numbers currently just over a billion, this has proved a lucrative advertising revenue platform for Tencent.

Given all of these activities it is no surprise to see that Tencent is now one of the world’s largest companies, with a market capitalization in the region of $500 billion (similar in scale to Alibaba).

On the streaming front, Tencent Video is pursuing a similar strategy to iQiyi – transforming non-paying customers into subscribers. At time of writing it had 43 million subs, up from 20 million at the end of 2017.

The company has been an active buyer of international content for the last five years or so, but recently it has stepped up its investment in the kind of compelling content that wins subscribers.

In 2015, for example, it acquired NBA basketball streaming rights for $700 million and it has also bet big on HBO’s iconic drama series Game Of Thrones. More recently, it teamed up with FremantleMedia and Syco Entertainment to launch a kids version of the Got Talent franchise.

It also acquired a 10% stake in US production company Skydance, and has been an active international co-production player, teaming up with the BBC on its natural history epic Blue Planet.

This year, the two partners also unveiled a three-year co-production alliance. Analyst Media Partners Asia reckon Tencent is currently spending around $2 billion a year on content as it chases down market-leader iQiyi.

While China’s streaming platforms all want exclusive content to distinguish their services, they are also willing to do non-exclusive deals to service their non-paying customers. For example, eOne’s popular animation series PJ Masks is available on Tencent, iQiyi and Youku. It’s important to keep in mind that the streamers’ large non-paying audiences are still of significant interest to advertisers.

As the above examples illustrate, Tencent’s international ambition has so far been executed through the acquisition of stakes in established firms – and there is no particular reason to believe it will take on the FAANG companies directly with its China-originated brands.

That said, WeChat has a growing profile in Asia and it recently launched an international version of its gaming platform WeGame – expected to be a robust competitor for Steam. The company is also at the forefront of eSports, and has launched eSports theme parks.

At this stage, you may be wondering what the closest comparison to Facebook is in China. Well some analysts argue that this titles goes to Weibo, a social media platform often referred to as being China’s answer to both Facebook and Twitter.

At the end of 2017, Weibo had around 400 million users and revenues of $1 billion. But Tencent’s WeChat is a key rival to Weibo– and with its deep pockets may eventually be able to secure social media leadership for itself. Advertisers tend to view the two platforms as being complementary.

Can BAT take on FAANG?
The rapid growth of Alibaba, Baidu and Tencent is certain to impact on the global market in areas like AI, cloud computing, self-driving cars, gaming etc, though it is not clear whether the three companies will become consumer-facing brands outside China, like Facebook, Apple, Amazon, Netflix and Google.

Of the three, Alibaba’s activities in elite sports sponsorship suggest that it is furthest down the road in this regard (though even here the FIFA partnership may be more of a B2B strategy).

In terms of what FAANG can learn from China, two things stand out. Firstly, China has proved to be an extremely mobile-centric society – more so even than the West. To a large extent, Tencent’s remarkable growth has been the result of its ability to rapidly develop services that seamlessly integrate with small screen behaviour in China.

Secondly, Chinese consumers have proved much more willing to use social media as the gateway to general day-to-day activities such as retail, banking, gaming, ticket purchase etc. This has led to important commercial developments such as social shopping. 

Potential Western beneficiaries – if they can harness this trend – include Facebook.

Other fast-moving Chinese innovations that could spread internationally include mobile payments (echoing Alipay and WeChat Pay). However analysts tend to take the view that the Chinese firms will encounter pretty insurmountable competition from incumbents (and regulators) in this sensitive sector.

One company that we haven’t discussed much here that could benefit from Chinese innovation is Apple. Apple is the only member of FAANG that does serious business in China. Although it is always subject to the vagaries of Chinese government protectionism, it’s as well positioned as anyone to export Chinese product and service learnings to the global market.