Tencent (the most powerful company in China) Part Three.

 The entry of Big competitor (a war between Tencent QQ & Microsoft MSN)

 

Unfortunately for Pony, that happiness would be short-lived, as little did he realize his company was about to go to war. And their opponent was a hundred-billion-dollar corporation called Microsoft. In 2004, a chat service called MSN entered the China market, as a direct competitor to Tencent QQ. MSN was run by Microsoft, which was terrifying for Tencent, as Microsoft had such vast wealth and resources. And Microsoft had decided to double down on its efforts in China, given it was such a massive market. And since their chat service was much more professional and streamlined than QQ, MSN quickly attracted businesses and students.

 

QQ seemed more like a casual chat application, but less of a serious communication tool. On the other hand, MSN was becoming more widely used in offices in China and thus was quickly eating into QQ’s market share. Tencent really just had one big advantage over Microsoft though: MSN’s decision-making was much slower because of their bureaucratic corporate hierarchy, where every big decision had to be signed off by their American headquarters.

 

For example, it was actually MSN’s China team who suggested the idea that users should be able to still receive messages even while offline, and be able to see them when they came back. But the suggestion never went anywhere. Meanwhile, Tencent managed to incorporate the same feature in just a couple of weeks, and it proved to be hugely popular.

 

And so even though Tencent had grown into a fairly big company by this point, it still acted more like a scrappy startup. This often meant their apps were a bit buggy and had some issues, but they were able to launch new features really fast, get real-time feedback, and just fix issues along the way with very regular updates. Another issue for Microsoft’s MSN chat was that initially, they kept all their data back on US servers, which meant Tencent QQ chat service that ran on local China servers was much faster to use.

 

But the biggest mistake for MSN was that they later incorporated their MSN chat into their platform MSN Live, and this just confused users, as now to use the chat they had to go to a website instead and it was just an unnecessary extra step. Ultimately, despite having greater resources, MSN lost the fight to Tencent. In truth, China hadn’t been a main priority of theirs - Microsoft had bigger battles going on elsewhere like with Google in the US.

 

Whereas Tencent at the time had just one focus, which allowed them to go all in. But this victory over Microsoft was a critical turning point for Tencent, as after defeating a much bigger competitor, they went on to completely dominate the chat market in China, passing half a billion users in late 2005. And it was this dominance that would be the springboard for all of Pony’s other plans.

 

You see, Pony had a vision of being much more than just a popular chat platform, but instead a whole network of integrated internet services, as that would make it harder for anyone else in the future to try and compete with them. And so Tencent began adding several other features to QQ; like the ability to access news. After seeing how quickly Tencent was growing, a South African company called Naspers decided to invest $32 million dollars in Tencent and became their largest shareholder.

 

In fact, they still are to this day, meaning Naspers got one of the highest investment returns ever. But back when they first invested in Tencent, this gave Pony the influx of cash he needed to begin the next stage of his plan. And this is where things start to get crazy. Tencent had realized that a lot of people used QQ whilst playing games, as people would chat with their friends whilst they were all playing. So Tencent decided the next logical place for them to expand was into both acquiring and building games of their own.

 

The next stage for Tencent

 

Since they already had such an active user base, within just a year of integrating games into QQ, Tencent had added another $50 million dollars in annual revenue. Now, Tencent's quick expansion into the gaming market was aided massively by the fact they were a China company. As you may know, the internet in China is restricted by the great firewall, which stops people within China from accessing many websites the China government doesn’t want them to - including the likes of Facebook and YouTube. And that’s largely because it wants to censor what its citizens can see, but also because it wants to promote local China companies instead. And as a result, in many industries, China has a policy where foreign companies have to partner with a local China company to be able to sell their products or services in China, and so this meant Tencent could simply team up with makers of successful games in other countries and then adapt and distribute their game to the China market. These licensing deals allowed Tencent to make a lot of money quickly without even having to produce any games themselves. They could just partner with makers of popular games in other countries, bring their games to the China market, and promote them to their massive QQ user base.

 

Since international companies were reliant on finding a China partner if they wanted to enter the China market, Tencent knew they had a lot of leverage and an unfair advantage in negotiations. If game makers wanted to bring their games to China’s gigantic population, they needed a China partner, and who better than Tencent?

 

One example of Tencent's power is illustrated by an anecdote from the American video game developer Zynga when they were trying to agree on a deal with Tencent. An ex-Zynga employee said: “Negotiations go on for months and months, and then by the time you get to the redline stage in the contract, all of a sudden at the last minute, they change everything. It’s a business tactic they use to wear down their partner.”

 

But as well as licensing games for the China market, Tencent did make some of their own games too - normally by just replicating fairly simple games that were working well elsewhere; 

 

for example, QQ Speed was very heavily inspired by Mario Kart. This of course was even more lucrative than licensing as it meant they kept all the money for themselves. And it was a low risk as they were using game concepts that were already proven to work well abroad, and just making their own version of it for China.

 

However, since China had a major lack of digital piracy enforcement, Tencent realized if people weren’t paying for games upfront and were just sharing them for free, why not make the games free for everyone, and make money through in-game sales instead - like paying for extra lives, features, and upgrades. Nowadays of course micro-transactions within games are extremely normal, but Tencent was definitely one of the first to push this so heavily. And it worked - Tencent's revenue continued to rise. With monetization now going so well.

 

Tencent culture work on new projects.

 

Tencent IPO’d in 2004 on the Hong Kong stock market, which provided them a war chest for Tencent to invest heavily in more expansion and growth. However, that growth would only be possible thanks to Tencent's culture. Now, most China tech companies are notorious for their long work hours; the schedule is often referred to as the 996 schedules; meaning you work 9am to 9pm 6 days a week. And certainly, at Tencent, the culture was very demanding, with internal meetings often going on past midnight.

 

But Tencent also had a strict hiring process, as Pony believed that five A-players were better than a team of fifty who wasn’t fully committed, as even one person lowering the standards and not working hard, can reduce team morale and drag down everyone else to their level. Not just that, but one of the key cultural decisions Pony made after their battle with Microsoft, was to ensure that almost everyone in the business had the freedom to pitch new ideas and work on new projects. So rather than having a specific research and development division, everyone was expected to innovate.

 

As a result, the whole of Tencent workforce was actively monitoring the market for new apps and ideas they could essentially rip off and incorporate into QQ. Even Pony himself said in an interview at the time: ‘I don’t blindly innovate. The smartest approach is to learn from the best examples and then try to surpass them.’

 

Pony pointed out that this is exactly what American tech giants like Microsoft and Google did as well. But in China, it really was the wild west where anyone could just blatantly copy anyone else with no protection. And to be fair, this wasn’t one way; whilst Tencent copied others, others copied Tencent as well. But because Tencent QQ software gave them access to hundreds of millions of China users, it meant they could then divert that attention to the new features they launched, giving them a huge advantage.

 

Tencent antivirus QQ Doctor and the battle with Qihoo.

 

Before long, Tencent had a notorious reputation as a killer copycat. And Tencent's reputation took an even bigger hit after a battle with a security company called Qihoo, which offered a popular antivirus software called 360 Safeguard… Tencent had decided they wanted to get into the security market as well so they’d created their own very similar version of Qihoo’s security software, called QQ Doctor, and because they could simply integrate it into the already very-popular QQ software, they almost immediately gained a 40% market share in China.

 

So, Qihoo decided to fight back by launching a big media campaign accusing Tencent of spying on its users, saying Tencent accessed user data and files on people’s devices it didn’t have permission to. Tencent sued Qihoo as a result, but in the court of public opinion, this backfired, as it looked like a bigger company just trying to silence a smaller company with legal threats, rather than actually trying to demonstrate their innocence. And then Tencent made an extremely bold move: they informed users that Qihoo’s software was not compatible with QQ. Meaning users had to choose: either to keep Qihoo’s security software or keep the beloved chat app that connects them to all their friends and family.

 

You couldn’t use both. If QQ detected Qihoo 360 safeguard on your system, QQ stopped working. But Tencent's gamble paid off. Tencent knew that ultimately, most users were too connected to QQ to abandon it. So Qihoo were mostly the ones who lost users instead. People just switched to QQ’s antivirus software which was very similar anyway.

 

It was yet another victory for Tencent, and proof of how easily they could launch a new internet service, and almost immediately become the market leader. In the media, headlines such as ”Tencent Empire Out of Control” started to appear, as this was clearly monopolistic to essentially ban your users from using a competitor’s product.

 

But interestingly the China government showed no interest in intervening; they seemed quite happy to sit back and let Tencent grow. Only later would it become clear why. But with no regulations or laws to stop them, Between 2005 and 2010, Tencent's revenue went from $200 million dollars to $2.9 billion dollars. However as Tencent continued its expansion in China, opening up more internet services and then leveraging QQ’s massive user base to make them popular, eventually they realized a new strategy might be needed. For a while, Tencent had simply been trying to work on everything, competing in loads of different sectors, making clones of all different internet services and just seeing what worked. 

 

Do not turn everyone into your enemy.

 

Basically, they tried to compete everywhere, rather than playing to their own strengths. And really, Tecnent’s biggest strength was in leveraging its QQ chat platform with hundreds of millions of users, to direct traffic to other places, like they’d done with news and gaming. So as their copycat reputation got worse, one Tencent executive said: ‘There’s a lot of great entrepreneurs outside, and if you turn every single one of them into your enemy, it’s not a good thing. As a company you can’t actually hire these entrepreneurs, so what are you going to do?

 

Investment is actually the best way to get a piece of their action.’ Thus, Tencent began shifting its strategy towards investing in China companies instead of always trying to directly compete against them and crush them. For example, Tencent paid $448 million dollars for 36.5 percent of China’s third largest search engine, and merged their own search product into that, rather than competing.

 

Tencent was now willing to back a champion rather than do everything itself. Essentially, Tencent's new strategy was almost to become a start-up incubator. It would invest in businesses and take some of their equity, and then build an ecosystem of connected companies that it could help grow using its existing user base and infrastructure.

 

Another example was when Tencent combined with China’s second-largest online retailer, JD.com. Tencent had no real expertise in e-commerce themselves, so they figured it made sense to just back one of the most prominent companies in the industry in exchange for equity, and then leverage their own internet traffic, experience, and capital to help the company they backed to succeed.

 

As a result, Tencent became a kingmaker - as support from Tencent could help ensure a company was successful. And from Tencent's perspective, it meant they massively reduced operational complexity as they weren’t doing literally everything themselves anymore. Before long, Tencent was one of China’s biggest investment companies. And QQ was now much more than chat software - it was a portal to many other internet services that Tencent had either created or invested in. And thus, QQ seemed unstoppable. 

Click here to read part 4