VCs and mobile internet: The race to stay relevant

Within five days of its launch at the end of May, Changba became the most popular free iPhone app in China. Fifteen days later it was closing in on one million downloads. Changba is in effect a mobile karaoke bar, but differs from rival apps in its social media extension: a user selects a song, sings it into his or her phone, and then shares the result with friends. Members of the Changba community can comment on other users' songs and award virtual flowers to show their appreciation.

The app was developed by Zuitao, a Beijing-based company set up by Tony Chen, who previously co-founded travel portal Kuxun, which was sold to TripAdvisor in 2009. He spent 18 months bringing Changba to market and has claimed it could be worth $1 billion in 4-5 years.

Sequoia Capital China was sufficiently convinced by Zuitao's success that it invested in the company in July, reportedly paying $15 million for a 20% stake. Neil Shen, founding managing partner at the venture capital firm, admits that without input from younger members of the investment team, the deal might never have happened.

"It's difficult to imagine myself or most of my team members going to KTV more than three times a month but I checked with one of them who graduated this year and he said he loves this type of application," Shen explained during a panel discussion at the Venture Capital Summit that formed part of the 2012 AVCJ Forum. "Especially in the technology-media-telecom space, you need to pay a lot of attention to the younger generations. The user base could come from the 1980s and 1990s."

The entrepreneurs themselves also tend to be on the young side and therefore have an intuitive grasp of what customers want. The classic example is Pony Ma, who started internet behemoth Tencent 10 years ago when he was in his mid-20s; Zuitao's Chen is in his mid-30s.

Know your market

For all VC investors in Asia, success in mobile and social media essentially hinges on staying relevant. Almost every element of the market is changing rapidly, from the customers and their media preferences to the technology that underpins how content is delivered. What isn't emerging fast enough are sustainable monetization models.

An ability to identify emerging consumption and technological trends is therefore crucial - and it comes from being in touch with developments on the ground. "We are always looking at the capital needs curve of a technology against the technology's readiness level and trying to find the intersection between the two," said Jonathan Glen, co-founder and managing partner at China-focused VC firm Diverso. "You need to understand demand and the dynamics of that demand."

The situation is complicated by the fact that the evolution of more developed markets can seldom be used to plot an accurate trajectory for others due to a wealth of mitigating factors. One of the most prominent is that, while the US and Europe experienced linear progression - a PC revolution followed by an internet revolution followed by a mobile revolution - in Asia the revolutions are either happening at the same time or in a different order.

"More people in the developed world are interfacing through mobile devices but in Vietnam that has always been the case," said Henry Nguyen, managing general partner at IDG Ventures Vietnam. "More people own mobile phones than PCs and their first contact with technology is a phone. The way you interact with it - touching it, being closer to the screen - changes the whole dynamic in terms of providing any sort of service. That means a change in the whole media market landscape."

The practical implications are clear. How do marketers deal with the smaller screens on mobile devices for which visual display advertising is less effective? How do they take advantage of mobility - customers are on the move and could be walking past retail outlets - and the dissemination of information via social media platforms?

Vietnam is in many respects the ideal demographic Petri dish for these trends. More than two thirds of the population is 16-64 years old, and the median age is 26. Consumption has been growing at 20-24% per year for nearly a decade as, 20 years after the country introduced reforms, younger generations have unfettered access to media. And it's all in the palm of their hand; there are 2.7 million wired broadband subscribers and 20 million 3G subscribers.

China's development path is slightly more conventional. PCs came out before mobiles and now the PC market is slowing while mobile internet use continues to accelerate. Embryonic smart phone demand has been extraordinary, with close to 300 million users by the end of 2012, up from only 10 million in 2010.

However, even comparisons to Japan, which went through a similar PC-to-mobile transition 10 years ago, are skewed not only by the nature of technology available at the time, but also by the manner in which mobile emerged. As Shinichi Takamiya, a partner at Globis Capital Partners, noted, roughly 80% of Japan's population now accesses the internet via mobile devices, but this wouldn't have been possible without encouragement from the telecom operators.

"When mobile internet services were introduced in 1999 carriers played a crucial role," Takamiya said at the AVCJ Forum. "One of the biggest things is the transaction costs. In Japan, the carrier's take of the transaction fee is 7%; in the rest of the world it could be 50-70%. The carriers have also launched developer kits to support the content developers."

By contrast, China's mobile revolution has not been carrier-led; Ian Goh, a partner at Matrix Partners China, describes it as "more guerilla."

There are multiple standards and platforms, and the three companies that dominate the internet industry, Alibaba Group, Baidu and Tencent, are all looking to launch own-brand Android devices. Rather than challenge the incumbents by launching competing products such as social media platforms, Matrix looks at specific verticals and applications. For instance, the VC firm invested in Beijing Momo Technology, a dating app that had 4.5 million users within eight months of its launch in 2011.

That said Xiaomi has proved it is possible to create an independent mobile phone company from scratch with limited VC funding. This was achieved by recognizing what younger generations wanted (a low-cost smart phone) and how best to tell them about it (leveraging social and viral marketing channels).

The monetization issue

Xiaomi is a classic example of a disruptive model prevailing in a fast-changing industry. The uncertainty is exacerbated by the absence of leadership and proliferation of different standards, but Joe Zhou, managing partner at Keytone Ventures, warns this dynamic will lead to far more failures than success stories among start-ups. He would like to see more leadership on the advertising side so that monetizing businesses becomes easier.

"If you look at the early stage of China's internet, it took 3721, Yahoo and Baidu to build the distribution system to bring in the commercial advertisers," Zhou said. "Mobile needs the same driving force; we need someone to do the dirty work. People who raised large amounts of money last year in e-commerce at high valuations, like Dianping, were able to do that because they did a lot of the dirty work that no one else wanted to do and have more sustainable models."

There are three major monetization channels: advertising, subscriptions and transactions. Given that a paid-for content culture has yet to develop in China, Zhou sees mobile gaming as the only viable monetization strategy at present.

His dismal view on mobile advertising is shared by others. Although Beijing-based iResearch estimates that China's mobile advertising market was worth RMB5.52 billion ($885 million) in 2012, Huang Wei, chairman of consultancy Shanghai Power Stream Mobile Media, recently argued that the actual figure is more like RMB500 million - 1.3% of overall online advertising - because 90% of the takings are commissions from app downloads. Anecdotal evidence suggests that app developers are the principal buyers of these user-acquisition services, not mainstream consumer brands.

"I invested in a mobile ad company in 2005, but it was a big fish in a very small pond and it is still trying to justify its leadership position," added Matrix's Goh. "It started from WAP and two years later everyone was moving to smart phones. There are so many different operating systems for phones in China. Entrepreneurs have to be an advertising agency, deal with technology issues and be a platform themselves."

Vietnam, unsurprisingly, is even less developed. It is estimated that online ad spending as a whole might have surpassed $40 million in 2012, growing at 50% a year, but that equates to less than $0.50 per person. The mobile content and services market in Japan, meanwhile, is worth $20 billion and expanding at an annual rate of 15%. Even Android, supposedly the most difficult platform to monetize, has mobile games making $10 million each month.

Globis' Takamiya argues that it is just a matter of time before monetization ramps up in less developed Asian nations, but it isn't clear exactly how this will be realized. Monetization began in Japan with feature phones - user acquisition costs and conversion rates were low, and monthly spending was high. In the smart phone era, this has been turned on its head, with the emergence of Apple and Google as global distributors pushing up user acquisition costs.

"In Japan, the monetization problem appears to have been solved but in China it's still an issue," said Richard Hsu, managing director of Intel Capital China. "There are a lot of ad networks on the mobile side that are still being developed, and although people think it's going to big, there is no evidence of traction. A lot of people using these screens but it's a question of getting the infrastructure in place."

Predicting the future

There are plenty of ideas as to what a mobile-enabled world will look like: wireless broadband technology will allow consumers to live in the cloud, carrying all their data - for work and leisure - with them wherever they go, and hooking up mobile devices to different display units; advertisers will find more sophisticated ways to target prospective customers individually, based on geographical location and personal preferences.

Yet it remains to be seen which business models will succeed in making the breakthrough to profitability and then whether they have the staying power as new competitors flood the market. For VC investors who spend their days identifying underserved niches of demand and disruptive technologies, keeping a finger on the consumer pulse has never been more important - and this means looking towards youth.

"Communication power will continue to grow just like computing power and that changes the way you consume information," said IDG's Nguyen. "That is how kids are growing up today. If you look at Twitter or Facebook, they are always getting information about what's going on in their world. If you look at how they watch TV, they don't watch TV; they watch YouTube videos or Netflix. It's a whole new world in terms of communications, media and tech."

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• Topics
• Venture
• Technology
• Media
• Greater China
• North Asia
• Southeast Asia
• Vietnam
• Japan
• China
• Venture
• TMT
• Intel Capital
• IDG Ventures
• Sequoia Capital
• Matrix Partners