Strategic players in China's tech space: The upstarts

Befitting a company whose Chinese name translates as “headlines,” news aggregator Toutiao made a few of its own last month by taking legal action against search provider Baidu, citing unfair competition. The company alleged that Baidu deliberately placed negative news about Toutiao at the top of search result pages. Moreover, keyword searches for Toutiao came back with a warning below the hyperlink. “Toutiao’s website might not be accessible because of its unstable services,” it said. 

Baidu fought back. The company posted a statement on its Toutiao account, claiming Toutiao was struggling and the lawsuit – and accompanying public relations drive – was intended to deflect attention from its problems and hide its anxiety. Behind the bluster, the real story is about competition over news feed advertising.

Founded in 2012, Toutiao is the poster child for new generation social media businesses in China. The company extracts content from media outlets and distributes customized feeds to readers based on artificial intelligence (AI) technology that analyzes individual preferences. With nearly 200 million active users, Toutiao reportedly generates RMB15 billion ($2.4 billion) in annual revenue from mobile advertising. It is likely eating into ad spend that companies would previously have earmarked for Baidu. 

The tensions reflect the increasing significance of Toutiao, as well as fellow upstarts Meituan-Dianping and Didi Chuxing, in China’s internet economy. Baidu, Alibaba Group and Tencent Holdings have been so dominant that they earned their own acronym, the BAT. But these three younger companies are at the head of a group that is challenging the BAT in certain verticals – whether their core businesses or areas in which the BAT want to scale – through new technology and disruptive business models. 

Such is their impact that the competitive landscape is now being described as BAT versus TMD. It remains to be seen whether the still unprofitable TMD can sustain their challenge, but the point could ultimately be moot. Private equity and venture capital investors expect a variety of new internet-enabled giants to emerge as the technology sector becomes both deeper and more complex.

“This new generation of large tech companies, the TMD, are still very young. The scale of their businesses is still smaller than the BAT, especially Alibaba and Tencent. I don’t think they will be able to contend with the dominance of these two companies. Baidu faces some level of threat from Toutiao, but Baidu has been investing heavily in AI-driven products and technology. It will take some time to see how the space is going to evolve,” says Jixun Foo, a managing partner at GGV Capital. 

Disruption effect

Born in the desktop PC era, the BAT have grown far beyond their core businesses – online search, e-commerce, and online content, respectively – to cover everything from online payments to cloud computing. At first, they entered new segments at the ground level, resulting in direct competition with start-ups. However, following the surge in smart phone ownership and subsequent proliferation of new verticals, the BAT recognized it wasn’t possible to be greenfield everywhere. Alibaba and Tencent in particular have switched to M&A, seeking diversification by backing or buying start-ups. 

Meituan-Dianping and Didi – online-to-offline (O2O) platforms that address local services and transportation – were born in the mobile age. Each company is the product of a merger between one-time rivals that burned through capital as they subsidized users in the battle for market share, an arms race funded in part by Alibaba on one side and Tencent on the other. Having achieved post-deal valuations of $30 billion and $56 billion, respectively, in their most recent funding rounds, they are now giants in their own right.

“The emergence of new generation technology companies could create a critical mass in their verticals due to their innovative business models. Meituan-Dianping and Didi have adopted a unified approach to address the integration of online and offline businesses, something Alibaba and Tencent do not have expertise in. Moreover, Alibaba and Tencent were initially internet companies. They have to make investments in the others to expand and strengthen positions into those segments,” says Wei Zhou, a founding partner at China Creation Ventures. 

Toutiao differs from the other two in that its business model is content-driven, but all three have demonstrated an ability to build and monetize large user bases through mobile devices. They are powerful consumer-engagement platforms defined by high-volume use and multiple touch points with customers – characteristics that are conducive to expansion into new verticals.

“In today’s mobile economy, it’s all about which platform can attract the most attention from consumers and occupy the largest portion of their time. Whether they are reading articles, watching online TV, buying clothes or ordering food, someone could spend an entire day just looking at their mobile phone. Why do we say the TMD are challenging the BAT? Because the TMD have drawn lot of online traffic in certain areas, taking it away from the BAT,” says Linda Li, a managing director at Vickers Venture Partners.

The extent of the disruption is hard to quantify. In trying to map out the likely development of each of the BAT based on the defensibility of the core business, investments in new business, and acquisitiveness, one ends up with three very different journeys. It is also difficult to predict how progress might be facilitated or impeded by strategic decisions on the part of the TMD.

The Baidu-Toutiao conflict is a case in point. Both companies are developing mobile content distribution capabilities underpinned by AI technology, but their core products are different: Baidu’s DNA is purely online search while Toutiao has a news aggregation platform. Furthermore, they do not have the same priorities in terms of future deployment of this technology. 

“If you look at Toutiao, it is moving to the entertainment side, such as short-form video. In that respect, it is again a very different product offering compared to Baidu,” says an existing investor in Toutiao. “People might then conclude that Toutiao is going to disrupt Tencent’s entertainment business, but this is an oversimplified interpretation of the dynamics of the whole internet industry. It’s not really true.”

However, AI is putting other companies on a strategic collision course. Baidu, for example, is investing heavily in driverless car technology, which is not an area of interest for Toutiao but it does appeal to Didi. Alibaba has also made some strategic moves into driverless cars, recently unveiling plans to spend $15 billion on R&D for AI. Similar image-based technology is likely to find its way into the company’s “new retail” stores that can be accessed through facial recognition.

Alibaba and Tencent have been expanding aggressively into brick-and-mortar retail with a view to integrating online and offline functions. The approaches employed by the two companies are consistent with what they have done in other verticals – and therefore offer pointers as to how they think about O2O services. While it hasn’t been a core area for either player, in Alipay and WeChat Pay they still control the systems through which most people pay for these services, so there is a strategic angle.

In teaming up with JD.com to invest in offline retailer Better Life Commercial Chain Share, Tencent is working with a longstanding partner. The alliance was formed in 2014 when Tencent merged its self-developed e-commerce properties – including PaiPai and QQ Wanggou – with JD.com in exchange for a minority stake in the combined entity. JD.com has since consolidated its position as China’s second-largest e-commerce platform after Alibaba.

This collaborative mindset is apparent in Tencent’s engagement with Meituan-Dianping as well. Having agreed to invest in Indonesian ride-hailing and delivery platform Go-Jek last year, Tencent is said to have brought JD.com and Meituan-Dianping into the deal, effectively broadening the scope of the companies within its ecosystem. 

Alibaba represents the other extreme. The company completed outright acquisitions of online video business Youku Tudou and web browser provider UC Web, which were only tangentially relevant to its main interests in e-commerce and payments. Similarly, the investment in Sun Art Retail Group was a control deal, while Alibaba responded to Tencent’s involvement in Meituan-Dianping by selling its stake in the business and directing capital into self-run on-demand local services provider Koubei and third-party player Ele.me. A full purchase of Ele.me is reportedly now being considered.

“Alibaba abandoned Koubei for a while after its investment in Meituan in 2012. Then the company recognized the huge opportunity in food delivery and wanted to own it, which is when the relationship with Meitian-Dianping turned sour. Then it started investing in Koubei again,” observes an executive at a large Chinese technology company. “If this is typical behavior, whenever a new opportunity emerges, will the start-up want to take Alibaba’s money?”

Power dynamics 

Regardless of the rise of the TMD, the BAT are corporate powerhouses. During the last three months of 2017, Alibaba reported RMB55 billion in revenue, of which RMB46.6 billion came from e-commerce, while Tencent posted RMB65 billion, most of it from online games and social networking. Baidu was the poor relative with RMB24 billion primarily derived from marketing and advertising.

Alibaba and Tencent both generate more in a quarter than any of the TMD does in a year. Meituan-Dianping facilitated RMB360 billion in transactions in 2017, but revenue was just RMB33 billion. Meanwhile, Toutiao told local media it wants to hit RMB30 billion in mobile revenue in 2018, twice the total for 2017. None of them have managed to break even, although Didi claims it will do so this year.

Rumors abound about expansion into new verticals – Meituan-Dianping is said to be targeting ride-hailing, Didi wants to enter the food delivery space – and the TMD are beginning to make strategic investments. However, the primary objective remains achieving scale and then profitability in core business areas. Public market listings are on the agenda and they could be helpful in opening up new financing channels, but these companies are still a long way from becoming the BAT.

“In the absence of effective application of antitrust laws in China, the BAT are free to expand and build scale in any area they want. Platforms like Tencent and Alibaba are still growing very fast, while Baidu has also started investing in new businesses over the last two years. If these tech giants continue to innovate their products and show no sign of regression, it will be very difficult for new players to make a significant impact on them,” says China Creation’s Zhou. 

This doesn’t mean new players cannot emerge – given the evolution of China’s technology sector, this almost certainly will – but they are still likely to be subordinate to larger peers. Toutiao is unusual in that it has established itself without the patronage of Baidu, Alibaba or Tencent. Start-ups will need assistance to achieve scale, although in time these sponsors won’t be limited to the BAT, it could be the TMD or any other second or third-generation player made good.

“Acquisition and investments by large technology players will continue because of their fear of disruption, the fear of new emerging players that could attack their existing positions. My sense is that strategic investments and M&A will only continue, and perhaps become even more aggressive,” says GGV’s Foo. 

For venture capital firms, these dynamics contribute to a favorable exit environment. Investments are made in innovative business models and technologies with a view to meeting the needs of a growing number of established and acquisitive players. It could be a mobile app that uses celebrity endorsements to drive e-commerce that would be additive for Alibaba, a travel company that is a good fit for Ctrip, or a start-up operating in an area untouched by an incumbent technology giant. 

“The infrastructure of traditional businesses – no matter if it’s retail, catering or logistics – is relatively weak in China. When great products are developed by technology companies, they easy to scale. They have little competition from the traditional offline players and their innovative business models are meaningful to the whole economy. That’s why you have seen some platforms could grow fast,” says Eric Zhang, head of China at General Atlantic.   

 

SIDEBAR: Baidu - Back to basics 

The $306 million acquisition of travel booking site Qunar in 2011 was supposed to herald the start of an acquisition spree by Baidu, a Chinese search business looking to diversify. Two years later, the company wrote an even bigger check, snapping up mobile app store operator 91 Wireless for $1.85 billion. At the time, it was the largest deal ever seen in China’s sector. But then the buying activity ground to a halt.

“The company paid a lot of attention to one or two deals. It thought that the acquisition of 91 Wireless would help it establish a dominance in mobile app space, but then people started asking whether the asset was worth that much. As a result, Baidu lost confidence and basically stopped making new acquisitions,” observes one executive at a large Chinese technology company.  

Baidu has made various attempts to enter new verticals – including group buying, food delivery, and education – through greenfield expansion or investments, but most failed to achieve critical mass. In 2015, the company launched an initiative to raise external funding for certain businesses, resulting in the spin-out of 91 Desktop App, Baidu Waimai, and education platform Zuoyebang. Late last year, its food delivery business was merged with Ele.me, a larger industry peer. 

Baidu continues to invest, focusing on new initiatives in artificial intelligence (AI) technology and new electric cars, as well as strengthening its position in key mobile internet segments like content creation and distribution and online search. In 2016, the company established two independent investment units – Baidu Ventures and Baidu Capital – to capture broader opportunities in mobile internet technology and AI. It also has a directly-owned captive arm that invests in assets relevant to Baidu’s core business. 

Baidu Ventures, which reached a first close of more than RMB2 billion ($318 million) on its second fund earlier this year, focuses on early-stage investments in AI. In contrast, Baidu Capital targets at mid-to-late stage deals. The PE unit has made six investments across transportation, logistics, media content and healthcare, backing the likes of NIO, WM Motor, Grab, and Huochebang. In December, Baidu Capital closed a RMB14 billion fund in partnership with China Life Insurance. Operating under a co-GP model, the two parties will share industry insights and resources when making investments. 

“Every large company has experienced its up and down period, just like Baidu. Its business strategy was not very clear in the past,” says Jenny Wu, a managing partner at Baidu Capital. “But the management team has taken time for reflection and become more sensitive to the changing dynamics. It is no longer mainly focused on online search – which is already very profitable – but will increase investments in strategic areas to diversify its business.”

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• Topics
• Greater China
• Technology
• Consumer
• Venture
• China
• Alibaba Group
• Baidu
• Tencent
• Meituan-Dianping
• Didi Chuxing
• TMT