Tempering expectations for ad-based Chinese tech firms

As major US based tech firms such as Google, Facebook and Twitter have all held IPOs, attention has begun to shift to a cadre of Chinese web properties looking to go public. Yahoo’s earnings, reported this week, were entirely overshadowed by Alibaba’s results for the previous quarter, because Yahoo owns just under a quarter of it and is expected to list in the US later this year. Also this week, Chinese microblogging service Sina Weibo had its IPO in the US. However, Weibo’s poor showing at its IPO is a useful reminder China’s tech market is very different from the market in the US and there are a couple of fundamental challenges that face ad-funded businesses in China in particular.

Firstly, Chinese tech companies seem to have a much harder time expanding out of their home market than US companies. Secondly, ad-funded tech companies have far lower revenues per user in China than in the US, reflecting the much smaller overall ad spend in China. Taken together, these two factors dramatically limit the ability of ad-funded Chinese tech companies to achieve comparable levels of success to their US counterparts. We’ll explore both of these and the implications.

I’m going to make some comparisons between some of the largest US and Chinese web properties as measured by Alexa, which provides lots of free, useful data on its website for many countries. First, let’s look at the top 20 global web properties by the country with the largest number of visitors:

The list is dominated by the two countries we’re going to be looking at – the US and China. India, Japan and Russia each have one representative, though in the first two cases they’re simply localized versions of Yahoo and Google, with VKontakte being the only non-US, non-Chinese owned web property in the list. So far, pretty predictable.

However, now let’s look at the top 20 US and Chinese properties and the percentage of visitors that come from the US and China versus the rest of the world. First, here’s the US:

With a few exceptions, the top US websites derive only a minority of their visitors from the US itself with the majority coming from other countries. Only Amazon, Craigslist, Go.com (Disney’s portals), CNN and ESPN get a majority of their visitors from the US. Three quarters of the sites on the list have successfully expanded into a large number of other countries that now outweigh US visitors.

Now let’s look at China’s top 20 properties:

The contrast couldn’t be starker. All 20 of the top 20 sites in China get over 75% of their visitors from China. 16 of the 20 get over 90% of their visitors from China. Japan, South Korea, the US and Hong Kong make up countries 2-5 for many of these sites, but the US makes up no more than 4% of the audience for any of them. Why should this be? One explanation is many of these Chinese properties exist to provide China what other companies (many of them American) provide to the rest of the world but can’t provide there because of foreign ownership restrictions or censorship:

• Baidu is equivalent to Google – the dominant search engine
• Alibaba is a sort of combination of Amazon and eBay
• Weibo is frequently referred to as China’s Twitter
• QQ.com offers similar services to Yahoo and Facebook.

By definition then, these services exist solely to fill a gap that exists in China but not anywhere else and therefore it’s not surprising most of them have struggled to grow outside of China. To the extent they do have audiences outside of China, they’re largely composed of ex-pats rather than foreigners with a few exceptions. Most likely haven’t even tried to expand beyond China – Weibo has dabbled with an English version but is still virtually impossible to use without understanding Chinese (or heavy use of Google Translate).

In and of itself, this might not be a huge problem. China is the world’s largest mobile and Internet market, with a rapidly growing middle class. There is arguably a fair amount of headroom for many of these services today and they are growing rapidly. Weibo grew by over 100% year on year in 2013, Baidu grew 43% and Alibaba grew 62%. But if they never grow beyond the borders of China itself, that growth will be capped at some point. And China, despite its substantially larger population, will never deliver the sort of revenue the US does. As an illustration, Baidu, despite its dominance in China, generates just $13 billion a year in revenue, compared to Google’s $58 billion.

In fact, the US is somewhat unique in the size of its average revenues per user for online services compared with most other countries and regions around the world. The chart below shows average annual revenues per monthly active user for several US based web properties split between the US and the rest of the world:

The contrast is pretty dramatic, with US users generating anywhere from seven to ten times the revenue of users in the rest of the world. Horace Dediu this week estimated Google’s average revenue per US and UK user was over $80, whereas the rest of the world generates just $12 per user. Even though those revenues per user are lower, growth in those markets is much faster, and thus is bolstering overall growth for these companies. Compare these numbers with estimated annual revenues per active user for Weibo and Baidu: $1.50 for Weibo and about $10 for Baidu, with little prospect of expanding beyond the home market.

Why should this be so? The explanation is actually very simple: US ad spending is by far the highest in the world, as shown in these ZenithOptimedia figures:

The challenge for any Chinese-based, ad-funded business, then, is twofold: they tend not to grow outside of China and China itself is sure to saturate soon, leading to slowing growth; and far lower revenues per user than the US, which has set the benchmark for many comparable publicly traded companies.

What are the implications? We’re likely to see more disappointing IPOs like Weibo’s from those companies that fail to diversify their revenue streams beyond advertising and simultaneously fail to grow beyond China. Commerce-based businesses such as Alibaba’s are much more attractive since they can tap into burgeoning online consumer spending in China, as demonstrated by Alibaba’s results for Q4 2013. It generated more net income than Amazon and eBay put together despite far lower revenues. They also have better prospects for expanding outside of China, since commerce is much less language and culture dependent than social networking, portals and search (as Rakuten has shown in recent years).