On 17 August, one of China’s tech giants Tencent reported its first-ever quarterly year-on-year decrease in revenue by 3% to 134 billion RMB ($19.66 billion) in the second quarter of 2022. The decline was attributed to regulatory clampdowns on the tech industry over the past year, such as the so-called “Internet Purification Campaign” that strives to cleanse the Internet and social media of “illegal content and information.”
This was coupled with other national campaigns for safeguarding young Internet users, especially minors, resulting in stricter regulations on the live stream sector and video game restrictions for underage players have taken a further toll on the world’s largest video game vendor. With the country already suffering an economic downturn as a result of the COVID resurgence in China and the government’s stringent “zero COVID” policies, these regulatory hostilities further add to the business’ suffering.
The company saw domestic game revenues dip by 1% to 31.8 billion RMB ($4.66 billion), because of “a post-pandemic digestion period due to transitional issues including relatively fewer big game releases, the latest ban on issuing new gaming licenses, as well as lower user spending, and the implementation of minor protection measures.” Such restrictions have led to decreased revenue from Tencent’s hit games including Honour of Kings, Moonlight Blade Mobile, and League of Legends, and incremental revenues from recently launched games, such as League of Legends: Wild Rift, Return to Empire, and Fight of The Golden Spatula.
However, the Q2 earning results are not only being viewed as negative but has signalled a crucial transition in China’s tech industry, from the consumer market to the business-to-business (B2B) territory. Dao Insights joined a panel discussion hosted by Tech Tech China, an English website with a focus on China’s tech industry, deep diving into the market dynamics of China’s tech sector that are behind the declining figures.
Forces behind the transformation
Such transition is partly in response to Beijing’s efforts to align the technology sector with the development of “hard” or “core” technologies such as semiconductors, AI, and advanced enterprise software. As well as the Chinese government’s push for economic recovery from the global crisis and pulling up the growth of the real economy through industrial digitalisation.
This has also nudged businesses to invest in relevant directions such as agricultural technologies and smart new energies, in the hope that wider adoption of cutting-edge technologies in different industries will bring about higher productivity while also increasing China’s competitiveness in the hard tech sector race with their US counterparts.
“Many successful consumer-facing companies such as Amazon, Microsoft, and Apple have expanded their business offerings to include more B2B services, and Chinese firms are attempting similar transformations.”Paul Triolo, SVP for China & Technology Policy Lead at Albright Stonebridge Group
“Amazon with AWS, Microsoft with Azure, and Apple with iTunes, and App store offerings have been able to grow beyond their business models in ways that made the firms less reliant on consumer tastes and economic downturns,” added Triolo.
The idea has been echoed by Guus Keder, a veteran investor and partner at Zhou & Masters Consultancy, “So far these tech companies have been mainly focused on consumer applications, which has become saturated in China…What we see happening is that there is an emerging appetite for deep tech, which is closely related to the industrial internet sector. That will be booming over the next decades. Although it may not affect consumers directly, it will impact consumers indirectly. And therefore, it is in the interests of the Chinese government to support this type of move,” said Keder.
“But to transit into deep tech companies, you need real innovations,” Keder cautioned, “I think that’s the big switch that needs to be made, not only in China but also in the rest of the world. From chucking out codes for video games and consumer software to very integrated high tech that can afford the whole economy to become fully digital and completely seamless, that’s something that still hasn’t started and a process that could go on for the following decades.”
Tencent’s latest report also shows potential in enterprise-oriented business services as the company recorded a year-on-year gross margin expansion of over 30% from services such as PaaS and TDSQL database, which represented over 5% of its cloud revenue in Q2 2022. In addition, cloud services are also one of the new drivers for business growth and have turned out to be another battleground for China’s Internet companies, with Alibaba, ByteDance, and Tencent naturally being some of the frontrunners in this aspect.
Challenges in the marathon
Although great investment interest has been shown and despite the consensus that cloud services would be a lucrative market, questions have been raised by Triolo, as to the sector’s ability to generate profit in the long run.
“I think the challenge here for some of the big tech platforms as their traditional commercial [models] – the consumer-focused businesses come under pressure from all regulatory issues, is how do they transition into arguably more difficult and competitive areas and create more stable revenues from these new avenues in the long term.”
“The success of Chinese tech companies in this transformation will depend to a large degree on their ability to appeal to customers outside of China. Western companies such as Google, Microsoft, and Amazon/AWS have made their mark in the concerned areas because they are able to operate globally, leverage their own infrastructure, and appeal to businesses who need global connectivity and advanced services in the cloud, for example. So, they [Chinese tech players] are tapping into an area where others have been successful but trying to gain a slice of the market is not easy to do,” added Triolo.
He also believes that the transformation means there will likely be less negative competition in the consumer sector which drew a significant volume of complaints and fuelled the technology regulatory rectification campaign. It is also tied to Xi’s Common Prosperity agenda which has benefitted consumers.
“As major tech players concentrate more on “core” technologies, Internet companies will continue to derive major revenue from consumer-facing operations but will now be much more focused on improving consumer services and less on competing with rivals in ways Beijing and regulators have found to be wasteful and not contributing to the “real” economy. So, this should be a net benefit for consumers,” Triolo continued.
In the meantime, it is worth noting that hard technology investments can take a much longer time to pay off and generate significant revenue, as a result, in the short term there will be less explosive revenue growth. However, one thing that is certain is that despite being caught off guard by authorities’ regulations, officials in Beijing will encourage this transformation, although it will be different for each specific sector, depending on levels of reliance on foreign technology and supply chains, and the pace of domestic innovation. And it is in the interest of the Chinese government to keep these platforms alive and make them part of the country’s economy.