China ecosystems – Pie filling

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The Chinese ecosystems are buying up the pieces they don’t already own.

• Now that growth in the home market is slowing, I think that focus will shift from grabbing users to ensuring that they spend as much time within one ecosystem as possible.
• I do not think that the Chinese will repeat the mistakes made 15 years ago and build walled gardens.
• Users hate to be constrained and just as they did 15 years ago in the west, they are likely to refuse to spend their digital lives in a constricted environment.
• Instead, I think that they will they will follow the more modern approach used by the current ecosystems which RFM has termed “gated communities”.
• The idea here is that users can pick and choose which services they want from different providers but the objective for any one ecosystem is to entice them to pick as many of its own services as it can.
• In order to do that Baidu, Tencent, Alibaba, Xiaomi and China Mobile need to have a comprehensive offering of Digital Life services and it is that build phase that is going on now.
• Chinese users spend a large amount of online time engaged in media consumption and it comes as no surprise that all of the large Chinese ecosystems are making their first priority.
• Tencent is the latest to move with the likelihood that it will take a stake in web portal Sohu’s video service as a prelude to taking the whole company private.
• This follows Baidu’s association with Qiyi.com and Alibaba’s bid for YouKu.
• Xiaomi also has a strong offering as the vast majority of the usage that its devices register is found within its media consumption offering.
• I suspect that the focus will now quickly move into the other important areas of Digital Life such as Instant Messaging, Social Networking, Search and Gaming.
• Many of the major Chinese ecosystems are already strong in one or more of these services but I suspect the next few quarters will be characterised by tuck in acquisitions as the others move to fill the pieces that they lack.
• The problem with this method of growth is service integration.
• To really monetise an ecosystem properly, the services need to be integrated such that richer and deeper services can be delivered to the user.
• When it comes to growth by acquisition, this has proved to be extremely difficult and the likes of Amazon and Microsoft are still grappling with this issues and making little progress.
• The net result is that the M&A spree in China is likely to continue followed by a sullen period as the large ecosystems digest and try to wring some value from the services offering they have cobbled together.
• China currently has around 660m smartphone users which I can see expanding to 900m by 2018E.
• This is enough for 3 ecosystems to really flourish and earn a good return but there are 5 all jockeying to be one of the three.
• Baidu, Tencent and Alibaba currently look like the winners as I am not convinced that Xiaomi has the resources to really put up a fight and I am far from certain that China Mobile’s offering will appeal to users.
• I continue to be extremely cautious on Xiaomi and expect it to be forced to come to the private market at a valuation far below $45bn.