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China’s Monster ‘Facebook’ QQ: coming to a screen near you

Introduction

The world is full of fast-growing, hyper-fashionable social networking and user-generated content plays. Almost to a man, they lack one thing - profits, or even revenues. An English-speaking technology media and analyst/investor community obsessed by the US West Coast has practically ignored QQ.com, one example of spectacular success, because it’s Chinese.

A Profitable and Valuable Social Network

At the 30th of June, Tencent (QQ’s owners) had thrown off RMB993 million (US$145 million) in free cash in six months, even after spending RMB1.9bn in CAPEX and a further RMB593 million in financing costs. For comparison, Facebook went marginally cashflow positive for the first time in August and isn’t yet profitable.

The bottom line is impressive too; at the last count, Tencent’s gross margin was at 67.3% and net margin was 41.75% - this smashes HP’s investment criterion of “fascinating margins”, i.e. 45% gross, and Iliad’s 70% ROI on new fibre deployment. We previously estimated the gross margin for October 2008 as 63.5%, so it appears that things have consistently been going well for QQ.

The shares (listed in Hong Kong) have gone from HK$60 to 120 since April, showing that this performance is also attracting plenty of demand from investors - albeit at a somewhat toppy price/earnings ratio of over 50.

Nearly a Billion ‘Users’

There were 990 million user identities on QQ as at the 30th of June, 2009. Given the current growth rate, the billionth user will almost certainly be announced in the next quarterly results - but a nontrivial percentage of these are inactive, are multiple aliases, or are spambots. [NB. This is true of all IM communities except, perhaps, for the 17 million users of IBM Lotus Notes Sametime inside their enterprise firewalls, as we pointed out in the Consumer Voice & Messaging 2.0 strategy report.]

As impressive as this is, instant messaging user bases are usually only weakly bound to the service, they are usually non-paying, and many people have multiple usernames. A more useful metric is peak concurrent users - the maximum number of users simultaneously logged in during the period in question. To be counted, a user name has to be active in that they are online, so it’s reasonable to deduce that they exist. It doesn’t prove that they are a human being (or for that matter a useful application rather than a pest); however, whether or not a logged-in user is human, they are consuming system resources.

So, measuring peak concurrent users provides us both with better data on uptake and a more useful indicator of capacity related costs. It’s a standard telecommunications engineering principle to “provision for the peak” - that is to say, it’s useless to build a network with only sufficient capacity for the average traffic, as 50% of the time it will be congested and probably non-functional through overload. To be available, the system must supply enough spare capacity to handle the peaks in demand. Peak load determines scale, and hence cost.

In 2008, at various times, QQ’s parent company Tencent claimed to have between 355 and 570 million users. At the end of June, 2009, the user count stood at 990 million - so the nominal user base had roughly doubled. In 2008, peak concurrent users were 45.3 million, growing to 65 million in June 2009. According to QQ.com’s live statistics readout (you can watch it grow in real time here), the record at time of writing was 79 million. According to Alexa, 3.26% of global Web users visited one of the various qq.com sites in September 2009.

qq-growth.png

For comparison, Skype’s all-time peak concurrent user count is 15 million, although it has the advantage of using user-provided infrastructure, whereas QQ has a client-server architecture and therefore a constant need for rack-space.

Not just users, but Paying Users

In 2007, out of 12 million peak concurrent users, 7.3 million had spent money with QQ, or to put it another way, 61% of verifiable QQ users were buying value-added services. (How many mobile operators can claim that?)

In March, 2009, we thought it unlikely that this high proportion would continue to pay as the service grew - and that it was quite possible that the 7.3 million earlier payers were dominated by early adopters and power users, so that future recruits would be less committed to the community, less geeky, and lower-income.

However, when Tencent’s Q1 results appeared at the end of March, 36.9 million users had purchased value-added services during the quarter, growing at a monthly rate of 8.4% to reach 40 million by the end of June. This latter figure was against a concurrent user base of 65 million, meaning that 62% of concurrent users were paying users.

We think this is an impressively high proportion at such volumes, and suggests that the revenue may scale reasonably well as it grows penetration further. As one might expect the cost model of such a volume business to scale efficiently, this implies further prospects of profitability. It is likely that such thoughts are one of the influences on the aforementioned growth in QQ’s share valuation.

So, how did they do it?

qq-cpf.png

In our Serving the Digital Generation Strategy Report, we identified a list of key factors that anyone who wants to attract the customer of the future would have to address, which together describe what we call the participation imperative. Specifically, four axes define the customer’s aims:

To read the rest of this article, covering:

  • The Customer Participation Framework
  • The role of digital money
  • Why it beats advertising
  • QQ’s two-sided business model
  • What happens next

 

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