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The three NASDAQ-listed Chinese Internet companies Netease.com Inc, Sina Corp and Sohu.com Inc have released their 2003 financial results. Having experienced both difficulties and successes in the four years since listing and with the ups and downs seen in the Internet industry, these companies are at a turning point. James Cheng writes this analysis on their results and future trends.
China's big three portals have achieved five straight quarters of profitability, their business models are mature and stabilized, and their growth is steady. A discussion on these companies should not simply analyze financial figures but study the structure of their business lines and the outlook of their development models.
The main findings include:
The scale of the big three's business will continue to grow, but growth rates will slow; their business models will continue to expand, but their traditional businesses will continue to contribute the most to revenues; the scale advantage of Sina Corp is further strengthened and Netease continues to lead in business operation and profit-making capabilities.
Both Sina/Sohu and Netease models have taken different paths in terms of business structure and thinking on development. The characteristics of their business models have been decisive in the strategies they've undertaken.
The three Internet portals' influence among the Chinese people is not as strong as before. The expansion of these portals will bear characteristics of diversification and differentiation, but the companies will likely converge when opportunities in broadband Internet arise.
Financial results
The operation scales of the three portals continued to grow, but the growth rates of online advertising and non-advertising revenues began to slow down. However, growth rates still remained high. As for online advertising, Sohu Chairman and CEO Charles Zhang once said that the speed of growth would not slow down, particularly as data shows that Internet portals will continue to bite into the traditional media market. Multimedia messaging services (MMS), wireless application protocol (WAP), interactive voice response (IVR) and other wireless services will generate even more revenues, in addition to earnings from short messaging services (SMS), but they won't enjoy an explosive growth in the near future. Online gaming will encourage the three portals to make further investments in this field, and both Sina and Sohu said they would continue to explore this area. Netease launched Fantasy Westward Journey and began to charge players after making a full-scale entry into the industry.
Sina Corp's growth rate is slightly faster than the other two and the company has extended its scale advantage. Netease and Sohu revenues are about 60 percent of Sina's. Their future revenue pools will be enriched through their respective characteristics. Sina's main strongpoints are the acquisition of online travel service company Fortune Trip and the joint online auction platform with Yahoo!. And these two businesses both have huge potential. The acquisition of gaming information website 17173.com and real estate information website Focus.cn will help Sohu's expansion. Netease's Popo already took 4 percent of the instant messaging service market and began to charge users in January. It also had some material cooperation with China Mobile, NEC, MTV and other companies in MMS, WAP, IVR and other wireless services.
Their operating profits and operating profit margins continue to rise. Netease has the strongest operation ability with an operating profit margin of 54 percent, while Sohu's is 45 percent and Sina's is 40 percent. Netease's high profit-making capability does not only come from effective cost control, but also its reliance on self-development products, especially its biggest revenue pool, online gaming, which has a very high profit margin. I believe Sina's profit-making capability originates from its diversified investments and large amounts of marketing expenses. Large amounts of marketing expenses are helpful for Sina to establish its brand, which is key to beating the competition.
Different models
Both in terms of business structure and thinking on development models, Sina/Sohu and Netease form two different groups and have different characteristics.
Online advertising has traditionally been a large contributor to Sina and Sohu's revenues between 35 and 40 percent in the past several quarters while only accounting for about less than 15 percent of Netease's revenues. In non-advertising revenues, Sina and Sohu quickly entered the SMS area after it proved a success, and the companies became leaders due to their advantage of having heavy Internet traffic on their websites. In the online game business, they have had some difficulties in making breakthroughs. Netease has been a pioneer in SMS, online gaming and instant messaging. Its success in SMS was soon copied and it has been a top-runner in online gaming with its accumulation of experience in the area and first-mover advantage.
Since their business models are similar, Sohu faces more and more pressure from Sina. Its revenues in the fourth quarter were only 64 percent of Sina's and its revenues from advertising, SMS and instant messaging were smaller than Sina's. It is noteworthy that Sina has been growing faster than Sohu in the past four quarters and that the gap has widened. If Sohu cannot change the situation in the near future, it will be at a further disadvantage.
Netease has been quite successful due to its unique business model. But its role as an Internet portal is facing some challenges. Online gaming is helpful to boost profits and stock prices, but it is a business not closely related to the portal business. Heavy traffic on websites, which an Internet portal relies on, cannot necessarily guarantee success in online gaming, which is also a reason why Sina and Sohu can achieve breakthroughs in the area.
The essence of an Internet portal is content and online advertising, where Netease is quite weak, so the company decided to revitalize its content and increased investments recently. That will become the basis for Netease's expansion with its advantage as a portal.
Netease's core competitiveness lies in its technology and ability to innovate. It has been a leader in SMS, online gaming and instant messaging services mainly with its own technologies and research teams. This is a key reason for Netease's higher profit margin.
Sina and Sohu have adopted a conservative policy in expanding into new areas. Both Sina CEO Wang Yan and Sohu's Zhang both agree on moving in after knowing the market. The online travel service and online auction areas where Sina entered recently have already been successful for other companies. And 17173.com and Focus.cn were already profitable when Sohu bought them.
Branding has become an advantage for Sina thanks to heavy investments in marketing in its early stage. Branding will also become the basis for its fast development after entering new areas.
Meanwhile, Sohu's branding is slightly blurred. Zhang raised the concept of a "portal matrix" after Sohu acquired 17173.com and Focus.cn, but the acquisitions have not significantly boosted Sohu's branding. Non-distinct branding may become Sohu's bottleneck to achieving large-scale operations.
Future directions
Compared with two or three years ago, the influence of the three portals among the Chinese Internet population has been dropping mainly due to second-tier portals, like Tom.com, have been narrowing the gap. Also, vertical portals, like travel information company Ctrip.com, online recreation service provider eLong.com, search engine companies Baidu and HC International, e-commerce companies Eachnet.com and Alibaba.com have been increasing. And the listings of companies like Ctrip diverted investors' attention from the big three. In addition, overwhelming dominance in new areas like wireless services, e-commerce and search engines was not achieved by the companies.
Since 2003, the big three have been looking to enter new areas with huge amounts of money at hand.
However, affluent capital does not guarantee success. Sohu's Zhang once said at a forum that it was quite difficult for a portal to keep its professionalism and start-up enthusiasm while entering new areas and thus there was plenty of room for up-and-coming Internet companies. He also said that if a portal concentrates on one business, that would boost its competitiveness, but the problem is that concentration is impossible for a portal. A portal's biggest advantage is its Internet traffic and the more this resource is used, the higher value it will have. So cooperation should be key in developing new businesses for portals, such as the revenue-sharing model in search engines and the online auction joint venture between Sina and Yahoo!.
The development and positioning of the three portals will differ. The Internet is still a new thing and various models of portals will be developed but concentrating on their strengths will be key for the companies. Netease, which has already made some progress in setting itself apart from its competitors and Sohu, will surely take some actions.
But their expansion is based on the portal business, so the three companies will surely meet again when they decide to head into the broadband Internet business. The traditional content on the three portals is based on narrow-band Internet and mainly includes text and pictures, but audio and video content on broadband Internet is set to change the means of content provision.
Accordingly, the operation models and industrial chain will change, especially with the participation of telecom operators, such as China Telecom's broadband website Chinavnet.com and China Netcom's 116.com.cn.
How to merge into the broadband content provision industrial chain and transform their advantages on narrow-band Internet is a challenge that lies ahead for the three portals and will surely lead to a reshuffling of the industry.
(China Daily March 3, 2004)
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