Three Markets U.S. Internet Companies Can’t Ignore: Social, Mobile and … China

Pretty much every U.S. Internet start-up today has a social and mobile component to its business; it’s standard operating procedure in 2011. But a rising number of American companies also have a third focus of their growth strategies: China.

“Going to China” is a trend we began to see among start-ups early last year, and it has picked up considerable momentum since then. Given the track record of U.S. Internet companies in China — which could at best be described as “mixed” and, at worst, “disastrous” — one might wonder why today’s upstarts believe they’ve got what it takes to be successful in the world’s largest Internet market. China has an estimated 400 million Internet users today, and will have 750 million by 2015, according to a recent McKinsey & Company study.

From our vantage point, it’s not that American entrepreneurs and CEOs suddenly feel they’ve cracked the code on China. Rather, the Chinese market opportunity has become so large, they simply can’t ignore it. The massive potential rewards of “going to China” now outweigh the massive potential risks — especially now that the U.S. market, with all its recent troubles, is no sure bet itself.

The market potential in China is easy to see when you visit the bustling streets of Shanghai or Beijing. As investors in both China and the U.S., we have our own take on why we think China is rapidly becoming a core strategy for every high-growth Internet company today.

  • Growth for Fortune 100 companies is coming from China, not the U.S. (or Europe). Case in point: Mercedes sold more S-Class sedans in China last year than in the U.S. and Germany combined. Mercedes sales in China grew 60 percent last year versus nine percent in the rest of the world. Even if you own large-cap U.S. equities in your personal portfolio, mutual funds or 401K, those companies’ main revenue growth is likely coming from China — and economic growth in the U.S. is hardly assured at this point.
  • Incomes are rising in China while remaining flat in the U.S. The Chinese middle class numbers in the hundreds of millions (100-300 million, depending on your source), with household income rising an estimated 98 percent since 2004, according to Credit Suisse Group. Even the bottom 20 percent of households saw their incomes rise 50 percent in the same time period. Contrast this with the U.S., where household income growth has stagnated, barely keeping pace with the rate of inflation since 1990. This flat-line income stagnation isn’t likely to change anytime soon, especially in today’s challenging economic climate.
  • The Chinese have money, and they’re spending it. Chinese consumers buy an estimated 12 percent of the world’s luxury goods, growing at a 30 percent clip per year, according to Barclays Capital. Spend a day in Shanghai, Beijing or Hong Kong and you’ll be blown away at the breadth of luxury stores in major downtown areas — and the number of shoppers crowding the shops.

So what does this mean for U.S. Internet companies? It means the same thing it does for Mercedes, Apple or P&G — you simply can’t ignore China anymore.

To date, most success stories among U.S. tech companies in China are enterprise or mobile companies in the Fortune 1000 — HP, Microsoft, Cisco, Intel, etc. Each of these companies has built a $1B-plus business in China, but it took them decades to do so, with many speed bumps along the way.

We can’t argue with the dismal results of most U.S. Internet companies thus far in China — first-generation Internet companies like Amazon, eBay, Yahoo and Google have largely failed in China, and newcomers like Facebook and Twitter have been hampered due to strict Chinese government regulations. But we can highlight a few data points that suggest smart U.S. companies can and will attain success in China in the next five to 10 years.

  • Demographics. Internet demographics keep getting better in China. Robin Li, founder and CEO of Baidu, spoke at our 10th anniversary event in Shanghai last November. He pointed out that when he launched Baidu in 1999, there were fewer than 30 million Internet users in China, and the total Internet ad market was worth less than $50 million. Today, Baidu sports a $50 billion market cap and Robin is a billionaire. Today there are more than 400 million Internet users in China. Combine this audience size with the rising incomes mentioned above, and you just can’t get a better audience for an Internet company.

  • Market share. More than 70 percent of the world’s virtual goods sales in 2010 occurred in the Asia/Pacific region. It’s no wonder why Tencent, which pioneered the virtual goods market now being replicated by Zynga, generates more than $4 billion in annual revenue from gaming and virtual goods, and sports a $45 billion market capitalization. China’s Internet advertising market is growing at an estimated 50 percent or more per year.
  • Platform diversity. In the U.S., Facebook is the go-to outlet for social marketing, accounting for more than 80 percent of the market (though it will be interesting to see if Google+ makes a dent in this over the next 12 months). In China, there are social platforms you’ve never heard of that each have hundreds of millions of users. Sina Weibo (think “China’s Twitter”) has more than 140 million users, more than 50 million monthly actives, and is adding more than 10 million new users per month. YY has millions of users, many of whom spend hours per day on the platform. Last year, YY users consumed more Internet voice minutes than Skype. (Disclosure: Our firm, GGV Capital, is an investor in YY.)

In recent months, several U.S. Internet companies have made their move on China. Zynga recently announced a partnership with Tencent to launch its games in China. Earlier in the year, Groupon entered China through an investment into local group-buying site GaoPeng.com. Both of these companies are going after China a mere two to three years after launching in the U.S. — an unheard-of undertaking just a few short years ago.

Our bet is there will be hundreds more U.S. Internet companies talking about China in the boardroom over the next two years. We’d wager more than 90 percent of high-profile American Internet companies will spend a lot of time, money, and energy to enter China — either on their own or via local partnerships. Many will fail to catch on with Chinese consumers. But for the relatively small percentage of companies that succeed, China will bring massively outsized returns. Internet companies that win the hearts and minds of Chinese consumers are the companies to bet on for long-term growth.

Jeff Richards (Menlo Park) and Jenny Lee (Shanghai) are Partners at GGV Capital, a $1 billion venture capital firm investing in the U.S. and China since 2000. Representative GGV investments include Alibaba Group, Pandora Media, YY, Buddy Media, Tudou, SuccessFactors, Square, and 21ViaNet.


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