Money Games: Tencent

Tim Merel investigates the biggest games company you may never have heard of... yet

As the business of videogames moves ever more into the spotlight, is pleased to bring you a new monthly column from IBIS Capital director Tim Merel.

Each month he'll be examining a subject or sector of interest, beginning here with China-based company Tencent - and why it could be the biggest videogames company you might not have heard of.

Who am I?

Let me start by apologising - I used to be a lawyer, then I worked for Rupert Murdoch... and now I'm an investment banker. But - I'm also a software engineer, I write adventure stories, and I play a mean guitar, so life is a balance!

We're starting my monthly column with a profile of the greatest games company you may not know, Tencent. "No!" I hear you cry. "Surely Activision Blizzard, Electronic Arts, Take-Two or Zynga is the greatest?" Well, this all depends on your perspective, and when your perspective happens to be money, things change.

So who is Tencent?

To explain the praise for Tencent, let's start with some data. And again, I apologise; I tend to use a lot of data. For the innumerate, please look away now.

  • China has 29 per cent internet penetration, but 382 million users.
  • China is forecast to reach 56 per cent internet penetration (754 million users) by 2015.
  • Tencent holds dominant or leading stakes in many Chinese online/mobile markets (IM, games, eCommerce, search, mobile services).
  • Tencent's Chinese games market share was 20 per cent in 2009, forecast to hit 27 per cent by 2012.
  • Tencent's market capitalisation - which is in the order of ¥241 billion ($35 billion) with an enterprise value of 35x 2009 EBITDA in August 2010 - was greater than Activision Blizzard, Electronic Arts, GameStop, Take-Two, THQ, Atari, Game Group and Ubisoft combined.

So what about Sony, Microsoft and Nintendo? Okay, so Tencent is about halfway between Sony and Nintendo's market caps, and nowhere near as large as Microsoft. But (a) we're talking about game software not hardware and (b) Sony and Microsoft do a couple of other things too.

Tencent's integrated model is where the market is headed

Tencent generates around a 50 per cent operating margin. Online/mobile games (MMO, board & chess, casual/social) generate more than 40 per cent of its revenue. Tencent's business model appears to be migrating from virtual items (higher Average Revenue per User) to subscriptions (short term revenue reduction, but lower volatility), which is a reversal of the trend they started.

Expect to see the same thing happening in Western markets in 12-18 months time, which is roughly the lag between China's pioneers and the West's followers.

Of great importance, Tencent has an integrated business model with upgrades and privileges across online, mobile and offline (not just games), delivering a significant advantage for customer acquisition, development and retention.

It capitalises on enhanced capabilities to cross-promote, upsell and cross-sell. Facebook could learn a lot from them about how to make even more money.

Tencent has some natural advantages which help enormously

I like this first chart a lot, because it contrasts the growth in online/mobile games with the flat console games market, which is great if you're a pure online/mobile company like Tencent.

The next chart helps to clarify things further, forecasting that Asia-Pacific will become the number one market by revenue, with Europe at number two and North America at number three.

A very large proportion of Asia's strength comes from China - Tencent's home market - where online/mobile games account for the bulk of revenue.

Whether or not you have faith in the forecasts themselves, directionally they're correct. The videogames market is going online and mobile, with China a large part of those markets. Again, that's great if you're the leading player in online/mobile games in China.

While not going into depth on how Chinese online/mobile videogames business models work, there are a few key elements to note:

  • Community focus around the games experience
  • Active interaction with gamers to refine both user experience and commercialisation
  • Focused commercialisation based around high volume, micro-transaction subscriptions, virtual items and some advertising
  • Games as a service, not a product, with multi-year revenue streams, revenue sharing post recoupment of development budgets and continuous, low cost development through game lifecycles post-launch

The charts below help to understand Chinese online game dynamics in general.

Chinese Gross Game Revenue Profile (¥) Example*

Chinese Total Staffing per Game Profile Example*

And what does all of this produce? 49 per cent games revenue growth over the last five quarters, and around seven million peak concurrent users of Tencent's mini casual games alone. Snap your fingers, and more than the population of Ireland are playing a Tencent mini casual game - not 7 million uniques per month, 7 million uniques right now.

Tencent Quarterly Game Revenue (¥ million)

Tencent will be in your market soon, if it isn't already

Across the full Tencent games portfolio, you reach around 20 million peak concurrent users, or slightly less than the population of Australia. That's what happens when you're the number one Chinese games company.

Tencent Mini Casual Game Concurrent Users

Chinese Game Company Revenues ($ million)*

I was lucky enough to have lunch with Bo Wang from Tencent recently, and it is clear that despite Tencent's advantages the company is actively expanding into new areas. Now annual market growth has cooled to a mere 30 per cent (from 70 per cent-plus), Tencent is looking to leverage its strengths across segments domestically and internationally.

But as with all things Tencent, this isn't just talk and it isn't small. There are domestic partnerships:

  • China Unicom (fixed line, 3G, operations, "QQ Wallet")
  • Hunan TV (talent, animation, online/mobile games)
  • China Merchants Bank (financial services)

There are also international partnerships/investments:

  • Digital Sky Technologies (Facebook, Zynga, investor)
  • Vina Games (Vietnamese online games/internet)
  • MIH India Global Internet (licensed software, content & trademarks)
  • Naspers (36 per cent Tencent investor) with global reach in high growth markets

All the major videogame, technology and media companies in North America and Europe are both fascinated and slightly nervous about the major Chinese companies entering their home markets. The only advice I can give is to learn from Tencent fast, because these guys mean business and they know what they're doing. It is only a matter of time before they become as strong internationally as they are at home, so watch out!

The UK Government has asked Tim to present his Global Video Games Investment Review to 100 senior executives from videogames companies, media companies and investors at the Shanghai World Expo UK Pavilion on September 28.

The session and following meetings with will focus on both Chinese companies and investors investing internationally, and international companies and investors seeking to co-operate with Chinese firms in China.

In conjunction with, Tim is offering five free invitations. Please contact him directly if you would like a chance to attend.

Sources: PWC, Capital IQ, Credit Suisse, Companies, *presented by Bo Wang at GDC Europe 2010

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Latest comments (10)

Matthew Hill Head of Recruitment, Specialmove11 years ago
Thanks Tim - that's a great article and I'm sure lots can be learnt from their activities. Definitely interesting to see the shift away from subscription and towards microtransactions.
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Daniel Mesonero Studio Manager, Toadman Interactive11 years ago
@ Matthew: Doesn't it say that they are shifting away from microtransaction and towards subscriptions?

@Tim (in case you read these comments): Could you maybe expand upon the microtransaction subscriptions mentioned on page 2? Is that virtual items through a paid service or? I just don't completely understand and I haven't sat down to play their games yet.
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Mike Clegg Marketing/Design 11 years ago
Tencent are already gearing up and hiring up for the western market (California I believe). Check those margins, and their cash flow is formidable - no not formidable -staggering. As the article says they understand that in order to increase margins they operate as a service led organisation as opposed to a product led business. I really really don't think western games companies have really understood this properly yet.
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Tim Merel Managing Director, Digi-Capital11 years ago
Below are some examples of subscriptions by price, product and privilege from earlier in the year. In essence the size of amounts for subscriptions and virtual items are both what we would consider micro-transactions compared to what one would typically see in North American and European markets. Part of the reason why this model works so well is the very high volume, relatively low sticker price combination. Another part is the cross-promotion, upselling and cross-selling across non-game products as well. As a non-Mandarin speaker (although I'm starting to learn), I would defer to the local experts in this regard.

I hope this helps.

Example subscription packages: products - (Rmb/month) and privileges

QQ membership: QQ IM/e-commerce/others - 10 ¥/mth provides 50 privileges for IM, e-commerce and other fields
Yellow diamond noble: Qzone - 10 ¥/mth provides free avatar, items, and letter paper in Qzone, 1G photo album, exclusive VIP upload, customised domain name
Red diamond noble: QQ show - 10 ¥/mth provides all QQ avatars are free; free flower gifting to friends
Green diamond noble: Qzone - 10 ¥/mth provides free to use all music background in Qzone, free to download MP3
Blue diamond noble: Board & chess games - 10 ¥/mth provides QQ games kick-out and anti-kick-out function, double score
QQ speed purple diamond: QQ speed - 10 ¥/mth provides kick-out ability, anti-kick-out protection, multiple experience is increased, exclusive items and tasks, discount coupon
Pink diamond noble: QQ pet - 10 ¥/mth provides QQ pet shopping offers a 12% discount, free dish wash and other services
QQ dance purple diamond: QQ Dance - 20 ¥/mth provides anti-kick-out protection, multiple experience is increased, and other benefit packaged in ad-hoc VIP gift
DNF black diamond: D&F - 20 ¥/mth provides extend upper tiredness limit, experience reward after clearance, noble gamer identification
Journey to Fairyland VIP: Journey to Fairyland - 20 ¥/mth provides 8% extra experience increase, exclusive task and scenes for VIP, auto reply, noble gamer identification
CF VIP: Cross Fire - 30 ¥/mth provides VIP identification, gamers experience level rose by 25%, privilege to buy certain virtual items, anti-kick-out (twice/game), kick-out ability across camps, penalty-free quit during ongoing games
QQ R2Beat purple diamond: R2Beat - 10 ¥/mth provides QQ R2Beat kick-out and anti-kick-out function, discount coupon
QQ tang purple diamond: QQ tang - 10 ¥/mth provides QQ tang exclusive VIP role and items, anti-kick-out protection
Reading VIP: QQ book - 10 ¥/mth provides free to read all books covered in the VIP monthly package
Super QQ : Mobile QQ - 10 ¥/mth provides mobile QQ service

Edited 1 times. Last edit by Tim Merel on 14th September 2010 4:03pm

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John Blackburne Programmers 11 years ago
It's worth looking at QQ if you can as it's an eye-opener. Imagine something like MSN, Facebook and Steam rolled into one. That's only an approximation, especially on the game side, but there's nothing else like it. Maybe Xbox Live is another model, with a single avatar which is used across games. The games aren't web based but are PC games with their own launcher and lobby. Very like Flash games except slicker: I've see mahjong, card games, pool, a Zuma copy. Maybe half the players of the games are subscribers judging by their avatars, many spending more than 10元, but that's probably only a small fraction of the installed base: the games are PC-only but QQ (the chat program) is available on many platforms and their Facebook equivalent (Qzone) is web based, while a lot use it only for chat and web hosting even on the PC.

And it's about 10 RMB to the £ right now, so even the most expensive of those is about the same as a beer or coffee a month, and not excessive even in China: comparable maybe to a WoW subscription, or a heavy Farmville habit.
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Yiannis Koumoutzelis Founder & Creative Director, Neriad Games11 years ago
Unsung heroes eh? :) Good one!

As games become more and more part of the local culture in countries like China and India, prepare to be amazed the years to come!

the game is afoot! :)
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Tomas Lidström Lighting Artist, Rebellion11 years ago
I have been hearing for the last 10 years that the video game industry is changing and will never, ever be the same. But at the end of the day, I come home from work and I sit down and play some first person shooter (like i have done since, Doom), RTS (since C&C) or RPG (since Baulders gate) using a keyboard and mouse or gamepad. Where is this grand revolution everyone is so hyped up about?

I am probably falling behind with this "reaching new auidences" stuff but I simply dont see the fun in Facebook games and casual games. Yes, its a great market and Im sure its awesome for the companies leading up front as well as the people who found a new entertainment platform in casual games, but when will we see a revolution worthy for the old school gamers? Sorry if this is all too personal to have any real impact on anyone out there but.. Well, its the internet. I say what I want! :)

Good article, i kept at it even through the charts and all the statistical data I barly understood, and that is saying alot! :)
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Daniel Mesonero Studio Manager, Toadman Interactive11 years ago
Thanks for the expanded info. I'll be sure to keep an eye on them. And judging from their margins, I think we all indeed should be learning Mandarin..

@ John Blackburne: In fact, my local Chinese Starbucks charges me almost 20RMB for a cup of coffee =S
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Rodrigo Medeiros11 years ago
Tim, I wonder what's the Chinese Government take in all this... Is this company leveraged in any way, or do they have exclusive access to partnerships, cheap credit or other government-backed benefits like companies from other industries in that country (mainly energy, telecom and commodities/industrial products)? I ask you this because it's too easy to compare Chinese to western companies these days, but we often forget that their particular type of capitalism is quite different, in no small way, to the free-market (or 'almost free') model we have in the western developed world. Well, you probably get my point already... would be great to hear you on this. Thanks for the great article!
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John Blackburne Programmers 11 years ago
I'm not Tim but my take is the Chinese government is quite happy. On the chat and web hosting aspect I'm sure they're much happier if people use a service run by a Chinese company (rather than e.g. a US one) as it keeps the money in the country and they can monitor it more easily for e.g. unwanted political activism.

It's also notable that although there's real money involved and there are games of skill and chance there's no gambling, as gambling is illegal in the PRC (though very popular). Instead you win ranking points which you can compare with other players - a bit like but without the money prizes. Some of the subscriptions boost the rate you collect points. China's economy has grown rapidly in the last two decades; many people have internet access and money to spend, which they will use somehow. Using it in QQ's walled garden must be much more acceptable to the authorities than foreign sites and games.
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