Tencent vs Alibaba on the Quest to Go Global

Finally catching up on some reading: Bloomberg published an excellent profile on Tencent and the co’s strategist, Martin Lau. I highly recommend the article as it not only goes through the history of the company, but reveals the type of thinking and mentality that has helped Tencent become one of the most successful companies in the world.

For the uninitiated, Tencent is one of the “BAT” trinity (Baidu, Alibaba, Tencent) that dominate the Chinese tech space. The Chinese are increasingly living their lives in a “digital-first” manner, and as a result, BAT’s influence extends across nearly all aspects of Chinese life in a way that Google, Facebook, Amazon, Apple can only wish (and try to replicate with limited success thus far). All three players operate across nearly all verticals including social, video/entertainment, e-commerce, search, browsers, app stores, delivery, cloud services, payments, finance, and many more. They have gone beyond being just software/service companies to essentially digital lifestyle companies.

Despite the BAT moniker, investors view the strengths of each company quite differently.

Generally, Baidu (the company with search as its core strength) is viewed as the weakest. Unlike Google’s dominance in the US, Baidu has struggled to find its place in China’s highly digitized mobile world were users largely spend their time in Tencent or Alibaba’s walled gardens. Whereas Google has been able to run its search crawlers through the open internet and through the Android platform (majority global share), Baidu does not have the luxury of a dominant mobile platform nor access to the increasingly large amounts of data that is generated outside of the browser.

Of the remaining two, Alibaba and Tencent are generally neck-and-neck. Alibaba absolutely dominates in e-commerce and payments/finance while Tencent owns the incredibly sticky WeChat messaging super-app with a fast growing payments solution. Nonetheless, investors overwhelmingly consider Tencent to be a much stronger business with a 1yr forward P/E of 45x to Alibaba’s 34x despite similar growth rates according to consensus estimates. The difference in perception largely comes down to the fact that investors consider WeChat to be mostly un-disruptable while Alibaba is currently contending with a sizable #2 player in JD.

However, I believe that perception is misplaced especially when we consider Tencent’s and Alibaba’s prospects for going global.

The Bloomberg article mentioned above highlights the challenges that Tencent faces in trying to export its WeChat model abroad:

Then there’s the matter of Facebook Inc. and WhatsApp, which have a huge market advantage pretty much everywhere outside China. Going overseas, Lau says, “is essentially the challenge of every Chinese company. We tried to make WeChat international. The reality was that there were other products in the market already.”

Tencent faces a much more formidable competitor in Facebook as they try to expand abroad, while the global e-commerce landscape is much more benign for Alibaba. E-commerce is much more fragmented on a global scale, and Amazon is nowhere near as dominant on a global scale as Facebook is for social networking.

The valuation gap between the two companies only make sense in a China-specific context. In a global context, why should that gap exist?

Disclosure: I have no direct beneficial interest in Tencent (700 HK) or Alibaba (BABA) as of publishing date and have no intent to initiate a position within the next 48 hours. 

What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future

 

Judging from market multiples, it’s clear the market is skeptical of Apple’s ability to continue to succeed and has been for many years (currently, 1-yr forward P/E of ~15x despite recent re-rating), while holding limited concern for Google and Facebook (both 1-yr forward at ~26x).

This concern is understandable given the ever-changing tech environment and the long list of tech companies that have been buried over time (e.g. Nokia, Blackberry, Motorola). Even industry stalwarts of the bygone PC-era such as HP, Dell, and even Intel/Microsoft now stand on far weaker ground. And this concern for Apple is not new as Horace Dediu points out at Asymco

However, I contend that Apple’s business model is far more robust than Google’s in the coming artificial intelligence (AI)-revolution. 

Leaving aside potential differences in technical competency, AI is likely more complementary to Apple’s business model, but potentially highly disruptive to Google’s.

And to understand why, it requires understanding the job-to-be-done for search users and how Google’s ad-centric business model fits in.

The Assumptions Behind Search

Let’s start with the user – why do Google users search? What is the job-to-be-done?Seemingly simple question with a straight-forward answer: We are curious about many things and don’t have perfect knowledge. Google can help us answer what we don’t know. For most of Google Search’s existence, the service has approached this job-to-be-done by returning a curated list of search results that are most likely to match what the user is looking for. These are organic results that are designed to improve over time as the algorithm takes into account the answers/results users found most useful in the aggregate. Fairly simple and straight-forward.

So now turning to the business model – Google Search makes money on the ads that appear alongside search results. Every click on an ad (as opposed to an organic result) generates a small bit of revenue for Google.

Under what circumstances would a user prefer an ad over an organic result? 

Philosophically, Ben Evans (A16Z partner and almost always more than a few steps ahead of the curve) hits the nail on the spot:

In essence, the existence of ads on Google Search is the most egregious effigy to the failure of the underlying search algorithm. Every time a user clicks on an ad, it is an implicit acknowledgement that Google Search did not accomplish its job-to-be-done, that the desired answer would not have been provided had the advertiser not paid for that placement.

Given a long enough time horizon, if Google Search is truly improving, barreling towards a future where Google can answer any question without doubt and with perfect context, Google’s business model would have to evolve because ads do not have an obvious place in that future. 

And that future is coming closer with the advancements in AI. 

Search and AI

What could search look like in an AI-driven world?

It might not look all that different – perhaps Google’s I’m Feeling Lucky option or the knowledge graph cards.

But, it could also be radically different such as the search results provided by assistants such as Apple’s Siri or Amazon’s Alexa.

Regardless of the ultimate direction, it’s clear that ads have a far less obvious place in this future. If AI can be used to surface the right answer the user needs, the user would have less of a need to click on an ad.

I think we’ve seen the first instance of this issue with Google’s recent Beauty and the Beast ad on Google Home. The Google Home assistant (like Alexa) does not offer a natural channel for ads, and as a result, Google will have to find increasingly creative ways to adapt their business model for the changing environment. But history is filled with examples of failed business model surgeries.

It also makes Google’s persistent pursuit of a hardware/software business model a la Apple much more understandable. Perhaps selling hardware isn’t just about protecting access to market (after all, it’s unlikely that Android will be unseated now that it is so entrenched, so why continue with the direct hardware efforts?), it could be a deliberate attempt to evolve their business model to ensure financial relevancy in the AI-driven future.

Why Investors Seem Complacent

I contend that investors (or analysts) are confusing two separate concepts to be the same thing – the universal desire to know (hence search) and the need for ads to provide that information.

There is no doubt that search queries will only grow. It’s not farfetched to imagine a future where there are 7 billion search users instead of the less than 2 billion today. But that’s a far different conclusion from assuming Google’s financial future and business model are robust as long as search queries grow.

Search is robust, but are ads robust relative to our AI-future?

Apple’s Business Model is Far More Complementary to AI

Apple’s business model, on the other hand, is much more aligned. Sell the best products available for customers’ job-to-be-done.

AI is not orthogonal to this pursuit and business model. The only question is whether Apple has the technological capabilities to do so. However, even under the assumption that Apple is not the leader in AI-technology, it is not clear that it matters. After all, Apple was not the original leader in GUIs (Xerox PARC was). Apple was not the original leader in phones (Microsoft, Palm, Blackberry, Nokia, etc. were). Despite not being the original leader, Apple had the business model and insight to ensure that they could ride the underlying technological trend, and if I were to take a bet today, I believe Apple’s business model makes them more prepared to usher in an AI-world than Google is. AI is a feature to Apple. AI is a potential danger to Google’s business model.

From a business model standpoint, Apple is far more robust in an AI-world.

What About Facebook?

Facebook’s an ad-driven business model. What about them? Surely, Facebook is potentially in danger as well.

Facebook’s situation is less clear cut because the job-to-be-done for users is different vs search. Search has a “right” set of answers. Facebook’s feeds do not. Users are not necessarily searching for anything specific but rather using the services as an outlet for time. The “wrong” answer in a search query is far more obvious than a “wrong” answer in a Facebook feed.

And if AI can be used effectively to ensure that organic content on News Feed, Instagram, etc. are more relevant and engaging, then perhaps that can even offset any deterioration in experience from an increase in ad load. AI can never make Google’s organic results more engaging to the point where a user will tolerate a less user-friendly ad environment.

Facebook’s job-to-be-done is to, cynically, offer a time sink. Google’s job-to-be-done is to get you your answer as fast as possible. One of these is more complementary for an ad-driven business model. 

Concluding Thought

Is Google as robust as investors think? Borrowing from Peter Thiel – is this something that could be true that no one believes? Is Apple in as much danger as the average person believes?

Disclosure: I have no direct beneficial interest in AAPL, GOOGL, or FB as of publishing date and have no intent to initiate a position within the next 48 hours.