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ByteDance´s path of breaking into the top tier of China Tech (2/2): Decomposing the portfolio of growth initiatives

ByteDance successfully reached an astonishing 100 billion USD valuation in private markets by achieving a leading position in China´s advertising market. But as growth slows at home, ByteDance has to find new avenues of growth. Will it be enough to break into the ranks of Alibaba and Tencent?

· internet

{{{Cedric Jaeger and Alexander Kremer}}}

In the first part of this series, we investigated how ByteDance was able to reach a leading position in the Chinese advertising market within just 8 years, justifying its high valuation as one of the world´s highest valued pre-IPO companies. Simultaneously, we identified the already-high market share as a potential limitation for future growth, leading to a decline in the revenue growth rate from 150% in 2019 to around 40% in 2020 (target). This is putting a high importance on new initiatives and international expansion. Thus, part two of our series is going to focus on new potential growth avenues that ByteDance already embarked on and evaluates the prospect for success.

In our analysis, we conclude that ByteDance launched a large series of new growth initiatives starting from around 2019 onwards, probably foreseeing an upcoming slowdown in the Chinese core business. Since then, ByteDance has been following a portfolio approach to its numerous products. Moreover, we conclude that in the short-term, TikTok in the US (and partly in Europe) will most likely bring new revenue growth. Last, we believe that gaming will be a major driver for future revenue growth in the mid-term

ByteDance has become a lively debated company over the course of this year. Established in 2012, it emerged into the spotlight in Western media only after its international short-video product TikTok achieved around 100 mn MAU in the US during the Covid-19 pandemic, with people stuck at home during lockdown.

Figure 1: 12 Months Global Search Trends (Source: Google Trends)

The last months were dominated by the arrival and departure of Kevin Mayer, then CEO of TikTok and COO of ByteDance; as well as the ongoing sale/carve-out of the US business due to a possible ban. Furthermore, apps of ByteDance have been blocked in India since the border dispute between China and India escalated over the summer. With all the heated debate, it is easy to lose track of what strategic direction the “Super App Factory” is taking for the overall business.

Consequently, in the following, we will decompose ByteDance’s complex growth portfolio and analyze its individual components. Tying the results to our understanding of the company’s product philosophy, development capabilities and past GTM strategies – as elaborated on in the first part – will allow us to judge its likelihood of success.

ByteDance’s Growth Portfolio

ByteDance’s growth initiatives can be broken down into four categories:

  1. Strengthening its core business inside of China (e.g., Douyin, Toutiao);
  2. Expanding its industry scope in China (e.g., education, consumer finance);
  3. Growing news/social platforms outside of China (e.g., TikTok, Helo);
  4. Diversifying abroad with product types that have not been introduced in China before (e.g., music streaming).

Figure 2: ByteDance's portfolio of growth initiatives

Mapping out key products and their performance in different regions, a couple of interesting patterns emerge (see Figure 2). First, growth initiatives outside of ByteDance’s core business have mostly been launched within the last year, likely as a response to the slowing growth in the core business. We also find that ByteDance usually first aims to grow a user base and then starts to consider monetization. Second, products are, whenever possible, first designed, launched, and optimized in China before deploying them in foreign markets. Third, if a product is first launched abroad, it is likely that there is a good reason for it, e.g. Resso, a music streaming service, was unlikely to succeed in China given strong competition from the likes of Tencent and NetEase. Overall, we find that ByteDance is following a portfolio approach to its numerous products.

Together, these patterns give us a glimpse of ByteDance’s overall growth strategy. In order to better understand these four branches, we will now take a closer look at each quadrant individually.

1) Increasing market penetration in China with (adding functionality to) existing products

The most obvious way of boosting revenue is to further penetrate into the existing core business. In ByteDance’s case this would concern mainly Douyin and Toutiao, its Chinese social media and news platforms.

As we have elaborated in the first part of our series, most growth in this segment will come from a higher ads load and introducing new advertising use cases. The potential in terms of user growth and higher usage intensity is limited due to an already formidable performance and high penetration of ByteDance. Moreover, the Chinese (digital) advertising market is growing at an overall slow pace of a mere 3.6% this year, further constrained by Covid-19 pressure on advertising budgets.

Allowing direct e-commerce conversion from short videos/live-streams has been an initiative of major importance for ByteDance at least since 2018 and it has since started a new internal division to oversee this project across platforms. Pushing further into local e-commerce direct conversion has two potential streams on the revenue side: 1) charge commissions on transactions, 2) expand advertising offering from branding closer to conversion. However, despite all the years and resources poured into this, the customer experience of buying directly from Douyin, for instance, remains far from smooth. Looking at this initiative from the brand side, it is questionable how convincing it is to yet maintain another platform – next to Taobao/Tmall, JD.com, Pinduoduo – when brands can already drive sales to their shops on the major e-commerce platforms from ByteDance´s products. However, being at the source of the traffic, ByteDance has a lot of power to control the flow of it.

Beyond Douyin and Toutiao, ByteDance has conquered adjacent content types in its local market, most notably through Xigua Video (“Watermelon Video” in English). Despite an impressive usage duration of 70 minutes per day, the Netflix-like service only caters to 55 million DAU’s compared to 400 million on Douyin and 120 million on Toutiao. Growth rate in this industry remains high. Bilibli, for instance, continues seeing revenue growth of 60%+ in 2020. In terms of growth expectations for Xigua though, the prospects do not seem overly promising given extremely strong and resourceful competitors of bespoke Bilibili and Huya in an industry with strong network effects. Additionally, Xigua does not bring in strong extra value for users. Yet, despite all of this, recent deals with individual content creators and major local and international content studios show some positive traction for the service. An ever-stronger integration with Douyin, Toutiao and other services could certainly add to the user experience and advertising ROI alike.

2) Expanding into new verticals in China

As shown in the bottom right quadrant of Figure 2, launching products and services fairly unrelated to news and social is yet another way of improving top-line growth. Our analysis revealed significant activity in several additional sectors.

First: Gaming. ByteDance has been very vocal about entering gaming. Through a combination of organic and inorganic growth, its gaming division has now surpassed 1,000 employees. We also found that there are currently more than 500 job openings for the gaming group. Whether via acquisition or self-developed titles, ByteDance’s mobile games have so far been extremely successful. On the first day of Chinese Lunar New Year, the 25 January 2020, three of the top five free mobile games published were by ByteDance. While most of its developers are based in China, initial successes abroad like the free iOS game “Combat of Hero” in Japan (most downloaded in March) show potential for internationalization despite the industry-specific challenge of localization. The very fact that China is not only leading in gaming revenues but also terms of mobile gaming globally, accounting for almost 40% of total global market in terms of sales, certainly plays into the efforts of ByteDance. As proven several times, ByteDance can leverage its vast network of other apps to drive traffic to new offerings and has developed a set of capabilities to develop mobile-only applications. Indeed, Tencent originally also started out with social (QQ) and then launched its foray into gaming. External sources estimate that ByteDance might achieve USD 300-400 mn in non-advertising gaming revenues in 2020 through a combination of distribution and self-developed titles.

Figure 3: Global gaming revenues 2019 by region in USD (Source: Newzoo)

Second: Consumer Finance. For platform players with billions of users, financial products and services offer substantial monetization potential. As a result, Alibaba and Tencent have entered this space years ago and built up moat. This, however, has not discouraged ByteDance to launch Manfen in October 2019. Manfen is an independent app, offering consumer credit while linking back to Fangxinjie, Toutiao’s loan feature. Furthermore, Toutiao offers a number of medical insurance products. We believe that ByteDance will find ways to push this offering further as it provides more applications, including e-commerce.

Third: Education. Education is a huge industry in China due to hundreds of millions of parents pouring thousands of yuan every month into extra activities to increase the odds of their kids succeeding at the critical Gaokao (university entrance examination). However, the industry is still mostly analog and new digital-first education ventures have only been emerging during the last 10 years. With Chen Lin, the former CEO of Toutiao, now in charge of new ventures and plans to hire ten thousand new employees in the education vertical, ByteDance sets a clear priority in this segment after some unsuccessful attempts in the past. Gogokid, for instance, was launched in 2018 as an English-learning platform, only to lay off 70% of its staff in April of the same year. The company’s most recent public product release was that of Qingbei Wangxiao in May 2019. So far, the K-12 online education portal has only had mediocre success. Moreover, ByteDance invested into start-up institution Minerva. Despite this poor track record, ByteDance´s strong commitment and the continued industry user growth rates of 20%+ per year show that there is more potential.

Fourth: Messaging. Developing a messaging product appears to be another high priority but has proven difficult because of intense competition. Tencent, for example, removed Duoshan, a Snapchat-like messaging app from its popular app store YingYongBao after an initially successful launch in early 2019. Another attempt was through an application called Feiliao, or Flipchat in English. Launched in May 2019, the messenger-forum hybrid has seen some success but remains in a niche position compared to the dominating force WeChat. Efforts to leverage Douyin’s substantial user base by offering direct messaging have shown to be a compliment rather than a substitute to traditional communication products.

Fifth: Hardware. ByteDance launched a low-end Android handset in China in 2019. The device comes pre-loaded with its suite of apps and the first iteration of an “AI-first” operating system. Consequently, revenue will not only come from hardware sales but the additional distribution channel for all of its apps. The handset eventually could offer extra-value to consumers if it combines the dozens of services ByteDance has to offer exclusively. However, many must feel remembered of the HTC First, also called “the Facebook phone”, which was later considered dead on arrival for several reasons ranging from pricing to competition and lack of differentiation. Amazon´s Fire phone is yet another failed experiment. We believe the fate of ByteDance´s handset is likely to be the same.

Sixth: Workplace Productivity. It is a well-known fact that China´s domestic B2B software industry is behind in competitive services and products. As a result, China´s companies often lack efficient and reliable internal structures. ByteDance attempts to contribute to filling this gap with Feishu (English: Lark), a workplace productivity tool which offers document management, massaging, video conferencing and many other features. Originally launched as an internal tool in 2018, it followed the path of Alibaba´s DingTalk or JD.com´s DongDong to be offered to external customers as well. Despite an increased usage as a result of Covid-19, Feishu is way behind competitors DingTalk and Wechat Work (less than 1 mio MAU as of Feb 2020). Also, Lark´s success in international markets has been very limited. However, globally this market certainly is expected to grow rapidly in the coming years and there is space for more workplace productivity tools in it. Yet, as many other examples show, monetizing this type of service remains a major challenge. With Feishu/Lark offered free of charge for now, a major contribution to the topline of ByteDance is unlikely in the mid-term future.

Source 4: China´s leading workplace productivity tools as of Feb 2020 in mn (Source: Kawo)

3) Internationalization of news and social

Having analyzed initiatives aimed at the domestic Chinese market, we will further dive into the initiatives for international revenue growth.

First, we will cover the growth potential of news and social media platforms outside of China. This includes apps such as TikTok, the international version of Douyin, and BaBe, Indonesia’s leading news and content app. At this point, it is important to note that all the products discussed in this chapter are either direct copies of Chinese news/social application or heavily draw on ByteDance’s experience within this vertical in its domestic market.

As of now, North America, India and Southeast Asia are the most relevant markets for ByteDance according to our analysis, with an increasing importance expected for Europe in the months to come. In the following, we will present ByteDance’s operations in each one of those three priority regions, followed by an analysis of their overall potential.

Figure 5: TikTok penetration by region (Source: GlobalWebIndex)

ByteDance is highly active in North America. With 46 million US TikTok downloads in 2019, the region comes in second, only after India. In 2020, the number of MAU reached 100 mio, according to reports. There is more room for growth given that only 30% of US internet users have used TikTok. In its primary target group, teenage users, this figure is already much higher. To compare, Facebook has 250+ MAU in the US.

Already in August 2017, Douyin rebranded as TikTok for the international market. At the time, Musical.ly was dominating the segment in North America and Europe. To overcome this barrier, ByteDance decided to enter the market inorganically and acquired Musical.ly for USD 1 bn in November 2017. With 100 million registered users at the time, ByteDance accepted USD 10 CAC per user. The merger of the two platforms and rebranding into one app took roughly one year. At first, TikTok’s retention of new users was as low as 10%. Retention improved over time as the platform attracted more content creators; and has been between 28-40% since early 2019.

In terms of other products, TopBuzz is worth noting. While heavily borrowing from Toutiao, the news app was intended to put pressure on Facebook and Twitter but had limited success, especially after a failed attempt to buy Reddit in 2016. As a result, over the summer of 2020, ByteDance stopped providing updates for TopBuzz. In general, ByteDance has not been able to enter the competitive news platform market in developed markets.

By far and large, the US remains the largest advertising market in the world and combined with its low penetration so far, the US market is of utmost importance for ByteDance as it wants to grow international revenues for TikTok and other major products to a sizable contribution in the future

With 323 million downloads, India remains the top market for TikTok in 2019, outside of China. This represents 40+% of global downloads and shows how important this market is for ByteDance. Moreover, Helo, a country-specific product launched in June 2018, has become one of India's leading social media platforms by offering over 15 languages including Hindi, Telugu, Tamil, Malayalam. However, with rising border tensions between China and India from summer 2020 onwards, major apps of ByteDance got blocked in India and since then, no change of the situation in terms of selling of the business or loosening of restrictions, has been achieved.

With that in mind, ByteDance is probably carefully considering its future approach to India. Famously, other social media and advertising-based companies had previously altogether avoided the Indian market, given the limited spending power and advertising budgets. As a result, a total retreat from the Indian market still seems possible and would not hurt the topline in the mid-term.

Figure 6: Global digital advertising markets 2019 by region, in USD bn (Source: Statista)

With more than 641 million internet users, the internet economy of Southeast Asia - i.e. Indonesia, Vietnam, Thailand, Philippines, and Malaysia - has now reached USD 100 billion. The connected and tech-savvy population with a median age of only 29 years, makes this combined market a prime target for technology companies. Despite attractive market prospects, short-video sharing apps were rather rare back in 2017. Trying to tap into this opportunity and following the footsteps of other Chinese internet companies, ByteDance opened a local office in Indonesia as early as August 2017. For its GTM strategy, the local operations team utilized internet celebrities on other channels, e.g. YouTube or Instagram as marquee users, and ensured continuous localization of content. As a result, TikTok has achieved top ranks in the short video category of all Southeast Asian app stores. In Thailand, TikTok accumulated 10 million downloads, almost 1/6 of the total population (compared to 1/10 in Germany, for reference).

 

Beyond TikTok, news aggregator BaBe is also noteworthy. Through an acquisition in December 2016, ByteDance has now access to news and entertainment content from more than one thousand publishing partners. BaBe consequently is the exception to the overall limited success of ByteDance’s news products abroad.

 

Considering the favorable political climate, the large and rapidly growing user base, and the cultural fit in terms of product, it is expected that ByteDance will continue to double-down on Southeast Asia for long-term growth prospect.

4) Diversification into new verticals outside of China

Finally, we cover diversification abroad with product types that have not been introduced in China before - as shown in the top right quadrant of Figure 2. Clearly, this is not a major priority for ByteDance at the moment. All activities have been clustered into music streaming, cloud and other bets.

First: Music Streaming. With TikTok already being a music discovery platform, ByteDance launched its own music streaming app, Resso, in March 2020. So far, the service is available in India, Indonesia and Brazil and comes with a heavy focus on UI that emphasizes visual and social aspects such as lyrics and sharing functionality. A global rollout is expected and will likely come with a low-price strategy undercutting Apple Music and Spotify in Western countries. From a profitability perspective, this decision, however, raises some questions given the already challenging unit economics in the industry; it will also hamper the potential for topline contribution in the years to come.

Second: Cloud Hosting. Although no cloud hosting services have been launched yet, the path forward seems obvious. Internal computing capacity is significant after opening data centers in India and the US in 2019 and can easily be opened up for external use, following the initial path Amazon took with AWS. Moreover, ByteDance absorbed Terark’s data compression technology through a strategic acquisition during the same year.

Third: Other Bets. Other products we may see from ByteDance outside of China include live streaming, search, workplace productivity, more traditional e-commerce, a web browser, and e-books according to several rumors. Search and a browser seem particularly interesting. Search would boost ad inventory and build an intent loop similar to Google.

TikTok remains most promising bet in the short-term but mid-term growth initiatives in Chinese market have promising potential

Finding 1: Future growth in the advertising space in China is limited

As we have shown in part 1 of our series, with slowing growth in the domestic market, ByteDance heavily relies on success from its new initiatives to keep the rapid growth going. In fact, the growth from Douyin and Toutiao will probably be limited to introducing new advertising use cases, such as e-commerce direct conversion.

Finding 2: ByteDance is further expanding and seriously pursuing a large number of growth initiatives

As it turned out, ByteDance is clearly living up to its reputation as a “Super App Factory”, pursuing multiple products in a wide range of industries and regions at the same time. Indeed, we believe that ByteDance is considering its product development efforts with a portfolio management approach in mind. One thing for sure though is that ByteDance is not done yet and does not stop to innovate. This pattern most reminds us to some degree of Amazon which expanded from e-commerce into partly unrelated verticals areas such as hardware, content, streaming, cloud, and gaming. With that, it still has the potential to emerge into the tier-1 of China tech, joining the likes of Alibaba and Tencent in the mid-term.

Finding 3: ByteDance usually first achieves product design and operations maturity in the Chinese market

As seen in the case of Douyin and Toutiao, ByteDance uses a portfolio approach where it first develops and tests products in the Chinese market. If successful, it considers taking products global. In that case, as with TikTok, important strategic decisions are still made from headquarters and also engineering teams remain in China. However, sales, customer service, PR/GR might move into new geographies.

Finding 4: TikTok is the main engine of growth in the short-term

As the pioneer with a strong product in this segment, taking TikTok global and increasing market penetration in new markets seems the most obvious choice as ByteDance already understands all the important aspects ranging from design to operations. In the near-term, the importance of the US (and to some degree European) markets to reaccelerate growth rates cannot be understated, given market size. ByteDance already grew a significant user base, so that advertising revenues naturally will follow. This also explains the long fight ByteDance was willing to pursue to maintain control over operations and access to the American market. As it seems now, the TikTok Global business - to be headquarted in the US - might be valued at USD 50-60 bn, pointing to just how much more revenue growth potential there is. In the mid-term for TikTok/Toutiao, Southeast Asia and even Latin America could contribute to revenues while India remains an unsolved issue.

Finding 5: New initiatives in China seem promising in the mid-term

ByteDance has lined up a major portfolio of new products to penetrate into some of the most promising but crowded verticals in the Chinese market including gaming, education and workplace productivity. Especially early attempts into the mobile gaming industry seem progressing well, also considering that Tencent successfully combines social/gaming. Here again, as ByteDance grows its gaming user base, monetization will follow, we believe. All these segments are extremely competitive but given ByteDance´s capabilities of developing innovative and superior products as well as running operations in markets with network effects, none of those should be written off for now.

What certainly became clear in this two-part series is that ByteDance is a one-of-a-kind company and unique in its achievements so far, even on a global scale. If any company is able to break into the ranks of Alibaba and Tencent, it should be ByteDance.

With its achievements so far, ByteDance is a very special case for certain, but it also highlights some of the features that make Chinese internet companies so unique. For example, 8 years after establishment, where in the world can companies keep up a working culture of regular weekend work? Moreover, despite major success in one vertical, where can one find companies that still start foray into almost every promising industry vertical in the internet space? In spite of their unique characteristics, no Chinese internet company so far can claim victory in its respective internationalization journey. If there is one to achieve this feat, there is no doubt that it will be ByteDance. It will be exciting to see which of ByteDance´s numerous bets will create the next 100 mio MAU product. We believe it is just a matter of time.

All opinions expressed in this essay represent our personal views only.

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