Watching a stern Mark Zuckerberg testify before the U.S. Congress is a reminder how China’s tech companies, despite differences in economic structure and technological sophistication, follow similar trajectories with their American counterparts. Toutiao, China’s biggest personalized news app with a US$20 billion valuation, is experiencing a similar crisis these days as government and competitors attack its core business model.
Operated by Beijing Bytedance Telecommunications Co., Ltd., Toutiao has been the darling of investors and the public alike. It ranks eighth on China Money Network’s China Unicorn Ranking. And word on the street is that it is looking at an initial public offering later this year with a much higher price tag.
But in recent weeks, the six-year old company has found itself at the center of an increasingly harsh government crackdown that raises questions about the strength of its business model. At the same time, more established technology giants such as Baidu Inc, Alibaba Group and Tencent Holdings are cutting in on Toutiao’s core businesses.
The situation of Toutiao, a Chinese word that literally translates to "headlines," illustrates the challenges facing Chinese Internet companies, especially those that make money through the transfer of news, information and public opinion. It also challenges investors trying to value such companies, as unforeseen regulatory risks can quickly force sudden changes in business operations.
Zhang Yiming, founder and CEO of Toutiao, summed up that dilemma in a letter released last week in response to the Chinese government banning one of his company’s various news and video platforms. "As an engineer, my initial goal was to design a product that facilitate the communication and interaction of users. In the past few years, we focused more on the growth of our businesses, but did not spend enough resources for content censorship and social responsibility."
Born in 2012, Toutiao was the first company in China to use artificial intelligence algorithms to delivery customized news to readers. The company grew rapidly, with the highest usage penetration rate among all Chinese news apps in the first half of 2017, according to Cheetah Data. Its 120 million daily active users spend almost 80 minutes on the app on average, versus an average 33 minutes for the industry. It also dominates the news feed advertising market in China, with an estimated RMB15 billion (US$2.3 billion) revenue in 2017.
It has completed a series of high-profile, big dollar acquisition deals overseas, most recently its acquisition in November of a short music video app Musical.ly, estimated to be valued at US$1 billion, leading to predictions that Toutiao could become the world’s number-one online content destination, rivaling giants like Twitter and Facebook.
Government Scrutiny
Such rapid growth of users has made Toutiao a target for increased oversight and criticism from Chinese regulators, who appear to be tightening their grip on public discourse under a more aggressive President Xi Jinping.
In January, Toutiao was accused of spreading pornographic and vulgar information, and was ordered to suspend several sections for 24 hours. Then last week, CEO Zhang Yiming was compelled to issue a public apology at midnight after Chinese regulator ordered his firm to permanently shut down its joke app Neihan Duanzi, one of Toutiao’s most popular content products. The previous day, Toutiao, with three other news apps, were removed from Chinese smartphone app stores, as Beijing strengthens online censorship.
"Our product did not send messages that follow the core socialist values, and failed to shape the correct public opinion orientation,” Zhang wrote in a letter published on Toutiao’s official WeChat account. “We are willing to accept punishment and I will take full responsibility."
Specifically, China’s State Administration of Radio and Television said contents on Neihan Duanzi, an entertainment portal contains short videos, funny comments, jokes, pictures and memes, were "vulgar" with "wrong public opinion orientation," and "triggered strong resentment among Internet users."
As a result, the regulator asked Toutiao to permanently shut down Neihan Duanzi and its associated accounts, and clean up its similar audio and video products. Neihan Duanzi has daily active users of over 11 million with an average of 40 minutes spent by each users daily browsing through such product. Cutting down this popular product will not have significant immediate impact to Toutiao’s operations, but this points to great uncertainties to Toutiao’s future if more bans from Beijing force it to suspend more central business units.
Right now, Toutiao is in crisis management mode. Founder Zhang said the company will expand its editorial team to 10,000 from 6,000 currently to strengthen content censorship, and set up a special committee to launch a content overhaul. The firm will also set up a content supervision group made up of experts from media, academia, and politics.
Competition Intensifies
Pressure from the government comes as Toutiao faces increased competition from China’s three dominant Internet giants, Baidu, Alibaba and Tencent, commonly known as the "BAT." The three each holds monopolies in search engine, e-commerce and social media, respectively, but are increasingly competing in the same sectors as they expand their business empires to deepen relationships with users. Many Chinese tech start-ups have failed to grow because the BAT, sensing a rival, quickly replicate their business model and cut into their market share.
Until recently, Toutiao has been lucky to avoid clashing with the BAT directly, in part because it was created at a time when the three giants were too busy competing with each other. But as Toutiao grew to become a "mini tech giant" itself, the BAT now appear determined to take back the lost battleground from Toutiao.
“Toutiao’s high-profile strategy has made it a target of the BAT,” said Zhang Xueru, an analyst at 86Research, a boutique equity research firm based in Shanghai. “It is obvious that Baidu and Tencent developed their news feed strategy to compete with Toutiao.”
In the news aggregation sector, Tencent launched a similar news aggregation app Tiantian Kuaibao. Although Toutiao is the most active news app, Tencent News has the largest number of monthly active users, at 240 billion, almost double the size of Toutiao’s users.
In the news feed market, Baidu is also catching up. Within a year of launching its news feed service, Baidu’s daily active users surpassed 100 million, close to Toutiao’s 120 million. Its feed revenue on an annualized basis exceeded US$1 billion at the end of September, almost half of Toutiao’s estimated revenue of RMB15 billion (US$2.3 billion) this year.
"Strategically, it is very difficult for (Toutiao) as they don’t have so many strategic options as large companies,” said Kirk Boodry, analyst at New Street Research. “For example, Baidu can migrate its news feed to its search function."
To compete, Toutiao has had to increase spending. The company provides generous subsidies to content creators and influencers on its various platforms. At its annual conference in November, Toutiao promised to invest RMB1 billion (US$152 million) to subsidize more than 5000 influencers on Wukong Wenda, its question-and-answer site. Last year, the company invested another RMB1 billion (US$152 million) to subsidize high-quality video makers.
But relying on subsidies is an expensive, and likely losing strategy for Toutiao. More established Internet players like Tencent and Baidu can draw on existing users, while Toutiao bears the cost of gaining organic traffic.
Looking Overseas For Growth
Toutiao’s stated strategy for escaping increased competition at home is to expand overseas. Founder Zhang Yiming spelled out the strategic logic at an event last year, stating, “The number of Internet users in China only accounts for about one fifth in the world, if we don’t allocate assets globally and pursue the economies of scale, one fifth can’t compete with four fifths and going overseas is a must.”
"Global expansion will be an important strategy for Toutiao. By investing in similar products in different regions, Toutiao can grow its market share. Toutiao can also export its business model abroad and adjust to the local market," Hans Tung, managing partner of GGV Capital, told China Money Network.
Underscoring its commitment to global growth, the company announced three overseas investments in one week last year. Along with Musical.ly, it invested US$50 million in live streaming platform Live.me and acquired news aggregation site News Republic for US$86.6 million. Last February, Toutiao acquired Los Angeles-based short video app Flipagram. The most recent deal rumor was that Toutiao is reportedly acquiring augmented reality-based selfie app Faceu for US$300 million.
Yet expanding overseas means running into competitors who are even more established, and better funded than any of its Chinese rivals. Foremost among them is Facebook.
“One thing worth noting is that in markets where Facebook is strong, it is quite hard for news aggregation apps to gain traction because Facebook is essentially a news aggregation app with social media function around it,” said Kirk Boodry, analyst at New Street Research.
And with Facebook itself under fire for failing to maintain the privacy of its users, a Chinese competitor that is trying to ingratiate itself with the Beijing government may find it even harder to convince users that their identities are protected.
The key challenges facing Toutiao is whether it can withstand the current attacks from the government and competitors. Similar to Facebook, there is no question that this young Chinese tech giant is experiencing its first major crisis. How it handles this challenge will make or break the company.
"I think Toutiao will try to complete a public float overseas as soon as possible to make the company more transparent and to obtain more international recognition. That will give it certain degrees of protection and leverage against further government intervention," an investors in Toutiao told China Money Network on the conditions of anonymity.