China’s internet sector has reached a new stage of development, fuelled by commoditisation of the smartphone market. As companies migrate their business from PC to mobile, monetisation of online channels is growing. Those players that have a large user base and clear revenue strategies are likely to win – in fact, shares in some of these companies have already soared and may be due a correction. Recent financial reforms are providing a tail wind for internet finance, although this may prompt increased regulation.

Commoditisation of the smartphone market in China is being driven by lower-cost, domestically produced smartphones, especially within rural areas. In a country where there is almost 100% mobile penetration, monetisation of the internet is being spurred by mobile gaming, increased e-commerce and new forms of mobile payments.

By the end of 2013, the number of mobile phone users in China exceeded one billion, with more than 50% of these being smartphone users. Gartner estimates that the penetration rate for smartphones in China will reach 90% or higher this year. However, foreign smartphone shipments to China in 4Q 2013 fell by 4.3% Q-o-Q, the first drop since 2Q 2011. This is because local smartphone brands, such as Lenovo, Xiaomi and Coolpad, are pricing at around half the price or less than the latest Apple iPhone. The average purchase price of a smartphone in China dropped to 1,773 yuan (US$286) in 2013 from 2,321 yuan in 2011, with the lowest-end smartphones a good deal cheaper.

With the emergence of affordable, domestically produced smartphones, many people in rural areas will be able to access the internet for the first time via mobile phones. According to recent research by Analysys, an IT consulting firm in China, 62% of mobile internet users earn less than 4,000 yuan per month, with migrant workers comprising a large part of this total. However, as part of the 12th five-year plan, China has set itself the task of helping rural areas catch up with the more affluent cities. In line with this objective, the government is trying to increase internet coverage to improve connectivity. The National Broadband Strategy aims to achieve 85% fixed broadband penetration and 95% 3G/4G user penetration by 2020.1

The recent US$19 billion acquisition of messaging service WhatsApp by Facebook reflects the potential of mobile internet monetisation. WeChat, a messaging service owned by Tencent, is arguably ahead of WhatsApp in terms of having a clear strategy and initiatives to monetise its large user base. Many investors have already cottoned on to this potential and Tencent’s share price soared over 90% in 2013 alone. WeChat has 600 million users in China currently (and 100 million overseas) – numbers that would be hard to replicate anywhere else. With WeChat, Tencent will likely surpass its success with PC internet users and benefit from the new type of consumer behaviour emerging via the mobile internet.

Asia has the highest number of computer game players globally. Mobile-gaming revenues in Asia have grown fivefold in the past two years alone and are likely to remain a sweet-spot for monetisation in the years to come. Given this trend, it is likely that leading PC game developers will ramp up production of mobile games, and mobile-game-platform operators will likely be big winners due to their strong distribution power and fee revenue from developers and gamers alike.

Entertainment is a key factor for internet usage in China in particular. Online gaming is hugely popular, especially among lower-income youth, due to easy access and affordability. By leveraging its large user base, Tencent has established clear revenue streams from online games, which have contributed more than 50% to its total revenue since 2010. With smartphone commoditisation, mobile games will likely sustain this growth momentum as online gaming enterprises continue to migrate from PC to mobile.

According to iResearch, smartphone game revenues in China increased almost fivefold to 9.2 billion yuan in 2013 from 2012 and are expected to double this year. It also expects the share of mobile gaming to expand from 11.6% in 2011 to 20.6% of total gaming, while PC games will decline from 76% to 65.5%.

E-commerce bonanza

Thanks to the growing penetration rate of smartphones, the mobile internet is becoming a new growth engine for e-commerce in China. Online shopping is booming because of its convenience and cost-effectiveness. And it’s not only young affluent urban dwellers who are purchasing luxury items online at cheaper prices than shopping malls – residents in less-developed regions are buying products that are not available in their home towns. Online transactions reached a value of 1.9 billion yuan in 2013, accounting for 7.8% of total retail sales in China, iResearch data indicates. And the total transaction value of mobile shopping in China grew by 165% to 168 billion yuan, taking a 9% share of the total online shopping market (versus 4.8% in 2012), and is likely to reach one trillion yuan by 2017, accounting for almost a quarter of the total e-commerce space (B2C and C2C). The share of mobile shopping is expected to rise.

There are two main reasons behind the migration of Chinese online shoppers from PC to mobile. Firstly, e-commerce giants such as Alibaba (the largest C2C e-commerce player in China and a company which is part eBay, part Google and part PayPal) and JD (JingDong Mall, formerly called 360Buy and one of the largest B2C online retailers in China) are encouraging users to adopt mobile shopping through heavy promotion efforts. Secondly, more consumers are deciding to use their fragmentary time to shop online via their smartphones and tablets as opposed to stepping down to the mall.

Tencent is perhaps best positioned to tap into mobile commerce due to its large user base and the functionalities embedded into its WeChat messenging platform. For example, during the period leading up to Chinese New Year 2014, WeChat launched a Red Packet feature allowing users to send virtual money to friends and designated chat groups via its WeChat payment system. This move paves the way for future monetisation of mobile commerce by essentially turning WeChat into mobile wallets. In future, with the likely rollout of more virtual shops and lifestyle-related features (in addition to existing mobile top-ups and taxi booking capabilities), WeChat could become a one-stop online lifestyle service platform, putting the e-commerce business in a strong position for future growth.

Other large e-commerce operators have lost no time recruiting more users by launching similar mobile IM tools, such as Alibaba’s Laiwang, Netease’s Yixin and Suning’s Yunxin. They’ve also made efforts to partner with telcos to lower the traffic threshold to acquire mobile users. Even though Alibaba is the undisputed market leader in e-commerce (90% share in C2C and 50% in the B2C space) thanks to its strong ecosystem in PCs, it still needs to catch up in the mobile space. Last year, in collaboration with China Unicom and China Mobile, Taobao (Alibaba’s online shopping website, similar to eBay) launched a “free traffic” plan by subsidising users of mobile Taobao and Laiwang in some cities with 2GB of free traffic per month.

As e-commerce in China enters a more mature phase, the focus is shifting towards the logistics front, including timely delivery of goods and low-cost storage for sellers. In January, Tencent bought 9.9% of China South City to gain access to its warehouse and logistics businesses. Prior to that deal, Alibaba invested two billion yuan in a logistics partnership with white goods supplier Haier. The trend of “Physical+Online” service integration will likely continue and more vertical integration M&A deals are expected in the near future. In fact, both Tencent and Alibaba (which has applied to launch an IPO in New York) have established private-equity arms to invest in companies that can create synergies with their existing business. These developments will likely bring investment and trading opportunities for investors.