According to a report released by the China Internet Network Information Center (CNNIC), the number of internet users in China has reached 253 million by the end of June 2008. It’s almost the same as the whole US population (~304 million). The scary part is that 253 million is only 19.1% of the whole China population. If you look at the Internet penetration rate of other countries, like United States (72.3%), Japan (73.8%), South Korea (70.7%) and Hong Kong (69.5%), it is obvious that China has enormous growth potential for their Internet market. Imagine China’s Internet penetration rate increases to 70% – that is 910 million of Internet users, almost 4 times the current Internet market in the US.

Country or Region	Penetration rate	Internet Users	Population
China	19.1%	253 Million	1.3 Billion
United States	72.3%	220 Million	304 Million
Japan	73.8%	94 Million	127 Million
South Korea	70.7%	35 Million	49 Million
Hong Kong	69.5%	4.8 Million	7 Million

While these numbers seem to be very promising, the Internet business environment in China is actually a bit complicated because there are significant differences between the US and China markets. Let’s look at the China market now.

Demographic structure

Compare to the US, the net population in China is very young – 68.6% of the web users are under 30 years old, while 70% are above 30 in the United States. Currently, the ratio of male to female is 57%:43%, closely related to the real China population. Based on the data from China State Statistics Bureau, the education level of male is higher than that of female but the gap is gradually being narrowed.

In terms of education level, 62.8% of them have high school or secondary school education and only 30% have Junior college or Bachelor’s degree. Not surprisingly, students is the largest group in the net population (30%) and more than half of the internet users (55%) are single.

How about income? 74% of the net users in China earns less than RMB 2,000 per month. That is US$292, an annual income of US$3,504.

After seeing these facts, I believe US Internet companies understand that in order to succeed in China, they need to adopt a totally different business model there. Needless to say, if you simply plan to translate your site to Chinese language and think you will have the same success in the US, it’s not possible for you to compete against the local leaders.

Internet Access

While most Chinese surf the web at home (74.1%), Internet cafes have become an important places for Internet access in recent years. More than 39% of the users have accessed the net at Internet cafes and most of them are youngsters with a high school and below education.

Unlike the US, mobile phone is a popular surfing equipment in China. Because of convenience, around 76 million people (~30% of total net population) have chosen to access the web through mobile phones. This number is expected to increase rapidly because 41% of the Chinese population, >530 million people, are already using mobile phones everyday. Despite the high cost, desktop PC still has the leading position among all equipments. Home is still the main place for users to get online. In addition, 87% of them have used desktop computers with broadband internet connection (China is the world’s No.1 broadband market).

Current Business Models

Below are the top online applications in China today:

1. Online Music
2. Instant Message
3. Online Video
4. Online News
5. Search Engine
6. Internet Games
7. E-mail

As we can see from this data, the China’s internet market focuses a lot on entertainment rather than the main applications in the western markets – information research, online shopping and e-mail communication. Currently, only 119 million Chinese are using e-mail, with the an application rate of 56.5%. In contrast, the e-mail application rate in the US is 91% and 82.1% in South Korea.

According to the report, the e-mail application rate in China is actually co-related to the education level. The higher the education level, the higher the email application rate is. For example, users with postgraduate and above education have a 94.2% rate. People with lower education mainly use instant messaging to communicate.

Because of this unique characteristic, virtual goods and micro-transactions have become the major money making products for internet companies in China. In the US, online advertising is the big revenue driver for businesses. However, because online shopping is not popular, the web advertising market in China is very small compared to US and Japan.

For example, in 2007, Tencent, the largest internet company in China with market capital of US$14.5B, had a revenue of $523 million and $224 million in operating profits. Online advertising only makes up 13% of their revenue. 87% comes from micro-transactions for digital goods, online games and mobile services. This special business model gives Tencent a huge operating margin (43%). In comparison, Yahoo’s operating margin is 10.4% and Google is around 30%.

In the online gaming areas, many games are designed on a “Free-To-Play” model. Players can access the free game at no cost, but need to pay for virtual products and services within the game.

Below is an interesting analysis I got it from TrendsSpotting.com. We can see the revenue breakdown of most of the major online companies in China.

Company	2008 Q1 Revenue (Million US$)	% of Revenue			Operating Margin
		MVAS	Gaming/ IVAS	Advertising
Sohu	$84.4	10%	49%	41%	40%
Baidu	$81.9	–	–	100%	27%
Sina	$71.3	33%	–	67%	19%
Shanda	$111	–	97%	3%	40%
NetEase	$93	–	86%	14%	63%
Tencent	$204.1	20%	70%	10%	51%
**Total**	**$646**	**11%**	**58%**	**31%**	**40%**
MVAS = Mobile Value-Added Service, IVAS = Internet Value-Added Service Source: TrendsSpotting.com

The Reality in the Wild Wild West

So after all this positive data, does it mean that the China Internet market will easily become 4 times bigger than the US market in the near future? With the current US Internet market size, Americans have already produced huge corporations, like Google (Market Cap:$146B), Amazon.com ($34B), eBay ($32B), Yahoo ($27B)…etc. So China will produce corporations much bigger than those in the near future? Unfortunately, it is not as easy as the numbers suggest. China web companies still have to overcome several local obstacles in order to succeed in this competitive environment.

First of all, the unfavorable urban-rural ratio. There are 767 million people living in the China rural area now. That is 57.7% of the total population. Among the net population, 25% of the internet users are living in rural areas, which means they are probably earning a lot less than RMB 2,000 (US$ 292) per month because people in villages usually have lower education level and lower income. This will be a great challenge faced by companies who want to develop the e-commerce and online advertising market in China.

Also, at this moment, every home Internet-connected PC is shared by 2.7 users in average. This means the Internet users may not be able to use the Internet whenever they want. So they are not maximizing the value of the Internet yet.

According to BBC, the whole China’s Internet economy has generated US$5.9 billion in revenue in 2007, while US companies pulled in US$21.2 billion just in online advertising revenue. Even though China companies have an unusual business model in virtual goods and micro-transaction, it seems most of the money are just going to the big local players in China now. Smaller local firms probably couldn’t get a big slice from the small US$5.9 billion market. Tencent alone is projected to earn around US$1 billion in 2008. And you still have other major sites, like Baidu, NetEase, Sina, Sohu, Alibaba…etc.

Another problem is the Great Firewall of China (GFW). Internet censorship in China is well known around the world. It is the government’s effort to neutralize critical online opinion. While I understand the purpose of this system, this will also limit the growth of the China Internet market. They even have virtual cops, JingJing and ChaCha, walk, bike or drive across your screen every 20 minutes to ask Internet users to stay away from illegal content and bad websites. I have to say this is actually a pretty innovative idea. Never heard something like this before.

Future Trend

Younger Target Customers: The Internet market in China is currently dominated by youngsters. Influenced by the one-child policy, local adolescents like to form virtual friendships using Instant Messaging. Their main purpose of getting online is to look for entertainment. This group of users tend to use more Bulletin boards and less emails, probably because IM and BBS are more suitable for leisure chats. So I suggest companies should develop a style and culture more like Disney or Facebook but not LinkedIn.

Learn from Asian Countries: Since teenagers like to consume trendy and branded goods, companies should keep up with the latest trend of the Internet Consumer market in countries, like Japan and South Korea. These three Asian countries have very similar culture and value. More importantly, the internet industry in Japan and South Korea is more well developed than China. China can definitely look up to them.

Mobile Internet Content: 41% of the whole population in China are mobile phone users. That is 533 million people!!! Downloading ring tones on cellphones is already very popular among users. For example, there was a popular ring tone generated over $10M in sales of download few years ago. More and more people will access the Internet through their cell phones. So Mobile Value-Added Services will be a very important business model in the future.

Innovative Technology: In the past, Chinese startups often liked to copy the Silicon Valley models. However, in order to be the major leaders on the Internet, Chinese companies have to be creative and to develop their own brands and new technology.

Open the Market: As the education level of local users increases, the Chinese government will have less control on the Internet. However, China’s Internet is still highly internally referential, with fewer than 6% of China’s websites linking to outside the country. Local firms still have a huge home court advantage at this moment. To improve the condition of the industry, users and businesses have to look beyond the local market for opportunities.

Payment System: A trusting online payment system, which can avoid fraud, can facilitate the growth of the local e-commerce market. However, there is still no ONE dominating payment system, like Paypal, has established in China yet.

Advertising Market: Although the China online ad market is still tiny, it has a YoY revenue increase of 72.5% in 2008. This area is expected to grow rapidly in the near future. Before that, web companies have to educate local businesses about the true value of online advertising because a lot of them still don’t understand the importance of this new digital media. With a healthy ad market, it will encourage people to start more online ventures, create competition and provide better services.

Affiliate Programs: Affiliate program has a crucial role in the US Internet ecosystem. Affiliate Marketing not only help businesses to generate sales lead but also find and retain new customers. Each affiliate partners is an extra sales person working for the advertisers on the Internet. Most importantly, the advertisers only have to pay for the marketing costs if they got additional revenue from these programs. Right now, the affiliate marketing industry in China is still not well developed yet.

Niche and Targeted Market: Since the market in China is so big, it is really hard to compete with the local leaders directly. Startups should focus on a smaller targeted market in the beginning. Wealthier cities with higher education level, like Beijing, Shanghai and Guangzhou, will be good starting points. After all, the net population in these three cities is more than 49 million people, which is already larger than the whole South Korea online market!

The China Internet has its own unique culture and characteristics. Companies have to adapt these differences to fit in and don’t try to ignore them. It is a very difficult task to accomplish but if your company can rise to the challenge, this will be a once-in-a-lifetime opportunity for you to be succeed in the biggest market in the future world.

Additional Resources

China Internet Network Information Center (CNNIC)

Virtual Goods: the next big business model (TechCrunch)

For Chinese IM Portal Tencent, The Money Is In Micro-Transactions (TechCrunch)

China’s Internet User Base Is Growing Faster Than Mobile (Seeking Alpha)

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Hi, I'm Vincent Chan. I work on product, design and growth at startups. After one failed attempt, I'm still inspired to build a lasting company some day. This blog covers the lessons and failures that I've learned along the way.

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