When Tencent lost out in its bid to buy Friendster, the California-based social networking firm, a few weeks ago, one consolation was that it was in good company. Rival Google was among the other top-name companies that were also turned down by Friendster, which opted for an as yet unnamed Asian buyer, according to Reuters.


No one ever said going global was easy. But it’s even harder for Internet companies, says Richard Peng, vice-president of corporate development at Tencent, China’s biggest Internet company by market share. For that reason, the Shenzhen-based, Hong Kong-listed company is taking its international expansion step by step — focusing first primarily on Asia before heading to the West, notes Peng in an interview with China Knowledge at Wharton. Beyond the general challenges of globalizing the Internet, Peng also talks about why Tencent is succeeding where others are failing, what it’s like to work at one of China’s hottest companies and everything that Western companies want to know about China’s Internet users but are afraid to ask.


The following are edited excerpts from the interview.


China Knowledge at Wharton: The global financial crisis has affected a lot of companies, however Tencent has remained buoyant throughout. Your unaudited third quarter results announced in November reported gross profit of RMB 2.3 billion (US$343.4 million), a 70% increase year on year, on revenue of RMB3.4 billion (US$493 million), a 66% increase year on year. Can you explain the company’s development to date?


Richard Peng: The global financial crisis has had a huge impact on the economy, but fortunately it has not hit [all] Internet companies too hard, especially in China. Yet companies like Google have been affected. [Google reported 7% revenue growth, to $5.4 billion, in the third quarter of 2009.]


Where China has been affected is in advertising – our advertising growth rate has been rather limited. Nevertheless, in terms of core Internet services, consumer activity has been really strong.


There are a few reasons for this. The first is that the [Internet] penetration rate in China is increasing, meaning that there are more and more customers. The second is that although in the real economy, there is legitimate concern about [low levels of consumer] spending, Internet spending is so minimal to begin with — RMB 8 to RMB 10 a month for most customers — that it has not really felt the affects of the financial crisis. The proportion of users buying services is also rising. The third reason is that as the crisis affects employment so drastically, many people are spending more time online and that has [resulted in] upward pressure on average revenue per customer. These three factors [at Tencent] have led to an increase in the number of users, revenue as well as revenue per user, helping overall growth to maintain its relatively fast pace.


Knowledge at Wharton: Regarding e-commerce and China’s Internet development, which services have the greatest potential: games, ads, e-commerce or mobile services?


Peng: They have a lot of room for growth and let me address them one by one. Online games are going to keep growing quite rapidly over the next three to four years. For mobile, now is a critical period because it grew rapidly a few years ago, but has slowed considerably of late. It’s also a critical time because China is converting from 2G to 3G (and in some cases to 4G), which will improve speed, user experience and service. So we should see explosive growth in mobile over the next several years.


Advertising has been a huge area for Internet companies’ income, but because it was [the basis of] the original revenue model, it’s already quite mature, which means slower growth. However, Tencent got into the mobile advertising business rather late. Today, it only contributes 10% to our top line. So we see good growth ahead for us there, especially given how much traffic we get to our site.


The last area of growth is Internet value-added services. If you look at the U.S., although [consumers] are not as accustomed to virtual transactions as their counterparts in Asia are, they are becoming more used to the idea. You see this as [annual] revenue for each of the top three players in this space — Zynga, PlayFish and Playdom — has already passed $500 million.


China Knowledge at Wharton: Your QQ.com is the most popular free instant messaging program in mainland China. Whether the demographics are urban or rural, old or young, it seems everybody has a QQ account, including some companies. What’s the secret to QQ’s success?


Peng: First, QQ did a great job of meeting customer demand. Years ago in China, when telecommunications was in its infancy and cell phones were not widely available, QQ instant messaging filled the gap. It was really easy to use, including the offline messaging system.


The other major part was that Tencent’s culture encouraged innovation. Despite initial success, Tencent’s managers remained humble, hardworking and focused on improving the product. As the product improved, the user experience did as well. If you provide a good product and enhance the user experience, you’re going to have good results and this is what QQ has done really well.


China Knowledge at Wharton: It’s been said that Tencent’s work environment facilitates rapid product development and an ability to take advantage of market opportunities. Can you tell us about what this means at Tencent?


Peng: It’s part of the fabric of Tencent’s culture and means everything to us.… [We have] a simple environment, which allows us to focus on our work. The other part is that if you have a culture of communication, everyone feels comfortable sharing ideas with others, which is another critical stimulus for innovation…. If you don’t have an open environment, you’re not going to come up with … innovative products.


China Knowledge at Wharton: What should Western companies know about China’s Internet users?


Peng: Internet users in China are very young – close to 60% of them are between the ages of 14 and 25…. This is a good thing because younger people tend to want more access to information. This helps the economy develop as it opens the minds of young people and gives them more tools for interaction…. You’ll see this youth movement on the Internet continue….


Compared to Americans, Chinese prefer to use the Internet for communication and entertainment rather than knowledge. In China, instant messaging programs are quite developed, but in the U.S., the use of MSN, Yahoo, etc. is lower than in China.


China Knowledge at Wharton: Can you tell us about Tencent’s globalization strategy?


Peng: We’ve really just kicked off international expansion. The globalization of the Internet is much more difficult than for traditional industries. We look at this from two angles: technical barriers to entry and cultural sensitivity. If you look at Intel’s microprocessors or Microsoft Office, their global platforms grew very similarly to their domestic ones. All they really did was change the language and copyright. Intel’s processors are the same everywhere in the world. Their cultural sensitivity is low, but the technical barriers to entry are very high.


For Internet businesses, the technical barrier to entry is very low – for example, eBay and [Chinese online auction site] Taobao are basically the same. Likewise, Google and [Chinese search engine] Baidu are basically the same. At the same time, the cultural sensitivity is very high, which makes international expansion really difficult. A lot of American Internet companies face challenges trying to expand internationally.


Tencent is expanding globally, but we are being very cautious. We want to do this the right way, using proper planning and methodology, and we are circumspect about making big mistakes that could kill our business. Because of our cultural sensitivity and sophistication, we are starting off in places that are culturally very close to China – such as Vietnam and Southeast Asia. Once we develop a certain level of experience there, we’ll see about entering the U.S.


The other part is that as we develop internationally, we always look for a local partner – we did this in Vietnam and India and we are looking for local partners elsewhere. When you consider the cultural sensitivity aspect, the local partner becomes paramount for the organization to understand the local culture, market, users and other dynamics.


China Knowledge at Wharton: What role do Tencent’s offices in Silicon Valley, Boston and elsewhere play?


Peng: Our offices in Vietnam and India are joint offices managed by local partners. Our office in Silicon Valley is very small and it is responsible for testing products and gauging the American appetite for products. In Boston, we have a small studio, which develops games for China and the U.S.


China Knowledge at Wharton: Almost all of the students at a recent Wharton recruitment session said  they have [tried] QQ, but only 20% still use it. What are the implications of such a trend for the online chat market?


Peng: The sample of Wharton students may not be the best representative group. In the online chat market in China, Tencent has over 90% market share while our main competitors — MSN, Taobao’s Wangwang and 51guagua — have relatively small market shares.


But we are facing a major problem in the big cities, such as Beijing, Shanghai, Guangzhou and Shenzhen. A lot of white-collar workers who are university graduates tend to switch to MSN. This is logical because a lot of them are in multinational companies so their bosses use MSN and so they switch to MSN. Also, their classmates and friends are switching too to keep in touch. Though this is a small circle of users, it is a big challenge for us and we’re trying to think of a way to keep these high-income customers with us.


Outside the big cities, no matter what the age, everyone uses QQ. Also, even if people in big cities are using MSN, they still tend to use QQ to keep in touch with  friends and family back home. It really depends on where your circle of friends is. If they are on MSN, you will use MSN, and if they are on QQ, you will use QQ, and if [they use] both, you’ll use both services.


Another important thing is that as our users grow up, we have to keep pace with their evolving demand. For example, as students graduate and enter a professional environment, they need a professional instant messaging program. If we can create this for them, they will probably stay with us.


China Knowledge at Wharton: Internet companies have been competing with traditional media companies for advertising dollar and page views. How do you see this evolving? Will it be pure Darwinism or can the two sides co-exist?


Peng: The rise of the Internet has definitely replaced certain things, just as cars and trains replaced the horse and buggy. When planes were introduced, few people took a boat across the Pacific. Linking the traditional economy with the new economy is a process of fusion. The traditional economy has become much more efficient, especially in terms of communications and logistics. For example, when e-commerce started, everyone said we were entering a “mouse” economy, but e-commerce is really a “mouse and brick” economy, bringing together the traditional and new economies. If you can link logistics and online services, you will be a very competitive company. The Internet is ultimately a tool for the traditional economy, which can replace a few things and makes it more efficient.


China Knowledge at Wharton: Tencent’s average employee is 28 years old, and the CEO and founder [Ma Huateng] is 38 years old. How do you handle the challenges of this dynamic?


Peng: The biggest challenge is that we do not have enough people. Our people are outstanding and our management team is terrific, but as the company grows, it needs more people to join the team. We are tackling this challenge. The first thing we’re doing is expanding the scope of our recruiting. In 2009, we recruited 2,000 college students and acquired a lot of good people. In the U.S. recently, I conducted our first recruitment drive at top business schools….


The other thing that we have done is dedicate resources to our people. We have set up a Tencent University to offer training opportunities. For example, starting this year, every manager has to conduct leadership training. We also hope that through this curriculum, we can institute training as a part of the company culture and ensure everyone helps subordinates mature.


China Knowledge at Wharton: What was Tencent’s first trip to the U.S. to recruit like?


Peng: I’ve gone to seven of the top schools, including Stanford, Harvard, MIT and Wharton, and the reaction has been very enthusiastic at all of them. Before arriving, we generally received only a few resumes. But once the students attend our sessions, we’ve been receiving a lot more interest. For example after [one] presentation, I received more than 10 resumes and I interviewed around 70 students. Our recruiting is very intensive. Once we find suitable candidates, we keep things going with them and hope a few will join the Tencent family and take part in Tencent’s growth and the future of the Internet in China.