Not many Westerners realize it, but Tencent has become the largest gaming company in China. The integrated Internet-services company is the gateway to the online world for hundreds of millions of Chinese, and its market value is $52 billion, not far from Facebook’s value of $60 billion. Tencent is a little like what you would get if you combined Aol, Facebook, Skype, Yahoo, Gmail, Norton, and Twitter under one roof. And now the company is heading west.
China has a ton of online gamers, and its Internet penetration is only about 40 percent, compared to 70 or 80 percent in developed markets. Tencent could easily grow more in the China, but it has been investing in Western game companies in recent years.
The company bought majority control of Riot Games last year for about $400 million, and it recently invested an undisclosed amount in Epic Games, the maker of the Unreal Engine and the Gears of War series.
To understand Tencent better, we invited David Wallerstein, the company’s senior executive vice president, for a fireside chat at our recent GamesBeat 2012 conference. Wallerstein has been with Tencent since its early days and has watched it grow massively in the past decade. Here’s an edited transcript of our chat.
GamesBeat: Can you explain Tencent to our audience? It’s not an everyday company.
David Wallerstein: China now has more online gamers than the U.S. and, I believe, Japan combined. So you can run around crazy in the U.S. market, or you can take on China, and your results may be pretty darned similar at the end of the day. The size of the markets is pretty similar. I think this year, the Chinese online game market will be about $8 billion, and the global market for online games is about $15 billion. So it’s roughly half. It’s a very good market. Now, Tencent is a leading gaming company in the market by pretty much all the metrics. In Asia, people already know we’re very big, so we usually don’t talk about the company and try to provide a lot of data to establish our credibility. But here, I have to note that we are a $52 billion market-cap company. We’re actually one of the biggest Internet companies, bar none, in the world. But in the West, people don’t really hear about that.
GamesBeat: Facebook is around $57 billion [now $60 billion], last I checked.
Wallerstein: We’re not exactly the anything of…. We’re not the Facebook of China. As an American, I’ve worked with Tencent for 12 years.
Wallerstein: No, I’m not. I’m from Santa Rosa. I grew up there. But I spent a lot of time in Asia when I was a teen. I’ve been with Tencent for 12 years. I’m just called senior executive vice president. We dropped the “international” title a while ago. I’ve been part of the executive team since when we were about 45 people. It was a much smaller operation. I’ve seen it grow into about 22,000 people today at Tencent.
It’s been a spectacular ride. In the beginning, for the first, say, three or four years of the company, gaming had nothing to do with what we did. That has really informed our development into gaming today. We started off with instant messaging, kind of how Google started off with search or Facebook started with their social networking services. We started with messaging and grew beyond that. For many years we thought about things like connectivity and social-networking services, how to provide richer media services, voice service.
What we found in 2003 was that online games started coming out, and our online games in China, the most popular type of online games to this day, are client based. They’re PC games, massively multiplayer online role-playing games (MMORPGs), where you play with other people. And we found that these experiences were going to become the richest way for people to interact together online. Tencent fundamentally, at the core, has been about using the power of the Internet to connect people, whether it’s through video or voice or anything else. But the magic that happens through the Internet, to us, was a whole new transition in telecom that was going from the very beginning when you could pick up and call someone. Now I could pick up the PC, and I could steal their stuff or attack them in a game. These clients just seemed to us to be the future of online interaction. So we felt like we could not afford to miss this transition on the Internet.
We started investing our resources, developers, into building these kinds of gaming services. We started integrating them with our instant messaging service. We started with very simple, casual games like poker or three-in-a-row games where you’re actually competing with five or six people at a time. Everything was always about interaction. It was always about the joy of having an experience with someone else that was potentially thousands of miles away from you. And then we went into what are called advanced casual games, like racing games, or chasing guys around a map shooting at each other. And then we starting going for the big MMO-type worlds, like World of Warcraft and Lineage, that have been popular in the western world. And now we just do every kind of gaming in every kind of genre, including social games and mobile.
As we’ve moved along, we’ve gained a greater appreciation for game design for all the disciplines of gaming. But at the very beginning, it wasn’t really all about that. I think in this day, when we think of gaming, what we’re really going after is providing deeper, richer, more intelligent experiences with people in real time over the Internet. We have a very vibrant social-networking service. Our Qzone service is kind of the equivalent of Facebook in China. We absolutely understand what it is, and we do a lot of gaming services through that.
But at the end of the day, for the majority of our cash and revenues and profit and so on and so forth, it’s coming from these deep, immersive experiences that really parallel what’s happening with consoles in the U.S. The only difference in China is that everything’s online. Everything’s multiplayer. And these experiences, for the most part, are only on the PC. This kind of game is also growing in the U.S. as well. In recent years, other than, for example, World of Warcraft, I think Riot Games has done a lot to show what’s possible in this area with League of Legends.
GamesBeat: And you bought a majority stake in Riot….
Wallerstein: Yes, we acquired a majority stake in Riot.
GamesBeat: Did you notice a raise in your profile after that? It was a big deal…
Wallerstein: I think in the West we were noticed. It was just kind of hard for people to figure out what we do. It seems somewhat unrelated to a lot of game people. I’ll have to be honest with you. I think in my own personal interactions. I think Riot is still not extremely well-understood here in Silicon Valley. I think in the world of gaming they’re better understood. But I think, probably, the average comment I get is more on the PC side, like, hey, that was a good deal. The players get it. The players who play League of Legends, they get it.
GamesBeat: It seemed to me like it was a wake-up call. Then a lot of people thought that Chinese companies were going to come here by the busload and start buying a lot of companies here. That hasn’t really come to pass. I don’t know if that surprises you or not.
Wallerstein: The difference in what we do, certainly in our relationship with Riot, is that we didn’t buy them. We’re investors in Riot. We acquired a majority stake, but the founders and the staff and the management of Riot still maintain a very healthy ownership. I think after we’d done this deal, their ownership percentage of the pie grew. There were the VCs in the company and angel investors. But the actual people who work in the company, their shares will be growing even more over time. It’s very likely that they will have more of an ownership.GamesBeat: That’s a very different approach from buying something outright. Why did you actually take that approach?
Wallerstein: That’s a great question, because it is something I wanted to let people become more familiar with. We also did a very substantial investment in Epic Games. I don’t know if there are any Gears of War fans out there, but we did a substantial investment there. It was along the lines of things we’ve done in other countries around the world, that maybe in the U.S. people are less familiar with. We really do see our mission as getting behind developers. We become supporters of their vision, and that is pretty simple to do it, at the end of the day.
I’m often handling things like our relationships with them. On an average day, that may mean I am not be doing anything. We let them operate the way they want to operate the company. And then we have an opportunity to shine and prove that we can be a great partner when there’s a request. A request is like the best gift we can ever get. Riot almost never has a request for us. But when they do, that’s our opportunity to execute beautifully and make them feel like, wow, we’re so lucky to have this fantastic partner in Tencent.
GamesBeat: It’s a hands-off approach?
But we really see, when we work with a company like Riot or Epic, their DNA has become part of our DNA, by being who they are and becoming the best they can be. That’s really exciting for us. We really want to have that kind of diversity in the Tencent holdings family, our group overall. There’s going to be many different strategies to succeed in many markets. The U.S. is where we’re really looking at the market as a new opportunity. There are so many different approaches. We just want to get behind the best partners that share our values. I think Riot was very exciting for us because they care so much about players. I think anyone who plays LoL can probably at some point get a feel for that.
I get a lot of feedback saying that they don’t really try to monetize that aggressively, and that’s really important because you always want your customers to feel like they’ve gotten more value than they came for. And of course, we started off on the right foot because the game’s being provided for free. We do fairly substantial free-to-play games that people would usually perceive to be a $60 console game. We’re having a parallel experience, what people buy on the PC to what people would be experiencing on console. Those things are very important to us.
Wallerstein: We’re a founder-driven company. I mentioned I’ve been there 12 years; the company started about 15 years ago. There were five founders, and everyone except for one guy is with the company to this day. We have a large executive team. I was number six. Almost everyone on the top team has been around for almost 12 years. We’ve become a pretty big company at 22,000 people, but we’re still founder driven.
Because of that, we have this interesting mix of entrepreneurial activity and then the challenge of managing 22,000 people. I think at the end of the day, we care about user values. Ultimately, we’re not very focused on competing with other companies. We’re always focused on competing for the customer. That really helps ground us in so many situations, whether we’re talking about a new game, talking about relations, talking about hiring someone, talking about investment. Do these people really care about users? Do they see what they’re doing as catering to users? And if they do, we feel like there’s a commonality of interest.
Not every environment is like that. Sometimes we feel like someone is fundamentally a good person, but they’ve been in an environment that hasn’t been about that. And then it just takes so much work to get them to change their mindset. They’re thinking about profits and margins first and foremost, dealing with budgets. That just doesn’t work. We’re really about user experience. I think we’re a service. So we have dozens of games out there. We have hundreds of millions of online gamers. Online gaming revenue last quarter was over $800 million.
We can give away a game for free, and it’s a very big title. This title may have taken three or four years to build, sometimes longer, five or six years. And we’re going to give it away for free. Well, the most dangerous thing that will happen to us in that situation is that people play the game for a few days. We’re really not going to monetize it until something clicks. They have to fundamentally commit to this game. We need replayable games. We need people to feel like this game is so awesome, I can’t wait to get home and play it again, do something new in it.
We feel like the games that we have to make are not really about flash or a really great five-to-10-hour experience. There’s a great market for that, by the way. That’s the majority of the U.S. console business, but for us, it’s about an experience that grows on you, that becomes richer and more interesting over time. We feel like it’s a really healthy relationship between developer and user because as a developer, when you build a game and you ship it. It’s never complete, right? The game is never complete. You always feel like, oh, there’s so much more I could have done. And then you get some user feedback. You go to a colleague. You’ll say, I told you so! They didn’t like that! I guess we’ll fix it in the next version next year.
Well, when you do an online game, you can fix that problem next week. You can fix it any time. It’s really a matter of priorities and how many resources you have. But you feel like there’s this really deep iterative relationship happening between developers and users. It’s very fulfilling and very exciting for the developer because you’re actually, over time. All of our services, whether it’s games or any Internet service we do, they’re all really interactive dialogues with users. It’s such a gratifying way to work because you do something, you add a feature, you add a new level in a game, and immediately people are telling you they love it. Or if they hate it, you have an opportunity to correct it. I know people are doing that with other types of games here, social games, mobile games, but certainly it’s also happening with these larger client-based games.
Wallerstein: Well, yeah, that’s a good question. You might find this interesting because I did too. I speak Chinese. I know everything that’s said, and sometimes you’ll overhear a skeptic. Like, we think this could go over great in the U.S., and they say, why would I do that? It’s such a small market. [Laughs]
Then you actually look at the facts and say, oh, you’re right, that market is only 30 percent of the size we have in China. So it is bigger just to focus on China. We don’t necessarily have to do anything here. But we’re really excited about working with teams that share our passion for users and share our passion for quality. I think working with Riot and Epic, hopefully, we’re all doing a good job in the market to show that we do stand behind those things. If people don’t feel that way, we need to work harder because those are things that are important to us.
The U.S. has definitely the strictest quality standards of any market. It’s a great challenge to put something in front of the American consumers. When I look at the globe, and I’m exposed to China and other markets, in my own personal opinion, Americans value their time much more than anyone else in the world. They have so many options, so many entertainment options, including a beautiful outdoors. Not every country has this kind of outdoors. You have every kind of opportunity to spend your time. If you can, despite all that, be a game of choice, an experience of choice for the American consumer, you’ve probably created something really awesome. It’s a challenge to ourselves, to learn more about raising the American quality bar. I don’t think we’ve done anything yet out of China that’s truly met that quality bar. It’s a challenge for us, and it’s something great to aspire to for us. And of course it is a big market.
Wallerstein: We can do it by working with a great team here. I think that’s often the more practical way. Those companies are part of Tencent. A company that we own the majority of shares in, that’s as much Tencent as anything else. We work with a lot of companies, a lot of our teams in very comfortable ways. These companies are very much part of the Tencent family. So it’s not like you’re only part of Tencent if you started in China and you’re a 10-year person. It’s not like that. We want this company to very much be a global company, and one way to get the best talent to come in is that you’re going to have to go the M&A path.
GamesBeat: Have you tried to grow organically here by just hiring people, opening studios?
Wallerstein: Not much. We’ve done some social games here. At one point we debuted a social game at something like number 85, which we were actually really happy with. [Laughs] We didn’t totally fail! We’ve done some things that didn’t go well. But I think we’ve felt like we’re starting to get pieces of it. We’ve got a lot to learn still. I think the majority of our operations are still focused on smaller-scale gaming, browser-based gaming, social gaming. It’s still experimental. We have a lot more to learn.
GamesBeat: So you’re looking here for companies to invest in. What kinds of things are you looking for, and what platforms and business models are attractive right now?
Wallerstein: We look at a lot. Hopefully we’re seeing most of what’s available. First of all, I think we’re mostly comfortable working with entrepreneur-backed companies. It doesn’t have to be the guy that started it. It could be someone who came in later and takes on that role, takes on that mission the way a founder would. We have to look at who we’re working with. We feel so strongly that the Internet is about people. Software businesses are about people. The code is evolving every day. You need people to evolve the code in a very smart way. So the first question is, who are we working with?
Sometimes the deal is pitched to us and it’s like, this would be the most ultimate deal because this company is such and such. That’s just not how we feel. The world isn’t a chessboard where you can buy something and throw it in your suite. It’s more like, who are the people? Do they share our DNA? What’s their plan? We want to get behind people. We want to back people. So we don’t see opportunities where we could use your distribution, buy it. We’ve got all this Chinese stuff. Put it through their pipe or something. It’s never about that. It’s always about, does this team have a great plan? Will they become stronger if we get behind them? We always have capital. We have operational expertise. We may have some resources and experience there. We want to get behind them.
GamesBeat: A while ago Disney had a game plan where they actually stated, in five years we want to triple the size of our games business or something like that. Do you have a goal for the U.S. side of Tencent in that way?
Wallerstein: There are goals inside the company. I think they’re a little bit artificial. We’re not rushing to get anywhere fast. It has to be done the right way. Some bad operations, some bad deals, they can really derail your company. They put you on the wrong path, and then correcting those things can become a lot of trouble down the road. It’s something every company goes through. We would prefer to avoid as much of that as possible and just make the right decision at every step. Work with the right people, instead of doing 10 deals a year, just do one really good one. Something that is very meaningful and really makes a difference in the industry. I think that’s the most important thing.
And if you’re doing something well and users value it, the money is going to be there. One thing we learned from QQ. QQ is our instant messaging platform. It has over 700 million users. It was impossible to monetize it. But so many good things came out of having that, including helping to support growing our games business by having some users we can throw games at. It meant so much to our business, but that thing in itself didn’t monetize. What you need on the Internet is you need a starting point to have a dialogue with the user, a point where you can start to engage. Once you have that engagement, you may not be able to monetize on the thing you wanted to monetize on, but that’s okay. If they’re still engaged, you’ve got the next opportunity. Oh, you didn’t like that special gun that I made for you in that game? Okay, let me try this. And at some point you’re going to crack it. And then you’ll start to monetize well. But you fundamentally need to have that engagement.
Wallerstein: Well, I want to address the assumption there. I find it interesting. First of all, I really am very curious to see, are PCs really declining? I will lament the PC era if it happens as quickly as some people are predicting because it’s such a great open platform. I know the other ones are exciting, but there’s no gatekeepers on the PC. It’s such a vibrant platform. You can do so many things without asking for permission and without upsetting someone. Certainly, we like the fact that it doesn’t have a toll going to any particular party. We respect the fact that platforms have that, but it’s the only platform that’s purely free. The other alternatives are Facebook and the mobile platforms. We don’t see that trend in our markets. In Asia, the PC isn’t going away.
Anyway, I hope the PC can last, I think it’s such a fantastic platform. If it’s not the PC, then something should replace it with the same characteristics, being very open and just doing whatever you want on it. I think Microsoft could have done a better job of organizing that ecosystem. Think of all the value that comes through curation. Look at the platform providers. Microsoft didn’t really do much of that. They could read the economics and say, don’t have to charge 30 percent, but then just do a wonderful job curating it. Because, you know what, client-based games on PC, I still love these games. They’re so rich. There’s so much to offer.
GamesBeat: Will you bring games over from China?
Bringing our games over here is something that we may or may not do. It has to be the right game. We don’t think there’s much point in bringing over a game that people aren’t crazy about. We thought about it. We’ve looked at certain titles internally, and it’s been really tough. For us to bring a game over, it has to be the right game. The unique thing about China, while it’s maybe less interesting to people in the U.S., is that some games are very Chinese. A lot of the games are like historical Ming Dynasty fantasy. Some of you might dig that type of stuff. I don’t personally. I don’t really care about Ming Dynasty stuff. But a lot of the big, famous games that we’re building over there have that content.
That’s one of the biggest differences. It’s not the technology. It’s not the experiences. It’s that kind of stuff. We would be very careful about that. I would say, what we would do if we decided to bring a game over here, we would have as many testers test it as possible, and we would want to sit with the gamers and talk about it and learn about what’s working for them, go in really deep with people. And when we see something resonate, I’m going to be totally stoked because we’ll go all out. But to be quite honest with you, we haven’t found it yet. I wish I could say stay tuned, but I don’t want to make everyone wait too long.