Tencent Music is in a dilemma

Revenues for the fourth quarter and the entire year both declined, monthly active users and paying users continued to decline, but net profit for a single quarter hit the best level in recent years... This contradictory situation occurred in Tencent Music Group, which announced its financial report on March 21.

However, the capital market is not buying into this, and will not turn a blind eye just because the overall environment is not good. After the Hong Kong stock market opened on March 22, Tencent Music opened lower and continued to fall, falling more than 7% in the early trading. Investors have put heavy pressure on Tencent Music with their actual actions.

Objectively speaking, Tencent Music's financial report is not that bad, but it does send some unfavorable signals. Where is the digital music market going? Tencent Music wants to know the answer more than the netizens who are watching.

(Image from UNsplash)

Save profits, lose users

Tencent Music: A happy ending amidst sadness

Tencent Music’s latest financial report highlights both its strengths and weaknesses.

Let’s first look at the revenue. The overall situation is not optimistic and continues the downward trend in recent quarters.

Data shows that Tencent Music's revenue in the fourth quarter was 7.425 billion yuan, down 2.4% year-on-year, but slightly higher than the market expectation of 7.344 billion yuan; total revenue for fiscal year 2022 was 28.34 billion yuan, down 9.3% year-on-year. Looking at the quarterly growth curve, its revenue has recorded five consecutive declines: from the fourth quarter of 2021 to the third quarter of last year, the year-on-year growth rates were -8.7%, -15.1%, -13.8% and -5.6%, respectively.

From the revenue structure, online music subscription and other online music business revenues in the fourth quarter were 2.363 billion yuan and 1.196 billion yuan, up 21.6% and 27.7% year-on-year, respectively, which is basically in line with market expectations. The decline in total revenue is largely attributed to the decline in social entertainment revenue. According to the financial report, Tencent Music's social entertainment business revenue in the fourth quarter was only 3.866 billion yuan, a year-on-year decrease of 18.2%.

Secondly, let’s look at the profit, which is also the biggest highlight of Tencent Music’s financial report.

In the fourth quarter, Tencent Music's operating profit and adjusted net profit were 1.388 billion yuan and 1.492 billion yuan, respectively. The former soared 103.5% year-on-year, while net profit attributable to the parent company was 1.151 billion yuan, a year-on-year increase of 114%. In vertical comparison, the gross profit margin of 33% and the net profit margin of 20.1% in the fourth quarter were both at a five-quarter high, and the operating profit margin of 18.7% was a full double of the same period in 2021.

Like other Internet giants, Tencent Music has set cost reduction and efficiency improvement as its main theme in the past year. In the expenditure structure, both sales expenses and administrative expenses have dropped significantly. Among them, Tencent Music's sales and marketing expenses for the full year of fiscal year 2022 were 1.14 billion yuan, a year-on-year decline of 57.3%. The full-year revenue cost decreased by 10.4% year-on-year to 19.57 billion yuan, and both figures performed well.

By reducing operating costs and adjusting marginal businesses, the group's profitability and capital reserves have reached an excellent level. The financial report shows that by the end of the fourth quarter of last year, Tencent Music's cash-like assets balance was 27.4 billion yuan, and operating cash inflow was 2.4 billion yuan, and the surplus is getting more and more abundant.

However, while cutting sales and marketing costs can save profits, it will also result in some side effects: such as increased difficulty in acquiring customers and loss of paying users.

Data shows that Tencent Music's online music and social entertainment monthly active users in the fourth quarter were 567 million and 146 million, respectively. The former has declined for five consecutive quarters, and the latter is also lower than 175 million in the same period of 2021. After reducing marketing investment, it will become increasingly difficult for Tencent Music to attract new fission in the stock era.

The good news is that the platform has high user stickiness and strong willingness to renew, and the scale of paying users and the payment penetration rate can still maintain growth. In the fourth quarter, the payment rate of social entertainment users was 5.2%, up 0.1% and 0.4% year-on-year and month-on-month respectively; the platform's total number of subscribers was 88.5 million, in line with market expectations, and the overall payment rate exceeded 15%.

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Tencent Music is in a dilemma as it has saved profits but lost users. After all, you can’t have your cake and eat it too. It can only be said that Tencent Music has chosen to prioritize dealing with the current problems, increase profit margins and cash reserves, and then consider future development.

From the perspective of development stage, the digital music market has already entered the stock era, and the user scale will not have much room for growth in the short term. Starting from the two main businesses of online music and social entertainment, Tencent Music needs to do two things well in the future: for online music, it needs to increase the payment rate and single-user revenue while maintaining the existing user scale, and for social entertainment, it needs to actively explore new payment scenarios and achieve revenue diversification.

Of course, neither of these two paths is easy.

No exclusive copyright

It’s not Tencent Music’s biggest worry

Turning back the clock to July 24, 2021, many media and netizens regarded it as a turning point in China's digital music market. On this day, the State Administration for Market Regulation officially issued a fine to Tencent Music, requiring the latter to terminate the exclusive copyright agreement within 30 days and suspend the payment of high advance fees.

This series of measures is equivalent to breaking Tencent Music’s long-standing exclusive copyright monopoly and objectively encouraging orderly market competition. As soon as the news came out, many media, institutions, and analysts were worried that Tencent Music would lose a large number of users.

But we all know what happened next. Tencent Music is losing users, but losing exclusive copyrights is not the only reason. Competitors such as NetEase Cloud Music are also unable to receive this dividend, and Tencent Music's market share is still far ahead.

As for Soda Music, which ByteDance spent huge amounts of money to create and which was very popular when it first went online, it is unlikely to pose a challenge to Tencent Music for the time being.

According to media reports, as of December 2022, the monthly active users of Qishui Music just exceeded 10 million, while the monthly active users of QQ Music, Kugou Music and Kuwo Music under Tencent Music have already exceeded 100 million, which is not at the same level at all. In addition to Qishui Music, ByteDance has not produced more competitive digital music products.

Unfortunately, just because Tencent Music cannot compete with its competitors doesn’t mean it can win easily. Since the outbreak of the epidemic, the ARPU (average revenue per user) and ARPPU (average revenue per user) of its online music business have been stagnant, and it has not enjoyed the growth dividends of long video applications.

In the fourth quarter, the average monthly ARPPU of Tencent Music's online music paid subscribers was 8.9 yuan, basically flat month-on-month, and increased by about 0.4 yuan year-on-year; the average monthly ARPPU of other users was only 4.5 yuan, lower than 4.6 yuan in the third quarter. If compared with the social entertainment business, the gap between the ARPPU and ARPU of online music's paid users is even more obvious. In the fourth quarter, the average monthly ARPPU of Tencent Music's social entertainment service was 169.6 yuan, but it fell both year-on-year and month-on-month.

In the view of the Value Research Institute (ID: jiazhiyanjiusuo), the obstacle to Tencent Music's first path - improving the value of single users around online music services - is mainly the limitations of the industry itself.

With the rise of short videos, the music market has already divided up a large number of users. The attention and time of the remaining users have also been dispersed, and they pay more attention to scenario-based innovation and social expression than content. The richness of copyright is of course an important consideration when they choose a music APP, but it is by no means the only one.

In this situation, long video platforms choose to raise prices against the trend, hoping to convince users with better content and make them willing to pay. However, compared with long videos, music creation has less room for improvement, the copyright value is low, and it is difficult to rely on so-called hits to drive consumption. This means that the platform membership pricing space is getting smaller and smaller, and aggressive price increases will only accelerate user loss.

In view of this, some platforms have started a "VIP price war" to try to retain users. NetEase Cloud Music has tried a different approach, testing a new model of listening to songs for free by watching ads.

It is reported that NetEase Cloud Music will test this feature on a small scale in early 2022 and expand the test scale at the end of the year. Non-VIP users can enjoy the limited-time listening service by watching advertisements ranging from 15 to 30 seconds. This move aims to increase advertising space and push frequency, increase advertising revenue, and make up for the reduction in revenue from paid subscription business.

NetEase Cloud Music's membership service has always been very "Buddhist": the annual fee for the vinyl VIP co-branded with Ali 88VIP has been reduced to 138 yuan since 2020, which is equivalent to a bundled sale with Ali 88VIP, half selling and half giving away. With the support of special ecological attributes, NetEase Cloud Music can give advertising a try instead of paid membership.

However, for Tencent Music, which has a more mature payment system and is more dependent on subscription services, the tactic of giving away VIP members for free is more risky. If it disrupts the original payment system, damages the rights of old users and accelerates their loss, it will be a loss.

In general, price reduction promotions are not very realistic for Tencent Music, so would another path be easier to take?

Limited ways to generate income

Is there any new way out for digital music?

Tencent Music has long been aware of the importance of diversifying its revenue structure. After merging Kugou and Kuwo, Tencent Music upgraded its positioning to an online entertainment platform that integrates watching, listening, singing, and playing, and began to explore more business scenarios. According to the observation of the Value Research Institute (ID: jiazhiyanjiusuo), since 2018, the innovative businesses that Tencent Music has explored include but are not limited to music e-commerce, social networking, digital distribution, O2O, etc.

However, I believe everyone is very clear about the effects of these new projects. As mentioned above, Tencent Music's revenue still comes from subscription membership, other online music services and social entertainment. In addition, the proportion of social entertainment services, which carry more innovative businesses, is still declining.

Data shows that Tencent Music's social entertainment business revenue contribution rate was 52.1% in the fourth quarter, down 10 percentage points from the same period in 2021. If we extend the comparison period a little, since it peaked at 69.3% in the third quarter of 2020, the proportion of social entertainment business revenue has been shrinking, and now it is almost unable to hold on to half of the market.

In the final analysis, although the social entertainment business has grown rapidly, the lack of moat and the increasing number of competitors have always been a problem for Tencent Music. Music social applications, led by Kugou, once had a strong growth curve. Unfortunately, with the increase in competitors and the cooling of user interest, they soon lost their magic. The live broadcast business, which was very popular in the early years, has fallen from the altar as the market environment shrinks.

In addition, in order to grab user time and compete with short video applications, Tencent Music has spent a lot of resources and money in the past few years to promote short video functions, but in the end it was a thankless task. In the QQ Music 11.5.5 version updated in the second quarter of last year, it even changed the original song playback interface to the MV video playback interface, but it did not cause much response.

In response to the current situation, the Value Research Institute (ID: jiazhiyanjiusuo) believes that although Tencent Music has many troubles, there is no need to be overly pessimistic. The most urgent task is to identify its own advantages and avoid its weaknesses.

The first path is not easy, but we cannot give up - after all, digital music is its basic market and core competitiveness, and it is not practical to talk about transformation without this scenario. The appropriate approach is to form a synergy between digital music and social entertainment, increase service scenarios and paid items, and improve membership value and pricing levels.

The popularity of WeSing and Kugou Live was due to their innovative social functions and the large number of music copyrights owned by Tencent Music. Social karaoke and live streaming will become obsolete, but the value of music copyrights and users' social needs will never disappear. Short video platforms are closing in, and necessary defense is understandable, but Tencent Music should still focus on the music scene.

As the "big brother" in the global digital music industry, Spotify has taught a lesson to Tencent Music and NetEase Cloud Music.

The fourth quarter financial report shows that Spotify's monthly active users and premium subscribers were 489 million and 205 million respectively, with the former increasing by more than 20% year-on-year, both figures exceeding market expectations. Spotify achieved its unexpected user growth not by price wars or money-burning marketing, but by combining music and podcasts as its latest selling point.

In the earnings call, Tencent Music CEO Liang Zhu mentioned that Tencent Music will continue to invest in virtual idols, visual effects, virtual entertainment experiences, etc. The specific approach may still need to be explored, but the principle that social entertainment cannot be separated from music should be very clear.

Final Thoughts

On March 21, while releasing its financial report, Tencent Music also announced another major news: it had reached a renewal agreement with JVR Music, so music fans don’t have to worry about Jay Chou’s playlists on QQ Music, Kugou Music, and Kuwo Music turning gray in the short term.

Judging from the market share, Tencent Music's position is also very stable and there is no danger of being overthrown for the time being. Diversification transformation is not easy, and Tencent Music will have to rely on paying users to make money for a long time to come. Only by holding on to the basic market of digital music and accumulating ammunition can we prepare for the development of new businesses in the future.

Tencent Music actually has a lot of stories to tell about the core scenario of digital music. But we still need to rethink the future path. After all, although the online concerts and long audio services explored during the epidemic had their moments of glory, they may not be in line with future trends.

Users and markets are constantly changing, and companies can only constantly adjust their strategies to adapt to new demands.

As a winner of Toutiao's Qingyun Plan and Baijiahao's Bai+ Plan, the 2019 Baidu Digital Author of the Year, the Baijiahao's Most Popular Author in the Technology Field, the 2019 Sogou Technology and Culture Author, and the 2021 Baijiahao Quarterly Influential Creator, he has won many awards, including the 2013 Sohu Best Industry Media Person, the 2015 China New Media Entrepreneurship Competition Beijing Third Place, the 2015 Guangmang Experience Award, the 2015 China New Media Entrepreneurship Competition Finals Third Place, and the 2018 Baidu Dynamic Annual Powerful Celebrity.