Many of China's top tech stocks recently tumbled after Chinese regulators drafted new antitrust rules targeting the country's top internet companies. The proposed rules target "monopolistic practices" like price discrimination, preferential treatment for online merchants who sign exclusive agreements, and the mandatory collection of user data.
China's State Administration for Market Regulation (SAMR) will seek public feedback on the drafted rules until Nov. 30. The SAMR could then finalize the rules to rein in leading internet companies like Baidu (BIDU -1.95%), Alibaba (BABA -2.84%), and Tencent (TCEHY -4.14%).
Let's see why China is trying to tighten its grip on its top internet companies, and how the new rules could change the sector's competitive landscape.
Meet China's dominant digital platforms
Baidu, Alibaba, and Tencent are often collectively referred to as the "BAT triumvirate" for their dominance of China's most important digital platforms.
Baidu controls 76% of China's online search market, according to StatCounter, and it's the top player in artificial intelligence and driverless cars. Alibaba controls 56% of China's e-commerce market, according to eMarketer, and Alibaba Cloud is the country's top cloud platform provider.
Tencent owns WeChat, the country's top mobile messaging platform with over 1.2 billion monthly active users. WeChat also hosts millions of Mini Programs, which allow users to order food, buy products, pay bills, hail rides, and access other services without leaving the app. Tencent is also the world's largest video game publisher, and it owns China's second-largest cloud platform.
This trio also dominates the streaming media market. Tencent owns a stake in Tencent Music (TME -6.49%), China's largest streaming music platform. In the streaming video market, Tencent Video, Baidu's iQiyi (IQ -6.00%), and Alibaba's Youku Tudou are the top three players.
Those ecosystems extend into the fintech market. Tencent's WeChat Pay and Alipay, which is owned by Alibaba's affiliate Ant Group, hold a near-duopoly in China's digital payments market. The BAT companies are also aggressively expanding with investments which tether smaller companies to their sprawling ecosystems.
The Chinese government wants to rein in these companies
The Chinese government has repeatedly tried to rein in the BAT triumvirate in recent years.
In 2016, the Chinese government reportedly considered buying stakes of about 1% in Tencent, Baidu, and other top tech companies and appointing government representatives to their boards. To this date, it's still unclear if the government went through with that plan.
In 2017, China's Ministry of Science and Technology assigned the first wave of open AI technologies to Baidu, Alibaba, and Tencent. It set Baidu on self-driving cars, Alibaba on smart cities, and Tencent on digital healthcare.
In 2018, China passed new e-commerce laws which held companies like Alibaba liable for counterfeit products, data breaches, and other violations. That same year, China temporarily suspended new video game approvals, citing concerns about gaming addiction and inappropriate content, which throttled the growth of Tencent's gaming business.
Over the past few years, China's cyberspace regulators also repeatedly suspended services from Tencent, Baidu, and other tech companies for their perceived lapses in censorship, but those suspensions were mostly temporary.
But all that tension seemingly led to China's recent decision to pull the plug on Ant Group's eagerly anticipated IPO. The government already believed Alipay and WeChat Pay were getting too big to regulate, and Jack Ma's controversial speech at a recent government forum -- in which he compared China's state-backed banks to "pawn shops" -- seemed to seal Ant's fate.
In that context, it isn't surprising that China is now drafting new antitrust rules to weaken the top players and encourage new companies to enter the market.
Bad news for BAT, good news for smaller companies
The new antitrust rules could certainly hurt the BAT companies. All three companies could struggle with new limits on data collection, since they access user data to either craft targeted ads or optimize product listings. Loosening that grip could make it easier for smaller advertising, e-commerce, and social platforms to gain traction.
The new rules could undo Alibaba's exclusive agreements with merchants, which its top rivals JD.com (JD -3.02%) and Pinduoduo (PDD -5.31%) have repeatedly complained about. If that happens, Alibaba could be barred from delisting merchants who also sell their products on rival marketplaces.
But that's a double-edged sword since all three e-commerce leaders could be blocked from launching exclusive sales with big brands. It would also open the door to fresh competition from smaller e-commerce platforms or direct online sales from big brands. The three market leaders could also be barred from using aggressive subsidies, such as free shipping, to drive smaller players out of the market.
The new rules could also make it easier for disruptive new platforms -- such as ByteDance's Douyin short video app (also known as TikTok overseas) and Jinri Toutiao news app -- to gain ground against the market incumbents.
Investors in the BAT companies shouldn't panic yet, since they'll still have wide moats if the new rules are passed. Nonetheless, investors should still follow this story closely and see how the BAT companies and other market leaders respond to the tighter antitrust regulations.