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By Paul Carsten
BEIJING (Reuters) - Apple Inc (O:AAPL) has a lot for which to thank people like Deng.
A Beijing-based quality analyst, she gave only her surname as she's embarrassed by how much money she spends playing mobile games on WeChat, a hugely popular messaging app developed by Chinese internet giant Tencent Holdings Ltd (HK:0700).
"The most expensive time was when I spent 68 yuan ($11.08) on a leopard on Tiantiankupao," said Deng, an avid iPhone user, referring to Tencent's hit game - called Timi Run Everyday in English - where characters run through obstacle courses. Having a leopard as a pet gives the characters extra power, helping players beat their friends.
Deng and tens of millions like her have made China Apple's third-largest market for software sales, and a huge chunk of that comes through WeChat. Known locally as Weixin, WeChat had 438 million monthly active users globally, mostly in China, at the end of June, and has rapidly evolved from a messaging tool into a digital Swiss Army knife, allowing users to send messages, play games, book taxis and shop online.
The app has proved a winning formula in getting people in China, a market notorious for not paying for software, to connect their bank accounts with their phones and pay for virtual goods like extra lives and power-ups in mobile games.
Apple takes a 30 percent cut on all sales.
"We're seeing some substantial strength there," Apple CEO Tim Cook said of China in a July earnings call. "The thing that's actually growing the most is the iTunes, Software and Services category, which has the App Store in it. That area is almost doubling year over year."
Apple's Greater China revenues, which include Hong Kong and Taiwan, soared 28 percent in April-June from a year earlier to $5.9 billion, and globally, iTunes, Software and Services sales were the company's second-fastest growing product category, up 12 percent year-on-year to $4.5 billion.
Tencent was the top game publisher for Apple's iOS operating system in China by revenue for both June and July, according to App Annie, a company that measures app usage. Apple is this week expected to launch its new iPhone - with a gamer-friendly larger screen.
"A VERY VIRTUOUS CYCLE"
Apple makes all software sales on the iPhone go through its App Store. Typically, the Cupertino, California-based company will take its 30 percent of the sales, while the rest goes to an app's developer or publisher.
WeChat, which itself hosts apps and games made by other developers, is no different. The cash from any products sold on the app are split between Apple, Tencent and the developer.
"By far the biggest factor driving App Store revenue in China is WeChat," said Ben Thompson, who writes about technology at stratechery.com. "WeChat has driven app download and usage, which drives people to want to buy stuff, which drives them to connect their payment information. It's been a very virtuous cycle."
Growth has also been helped by increased smartphone sales since China Mobile (HK:0941), the country's largest carrier, began offering the iPhone in January.
A big part of WeChat's success has been with casual games - highly addictive hits like Candy Crush Saga and Temple Run that are often free to download but let users pay for in-game upgrades. WeChat has its own stable of games, and also publishes Candy Crush in China.
Games integrated with WeChat and Tencent's other mobile social network, Mobile QQ, generated revenues of 3 billion yuan for Tencent in April-June, up from around 1.8 billion yuan in January-March.
"If you look at who's playing Temple Run and Candy Crush, a lot of these were non-gamers five years ago," said Junde Yu, App Annie's vice president of Asia Pacific. "With the advent of smartphones, the ease of use, they started to download apps, and because they're very casual and fun they start playing games. It hooks them and encourages them to start making payments."
REPEAT PURCHASES
China is unique in another way that helps push up spending on smartphones.
Both Apple and Tencent have tried to drive the adoption of mobile payments on their platforms, but China's banking payment system is complex at best, and makes it difficult to carry out any kind of online payment with ease.
Apple uses a top-up system for its App Store in China, with a 50 yuan ($8.15) minimum value, said Yu - for those using China's national bank card payment network rather than international credit cards. "This leads to a lot of repeat purchases as people aren't likely to spend 50 yuan on one purchase," Yu said. "After the first time, they won't stop but will keep purchasing and playing games."
iPhone users themselves are a big draw for app developers, and some value them more highly than people using smartphones operating on Google Inc's (O:GOOGL) Android system.
"I'd pay six times the price for an iOS user compared to Android," said Peng Tao, chief executive of breadtrip, a Beijing-based travel app. Part of the reason, in China at least, is that Android's Google Play app store isn't accessible, so dozens of smaller, less curated app stores have sprung up.
"On the iOS App Store front page apps are chosen by merit, whereas in China for Android they're chosen by who pays," said Peng. "Android users just like to download things, no matter the need. They see it's free and download it, so they shift apps quickly - download and delete, download and delete."
UNEASY ALLIES?
For Apple, though, WeChat may turn out to be a Trojan horse.
While the U.S. company is earning good money through WeChat's success, there is some concern that Tencent may want Apple to see less of that.
"WeChat made the market, Apple didn't, and it's becoming so powerful on mobile in China that, broadly speaking, it's a threat to Apple," said stratechery.com's Thompson. "If Tencent want to flex their muscles and keep more of that revenue, I could certainly see them leaning on the government to help them and keep a bigger percentage of the sales they're driving."
China's ruling Communist Party is no stranger to heavy-handed regulation. Last week, a U.S. business lobby said foreign companies are increasingly concerned they are being targeted by Chinese regulators, charges the regulators deny.
Apple itself has repeatedly come under fire from Chinese state media - more frequently since former U.S. National Security Agency contractor Edward Snowden's revelations about U.S. government cyber-espionage conducted through private companies including Apple, Google and Microsoft Corp (O:MSFT).
In July, China's state broadcaster branded the iPhone a national security threat because of its ability to track and time-stamp user locations, and government mouthpieces have called for 'severe punishment', accusing Apple of providing user data to U.S. intelligence agencies.
Some of WeChat's rivals in messaging apps have also fallen by the wayside in China because of the government.
Chinese authorities said in August they blocked South Korean firm Kakao Corp's KakaoTalk and Naver Corp's (KS:035420) Line as part of efforts to fight terrorism, according to the Korean government, explaining service disruptions in China that had begun a month earlier.
"The biggest danger for Apple in China is always the uncertain regulatory environment," said stratechery.com's Thompson. "It's very plausible to see the government moving against Apple's App Store policy."
(Editing by Ian Geoghegan)