Once high-flying Chinese tech giants are now looking to scale back costs

Chinese tech giants Alibaba and Tencent often talk about all their innovations and new products during earnings calls with investors.

But the second quarter was different. Executives at China’s two biggest tech firms have focused on something a little less flashy — keeping costs low.

It comes after Alibaba and Tencent posted a set of second-quarter results that confirmed these once free-flowing giants are no longer growing.

China’s biggest e-commerce player Alibaba reported solid growth for the first time in the April-June quarter. On Wednesday, gaming and social media giant Tencent reported its first quarterly revenue decline on a year-over-year basis.

Alibaba and Tencent have felt the effects of the Covid-induced economic slowdown in China, affecting everything from consumer spending to advertising budgets. A tightening of domestic tech regulations in areas from antitrust to gaming over the past year and a half also weighed on results.

As revenues remain under pressure, both giants appear to be more disciplined in their approach to spending.

“In the second quarter, we actively exited non-core businesses, tightened our marketing spending and reduced operating expenses,” Tencent CEO Ma Huateng told analysts on a call on Wednesday. “This has allowed us to consistently grow our earnings despite challenging revenue conditions.”

Indeed, Tencent’s profit, when excluding some non-cash items and the impact of M&A transactions, rose 10% from the previous quarter.

Tencent President Martin Lau said the company has exited non-core businesses such as online education, e-commerce and live game streaming. The company also tightened marketing spending and cut back on low investment areas such as user acquisition. Tencent’s sales and marketing expenses fell 21% year-on-year in the second quarter.

The Shenzhen-based company’s headcount also fell by 5,000 from the first quarter.

James Mitchell, chief strategy officer at Tencent, said that with these initiatives plus investments in new areas, the company can “return the business to annual revenue growth even if the macro environment remains as it is today” and even if revenue growth remains stable.

Meanwhile, Alibaba flagged its drive to cut costs earlier this year and continues to push it.

“In the coming quarters and the rest of this fiscal year, we will continue to pursue the strategy of cost optimization and cost control,” said Toby Xu, Alibaba’s chief financial officer, during the company’s earnings call this month.

Xu said the Chinese e-commerce giant had “cut losses” in some of its strategic businesses.

Alibaba and Tencent have had to play a delicate balance to convince investors that while costs are being cut, they are still investing in the future.

“To get back to them [the] profit growth path, cost optimization alone is not enough. They need to find new growth engines,” Winston Ma, an assistant professor of law at New York University, told CNBC via email.

Alibaba is focusing on boosting its cloud computing business, an area that executives and investors believe is key to better profitability for the company going forward. Cloud was Alibaba’s fastest-growing area by revenue in the June quarter.

Meanwhile, Tencent has talked about the potential for ads on its WeChat short video feature to become a “substantial” source of revenue in the future. Tencent operates WeChat, China’s largest messaging app with over one billion users.

Alibaba will continue to focus on areas with “long-term potential” such as cloud computing and overseas e-commerce, Chelsea Tam, senior equity analyst at Morningstar, told CNBC. “Costs and benefits will be assessed for unprofitable businesses.”

Ivan Su, senior equity analyst at Morningstar, said Tencent has “done a really good job balancing long-term investment and short-term returns.”

“If you look at the spending initiatives they’ve announced, some of the reductions are permanent, such as migrating to the cloud and closing unprofitable non-core businesses, while others (pulling the marketing budget and slowing hiring) are more temporary in nature.” So there are multiple levers they can pull to create that balance,” Su said.