Sherman So’s Weblog

The idea of writing a book about the China Internet occurred to me quite naturally.

Whenever I meet someone new and they ask what I do, I say, “I’m a journalist and I cover the China Internet.” 

They usually find that very interesting. China is a hot topic and so is the Internet, so the combination of the two ought to sizzling!

It took a few years for the China Internet population to reach the 150 million mark, but from there it took only six months more to reach 200 million. China now has more than 210 million users, but that is still only about 16 percent of its population. It will soon surpass the US – where penetration is 70 percent – as the largest online community.  (Researchers estimate the U.S. had only about 5 million more Internet users than China at the end of 2007.)   

Amazing fortunes have been made in a very short time. Baidu, the largest search engine, saw the price of its shares shoot up more than four times on their first day of trading; the stock market value of the obscurely-named Tencent, which runs the instant messaging platform QQ, has quietly grown to US$10 billion from practically nothing 10 years ago. 

Most foreigners, even Internet sophisticates, know little about the business in China. A few may recognise the name of Baidu’s founder Robin Li. Others might have heard of Jack Ma, a tiny man with a big mouth, whose business-to-business site Alibaba got a US$1 billion investment from Yahoo before raising another US$1.5 billion in its stock sale two years later, the largest Internet IPO since Google’s

But who would believe that Ma, an ex-English teacher, could become one of the richest men in the country by having the simple idea to set up an electronic message board for small businessmen in China and around the world to exchange trading information? Or that Baidu, which was copied from Google, could beat Google at its own game and become the most popular search engine in China and a US$9 billion company.
  
The fact that questions like these have not been sufficiently answered prompts me to want to write this book – to give readers a basic understanding of the companies, the people who run them and the environment they work in. I believe what they have done is being repeated every day in other parts of the world – stories about entrepreneurship, breaking old models and making new ones, alertness and flexibility, David vs Goliath.   

The China Internet is a fertile land for entrepreneurs, both local and foreign. There are roles for foreigners to play.  Many worked in the pioneer ventures and still do. A friend of mine, a Californian, is working on his startup, Darwin Marketing, which helps clients do search engine marketing in China.  Another foreigner I know is now on his second venture, Smartpay, a mobile payment company, after getting the first one, Linktone, a wireless valued added service provider, listed on the Nasdaq stock market. 

The recent financial crisis has hurt the sector a bit, just like other stocks.  But I think this is only temporary, as fundamentally these are companies are supplying services people like and making real money. Most are highly profitable and growing very fast. 

Tencent’s revenue grew more than 10 times in the five years from 2002 to 2006, and it made about 37 dollars of net profit for every 100 dollars it earned. No wonder its stock price has risen steadily since it was listed. One dollar invested in Tencent’s shares in June 2004 had become 18 dollars at the peak of the market last November.

Baidu’s net profit margin of 36 percent is almost as astonishing as Tencent’s and its revenue grew more than 75 times from 2002 to 2006. In the same period, Ctrip’s revenue grew 7.8 times, while its net profit soared 17 times. Its net margin was 30 percent. (The profit margins of some of the online game developers can be as high as 40 to 60 percent, although their growth rates are less predicable.)

Long-term investment in the sector can be extremely rewarding. Baidu, for instance, offered its shares at US$27 apiece when it listed in August 2005.  They were at US$420 last November, at the recent peak of the market.
 
It is true that China Internet sector started by imitating successful companies overseas, specially the U.S. ones.  Many got their original ideas and capital in America.

Prior to founding Baidu, Robin Li worked as a staff engineer for Infoseek, an early player in the search engine industry in the U.S.

However, direct copies of U.S. models usually fail miserably in China. After all, the differences between the two countries are vast – from people’s living standards to the business environment. 

That is why Google - the number one search engine, eBay - the leading online auctioneer, Yahoo - the number one online portal, Expedia - the largest online travel site, etc., have all failed to dominate the Chinese market. On the other hand those who adapted their ideas to local conditions thrived. 

Sina and Sohu, China’s leading online portals, built their dominance by posting news online – they employed hundreds of editors to painstakingly copy news from all the leading newspapers and magazines in China onto their site. News was not as available in China then, and people were, and still are, hungry for it.  It was very different on the Yahoo China site, which was largely a replica of its U.S. parent — news was part but not all of it. And by using technology, rather than people to gather and present news, Yahoo deprived itself of the sensational headlines that keep people browsing on Sina and Sohu.

After finding out how difficult it was to get the Chinese to book hotel rooms over the Internet, Ctrip, the leading online travel site, sent people out to distribute booklets containing room prices and reservation numbers in airports and railway stations. Most of the reservations Ctrip gets still come from its call centres.

While Baidu’s search engine was mostly copied from Google, it innovated in its manner of selling keywords to advertisers. From the very beginning, Baidu knew very few Chinese would go online and bid for keywords themselves, as they do in the U.S. Most small business owners in China simply aren’t aware of search engines as a marketing tool and don’t know how to deal with the technical details.

Baidu initially used sales agents with outside firms to sell keywords. They talked to potential customers and taught them the process step-by-step or simply dealt with the technical details for them. The company has since taken the operation in-house. It employs a large direct sale force – thousands of people cold-calling anyone who might be interested in advertising on the Internet. This might sound incredible, but it works.

When Google set up its China operation in 2005, it copied Baidu and used sales agents. But it never went as far as to employ its own sales team – too far off the U.S. model. 

The innovation of Chen Tianqiao, founder of Shanda, the first major online game company in China, was not the games, but how to get paid.  Its games were licensed in Korea, where MMORPG, or massive multiplayer online role playing games, had been going strong for several years.

The real problem that Shanda solved, which allowed it to list on Nasdaq about two years after launching its first game, was how to collect money from millions of players in China.  Credit cards were scarce in China, as were forms of electronic payment.  Most transactions were done in cash.

The solution was rather simple, but very much adapted to the business and social realities in China – scratch cards, printed with an access code and password and sold through hundreds of thousands of Internet cafes, the primary venue for online games in China

(One venture capitalist told me the reason he and his partners did not invest in Shanda was because it had no real technology. Their mandate was high-tech companies. They certainly missed out on a great deal.)

Stories like those are numerous. So are the myths about the U.S. Internet giants – for example, that their brand names are universally recognized and their pockets are deeper than anyone else’s. The big brands are well known in the U.S., but not in China. Most people in China cannot even spell Google. And while the head offices of such companies are flush with cash, their China subsidiaries are not. In contrast, first-class China Internet companies have no trouble attracting the capital they need, either from venture capitalists or through the stock exchange. 

In assessing who had the deeper pockets when eBay and Alibaba’s Taobao were competing for dominance of the online auction market in China, the following observations were made:
1) while eBay claimed to have invested US$100 million in China, ex-eBay China executives said most of the money had gone back to headquarters for upgrading the overall technology platform. What was actually available to the local team was not that much.
2) Alibaba got US$82 million from Softbank and other venture capital investors.  Then Yahoo announced its US$1 billion investment. Although US$750 million was used to buy out previous investors, it still left Alibaba with US$250 million.
3) At the time it took on eBay, Alibaba’s main business, its B2B site, was already turned profitable. It could support the loss-making Taobao. However, eBay China had no other business to support it. If it could not make a profit, it would bleed to death.     

Another reason for the failure of foreign companies to crack the Chinese market is less edifying – sometimes the local players stretch the limits of law and business ethics. This is something the U.S. giants cannot do without tarnishing their global reputations. 

One of the attractions of Baidu is its MP3 search. It allows users to download tens of thousands of copyright-infringed songs from the Internet. The four major music companies in the world, Universal, EMI, Warner and Sony BMG, sued Baidu in 2005.  But after more than two years of proceedings, Baidu was acquitted by a Beijing court. Google has never had such a service, even though it would probably attract teenage users in droves.

Ultimately, the key to understanding anything about the China Internet is to keep an eye on its 200 million plus users.Whereas 70 percent of the Internet population in the U.S. is over 30, in China 70 percent of users are under 30. Young people drive the web in China. They play online games.  They meet friends over QQ.  They write SMS novels and compose songs to share with their friends. They create and buy mobile-phone content. (The Internet and the mobile data markets go hand-in-hand in China. A lot of business models use the Internet as the promotional channel for mobile services.)

Among the people you will meet in this book are the Back Dorm Boys – Wei Wei and Huang Yi-xin.  They were students at the Guangzhou Arts Institute.  One day, they mugged for the web cam in their dorm room and lip-synched the Backstreet Boys’ “I Want It That Way”. They may lack the polish of the manufactured boy band they imitate, but somehow their grainy web cam broadcasts struck a chord with people around the world, becoming among the most viral on the web. With their matching Houston Rockets jerseys, synchronised swaying, bobbing heads, protruding lips and exaggerated facial expressions – you couldn’t help but laugh. Good Morning America aired their clips on U.S. television. Motorola also took notice and soon Wei and Huang were lip-synching their way through TV adverts for the handset maker.

And there are more examples of Chinese Internauts who turned their 15 minutes of fame into financial success, such as the online sex diarist “Lotus Sister”, and the musicians who wrote the pop hit “Mice Love Rice”. In many ways they represent the cultural and economic trends shaping the Internet development in China today.  

This book seeks to help readers to understand the multiple facets of China Internet sector.   And may be, one day, when they come to China, they can make better decisions either as competitors, investors or executives of these companies.

Moreover, the Internet sector is easier to understand than others in China, where government policies still determine most business decisions. By and large, Business 101 applies.  The biggest successes in this sector are not sons or daughters of high-ranking government officials, but hungry entrepreneurs ready to risk it all. There is no denying that rules are bent and fraud is everywhere in China, which is still an emerging market. But to a large extent, the Internet companies that win are the ones providing the most desirable products or services. 

In the first part of the book, I will talk about the leading players in the China Internet sector.  And in the second half, I will talk about certain facets crucial to understanding the sector, including its darker side.