Google’s China Odyssey

Pre-crisis, Google becomes a formidable competitor to Baidu, contrary to widespread belief

Google started slow in China, but had made real inroads on local
search engines before the current controversy and Google's threat to
leave the country. The following excerpt is adapted from "Red Wired:
China's Internet Revolution," by Sherman So, formerly lead technology
writer for the South China Morning Post, and her colleague, Christopher
J. Westland, a professor at the University of Illinois, Chicago. See
Ms. So's previous article, Is Google Really Leaving China?

Even
before it had an official presence in China, Google's services were
being widely used there. "Baidu's popularity only began to surge in
2003–04. Before that, most people in China used Google, as there were
few other choices of search engine," said Jacky Huang, China Internet
Research Manager of IDC.

Some Chinese advertisers were
already bidding for keywords on Google's American site. It was the
search engine of choice for some of the country's most sophisticated
internet users, those with the most income and education and with
foreign experience or regular contact with foreigners. Such people have
credit cards, and besides Google they also like Facebook and YouTube.
The problem was that there were just not that many of them.

Another
hindrance to Google's penetration was the behavior of the Chinese
government. From 2002 to 2005, access to Google was routinely blocked
any time there was sensitive news about China. Local users would find
themselves automatically diverted to Baidu or other Chinese search
engines. The problem was most serious during 2003–04.

By mid
2005, partly due to Baidu's effort and partly due to government
interference, the tables had been turned. Google's market share was
about 23 percent, lower than Baidu's 37 percent, but still it was well
ahead of the other local competition, according to the Beijing based
market research firm Analysys International.

To reach more users
and advertisers, and ensure a stable service in China, Google needed a
local presence, with servers and staff inside the country. But it would
have to tailor its services to Chinese laws. So it joined its local
competitors in filtering out of search results all politically
sensitive information—about the anti-communist Falun Gong religious
sect, for example, or the June 4, 1989 Beijing massacre.

Such
compromises certainly clashed with Google's stated mission—"to organize
the world's information and make it universally accessible and useful.
But the potential of the Chinese internet market, which was bound to
become the largest in the world, was just too great for a company from
Mountain View, California, to ignore. (China is not the only market
where Google has modified its practices to suit local laws. In Germany,
for example, access to neo-Nazi sites is banned.)

Despite a high
profile in the media, Google China was on shaky ground in its early
days. A year after setting up its office in China its market share had
actually dropped, bottoming out at around 16 percent in mid 2006;
Baidu, with its post-IPO momentum, had increased its share to 50
percent, according to Analysys International.

"The grassroots
Chinese internet users had not heard of Google. The high-end users
thought there was no hope for Google," said Lee Kaifu, president of
Google China. Adding insult to injury, Baidu was even running a
commercial on Chinese TV ridiculing the quality of Google's Chinese
search. By the end of 2006, some of the local media were already
anticipating the day when Google would exit China, just as eBay,
another supposed American world beater, already had.
Teething troubles

There
was a good reason for Google China's problems: It had few staff at the
start, and soon found itself facing a host of unforeseeable
obstacles."I was a general without an army," said Lee. The first
employee he hired, a developer, did not start work until January 2006.
In fact, a lawsuit brought by Microsoft, his former employer, had
prevented Lee himself from taking up his duties before September 2005.

Born
in Taiwan, Lee emigrated to America in 1973 while still in high school.
He later earned a PhD in computer science from Carnegie Mellon
University. While working as an assistant professor there, he developed
the world's first speaker-independent, continuous speech recognition
system, which BusinessWeek honored as the "Most Important Innovation"
of 1988. After leaving the university, Lee spent six years at Apple
Computer, where he developed QuickTime, QuickDraw 3D, QuickTime VR, and
PlainTalk speech technologies.

In 1998 he joined Microsoft,
where he was responsible for advanced natural language and user
interface technologies and founded Microsoft Research Asia, now
regarded as one of the best research centers in the world.

By
2005, he was ready to embark on a new journey with Google, but
Microsoft was not ready to let go. It sued Lee over the one-year
non-compete agreement that he had signed in 2000 on becoming
Microsoft's corporate vice president of interactive services.

The
lawsuit was barely out of the way when it became clear that while
getting a license for Google's research and development center would be
easy, the same could not be said of its website, Google.cn. "The
government tightened the approval process for foreign companies to get
ICP licenses," said Lee. An ICP, or internet content provider, license
is a must for all websites in China. While obtaining an ICP license is
a fairly easy matter for domestic players, Google did not get its own
until mid 2007. So it had to use a license "borrowed" from a local
player, Ganji.com, a classified advertising site that Google had once
considered acquiring, said Lee.

As Lee recalls, much of 2005,
the first year of Google China, was spent on preparation: getting
licenses, signing deals with partners, recruitment, and market
research. To better understand local requirements, Google interviewed
the Chinese advertisers who were bidding for keywords via the AdWords
service on its American site. But it understood that the majority of
Chinese small businesses were not so tech savvy. Rather than rely
completely on its online channel, Google followed Baidu's lead and used
third-party sales agents to target small businesses.

Traveling
executives from the American headquarters carried out most of Google
China's work in 2005. They signed up 25 local agents to be Google's
resellers in China.

Much of Lee's work in his early days was
hiring staff. He trolled for young talent in China's top universities.
Luckily, backing from headquarters was strong. "As long as I can find
qualified talent, there is no limit on how many I can hire," said Lee
in an interview in October 2006. By the end of 2006, Lee had recruited
over 300 staff, and the hiring continued.
Growing up in China

Real
work at Google China started in 2006. "The first thing we did was to
improve Chinese search. And that occupied most of our time in 2006,"
said Lee. Google's search engine was designed to support multiple
languages. At the time of its IPO in 2004, it supported at least 97 of
them, including Chinese.

The Chinese language presents its own
peculiar difficulties, however. Chinese consist of phrases, equivalent
to words in English, which are formed by multiple characters. A search
engine must index and segment the Chinese text phrases before
conducting keyword/phrase searches. Moreover, a Chinese language phrase
generally has more synonyms and closely associated phrases than an
English word. As a result, a Chinese language search engine must have a
comprehensive database of these synonyms and phrases in order to
function effectively. "For example, one of the top universities in
China is Tsinghua University. It is commonly known as just Tsinghua
(清華) in China. So if users search for the keyword university (大學),
should pages that contain only Tsinghua be included in the search
results?" said Lee.

Because Baidu was built to optimize Chinese
search from the start, the developers bore all of these factors in mind
when the system was built. Initially it was better at Chinese-language
search than Google was. But by 2006–07, most analysts agreed that
Google's Chinese search results were at least as good as Baidu's.

"In
2007, while we continued to improve our Chinese search, we started two
major non-search development programs: mobile search and map," said
Lee. Google China signed a deal with China Mobile, which serves more
than 70 percent of the country's cellphone users, to be its mobile
search provider in 2007. Developing mobile search features became a
major task for Google China in the next few years. Its developments in
map not only allowed users to find local businesses, view maps and get
driving directions, it also resulted in some applications with high
social impact. For example, a real-time map could be viewed showing
rail traffic around the Chinese New Year holidays, when people
traditionally return to their families and train stations are packed.

In
May 2008, an earthquake in Sichuan province killed at least 80,000
people. Google China launched a special real-time map that showed
people who wanted to make donations or offer direct help what resources
were needed in each of the affected districts. Such initiatives have
helped Google to improve its relationship with the Chinese government,
said Lee. "We now have regular meetings with the government to
understand their policy about the internet," he added. (Improving the
relationship with the Chinese government was important. A former Google
staffer considered government relationships to be an obstacle that held
back Google's development in China.)

After Google's CEO
Eric Schmidt visited China in April 2007 to show his support for the
China team, things started to improve. By mid 2007, Google's market
share had rebounded to 22 percent, according to Analysys International.
"Our efforts paid off. By 2008, our traffic in mobile search and map
increased by four times," said Lee. Market share had reached 26 percent
by the middle of the year. "Comparing the fourth quarter of 2008 to
that of 2007, our sales in China increased 109 percent," he continued.

In
2009, Google China began a new project to develop its advertising
products, AdSense and AdWords. In late 2009 [Before the current
controversy – editors] it had planned to start a music service that
would resemble Baidu's controversial MP3 search feature, but run on
legal music files.

"We have formed a joint venture with Top100 to offer ad-sponsored
streaming music or music download services," said Lee. Top100.cn is a
legitimate music site in China founded by NBA superstar Yao Ming, Gary
Chen, and Erik Zhang in 2006. Google purchased a minority stake in
2007. The new service will offer free music; music companies, Google,
and Top100 will share the revenue generated from selling ads on the
site. Lee said the service may offer little profit in the near term,
but in the long term it could change the way the music industry
worldwide does business.

"The music industry is seeking new
direction," said Lee. "China represents a good opportunity for testing.
If our model works, it may become a global trend."

china-googlegraph

Figure 4.2: Google China's market share in search engines (mid 2005–end 2008)
Data source: Analysys International
Transformation

In
adapting its business to China, Google seems to be a faster learner
than some of the American internet firms that entered China before it.
"We are latecomers. But being a latecomer has its advantages," said
Lee. "By the time we entered China, its importance had been proven. It
was the largest internet market in the world. Our headquarters fully
supports our operation and has delegated a lot of power to the local
team."

Lack of local autonomy and lack of support from
headquarters are factors that tripped up other American internet firms
making forays into China. The importance and the complexity of the
Chinese internet market were both underestimated. But Google seems to
have learned from their mistakes. There is only one layer of management
between Schmidt, the CEO, and Lee, the China head. And Lee said he
meets Schmidt regularly, almost every month, to brief him on the
situation in China.

How different from the experience of eBay.
"When eBay China moved its computer platform from China to America in
October 2004 traffic dropped by half on the very same day. But Meg
Whitman, then CEO of eBay, didn't find out about it until a month
later," said Bo Shao, founder of EachNet, which was sold to eBay in
2003 and became eBay China.

After the platform was moved to
headquarters and consolidated, eBay China lost control over its
website. "It took nine months to make any major changes and nine weeks
to alter a word on screen," said Shao. "This is unthinkable for an
internet business, which needs to be able to react rapidly to the
market."

"Such things could not happen to us," said Lee. Google
China has relatively good control over its technology platform. The
search service and ad platform (i.e., AdWords and AdSense) are core to
Google's technology. As mentioned before, Google China started
optimizing its Chinese search functions in 2006. In 2009, it started to
develop its advertising product for China.

It also seems to
have studied Baidu's moves closely. And it is not ashamed to imitate
the local market leader when it makes sense. "We are humble and we
listen to what the local market wants," said Lee.

The first
instance of this was Google China's decision to employ agents to sell
keywords. It also followed Baidu's lead in targeting the customers of
internet cafés. After Baidu bought Hao123.com, the directory website
most popular with internet café patrons, Google bought the second most
popular, 265.com.

Taking another leaf out of Baidu's book, it
lobbied with internet café owners to make its website (Google.cn) the
default search engine on their computer browsers. Lee arranged for
Google headquarters staff to visit internet cafés, so they would
appreciate how important internet cafés were as the point of first
contact with search engines for many young internet users in China.

In
response to complaints that the "Google" name was too difficult for
Chinese users to remember, it registered "guge.cn," which is the Pinyin
of its Chinese name , and a simpler version, "g.cn," at the risk of
being accused of diluting its brand image.

Moreover, Google
China has developed a lot of new applications for the local market.
These include the Pinyin inputting method and Shenghuo, a website
devoted to daily essentials, such as train time tables, apartment
rentals, and job hunting. And there were many other small developments
or adjustments that Google made as it acclimatized to the Chinese
market.

By early 2009, Google had around 800 people in its China
office. Most analysts believe its sales and profits have been growing
at a healthy rate. Nevertheless, it still lagged behind Baidu by a wide
margin. At of the end of 2008, the local rival controlled an estimated
60 percent of the search market, compared to 30 percent for Google,
according to Analysys International.

Baidu was just more
resourceful and aggressive. It operates on a much larger scale than
Google in China, and has tried that much harder to win traffic and
customers, sometimes crossing ethical and legal boundaries in the
process. The Chinese government's interference also helped to divert
traffic from Google to Baidu—a point we discussed in the last chapter.

Moreover,
a common criticism of Google China is that it is still not localized
enough. "If more of its decisions were made locally, Google would be
more successful in China," said T. R. Harrington, director of Darwin
Marketing, a search engine marketing firm based in Shanghai. Darwin
deals with both Baidu and Google on behalf of its clients.
Google's edge

Nevertheless,
Google has competitive advantages of its own, because of its technology
and global presence. Three in particular stand out: 1) Google's
advertising platform; 2) the size of its partner network; and 3) its
global reach.

1 Google's advertising platform
Because of its more advanced
technology, Google can match ads with keywords better than Baidu,
giving it a higher traffic-to-sales ratio.

Advertisers can also
target their ads more precisely on Google, leading to a better response
from users. "Third-party research has shown that while we have around
24 percent of total search engine traffic we have around 30 percent of
total revenue," said Lee.

Of course, advertisers in China may
not yet be technologically savvy enough to appreciate these
differences. The average spending of Baidu's clients was only US$674
per quarter in late 2008. But as they gain in sophistication, the
advantages of using Google's ad platform may become more apparent.

2 Its larger network of partner sites
"The virtuous cycle
kicked in quickly for our partner program. As our technology is better,
which results in a higher click-through rate of ads on our partner
sites and more revenue for them, more websites became our partners,"
said Lee. Moreover, it gives its partners a bigger share of ad revenue:
60–70 percent, compared to Baidu's 30–40 percent, according to one
industry insider.

"Google AdSense quickly became China's number
one alliance program," said Lee. Over 200,000 sites have become Google
partners, including some of the biggest names, such as Sina, the
leading portal. The partner sites help Google to build its brand in
China, as well as increase its traffic and revenues.

3 Global reach
Another advantage Google China has is its
global reach. Many small businesses in China are using it to market
their products and services overseas. Baidu cannot help them because it
lacks an audience outside of China. (Baidu has launched a Japanese
search site that has not proven very successful so far.) With time,
some experts say, Google can become a more serious threat to Baidu.

"Among
all the internet businesses, search engines are among the few that
require core technology. That gives Google an edge. I believe it can
narrow its gap with Baidu in the longer run," said Joe Chen, CEO of Oak
Pacific.

Bo Shao, founder of EachNet, which was sold to eBay to
become eBay China, said: "I believe search is still in its infancy, so
if Google manages to come up with a technology breakthrough that
dramatically improves its user experience, and if Baidu fails to catch
up quickly, Google might have a chance in China. Barring that, I
believe Baidu will remain the search leader in China."

Future tech
As
computers and broadband services get cheaper, more people in China are
going online. The internet is reaching beyond the big cities into
remote areas. Users are no longer just university graduates, but also
kids, teenagers, factory workers, and the elderly.

"Given that
new internet users in China are currently concentrated in second- or
third-tier cities and among low-end users, Baidu will continue to lead
over the next five years," said a hedge fund manager who invested in
Baidu.

Google, on the other hand, appeals to high-end and more
experienced users. As the country's internet population matures, more
users will prefer Google to Baidu. However, this could take a long
time, as Chinese internet penetration was only at 25 percent in June
2009.

Around 2007–08, satisfied with its Chinese search engine
performance, Baidu began casting about for new opportunities. It
launched a Japanese search engine, and developed an online chat
platform, Baidu "Hi," to challenge the dominant QQ, which belongs to
local player Tencent. It also developed an online auction market, Baidu
Youa, challenging e-commerce king Alibaba's Taobao. These initiatives
could become profitable business lines, but they could cause Baidu to
lose its focus, giving Google a chance to catch up in search. Or, to
Baidu's peril, they could alienate Alibaba and Tencent, two of the
strongest internet companies in China. The next battlefield for Baidu
and Google will almost certainly be mobile internet services.

Google
has been the mobile internet search partner of China Mobile, the
country's dominant cellphone operator, since 2007. In May 2009, Baidu
became the internet search partner for a new mobile operator, China
Telecom. As well as the search function, popular Baidu applications
such as Baidu Knows, Baidu Post-bar, image search, news search, MP3
search, and so on, will be available on China Telecom's 3G platform.

The
country's second largest mobile player, China Unicom, has yet to pick
an internet search partner. But Baidu also has an agreement with China
Netcom, the country's second largest fixed line operator and internet
services provider, to provide an internet search page for its users.

Under
the telecoms restructuring plan implemented by the government in 2008,
China Unicom merged with China Netcom. If Baidu can expand its contract
with China Netcom to include mobile search, it will have the country's
second largest cellphone operator on its side, too.

And
following industry restructuring, cellphone services market shares look
likely to fluctuate more than they ever have. The dominant fixed line
operator, China Telecom, acquired the CDMA (Code Division Multiple
Access) cellphone network of China Unicom and is developing its 3G
network using the CDMA-2000 standard. China Unicom keeps its GSM
network and offers 3G via WCDMA, a mature technology already in wide
use internationally.

China Mobile, which owns over 70 percent of
the cellphone market, will be using the unproven domestic technology
TD-SCDMA to offer 3G services. If TD-SCDMA gets off to a rocky start,
China Telecom and China Unicom could gain ground on its rival.

As
mentioned, Google China has worked on mobile internet since 2007. Its
headquarters launched the Android program to make internet-ready phones
easier to produce. "Many applications will be even more useful over the
cellphone. For example, Beijing is often choked with traffic. For
people who are driving, a real-time traffic map of the city available
on cellphone will be very useful," said Lee. "Google has an application
called Latitude. It shows the location of a user's friends so that the
user can message them to arrange a get-together, say. This kind of
application will be more useful in a cellphone whose location is
changing as a person travels than in a PC whose location is always
fixed," he added.

Applications that use GPS and cell
triangulation information to determine the person's location and show
restaurants, cinemas, and other nearby points of interest are
increasingly popular and numerous in America and Europe. But some
industry insiders feel such Google applications may be too
sophisticated for the broad Chinese public.

"In our experience,
cellphone users are generally more low-end than people who use a PC to
access the internet. They prefer entertainment and simple
applications," said Jay Chang, CFO of Kongzhong, a leading mobile data
service provider in China. In Chang's view, the ideal mobile internet
applications are multiple-player games and novel downloads.

Baidu
has yet to launch special cellphone applications, but some analysts
believe its share of mobile traffic is larger than Google's merely on
the strength of its local name recognition. Baidu has also teamed up
with handset makers such as Samsung, Lenovo, Nokia and Motorola—one
development is the pre-installation of a search box on the handset,
making it easy for users to access Baidu's service. However, the site
that attracts the most cellphone traffic belongs to neither Baidu nor
Google. It is Tencent's QQ.com, the dominant online chat platform.

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