Google's recent announcement that Chinese government interference might drive it out of what is set to become the world's biggest Internet market was a surprise, especially when Google China's business is in fact getting better fast and it appears to have the momentum against its Chinese rivals.

In particular Google has recently begun to make inroads on the local leader and key rival, Baidu, with its fourth-quarter 2009 share of the market growing to 35.6 against 31.3 percent in the third quarter, while Baidu's share fell to 58.4 percent from 63.9 percent, according to Analysys International, a Beijing-based market research firm. This is a dramatic upsurge from three to four years ago when its share was as low as 16 percent in the second quarter of 2006, a year after it set up its China office. At that time, Baidu had 50 percent, Analysys said.

Google does not disclose its financials in China, but there is certainly no reason to assume it is not profitable. Baidu, its key rival, reported net profit of about US$153 million on revenue of US$468 million for 2008, when it said it had 6,387 employees. Google's revenue would have been perhaps half or two thirds that, but it likely has a much lower cost base than Baidu, since Google employs about 800 employees in the country and can use technology developed by its US headquarters.

Google has the impetus to do even better. It developed a mobile search function much earlier than Baidu, starting in 2007 in partnership with China Mobile, the country's biggest mobile operator according to Google's former China president, Lee Kaifu, Baidu only began developing mobile search last year and last May partnered with the smallest of the three operators, China Telecom. As 3G rolls out, more and more people will search the internet with their phones, making Google's advantage even more apparent if it stays.

A further 5 percent gain on Baidu would bring Google to 40 percent against Baidu's 50-55 percent and it would no longer be just a small rival but rather be a serious competitor to Baidu and a powerful player in China's Internet space.

So why leave China now? With 384 million users, China has become the world's largest Internet market and it is still growing very fast – users increased 28.9 percent from a year earlier, according to CNNIC, a Chinese government-backed research institute. Moreover, it has a lot of room to grow, as only 29 percent of China's population is online. Why walk away from such potential when your China operation is in fact doing well?

An industrial insider suggests Google may be playing high-stakes chess. The California-based company's announcement (link: New Approach to China) said it detected "a highly sophisticated and targeted attack originating from China" and said "a primary goal of the attackers was accessing the Gmail accounts of Chinese human rights activists."

Then after a long discussion of the significance, Google said, "We have decided we are no longer willing to continue censoring our results on Google.cn, and so over the next few weeks we will be discussing with the Chinese government the basis on which we could operate an unfiltered search engine within the law, if at all."

At first glance, that looks like a suicide note. The Chinese government doesn't back down on foreign company threats. Dick Wei, China Internet analyst for JP Morgan, predicted Google would leave by February. Most analysts agreed.

But let's look closer to the announcement. Human rights and unfiltered search result are related, because freedom of speech is part of human rights. However, they are separate issues. Google mentioned the hacker attacks to human right activists' account as the pretext of its intention to run an unfiltered search engine in China. Just as Microsoft's CEO Steve Ballmer said, "There are attacks every day." So why now?

China is not the only place Google censors search engine results. In France and German, it bans neo-Nazi information. To abide by obscenity laws, Google strips out certain pornographic results from its Indian search pages. Google also blocks Thai users from viewing Youtube videos insulting to the king.

Google may have hard evidence tracing the hackers to the Chinese government. As the world's largest search engine, it should have the technology and capability to trace the hackers back to their origins. The company may have given the evidence to the US government, which is why Washington is willing to back it up.

"We have been briefed by Google on these allegations, which raise very serious concerns and questions," said U.S. Secretary of State Hillary Clinton right after the announcement. "We look to the Chinese government for an explanation. The ability to operate with confidence in cyberspace is critical in a modern society and economy," On January 21, she delivered a major policy address on internet freedom and called for China to investigate Google's accusations and be open about its findings.

With hard evidence on the hacker attack, Google appears to hope to use this as leverage to gain better cooperation from Beijing – and what it wants most is no censorship on search results. The pressure is ratcheting up on China as well from calls to take Beijing to the World Trade Organization for violation of global trade rules be restricting the free flow of information.

As Chinese online users approach 30 percent of the population, government Internet censorship is becoming harsher and harsher. Past experience shows that even with self-imposed censorship, Google.cn still upsets the Chinese government from time to time. Stated-owned China Central Television in a news program in December accused Google of providing links to obscene content.

(This was in fact not limited to Google. Some Chinese search engines, Baidu and Sohu's Sogou, also suffered.)

Google said at the end of its statement, however, that it would talk to Beijing in the next few weeks. What this may mean is: leveraging on the hard evidence of hacker attacks, Google wants to negotiate with the government for a better working environment.

So far, Beijing's reaction has been to stonewall – Foreign Ministry spokeswoman Jiang Yu said the company has to cooperate "according to law."Other foreign ministry officials echoed Jiang's statement.

But "China's Internet is open," Jiang stressed, "The Chinese government works hard to encourage the healthy development and expansion of the Internet, and works to create a favorable environment for that."

That may be an indication that the government is willing to negotiate. In the next few weeks, it will be interesting to see what comes out of this showdown. Is there an arrangement that would make both look like winners? This might be tricky, but not impossible. "According to Chinese law" can be quite flexible, as people doing business in China know.

One way of might be to let Beijing do the censoring, said an industry insider. Google will run the unfiltered search engine, and Chinese government can block any results they do not like, just as before Google formally entered China. Only the blocking might not be as heavy-handed as people expected. And Chinese internet users can still use Google for most of their daily searches.

If Google can negotiate delicately and find areas for compromise, it might have even more room to maneuver in the future. If that is the case, Baidu, whose stock price rose 10 percent right after Google's announcement, might be the one to be threatened.

Google is already the preferred search engine of many better-educated and wealthier Chinese internet users, especially in the major cities. The publicity Google gained over the incident inside China is like free advertising. Just look at the pictures of people placing flowers in front of Google's Beijing office. And contrary to some reports, local press carried those, too. (Here is a link to Global Times, a Beijing based newspaper).

More Chinese internet users seek out Google. They might do it purely out of curiosity, might just to see if there is a difference from Baidu. Some will stay, because Google is actually better in some aspects. For example, its translation and map applications are more sophisticated than Baidu's – and there is the mobile phone app.

Even if negotiations fail and Google leaves, that does not mean it is a total loss. Google's China business can be divided into three parts: 1) selling search ads to target the domestic market, i.e. Google.cn, 2) selling search ads to target the international market, i.e. Google.com, and 3) Ad sense Network, through which Google directs ads of its advertisers to websites that joined its affiliated program.

Only the first business is directly affected if Google.cn closes. Chinese advertisers who want to target the international market can still use Google.com. And Google's Adsense network can still operate for advertisers to reach Chinese consumers through hundreds of thousands Chinese websites which have joined Google's affiliated program. Google runs the largest affiliated network in China, with more than 200,000 websites including the leading Chinese portal, Sina.

History shows that Google has done what has seemed antithetical to its business model on the surface, but smart in retrospect -- for example, the spectrum auction in the US, the Android free mobile phone software, the original idea of a stand-alone search website with free results paid for with text advertising, etc. This showdown with China might be another huge bet the search engine giant made, which might pay off in the end.

No matter what happens in China, Google has already won this chess game -- the hearts of its global audience, especially those in the US. The positive publicity generated can help to secure Google's position as the number one search engine in the world. If it were to really leave China and close its offices, it would lay off about 800 people. That might damage Google's image of "do no evil" in China, but worldwide that is another question.

Sherman So is co-author of Red Wired: China's Internet Revolution (redwiredrevolution.com)