Baidu - Icarus in the Making?

Note: this post was carried today on Wallstrip

Overview

Baidu is an awesome company. Their success in fending off, no, actually trouncing, the likes of Google and Yahoo! at home is something to behold. They have been at this six years and kicking some serious butt in the process. However, now they are getting aspirational and wanting to compete in far-flung markets against both global and domestic rivals. They’ve got something really good going in China with lots of organic growth on the horizon, but they are getting pushed to go toe-to-toe with the Googles and Yahoo!s of the world. Making money is not about ego and it’s not a bloodsport, its about using cool, calm rationality to crush the competition. I’m concerned that ego might be pushing Baidu towards sub-optimal expansionist behaviors, flying so close to the sun that their metaphorical wings might melt. And it is this conscious ascent challenged by forces of gravity that should be watched very, very carefully.

China and Search - Why it’s a Unique Landscape

China has a culture and a control structure all its own. These “terms of trade” have made it very difficult for foreigners to effectively compete against Baidu’s local presence and influence. And this is in addition to factors such as government regulations, language barriers, cultural barriers, and nationalistic appeal that give local providers the inside track against powerful offshore competitors. This was clearly highlighted in a fascinating story in the Chicago Tribune:

With Li at the helm and the stock now trading around $110, Baidu has built a dominant position. It has astutely designed features that appeal to Chinese users, beat its competitors to market and cast its most lethal opponent, Google, as a foreigner with suspicious ambitions.

Baidu’s none-too-subtle use of nationalism was on display in a recent online advertising campaign. It didn’t slam Google by name, but it featured a group of villagers accosting a foreign couple. “You don’t understand us, you don’t understand us,” one village elder scolded the outsiders. In a country with an ingrained distrust of outsiders, the message resonated.

Li, who was educated in the U.S. and helped design the pioneering search engine InfoSeek, has no qualms about playing the nationalism card. “We think search is not just about technology,” Li said. “It’s also about language. It’s also about culture.”

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Since it first became available in China in 2000, Google.com has been plagued by sluggish performance and frequent breakdowns. Google says Baidu gains an advantage because Chinese service providers deliberately slow Google’s service. And any search terms deemed politically sensitive–”Tiananmen Square” or “Dalai Lama”–slow the service even more. Repeated efforts will sever the Internet connection.

Chinese citizens need no explanations, of course. They know the telltale signs of censorship. Since Google has no servers for its site inside China, it is believed that sensitive Google.com queries get caught by censors as they exit China en route to Google’s servers outside the country–”the Great Firewall of China,” some have dubbed it.

Another interesting post further amplified the value of being inside the Great Firewall:

Partisans of Baidu, the main local search-engine company (which is listed on NASDAQ and has Americans as its main investors) recently ran a blog campaign touting it over Google. One illustration was Google¹s supposed inability to return any results for searches on ³Nanjing Massacre² (or ³Nanking,² the older Western spelling) whereas Baidu returned plenty. There was a technical reason”Google¹s servers are outside China and thus must cross the government¹s ³Great Firewall² to send results to users in China. The firewall routinely screens out references to ³massacre,² as in ³Tiananmen Square massacre,² and so it blocked Google¹s results. Baidu¹s servers and resources are all inside the firewall, and have been pre-scrubbed to remove references to Tiananmen and other prohibited topics. Google has since made adjustments so that it too can report on Nanking, but the episode showed the sensitivity of the issue.

The Rise of the Blogs - Baidu Beware

Another interesting point to note is the rising importance of blogs in China, a place where Baidu is currently not a big player:

Loverty made an interesting comparison in his blog post today. Based on Alexa data, he compared the percentage of traffic to blog service in overall traffic of China’s major internet portals, including Sina, Sohu, Netease, QQ and Baidu.

According to Alexa data, QQ’s Q-zone service is the most trafficed service among all QQ’s services, it accounts for 19% traffic of QQ. (including the sub-domain of qzone.qq.com and q-zone.qq.com).

11% of Sina’s traffic comes from blog.sina.com.cn, which is the third most traffic service in Sina, just after Sina’s very popular news channel and sports channel.

Blog service of Sohu is its second most popular service as well, accounting for 8% overall traffic.

Both Baidu’s Space service (hi.baidu.com) and Netease’s blog service just contribute 1% traffic to their overall traffic respectively. In Netease’s new homepage, which is launched today, blog service has been emphasised, thus the traffic to its blog service is expected to increase significantly in coming future.

The data illustrate that blog service becomes more and more important to China’s web portals. However, among all five portals, only QQ has a viable business model of selling virtual items to its users to decorate their q-zone. Therefore, for Sina and Sohu, how to monetize these heavily trafficed blog service is an critical issue to deal with.

New Models of Search - Can Baidu Stay a Step Ahead?

Search in China appears to be a unique phenomenon. For example, pay-for-placement is frequently viewed as unethical in the U.S. but perfectly acceptable in China. However, paid search is rapidly being viewed as the last generation, with social search as the next frontier that must be achieved to stay ahead of the competition. This was well-addressed in a post by Gordon Choi:

Baidu as a search engine, like Google, has built a financially successful business around its paid search program, Baidu Jingjia. In China¹s Internet search market, paid search is regarded as the 3rd generation. However, Baidu is actively pursuing the next emerging stage of search ­ social search!

Baidu CEO Robin Li recently explained, ³In the next couple of years, social search in China will become very predominant. Search engines in China at the very moment is at the 3rd generation - paid search. And this is where Baidu is currently positioned and mastered.²

Earlier this year, Baidu has already shown active signs of digging into the social search area by launching some social verticals like Baidu Post and Baidu Baike.

I reckon the following are the 4 generations of Internet search in China:

1. The Keyword Count Generation: This is the pre-Google stage, though in China it barely had existed. However in the US, those search engines in the early years were very user-unfriendly in terms of search results. All they did to rank search results was to count the number of keywords (or keyword
phrases) entirely based on on-page factors.

2. The Link Popularity Generation: This is when Google and PageRank were born.

3. The Paid Search / Sponsored Search Generation: PPC advertising programs like Overture, Findwhat, Google Adwords, and Baidu Jingjia emerged to become monetizing channel of the search engines.

4. The Social Search Generation

So where does Local Search fit in? Maybe there is no place for it in China.

Manifest Destiny - Baidu in Japan?

Baidu recently announced its new Japan initiative, something that has quitely been in the works since May. They have been accumulating talent with pan-asian foreign language skills, preparing for their assault on new markets. The China Tech Stories blog had the coverage of Baidu’s Japan and Vietnam expansion plans:

In fact, rumor has been spreading inside the industry about Baidu’s ambition to expand internationally. Baidu has been working hard on the domestic market for six years and has fullfilled their goal to become the dominant player in China. However, comparing with the giants Google and Yahoo, with both have products in dozens of languages, Baidu is still small and weak.

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“Time for Baidu to go out”, analysts opinioned. If Baidu intends to become a search giant like Google, it is not enough to depend only in domestic market. Having already built up a strong base domestically, the time has come for expanding overseas.

Nevertheless, Baidu will face the same culture barrier when they enter the foreign market. At it’s IPO time, Baidu’s message to Wallstreet was :”The search engine who truely understands Chinese market”. Now preparing for entering foreign territory, it is yet known whether Baidu will be able to fit into the local cultures quickly.

Exactly. It’s not easy breaking into a new culture, as Google and Yahoo! know so well. So while Baidu has been massively successful at home, whose to say that they won’t encounter Google-esque problems as a newcomer to its target countries, say Japan? One mitigant is that Japanese searches use Chinese character sets, something at which Baidu has great expertise. These are smart people, to be sure.

So What’s Next for Baidu?

Baidu has been intensely client-focused while working to improve its core search algorithms. Its decision to introduce the Combined Ranking Index to its PPC algorithm has been hailed by several analysts as a vehicle for maintaining its leadership position and continuing its market dominance.

Baidu has changed its PPC (or Jingjia) algorithm since 11 Sep 2006 in which cost-per-click (CPC) is not anymore the only factor in determining its PPC ad rankings. Baidu has introduced the Combined Ranking Index to its new PPC algorithm which is determined by:

CPC x Keyword Quality

The higher the Combined Ranking Index of an individual keyword, the higher that keyword is ranked. Keyword Quality includes the following factors:

* Clickthrough Rate (CTR)
* Adcopy
* Landing Page
* Other Historical Factors

I believe obviously this is Baidu’s great advancement in terms of its PPC ad platform. The change is inevitable as two other American major PPC players MSN Adcenter and Ask.com Sponsored Listings have already included CTR and some other factors into calculating PPC ad rankings. By Q4 Yahoo Search Marketing (formerly Overture) will also be doing the same via its new PPC platform, Panama.

Further, Baidu’s partnership with Ebay will considerably benefit its market standing and improve the deployment of products and services, while adding more customers to the client base.

eBay recently announced to partner Baidu in China. The agreement between Baidu and eBay China (eBay Eachnet) includes the three major areas below:

* Baidu is to promote Paypal Beibao, PayPal’s service in China, as the preferred online payment mechanism on the Baidu Points platform.

* Baidu is to become the exclusive provider of text-based search advertising on eBay Eachnet. The testing of this text-based search advertising feature is expected to start in Q1 2007 with the full implementation in place by Q2 2007.

* Baidu and eBay Eachnet are to develop a co-branded toobar. The toolbar will let users to click on an eBay EachNet icon directly from the Baidu toolbar menu and be redirected to eBay EachNet’s online auction.

Conclusion

Baidu has made almost all the right moves in China over the past six years. They have exploited their position as THE local search company against their foreign competitors, used the structural advantage of having their infrastructure inside the country as opposed to their arch-rivals Google and Yahoo! and fully leveraged their local knowledge of language, customs and tastes. In short, they have used every asset at their disposal to kick the crap out of their competition. Bravo. But it is hard for me to see how these winning strategies translate abroad, where the terms of trade are different, the playing field level at best, if not tilted in their local competitors’ direction. And I haven’t even mentioned the real global threats, Google and Yahoo!, who have been competiting fiercely abroad for years. So as good as Baidu is in China, I am deeply cynical at their ability to make their strategies and plans take flight abroad. We’ll see - but I’ll bet it will be a turblent ride.

Thanks to Rob Passarella for his perspective, insights and research.
The author does not hold a position in the securities of Baidu.

Comments

[Yaser Anwar]

China has more Internet users than any other country and rapidly increasing levels of broadband penetration. According to Analysys International, the Chinese Internet advertising market will more than double in size from 2005 to 2008.

In 2ndQ of 06 BIDU was the leader in this segment, with 50%+ share of its revenues, followed by GOOG with 16.2%, and Alibaba.com (40% owned by YHOO) with 15ish%.

What investors need to consider though is rivals such as GOOG and Microsoft are much larger and better-capitalized companies than BIDU, and are aggressively investing in their Chinese Internet search capabilities and operations.

What worries me is Alibaba, given its unique and formidable combination of home grown Chinese businesses and management alongside financial resources contributed by YHOO. In addition, I think the company faces notable competition from a number of other Chinese Internet players that are much better diversified than BIDU.

That being said GOOG had similar problems, most notably increasing CAPEX quite significantly. As you know BIDU was a pioneer in online auction services, hence the 50% market leadership, and has around 102K active online marketing customers- no wonder it is said to be the GOOG of China