Search party

As industry insiders know, the battle for share in China's Internet search space, the second most popular application (after e-mail) in the world's second largest Internet market, is heating up.

With only 94m mainland Internet users (growing an average 25% a year over the next three), China's RMB2.25bn (US$273m) search engine market has growing to do. But the market is shifting up, evidenced most recently by a bid for a Nasdaq listing by Baidu, China's top search engine company. "

While the search advertising market is still relatively small, it will likely track what has happened in the US," says Victor Koo, former COO and president of Internet portal operator Sohu, which has a tiny piece of the market.

Search business pays
Online search advertising sales, largely driven by growth in the US, are projected to increase to more than US$5bn by 2008, up from US$2.7bn last year, says market watcher optionetics.com – though click fraud, which involves inflating hit numbers, could dampen that pace, warns Forrester Research, which revised its 2005 year-on-year sales growth projection down from 45% to 30%.

Revenue in China comes mostly from SMEs – 20 million of them. Last year, Sohu, a distant fourth in the search space with its Sogou engine, collected US$10m from 84,000 search advertisers in a 60%-40% split between "pay-for-performance" and "paid inclusion" revenue respectively. Under pay-for-performance, the primary revenue model used by Google and Baidu, advertisers bid for prominent sponsorship links when search keywords are triggered.

Paid inclusion charges a fixed rate depending on the keyword. Currently, Sohu's paid inclusion customers pay annual fees of US$50 to US$300 for keywords ('monopoly' won't command the same premium as say 'green tea' or 'mobile phone') and pay-forperformance customers pay RMB0.50 and RMB3 per user click.

Another pay model is "address search", which accounts for 40% of Yahoo!'s search revenue. Yahoo! has a virtual monopoly on address searches, thanks to its 2003 acquisition of 3721 Network Software, which developed the technology to translate Chineselanguage keywords into Roman alphabet domain names. From the 3721 site, users type the Chinese name of a organization instead of the long domain name address unknown to them. For now, pay-for-performance seems to be the winning model, but this is early days. "The pricing model for search in China is still in its formative stage," says Koo, who thinks future models could integrate other ancillary markets, like ecommerce.

In addition to pure plays like Baidu and Google, China's search market has attracted other portal operators like Netease and Sina, but they have largely been written off. Kelly Huang of i-Research says Sohu might just be the one general portal to weather the competition, if only because it offered search before Baidu, giving it some command on user loyalty.

Those earlier mass desertions from pioneering search sites to Google suggest otherwise, but Sohu is taking the business seriously, even if has less than 5% of the market. Promising to boost search traffic this year, Sohu recently upgraded its search engine to speed-track 500m web pages, and says it will push that page count up to 1bn in months.

Sohu says it expects its search revenue to grow 30% this year. "It's not too late for us," says Caroline Straathof, Sohu's investor relations director. "It will take some time, but we have the right strategy and the right technology."

On the tech front, Google just released a winner that goes beyond web search: its desktop search software which enables users to search files and emails on their PCs in simplified Chinese characters – from a Web browser. "Google's integrated approach means it will be the 'go-to' for all the search functions," says Edward Dong, an analyst with Zero2IPO.com, adding that the one-stop strategy will also cement user loyalty.

The big local guy
Baidu, now in its pre-IPO quiet period, also has a desktop product. "Its strength is in knowing the local market [and] turning up relevant results," says Dong, who also likes what Yahoo! has been doing. iResearch's Huang agrees, saying Yahoo!'s progress in MP3 search looks promising and its search engine, Yisou, meaning 'number one search engine' in Chinese, continues to make gains.

Entering the market only last year when it took an undisclosed stake in Baidu, Google, still needs a proper foothold in China, and soon – because Yahoo already has solid sales and distribution now and excellent local market capability through its 3721 property. Google got into trouble over China's finicky censorship rules, something Yahoo! has been clinically careful about. But Yahoo stumbled in the early days, too, thinking the mainland would be a cakewalk from Taiwan.

Yahoo! plans to invest US$20m in its China operations to become China's no 1 search engine, delivering more localized products than anyone, according to company spokesperson Jenny Xiao.

Bets are China's search market will come down to Baidu, Yahoo, and Google. "These three players have best all-around performance in the search market," Dong says. And with Baidu's planned IPO on the horizon, Dong says "the big will become bigger."

Speaking of which, where is the Big One? Dong says Microsoft is making its way into China, with its search tool already integrated into the latest MSN messenger. That's right, and didn't Bill Gates say everything would be integrated into Windows by 2006?