It was the consummate PR exercise. Bright lights, big names from US headquarters – and the questionable ethics of doctoring search results in exchange for access to the China market pushed as far to the side as possible.
Yet the attention to detail that went into the devising and launch of Google's new name – unfashionable "old dog" (Gugou) intended to give way to fresh-faced "harvest song" (Guge) – seems to have failed to score big with the people that matter most: China's Internet users. Soon after the name made its debut, petitions were circulating calling for a rethink, while domestic media accused the company of failing to understand consumer tastes.
Google's commitment to China is unsurprising. It's a compelling tech-led brand that has successfully sewn itself into the consciousness of a large part of the world's population. But operating in a market unlike any other, and facing a set of well established local players, money can only go so far in winning over consumers. Questions remain as to whether Google can reap what it has sown. "The business model for working in China is a local front office but a globalized back office," said Richard Ji, Internet analyst at Morgan Stanley. "The content supply and customer services need to be localized but things like corporate governance must reach global standards. Sometimes foreign companies get it the wrong way round."
The track record of overseas players in China's Internet industry is not strong. eBay arrived first in 2003 through the acquisition of Eachnet, then the leading domestic auction site; it has since been overtaken by Alibaba's Taobao. Yahoo bought China's first search engine, 3721.com, the same year; its pay-for-inclusion directory system was overhauled by the more powerful algorithmic models.
Amazon purchased online shopping site Joyo in 2004, but has failed to make significant ground on market leader Dangdang, while Expedia-controlled travel website eLong still trails rival Ctrip.
The criticisms of foreign firms' China strategies are both long and loud. A lack of understanding of the regulatory environment is cited as a key issue. A good relationship with the regulators – which inevitably involves complying with morally suspect state demands (See: The moral question: ceding to the censors) – is a must for those who want to get ahead. But this lack of understanding is also present on a far more fundamental level. Language barrier aside, foreign players fail to spend enough time looking into the practical and cultural needs of the market.
"The players that have the muscle to come in are large scale so they want to do things one way globally," said Richard Robinson, vice president at wireless value-added service (WVAS) provider Linktone. "But you need to have a team on the ground that is completely local."
Underlying this, though, is the sense that these US Internet companies, which successfully managed to overrun Europe, are underestimating the domestic competition they face in China. Just as US management models are alien to the Chinese market, so are American rules of engagement. "The Chinese companies compete more aggressively than the foreign ones," said Jason Brueschke, director of China Internet research at Citigroup. "The rules are different here – it's dirty, unsavory, like a knife fight. The ferocity of the competition is bare-knuckle."
Given the stakes being played for, perhaps this ferocity is understandable. EBay CEO Meg Whitman is often quoted as saying, "Whoever wins China will win the world," and the statistics seem to agree. As of year end 2005, there were 111 million Internet users in China, up 18.1% on 2004 and 179 times more than the 620,000 users recorded in 1997. IResearch expects this number to reach 338 million by 2010, as China supplants the US as the world's largest Internet market. The Internet penetration rate, currently around 10%, will break 25% in 2010, with penetration among the 200 million or so middle class closer to the 70%-plus level seen in the US.
More than 70% of Internet users are under 30 and over half have been educated to college level or above. In short, the Internet is already home to the next generation of high earners. Factor in China's 400 million mobile phone users – predicted to rise to 600 million by 2009 – who exhibit a larger appetite for mobile data than their Western counterparts, and you have a ready-made pool of customers for when the Internet shifts from desktops to mobile devices.
However, the full value of the Chinese Internet industry is still to be realized. Even if Google took majority control of China's search market, the impact on its current balance sheet would be minimal. "In five to 10 years it will be enormously important and so what we are seeing is a great game being played out here," said Citigroup's Brueschke. "The companies have to get in now or they will be excluded."
For Google, it comes down to gaining a foothold in the advertising market before first mover and current leader Baidu has it sewn up. Sohu's fast-emerging Sogou search engine and the Alibaba-run Yahoo are also likely to play key roles. According to iResearch, Baidu was the search engine of choice for 45.7% of users as of May 2005, while Google's share was 22.8%, a significant decline on the 30.1% it recorded in December 2004. The other players were all under 10%. But the rise in the competition since then means Baidu's lead is by no means insurmountable. A recent Citigroup report identifies the next 12-18 months as a key period in deciding whether the company can retain its stranglehold on the market in the long term.
While it is unfair to characterize the Baidu-Google contest as a battle between local knowledge and foreign wealth and expertise – Baidu is technically strong and well funded and Google has wasted little time hiring local talent – that is where the comparative strengths lie. "Google still needs to go through a learning curve with Chinese language search," said Morgan Stanley's Ji. "But it has succeeded in most other markets because it is the king of Internet technology."
As it closes in on Baidu in terms of technology, the accuracy of Google's search results will bring users, and therefore advertisers, to its website. However, the changing nature of China's online advertising market means first place won't be decided on web traffic alone. Traditionally, online advertising has involved buying banner space on a website with payments dependent on how long the ad stayed there. This has – and still does – make well-used portals such as Sina and Sohu very rich, but the future is likely to see significant growth in pay-for-performance (P4P) advertising on the search engines. "I think as the advertisers and agencies become more educated they are going to demand more results and data," said Linktone's Robinson. "The portals have had it easy charging US$5,000 a month for a banner ad."
The big spending currently taking place in the country's advertising market as a whole has propelled online marketing forwards, with advertisers keen to tap the ever-expanding base of Internet users. Online marketing was worth US$403 million in 2004, according to iResearch estimates, and this figure is expected to reach US$3.62 billion by 2010. Paid search – whereby companies pay for their name to appear on a search results page – currently accounts for 45% of the market to brand advertising's 54%, with email advertising making up the difference. Come 2010, the balance will have swung 57%-42% in favor of paid search.
The appeal of paid search is obvious: the ads are relevant to the user's search field, so the user is more likely to be interested in the companies' products. No other media can be tailored so precisely to individual demands, and it means small specialist companies can reach their target markets for a reasonable price.
The system has evolved from simply paying to appear in a company directory linked to an address bar search, through paying for a fixed ranking on a "natural" list of search results, to payment according to how many times users click on an ad placed next to a truly natural set of search results (P4P). The more natural the results, the more appealing they are to the user and this is likely to see the P4P share of the paid search market go from 51% in 2005 to 71% in 2010. Advertisers also benefit as they only pay when someone is genuinely interested in the products they're offering.
"If you want to target individual consumers, sponsored search is a beautiful way and it really helps the little guy," said Citigroup's Brueschke. In China's case, the little guy is the country's 25 million small and medium-sized enterprises (SMEs). Less than 2% of SMEs have websites and only a tiny proportion of these companies advertise through paid search.
Therefore they represent an enormous potential source of revenue – iResearch expects the number of SMEs using online marketing to rise from 410,000 in 2004 to 1.6 million by 2010 – but one that is largely ignorant of what P4P can do for their business. "There is a need to educate the smaller companies because they don't know the details about P4P advertising," said Hou Tao, deputy research director at iReseach. "In South China local media groups are running P4P promotions to achieve this." Quite simply, the search providers have to approach the advertisers, which means Google's tried and tested US method of having companies sign up online for advertising packages is ineffective.
The battle of the search engines will be won in the streets and, as the first mover in P4P, Baidu has built up a formidable sales network. A direct sales team of more than 600 targets large companies in major cities, but the real SME inroads are made by a 200-strong group of independent local distribution companies spread across the country. They are responsible for identifying, educating and billing advertisers.
Strength in sales
Google has been busy recruiting distributors but it remains to be seen how effectively it can tap the massive SME market. For domestic rivals Sohu and Alibaba, the barrier is not so high: they already have large sales networks from their other Internet businesses that can be used to pull in advertisers to Sogou and Yahoo. Although new to search, Alibaba can fall back on customers that already use the company's business-to-business platform as well as the sales team that brought in these customers in the first place.
"The same advertisers who advertise on Alibaba and Taobao also use search advertising," Alibaba founder and CEO Jack Ma told CHINA ECONOMIC REVIEW earlier in the year. "We now have both marketplaces and search advertising to help our customers market themselves. Although we are now in a come-from-behind position against Baidu we still think there's time to catch up."
Yahoo's decision to hand over US$1 billion and all its China assets – including 3721.com, which although out-dated is still thought to have 400,000 business customers – in exchange for 40% of Alibaba represented a new strategy for foreign Internet players. According to Citigroup's US-based director of Internet research Mark Mahaney, it "was interpreted as a defensive move", a plan B implemented after Yahoo had failed to make progress organically or through 3721.com. But it may turn out that by effectively outsourcing its China operations to Alibaba and committing its technical know-how to the venture, Yahoo has found a way to match rival Google.
"If the heart and soul of search is being able to attract people then there is no one better than Jack Ma," said Citigroup's Brueschke. "Alibaba is the best marketing company in China because he is a genius in building brands. If you had to point to the poster child of domestic firms out-competing the US, it's Jack Ma." Ma has certainly positioned his company well to exploit future growth in China's e-commerce market. The Yahoo deal added a business-to-consumer arm to business-to-business platform Alibaba and consumer-to-consumer auction site Taobao, with all three areas able to complement the others.
When it comes to competition, eBay can testify to the power of the Jack Ma effect (See: Burnt fingers: eBay gets Taobao-ed). It took Taobao less than a year to supplant eBay as China's leading auction site and while Ma believes there is little or no way back for the US giant, it could still find redemption because it has experienced in other markets the trajectory China is likely to follow. To a large extent, eBay's riches have been built on the foundations of the consumer credit system. A key barometer of which companies will become the major players in China's e-commerce business is how they respond to the growth in credit card use.
While the monetization of search hinges on persuading advertisers to part with their money, e-commerce is dependent on making it easier for the public to spend theirs. China's movement from an investment-led to a consumption-led economy is well documented; the positive effects will be felt by auction sites, online travel operators (See: Click to book: travel services thrive on the net), job sites and e-shopping channels.
"Right now credit card usage is less than 1% so it's a bit too early to say what will happen," said Morgan Stanley's Ji. "But eBay has global strength which it can leverage to bring its businesses together." Alibaba's AliPay system acts as an independent third party that holds the money put forward by the buyer until it receives confirmation that the seller has made good on the delivery. Ma points to this escrow-based model as evidence that e-commerce doesn't depend on credit cards and, similarly, Expedia's Asia Pacific president Barney Harford says eLong has payment and delivery procedures that work around the credit issue.
But there is little doubt that when credit cards hit the mainstream, consumers will have greater license to spend and this will take the gathering wave of e-commerce to an even higher peak. eBay's PayPal system, which has considerable experience facilitating electronic trade, launched in China last year and already links to more than a dozen local currency accounts and 20 or so debit cards. Beyond that, should restrictions on yuan leaving the country be lifted, eBay has a pool of 100 million users in 55 countries and regions waiting to do business with China. As well as straight consumer-to-consumer transactions, it could present SMEs with a cut-price means of exporting goods overseas.
The credit card effect is not limited to auction websites. Any e-commerce activity that involves a consumer making a financial transaction will become more convenient from air ticket bookings to luxury food orders. Even the online game companies, already equipped with strong networks of retail outlets and Internet cafes through which to sell gaming cards, can expect a boost in revenues as gamers start topping up their playing credits without leaving the sofa. But the biggest impact will be felt by the WVAS providers that, unlike their online games counterparts, don't currently have control of billing services (See: The operators' gambit: challenges of WVAS).
Indeed, the shift to monetization, and the knock-on effects it creates, will ask questions of all domestic players irrespective of foreign competition. The fact that this is taking place at the same time as a migration from desktop to mobile Internet usage only serves to add to the pressure.
It is the portals that face the sternest strategic challenges. Sina and Sohu's dominance was built on moving first to occupy a particular niche – news for Sina, entertainment-driven content for Sohu – and then maintaining it as the users flowed in. The strong flow of advertising money means these portals will remain in the top tier but they are still being forced to respond to rising competition in the sector.
"I think the portals are in for a lot more challenges," said Linktone's Robinson. "They're stuck in the circa 1995 approach to the Internet ad industry. There's been a view that you must be on a portal to attract customers – it's like being above the fold."
Both Sohu and Sina have been busy buying up smaller operators in a bid to differentiate their businesses. Sohu's acquisitions include alumni site ChinaRen, online games portal 17173.com and real estate portal Focus.net. All are leaders in their fields, which suggests that Sohu is trying to lock up certain channels, providing a guaranteed user base. It has also developed its Sogou search engine. "In the medium to long term, can you get by without a healthy search business? The conventional wisdom is no," said Citigroup's Brueschke. "Sohu realized this two years ago and started to build its own algorithm."
Sina, whose iAsk search engine is experiencing slow growth, has aggressively pursued WVAS, acquiring specialist providers Memestar and Crillion. The company's WVAS revenues had crept to US$35.7 million by the end of 2004, 62% of total revenues against advertising's 32%, but the subsequent decline in stock performance has been blamed wholly on this WVAS strategy. A Citigroup report savaged the company for investing US$6.7 million-plus in a TV ad campaign promoting SMS ring tones in a bid to revive its WVAS fortunes, saying it was killing the stock.
The report even suggests that Sina would have been better off "taking this US$10-11 million and out-bidding Sohu for the exclusive sponsorship of the 2008 Beijing Summer Olympic Games". Underpinning this argument is the belief that SMS, which makes up the bulk of Sina's WVAS revenues, is "yesterday's technology". SMS will remain important but the key money-spinners will be MMS, WAP, mobile gaming and mobile music.
Sina's strength appears to be as a platform for accessing these services, not necessarily as a provider of them. Across the industry, it is the companies that are focused on particular areas that are leading the way. Baidu is a search specialist and TOM Online prioritizes WVAS above all else. Netease scaled back its investment in WVAS and has since consolidated its lead in online gaming, while Shanda tried to set up a TV platform which appears to have cost it both online gaming strength and favor with the regulators.
As improved technology allows for faster connections, and the advent of 3G takes this from the desktop to the mobile device, richer media will follow. Content is becoming king and the most effective providers will be the ones who focus on meeting this demand. "Traditional media expertise will become more and more important to the WVAS providers," said Jesse Liu, CFO of WVAS specialists Hurray. "We have to establish more content expertise and be more creative in terms of building operations."
The major difference is that the data speed capability of mobile handsets will increase – Linktone's Robinson describes the likely impact of this as current applications behaving like they are "on steroids" – but with this will come a tailoring of services to suit consumer tastes. "It's all about personalization," said Robinson. "People want to express themselves through their mobile phones; then come graphics, things like wallpaper and screensavers; and then entertainment and communities."
As a result, exclusive content deals take on a new importance. Sohu has done well from its NBA basketball tie-up and is likely to see similar results with its Olympics coverage. TOM Online runs a number of hit mobile games and struck a deal with leading Chinese pop star Jay Chou to use his music content. KongZhong carved itself a lucrative niche by securing wireless rights to films such as Kung Fu Hustle and The Promise, using them as the basis for content ranging from ring tones to java games.
"These deals have definitely helped and they are not as expensive as you might think – US$200,000 at the most," said KongZhong CFO JP Gan. "The production companies understand that our channel is very important in terms of marketing." KongZhong is now developing a wireless Internet portal so that customers can go through the entire browse-select-download-use process on their handsets. The company is banking on this being the next step in WVAS delivery, effectively trying to recreate on a wireless platform the heavily trafficked portal as WVAS distribution channel model that has played such a major role in TOM Online's success.
The future is likely to see an explosion in direct-to-your-handset video services offering sports highlights, music video and movie clips as well as news packages. Meanwhile, online gaming companies will cross a big money frontier by turning mobile gaming from single- or dual -player into the massively multi-player model that packs out Internet cafes across the country. Instant messenger provider Tencent can also expect to do well with the expansion of its QQ community service onto a mobile platform, although the TOM-Skype joint venture could well pose a threat.
In order to provide these services effectively whilst maintaining focus, the Internet companies are expected eventually to go into partnerships with one another. "This is exactly what is happening in the US – you have alliances where there is a synergy in market assets," said Linktone's Robinson. Fritz Demopoulos, former head of business development at Netease and now co-founder of Qunar.com, a travel-based price comparison search engine, added: "These guys are certainly trying and there have been high-level meetings involving a number of companies."
Rumors abound of the possible tie-ins set to emerge. Many involve Sina due to its present situation as a prime brand with gaps to fill in certain key areas. Online games operator Shanda bought 19.5% of Sina on the open market last year, much to the portal's displeasure, and it has been suggested that TOM Online will acquire the stake. Another much-mooted plan is Google providing Sina's search engine services as it does for AOL in the US market.
"The answer for Google is a partnership with Sina," said Citigroup's Brueschke. "And if Sina does do a deal with Google then it is not out of the question that a deal with TOM Online could follow. TOM and Sina together could leverage their portals and effectively cover WAP and 3G services. An asset swap would make sense." It has even been claimed that eBay would buy into this illustrious triangle by purchasing TOM Online shares from Li Ka-shing and creating a super group to take on the Yahoo-Alibaba venture.
It's anyone's guess which partnerships will emerge from the ocean of rumors and when they will be consummated. The one certainty is that the Internet industry before us now will start to look and operate very differently as it ascends through higher commercial planes. It is also a relatively young industry, so the stars of today may not stay in pole position in the long term.
But perhaps the key change will be in the perception of the Internet itself. "People won't think about it in terms of 'mobile Internet' or even 'e-commerce'," said Alibaba's Ma. "The Internet will be everywhere and 'e-commerce' will become so normal it will just be 'commerce'."
The moral question: ceding to the censors
Access to the China market invariably comes at a price. But for overseas Internet companies, the cost is more moral than financial – they have to comply with requirements that enable the government to police the flow of information.
As an early entrant, Yahoo stands accused of a catalogue of misdemeanours that make a mockery of Western commitments to free speech. Reporters Without Borders claims that, as far back as 2003, Yahoo Hong Kong supplied information that led to the jailing of two people. Li Zhi and Jiang Lijun received sentences of eight and four years, respectively, for activities deemed to be subversive.
The US company's Hong Kong operation came to the government's aid again last year when it passed on email information relating to journalist Shi Tao, who was jailed for 10 years for revealing details of a Communist Party media crackdown.
Regulations that oblige search engines to filter out sensitive results are believed to be partly responsible for the delayed launch of Google – which espouses a "Don't Be Evil" philosophy – in China. "They were late to the market because they didn't want to change the way they do business," said Jason Brueschke, director of China Internet research at Citigroup. "But they cannot participate without doing evil – Google concluded that morality has to give way to economic reality."
Recognizing the need to gain a foothold in the world's biggest Internet market while it's still in its infancy, Google succumbed to the censors when it launched www.google.cn earlier this year. The exclusion of certain search results on topics such as Taiwan independence and Falun Gong was significant enough to turn heads in Washington. Google, Yahoo, Cisco Systems and Microsoft were called before Congress to explain why they had sold freedom of speech up the river for the sake of their profit margins.
The companies pointed out that they ultimately had to answer to shareholders and refusal to cooperate with Beijing's demands denied them access to their most promising market. Arguing that the censorship issue was too big for a private company to tackle on its own, they asked the US government to take leadership on the issue. Without any alternative guidance, they have no choice but to comply with local laws, they said.
China's Internet revolution is believed to have spawned 30,000 online monitors to keep tabs on the 111 million users, while human rights groups claim that more than 50 people have been jailed for using the Internet and SMS to express views deemed inappropriate. Foreign policy can do little to alter this, so the pragmatic view is that a censored Google is better than no Google at all.
"In terms of overall Internet censorship, it's becoming more liberal in China," said Richard Ji, Internet analyst at Morgan Stanley. "And Google's presence is helping China make progress towards an even more liberal system."
Click to book: travel services thrive on the net
Not only is online travel one of the fastest-growing areas of e-commerce, it is also the domain of two of China's strongest service-oriented companies, Ctrip and eLong. Internet travel services grew 96% year-on-year to US$62 million in 2004 and Morgan Stanley predicts it will expand at an average of 53% a year up to 2008, reaching a total of US$222 million.
In the midst of this highly fragmented market – there are believed to be more than 300 websites in China that specialize in travel services – Ctrip and eLong have managed to carve themselves distinct identities and a platform for growth.
For Ctrip, this means solid online and offline networks, strong ties with both consumers and suppliers, and the number one spot in the market. Second-placed eLong can draw reassurance from the backing of global giant Expedia, which has a 52% interest in the company.
"Ctrip is a first mover and one of the best-run companies in China," said Fritz Demopoulos, former head of business development at Netease and now co-founder of Qunar.com, a travel-based price comparison search engine. "ELong is a very strong number two, but while it is a star, Ctrip is a superstar."
The emergence of these companies has come largely thanks to a comprehensive offline presence – it is estimated that 70% of Ctrip's sales come through its call centers, staffed by around 2,000 people. A 40-city distribution team is also required to deliver air tickets to customers. Although the company's hotel reservations revenue is three times that generated by air tickets, there was 136% year-on-year growth in air ticket business in 2005.
If phase one of China's commercial travel development was based on the call center model, then phase two is expected to involve the mass migration of customers to purely online services. "If you look at what's been done in the US and Europe, China still lacks richness in the services available," said Barney Harford, president of Expedia Asia-Pacific. "We are looking at all the ways we can build a good online shopping experience."
Expedia has sent more than a dozen personnel to China to help eLong develop its services. As a result of this, last month eLong integrated Expedia's global inventory into its Chinese language website, giving consumers a taste of the online virtual hotel tours, same day booking services and wide range of hotel and holiday choices that have played a key role in the US company's success.
"We are presenting this to Chinese consumers in a way that has not been done before, it takes the Internet experience to a higher level" said eLong CEO Tom Soohoo. "We will continue to focus on the consumer experience with better products and services. As inbound and outbound travel increases, we will be in a position to take advantage."
Taking on Ctrip is no easy task, though. In addition to "guaranteed availability" deals with hotels and airlines, Ctrip has customer service standards that could well be the highest in China. It is one of few domestic companies to use the "Six Sigma" model pioneered by Motorola.
Designed as a means of assessing defects and devising ways to make improvements, "Six Sigma" can be credited with bringing a consistency and quality to Ctrip's services. As a result, repeat customers account for as much as 80% of transactions, giving the company one of the strongest client bases in the business.
Burnt fingers: eBay gets Taobaoed
Having successfully dominated every market it has entered (bar Japan), eBay must have felt cofident on making its China debut in 2004 with the purchase of leading auction site Eachnet. As it turned out, in the space of a year, Eachnet was reeled in and replaced by Taobao as the top player in what has become tale of caution for other foreign Internet investors.
Eachnet began 2004 with a 90% market share in terms of gross merchandise value (GMV). This plummeted to around 50% by December during which time Taobao's market share rose from 9% to 40%. Taobao's total GMV passed Eachnet's at the start of 2005 and the company has not looked back since.
The US firm's downturn has been linked to its inability to adapt to the China market. "EBay tried to put the whole of its business onto one global platform and this compromised the effectiveness of its China business," said Barney Harford, president of Expedia Asia-Pacific, when discussing Expedia's approach to its investment in online travel operator eLong. Specifically, the founders of Eachnet faded away after the eBay takeover, depriving the company of the management expertise that had made it number one.
Meanwhile, Taobao increased customers by scrapping fees charged to list products for auction and pioneered the AliPay online payment system now used by 90% of customers. EBay responded by reducing its listing fees and leaving its cut of sales fees unchanged, but this is unlikely to see it claim back the lost ground: switching to a new marketplace means leaving behind a trading community and many users aren't willing to do this. Online auctions were worth US$410 million in 2004, according to iResearch, and this is set to expand at 84% a year through to 2008.
In the opinion of Jack Ma, founder of Taobao's parent company Alibaba, eBay has already lost out in its bid for the largest slice of this revenue. "It's too late for eBay to make a comeback," he told CHINA ECONOMIC REVIEW earlier in the year. "Taobao is much more suitable for China's consumers and market conditions, and so long as eBay is directing eBay China from its Silicon Valley headquarters, it will be impossible for their local team to move fast enough to win."
Jason Brueschke, director of China Internet research at Citigroup, agrees that eBay needs to modify its approach but maintains that the US company could still stage a comeback. "Ma is innovating and defining the battle and I would not bet against him," Brueschke said. "If eBay continues on its current course then he will be proved correct but eBay still has a couple more maneuvers to make."
It's worth noting that the US company – which declined to comment for this article, saying it would prefer to wait until certain regulatory issues are clearer – is still the number two player in the market. It seems to be bedded in for the long term and time could see it exploit two areas in which it holds the upper hand over Alibaba: an international customer base and experience handling consumer credit.
The operators' gambit: challenges of WVAS
Mobile phone network operators don't enjoy universal popularity among the country's wireless value-added service (WVAS) providers. But there's little doubt they play a key role in the market – perhaps taking more than their fair share of the spoils.
With no way of billing customers directly for services, the likes of Linktone, KongZhong, Hurray and TOM Online rely on the mobile operators to do it for them. In addition to a 15-20% cut of the providers' revenues (consumer-to-person), the operators get all of the profits from any WVAS material then transferred between users (person-to-person).
"It's a mutually beneficial relationship," said KongZhong CFO JP Gan. "China Mobile has grown data revenues rapidly in the last 12 months to 20% of total revenues. At the same time, they only take 15% and this allows people who are creative to come into the business." This view is not shared by Hurray CFO Jesse Liu. "We have the regulatory body and the operating body connected in one entity and working in a self-serving mode – if China Mobile continues to abuse its monopoly like this, it will drive content providers away," he said. "They have tremendous power over the providers through regulatory changes."
Regulatory changes imposed over the last year saw operators instruct providers to clean up content, cancel delinquent accounts and meet new billing standards. The unpredictability surrounding these measures has led to several Internet companies scaling back their WVAS efforts.
For the providers, though, the much more real danger is the operators trying to cut them out of the loop, driven on by the prospect of MVAS revenues that are expected to increase nearly 30% a year over the next three years. It is claimed that China Mobile has been meeting with the big four record companies – Sony-BMG, Universal, Warner and EMI – with a view to sourcing the music for ring tones directly from them. The fragmented nature of China's music industry is likely to count against them, though. The big four account for just 30% of the market, with the remainder divided between Hong Kong and Taiwan labels, top-tier domestic operators and tiny local labels.
"Hurray is going upstream and acquiring record labels," said Liu. "We have recently acquired two top-tier independent labels, and this means we have as big a market share as any of the big four."
Ultimately, with the movement through 2.5G to 3G and the richer content it allows, China Mobile has neither the resources nor the expertise to meet ever-rising consumer demands. And why should they try? Until the providers find alternative methods of billing customers, which could be tied to an expansion in credit card use, network operators can continue taking a share of WVAS profits.
"We couldn't do it without them and, while in theory they could it without us, it doesn't make sense," said Richard Robinson, vice president of Linktone. "Why kill the goose that lays the golden egg?"