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2017-03-06 13:46:33

Qian Zhu, a Chinese professional who returned from New York in 2016, was surprised by how China’s largest internet search company, Baidu, answered one of her queries.

“When I searched ‘Rome, Italy’ on Baidu Maps to plan for my trip to Italy, what I got were locations of Chinese wallpaper manufacturers that named themselves ‘Rome,’” Qian says. Having lived in New York for 16 years, she found that one of the challenges of readapting to life in China was dealing with the logic of a Chinese search engine.

With the increasing popularity of Tencent and Alibaba, authorities do not need Baidu as much as they used to.

This is one of the milder criticisms Baidu has faced over the past year. In April, the death of a college student named Wei Zexi, who died after mistaking an advertisement on Baidu promoting an experimental cancer treatment for medically reliable information, generated a nationwide outcry. Both the government and Chinese users accused Baidu of failing to clearly differentiate paid advertisements from search results. In July, after an official investigation into the scandal and the release of tighter regulations on search advertisements, Baidu reported its worst quarterly earnings decline since it listed on Nasdaq in 2005.

The incident has put more pressure on Baidu at a time when web search ad revenues have already begun shrinking, raising serious questions about the future of the company, given its reliance on internet search services for its existence.

“Baidu has been overly reliant on search ads to generate revenue, which was a realistic choice during its early development,” says Wei Wuhui, a scholar of media development at Shanghai Jiao Tong University. “But now, such a sales model appears to be insufficient.”

Baidu also faces fierce competition from its two main domestic rivals in the internet space, Alibaba and Tencent, which along with the search giant make up the so-called BAT companies. Baidu is also more constrained than the other two companies in the acronym in terms of expanding abroad, due to the omnipresence of Google elsewhere in the world.

Early Success

In fact, Baidu — established in 2000 in Beijing’s Zhongguancun, China’s equivalent of Silicon Valley — is often described as China’s Google, which is true in terms of web search functions. Robin Li, Baidu’s CEO and co-founder, grew up in a family of factory workers in a town southwest of Beijing. He is now China’s seventh-richest man, with a $12.6 billion fortune. In 2015, Baidu had more than 46,000 employees and reported a profit of $1.8 billion on a $10.2 billion revenue. Baidu’s operating profit in the fourth quarter of 2016, by comparison, saw a 13.9 percent decrease from the same period in 2015. 

An advertisement for Baidu’s online marketing services is painted on a wall in rural Dezhou, Shandong province, May. 8, 2016. IC

An advertisement for Baidu’s online marketing services is painted on a wall in rural Dezhou, Shandong province, May. 8, 2016. IC

Baidu operates a broad range of products and services via both computer browsers and mobile, including search, advertising services, statistical tools, maps, and knowledge products — a package similar to Google’s core offerings.

Early on, Baidu adopted a strategy to aggressively penetrate the Chinese market, which was greatly different from the U.S. market at the time in terms of maturity and average age of users.

To expand its user base, Baidu initially took a surprisingly non-digital approach by putting large numbers of salespeople on the ground. It actively partnered with internet cafés, popular among young people, and set Baidu as their default search engine. The company also launched products specifically aimed at young users. In 2002 and 2003, Baidu launched MP3 downloading and online message board community Tieba, respectively, both of which rapidly became popular. By the time of its 2005 IPO, about a quarter of Baidu’s traffic came from its MP3 search function.

Although Chinese netizens were already using Google, the American company officially opened in China in 2005. It targeted educated users in big cities who appreciated its professional email services, as opposed to Baidu’s fun-based chat rooms.

Baidu’s early success was no surprise, as China’s regulatory environment offered the company an advantageous position over its global counterpart.

According to Chinese consulting firm iResearch, Baidu surpassed Google in visitor numbers in 2004 and has been in the lead domestically ever since. Also in 2004, Baidu acquired Hao123.com, a directory for first-time internet users, which was followed by Google’s similar acquisition in 2008 of 265.com. It was not until 2009 that Google launched a music-streaming service in China, which proved far too late to be effective.

In 2009, Baidu held 63 percent of China’s search revenue versus 33 percent for Google, according to iResearch. Last year, Baidu’s share of the market by revenue was 80 percent, with Google still holding 9.2 percent.

“Baidu’s early success was no surprise, as China’s regulatory environment offered the company an advantageous position over its global counterpart,” says scholar Wei Wuhui. “In the meantime, Baidu demonstrated a quicker reaction to and better understanding of Chinese people’s tastes than Google.”

But Baidu’s triumph has been coupled with criticism. The MP3 service, for instance, has been widely accused of relying on pirated music, although such problems have by no means been limited to China. There have also been several scandals surrounding search results. In 2008, news reports claimed that Baidu took payments in return for deleting negative news on Sanlu Group, a dairy product company that sold milk powder containing melamine, a plastic ingredient, which led to the deaths of six children. Baidu denied the reports. And last November, Baidu’s youngest and most promising vice president, Li Mingyuan, agreed to leave Baidu after being accused of engaging in “huge economic dealings” involving acquisitions.

Publicly, much criticism has continued to focus on Baidu’s business ethics, especially in contrast to that of Google, whose corporate motto is famously “Don’t be evil.” After the Wei Zexi scandal, easily Baidu’s most damaging, CEO Robin Li himself openly commented on the difference between the two companies, contrasting Google’s idealism with Baidu’s pragmatism. He said Baidu perhaps needs to be a bit more idealistic in the future to win people’s hearts.

Robin Li, billionaire and CEO of Baidu Inc., gives a speech during the 2007 Baidu World Conference in Beijing, Aug. 10, 2007. Bao Fan/VCG

Robin Li, billionaire and CEO of Baidu Inc., gives a speech during the 2007 Baidu World Conference in Beijing, Aug. 10, 2007. Bao Fan/VCG

On the other hand, some Chinese analysts believe Baidu’s pragmatic philosophy is the norm among privately owned Chinese companies, a product of dealing with China’s unpredictable regulatory environment.

However, with changing user habits and the growth of other domestic internet companies, Baidu is now facing new challenges beyond the search industry.

“The harsh reaction from the Chinese government after the Wei Zexi scandal can be seen as another sign indicating Baidu is losing its position as a powerful internet company,” says Wei. “With the increasing popularity of Tencent and Alibaba, authorities do not need Baidu as much as they used to.” Time is running short for Baidu to find a new strategy and new revenue sources, he adds.

Baidu’s Diversification

Despite massive changes in the high-tech and media spaces, online ads remain Baidu’s main revenue source, accounting for 97 percent of the total in 2015. With the increased competition and the downward pressure on online advertising rates, it is crucial for Baidu to diversify its business.

In 2015, Baidu made 23 investments totaling $1.1 billion in value, with the largest category by number falling outside of its core business in online-to-offline (O2O) services at 52 percent, followed by e-commerce at 13 percent, according to research by international banking group BNP Paribas.

But Baidu is conservative in terms of investments and partnerships compared with Alibaba and Tencent, whose investments in 2015 totaled $11 billion and $3.8 billion, respectively.

We’ve seen in the past [few] years that the tremendous growth of O2O users is largely built on operators offering subsidies to motivate users rather than on innovation.

Generally speaking, analysts believe Baidu’s strategic moves in developing new services have been weaker than those of its competitors.

iResearch suggests that Baidu is particularly weak in the online finance sector. Baidu Wallet, its online payment tool, accounted for only a 0.5 percent market share in China’s online transaction market in 2015. Alibaba’s Alipay dominated with 68.4 percent of the market, followed by Tencent’s Tenpay with 20.6 percent. In the mobile payment sector, Tencent is rapidly developing a user base for its payment system through the social networking app WeChat, which has 700 million active users each month. 

Zhou Xiaoqian, an analyst at iResearch, says the increasing cost of logistics and human resources might narrow down the profits of O2O operators in the coming years. The similarity of services from different operators is another problem.

“We’ve seen in the past [few] years that the tremendous growth of O2O users is largely built on operators offering subsidies to motivate users rather than on innovation,” Zhou says. “In the future, improvement of technology will be the key to success.”

Baidu’s investment in developing artificial intelligence services is believed to be a strategic move aiming for the future rather than quick returns.

“With the slowdown in the growth of the number of internet users and the increase in labor costs, AI can help to cut down human resources spending to improve efficiency,” says Connie Gu of brokerage firm BOCOM International Securities Ltd. “In the AI sector, Baidu is a front-runner, and it has advantages in data gathering.”

Baidu robot Xiaodu is seen on display at the 2015 Baidu World Conference in Beijing, Sept. 8, 2015. Kim Kyung-Hoon/VCG

Baidu robot Xiaodu is seen on display at the 2015 Baidu World Conference in Beijing, Sept. 8, 2015. Kim Kyung-Hoon/VCG

Baidu’s AI lab was established in 2013 — making it the first mover in developing AI in China — and it is a cutting-edge developer in the world market. In 2014, Baidu hired Andrew Ng, formerly the head of Google Brain and a leading AI expert, to lead its AI team. By 2015, Baidu had built the Baidu Brain, one of the largest computing neural networks in the world. Leveraging this resource, Baidu announced in September the establishment of a $200 million venture capital unit that will focus on early-stage AI and virtual reality projects.

Attempts to commercialize AI have already started. In 2015, Baidu launched a Siri-like AI service named Duer, which has been integrated with Baidu’s O2O platforms including group-buying portal Nuomi, allowing users to get AI assistance in everything from health care to travel planning. Baidu has also announced its intended public use of autonomous vehicles on fixed routes in select cities in China by 2018, as well as the mass production of driverless cars by 2021.

Globally, China and the U.S. are the two leaders in AI, and both countries have spent tremendous amounts of money on AI development. In 2015, the U.S. government announced a $1.1 billion investment in AI-related research for both innovation and security reasons. That same year, Baidu CEO Li proposed the development of a national-level artificial intelligence program through which he said private companies would partner with science research institutes and China’s national defense and military organs on AI development.

Going International

But Baidu still has ambitions outside China. In 2015, 94.6 percent of visits to Baidu’s search engine originated from within China. The U.S., its second-largest market, accounted for a mere 1.6 percent, according to Statista, a statistics website. But Li has said he expects Baidu to become a household name in 50 percent of the world’s markets by 2020.

In the AI sector, Baidu is a front-runner, and it has advantages in data gathering.

Achieving this will not be easy. Globally, Google is overwhelmingly dominant and highly effective. With only 25 percent more employees than Baidu, Google generated seven times more revenue than the Chinese company in 2015. In the mobile sector in particular, Google’s Android operating system is predominant globally. Without a competitive mobile system, Baidu has based its O2O apps on Google’s Android platform.

Baidu’s attempts at internationalization have not gone well. Its earliest expansion was to Japan, where it launched its search service in 2007. Japan was chosen because of cultural similarities to China, particular the use of Chinese characters. But Baidu did not prosper in Japan as it had expected. Eight years later, the company announced the closure of its search engine in Japan due to declining user numbers.

To avoid similar failures, Baidu has adopted a different strategy for its latest round of international expansion. According to Baidu’s president, Zhang Yaqin, the company will target Southeast Asia, South America, and the Arabic-speaking world as preferred regions, as these areas have large populations and are seen as ripe for mobile internet development.

People walk down a flight of stairs at the Baidu Technology Park in Beijing, Nov. 25, 2016. Qilai Shen/Getty Images/VCG

People walk down a flight of stairs at the Baidu Technology Park in Beijing, Nov. 25, 2016. Qilai Shen/Getty Images/VCG

But the ultimate challenge may come from Baidu’s innovation capacity and credibility, which have affected its performance in China. The future of Baidu will be increasingly based on whether Chinese and overseas consumers are impressed by its innovations and enhanced credibility.

This is an original article by CKGSB Knowledge and has been used with their permission. A version of the article was first published here on Jan. 4, 2017, under the headline “Searching for the Future: It’s Time to Upgrade the Baidu Business Model.”

(Header image: A Baidu employee talks on his mobile phone as he walks past the company’s logo at its headquarters in Beijing, Aug. 5, 2010. Barry Huang/Reuters)