The China Vortex

The Chinese government’s watchdog for equities, the CSRC (China Securities Regulatory Commission) has issued an edict to local fund managers that they are not to issue any pessimistic reports about equities during the Olympics in Beijing.

My question is “Why bother?”

The Shanghai market has been down 50% in the first half of the year, and what started out as a subprime mortgage problem in the US has now morphed into a banking problem with more US banks at risk.

In the meantime, Pony Ma, CEO of Tencent has joined in the chorus with Alibaba’s Jack Ma to talk about hard times ahead. The Chinese government has signaled that the rise of the yuan against the dollar will slow down, with a very public discussion in the People’s Daily. The signs of economic deceleration are everywhere.

When there is so much public discussion about upcoming economic challenges in the Chinese and western media, what good could possibly come from telling local fund managers not to say anything bad which might upset the Chinese equities markets? While many western observers of China see this as a sign of an authoritarian regime, for many Chinese, it looks more like desperation. Instead of allaying fears, it makes those who are still in the market fear the worst, and think that the government is trying to suppress even worse news, which in turn will fuel the rumor mill and make the market even more volatile.

In short, this looks more like a desperation move than a well-thought policy move. Instead of helping the market, it’s likely to make things worse.

This is what happens when politics interfere in the markets.

The biannual China Internet Network Information Center (CNNIC) report covering the first half of 2008 has been released (in Chinese) and is now available. The Ogilvy China Digital Watch website has provided an excellent job of capturing the main points in English. The most salient point of the report is that China now has 253 million Internet users, pushing China into first place worldwide, surpassing the US.

The CNNIC is the main official source of information for the state of the Internet in China, and is the most frequently quoted report on China Internet statistics. For more detailed information, especially ecommerce numbers, etc., there are a number of market research firms in China which provide services, including custom reports for paying clients.

I would like see some changes and improvement to the CNNIC report. Here are some of them:

1. Outline the methodology used. Explain how the data is collected and by what authorities. Also explain how the audience is chosen. Make the whole process transparent as possible.
2. Show the questionnaire used, and let people provide feedback about what questions are used so that they can be improved in future versions of the report.
3. Use the same questionnaire nationwide so that there is a level basis for comparison.
4. Current data is weighed too much towards national and tier one cities in China. This information is too broad and not granular enough. Break out the information by province.
5. Provide the names of the government officials who collect the data on the national, municipal and provincial levels along with their email contact information so that we know who is responsible for collecting what data on what level.
6. Provide a forum so that these same people can answer questions about the CNNIC report and reply to suggestions. Engage the audience in a continuous dialogue to improve the CNNIC report.
7. Keep the primary data in a data warehouse, and consider making it accessible to researchers so that they can write their own queries and generate reports for a one-time fee or on a long-term basis for a subscription fee.

Over the past year, the tone of coverage of many China-related topics in the US has improved. For the most part, writers covering China have tried to look past the generally-accepted stereotypes, and have tried to get a deeper understanding of what is going on in China.

But occasionally something finds its way through the cracks.

This article is really exemplary; it seems like the writer has taken all the stereotypes about Apple and China, and thrown them all together in one basket. Judging from the tone of the article, and what he professes to be truth, it seems like he has never set foot in China. Otherwise, how could be believe some of the things he writes?

Let’s take a look at some of the choice statements:

Apple has less than 8 percent market share in China for media players, and far less than 1 percent of either PC or cell phone market share.

Yes, so? I wonder if the writer has walked into any cafe in Shanghai, Beijing and Shenzhen, and looked around? Or has he taken any of the subways in any of those three cities and looked around for the signature white earbuds? The question should not be the percentage market share. It should be the trend, and whether it is tracking up or down.

Apple’s second biggest hit in China, the iPhone, isn’t authorized. One Chinese analyst estimates that some 1 million Apple iPhones are currently operating on just one Chinese carrier — China Mobile — with a smaller number on other carriers. Most Apple “Authorized Resellers” in China sell black-market iPhones, and many even offer illegal cracking services — a process that reportedly takes less time than activating an iPhone 3G in California.

Apple makes money off of every iPhone sold, whether it is through authorized or unauthorized channels. Sure, Apple would like to have a carrier agreement in China, but having a group of fans, even though it is relatively small percentage-wise, which is very enthusiastic about Apple products, is a good thing. Besides, there are a lot of people in China who pay even more for more expensive feature-packed mobile phones in China. In fact, the iPhone is not the most expensive phone in the market. Ask Nokia.

Apple succeeds because customers love the products and the brand. But in China, brands mean little to most potential customers, and hardware even less. Chinese consumers prize value above all.

This quote is a true gem and qualifies as one of the most ignorant sweeping statements about China for 2008, even though we are only halfway through the year. Obviously the writer has not been to China and walked in the downtown of any major city. Here is an article about the runup to the recent opening of the Sanlitun store in Beijing and another story about Chinese youth camping out in front of the Beijing Apple store, where they were behaving just like American Apple fans.
I guess that’s why there are no Mercedes Benzes, BMWs, and Chinese women don’t care about the labels they wear? Maybe he thinks that they still wear Mao suits?

The rest of the world’s love of the Apple brand has enabled Apple to get favorable terms with carriers around the world. But this hasn’t helped much in China. Apple initially demanded a big two-digit percentage of carriers’ wireless revenue as a condition for granting its coveted exclusivity deal, according to reports (one company says Apple demanded 30%). The Chinese carriers were apparently unimpressed by the value of Apple’s brand compared with the value to Apple of access to Chinese consumers. They appear to have forced Apple to drop its demand for any share of wireless revenues.

The reason Apple has not been able to get an agreement with China Mobile is because they are both big companies with very big egos who want to control everything. I would say that Apple and the carriers have trouble reaching an agreement because they are so much alike, and don’t believe in compromise.

One-party rule in China actually affects product quality. One example is that Apple will probably be required to disable the iPhone’s Wi-Fi feature in order to comply with the Communist Party’s strict Internet control and censorship rules.

The relationship between one-party rule and product quality is an arguable point. But if it is that simple, then why are ALL of Apple’s products made in China? As for the disabling of Wi-Fi on phones sold in China, that is a China Mobile requirement, not a State Council requirement. (If you think that the rulers of China don’t have better things to worry about than whether mobile phones in China have Wi-Fi functionality, you don’t know anything about the country and how it’s ruled.) Besides, with the recent re-arrangement of the Chinese telcos, it’s not as if China Mobile is able to control Wi-Fi as much as it would like.

China is number one in intellectual property theft

Apple’s whole business model is based on creating value through exquisite design, superior branding and the sale of creative intellectual property (IP) — then defending its rights against the IP thieves, pirates and counterfeiters.

How will this formula succeed if China doesn’t enforce intellectual property laws?

The music piracy rate in China is between 90 and 99 percent, depending on whom you ask. China is the global epicenter of intellectual property theft in general, and of Apple IP theft in particular — especially iPhones and iPods.

Fake iPhones, and phones that steal Apple branding; illegal iPhone unlocking services; trade in illegal movie and music files; all appear to be tolerated and even government-protected activities in China.

Oh yes, how can we talk about China without IP violations? Seriously though, this is an issue. The best way to fight IP though, is for a country to get more prosperous. As people become wealthier, they are more willing to spend money on software, music, etc. In China, it is also very important to explain the importance of IP to various government ministries, and even be flexible about how much you charge Chinese consumers. Many Chinese think that they should not have to pay as much for music as US consumers because they have a lower income and standard of living. Does that fit into any American companies’ equations? Up until four years ago, Microsoft had a very high level of illegally installed Windows licenses in China, and constantly lobbied with the US Congress to “punish” China. When Microsoft China changed tactics and chose to engage Chinese ministries, educate them, and lower the license fees (as China’s standard of living increased), first the ministries, then the schools, then the people started buying original software from Microsoft. Now Microsoft gets more revenue from China, and the relationship with the government is much less confrontational. Piracy of Microsoft software still exists, but again it’s about the trend, which is improving.

Steve Jobs is an exemplary business and marketing genius. But when it comes to learning about other markets, he is lazy. He would like nothing better than to set prices for all media products sold through iTunes himself, and he would like it to be the same all over the world. China is a major kink in his vision.

How many times has Bill Gates been to China? How many times has Steve Jobs been to China?

I rest my case.

On July 23, Jack Ma, founder and chairman of the Alibaba Group, a leading Chinese ecommerce company, published an internal email to Alibaba employees. This email found its way to Sina (h/t to Bill Bishop) and I have translated it here.

The company is listed on the Hong Kong stock exchange under the 1688 symbol. In typical Chinese fashion, the numbers are propitious for making money and sound like 一路发发 The original email includes exclamation marks at the end of almost every sentence. In an attempt to be faithful to the original text, I have also kept the original exclamation marks. I have added some extra hyperlinks where I think it would be helpful to understanding.

Fellow Alibaba employees:

When it comes to the recent share price of Alibaba, I’m sure that you’re feelings are complicated! Today, I want to share with you my views on the current business and economic environment, I hope that they are helpful.

I’m sure that you remember in the February all-employees conference I said that winter was coming, and that we all needed to prepare for winter! When our company listed in Hong Kong, and our share price tripled in price, dark clouds were forming and the thunder was coming closer. When a share price goes up this quickly, the retreat will be just as surprising and quick! I don’t want you to have any misunderstandings about how the market behaves. When we listed, I said that we would continue doing business as we have before, and that our mission would not change because of our listing. In the future, I hope that you forget about our share price, a remember our long-term commitments to our customers, our society and our fellow partners, our shareholders and our families. When we meet our commitments, our share price will reflect the value the value of your commitments.

The world economy is now facing major structural problems, and it is very likely that in the coming years it will go through a period of major challenges. My view is that the world economy will go through a very challenging period, and the challenges will be much bigger than anyone has thought possible! This winter will be longer, colder and more complicated than any have predicted! We need to prepare for this winter!

So what do we need to do?

First, we need to be prepared and have confidence!

Winter is not frightening; not being prepared is frightening! Not knowing how long it will be, and how cold it will be is frightening! Opportunities come equally to everyone and tragedies come equally to everyone! The ones who prepare for the winter are the survivors! The guarantors of survival are a strong desire to survive, psychological preparation and storage of materials. Having gone through the first Internet bubble and the SARS crisis, we know what it takes to survive multiple crises. By going public last year, we were able to raise US$2 billion to prepare for the upcoming winter. At the beginning of this year, our group “dug deep holes, stored grain and prepared reserves while avoiding major projects”, and this thinking has been pushed out to all member companies of the group. For this terrible winter, all Alibaba employees think “If not now, when? If not me, who?” In 2001, we said “Be the last man standing!” Even if we were on our knees we would be the very last to keel over! With our resources today maybe we will not keel over, but today we have an even greater responsibility to our customers. Not only must we not fall over, but we have a responsibility to protect them, the tens of thousands of small and medium sized businesses all over the world who count on our services! We need to protect them so that they will prosper and not keel over! In the upcoming business environment, these companies will face major challenges to their survival; it is our mission to help them to survive – to make it easier for anyone to do business anywhere. Remember, if our customers fail, then we will not survive to see another day!

Second, do what you should do for winter preparation!

Great companies survive not because they can take advantage of multiple opportunities, but because they can survive challenges which wipe out other companies. In 2002-2003, during the first Internet winter, we focused on building our Alibaba culture, our company structure, and developing talent. Today, aside from being grateful for the opportunity we got by going public last year, we need to be able to show our gratitude for the opportunity globalization and the world economy has given us. Alibaba has grown from 18 people to more than 10,000 employees today. Our culture, organization and talent have grown and we have faced challenges. We have had opportunities in the past five years, including founding Taobao.com, starting Alipay, buying Yahoo! China, starting Alisoft, the Alimama ad network, all the way to going public. We need to time to rest and recuperate, and are grateful for this opportunity.

We have thought about this deeply, and based on our principles of “customer first, employees second and shareholders third” our goals now are:

1. For Alibaba to become the world’s largest ecommerce company;
2. For Alibaba to become the world’s best employer;

In order to achieve these goals we must grasp the opportunities this harsh winter presents us! Let us now return to our ecommerce roots and our founding principles of treating our customers first and to grasp the opportunities which come to us! The power of a great army is not shown when it is advancing; it shows when it is in an organized retreat. The power of a great company is shown when it can survive in a harsh environment, and have a positive attitude and can continue to learn and grow.

In this new globalized world, the Chinese economy will play an ever greater role. We are pleased to see that world leaders are learning to communicate and coordinate their activities better on major issues like the Asian tsunami, earthquakes, fighting diseases, and fighting global warming. These are all good signs of a brighter future for humanity. This will change the world from one which is solely reliant on the US dollar to something more multilateral! The Internet powered by ecommerce will play a revolutionary role in this change! “Push consumer spending and creating jobs” will be our major missions in the next stage of Internet development! The future of ecommerce is bright, and will help our small and medium sized customers to survive this crisis, and when we emerge in ten years, it will be a whole new world!

Fellow Alibaba partners, we will be messengers and witnesses to this whole new world!

Jack Ma

Some signs point to a rapid deceleration of the Chinese economy:

• Politburo to convene urgent economic meeting
• Chinese Domestic Olympic Travel Falls Lower Than Expectations
• Unsold inventories climbing
• Shanghai Vanke first to lower real estate prices in Shanghai (in Chinese)

The whole idea of an urgent politburo meeting just three weeks before the Beijing Olympics is a strong indicator of how serious the ruling levels of the Chinese government see this situation and would, in my opinion, be an ominous sign.

All of the signs point to an economy which is rapidly deflating, following on the falling performance of the Shanghai stock exchange, which has fallen more than 50% in the first half of the year. A lot of money which people thought they had made, and did not think of converting into cash thinking that it would go higher, is no longer there.

In China, this is always a warning sign of potential social instability. It also explains a lot about why the Chinese government has introduced new licensing regulations for online video and other communications means where people can communicate quickly, spreading views contrary to the official line, and events can quickly spin out of control.

If the Chinese economy deteriorates, as signs suggest, then it would be safe to say the government controls would tighten further. This would especially be the case in areas where foreign investment capital has gone into sensitive media sectors, which is always viewed with some degree of suspicion by the Chinese government.

I have a guest post on Jeremiah Owyang’s blog, Web Strategist. The title of this article is “China: After the Earthquake, Before the Olympics“.

If you are one of the estimated 800,000+ iPhone users in China, then there is a more than 99% chance that your iPhone is cracked since Apple does not yet have a carrier partner in China.

For many of those users, there is the fear that once Apple ties up with a Chinese carrier and starts offering the iPhone3G in China, their first-generation iPhone will become an iBrick because it will not be recognized by the Chinese carrier and/or Apple, and there will be no upgrade path. (Apple and Steve Jobs are kind of famous for not particularly caring about background compatibility and upgrade paths. If you’re screwed, you’re screwed.)

Fortunately, Matt Cutts of Google has posted an article on his blog called “5 Steps to Upgrade From a Hacked iPhone To and iPhone3G”. The article is written for an American audience, but there is no reason why it could not apply to an iPhone user in China (or anywhere else).

The good news is that your first-generation iPhone will not become an iBrick, and you can likely sell it on Taobao. The bad news is in step two: there’s no way you can avoid spending money on another cool device from Apple.

UPDATE:One week after its release, the iPhone3G has been pwned (that’s geekspeak for cracked). So do you want to go legit or are you hardcore for open? It’s your call.

In an earlier post, I talked about a phenomenon called the Chinese hockey stick. The concept of the Chinese hockey stick is fairly simple: it takes a while for investment in a new sector to show results in China, but when it does, it takes off, going almost straight up like a hockey stick.

So far, the prevailing wisdom re ecommerce in China is that while the potential numbers are impressive, it’s going to be a while before the upside of the hockey stick becomes apparent. There are some reasons for this: low trust, fear of fraud, etc. So far, the only place where online commerce has performed well has been in online gaming with companies such as Shanda and Giant Interactive leading the way. The trouble with the demographics for online gamers is that it includes early adopters with low incomes who spend a considerable amount of time in China’s Internet cafes. These are people who are using the Internet for cheap entertainment, and are not likely to spend too much money on products sold in in-game ads.

Now, a new report released by the Research Institute Data Center of China Internet claims that online spending has increased to 37.5B US dollars for the first six months YOY, an increase of 58.2 percent over the same period in 2007. This is very good news, and suggests that we are beginning to see traction after many years of investment in the sector. In short, we are beginning to see the upside of the hockey stick, since according to the report, Chinese spend an average of 211.9 yuan on products/services on a monthly basis. If the trend continues there will be a double boost: the number of new spenders online will grow, and the monetary amounts spent by those already in will also go up.

This suggests that many upwardly-mobile Chinese are losing resistance to ecommerce and are overcoming fears to spending online. I believe that this represents the beginning of a secular uptrend for this sector. Within this field, companies which have a successful track record in fields such as Chinese online education will perform well. If Chinese consumers are convinced of the quality of these online companies’ products and services, it would be safe to assume that interactive advertising and Internet word of mouth will also gain greater traction.

Warning: This is geeky stuff which has nothing to do with China.

The Youtube Blog just put up a very entertaining video by Radiohead called House of Cards which uses 3D laser imaging technology. I don’t know if the song has anything to do with recent financial events and the generally grim outlook on the US economy now, but the video is certainly fun to watch.

The definition of astroturfing, according to Wikipedia is:

a neologism for formal public relations campaigns in politics and advertising which seek to create the impression of being spontaneous, grassroots behavior, hence the reference to the artificial grass AstroTurf.

The goal of such a campaign is to disguise the efforts of a political or commercial entity as an independent public reaction to some political entity—a politician, political group, product, service or event. Astroturfers attempt to orchestrate the actions of apparently diverse and geographically distributed individuals, by both overt (“outreach”, “awareness”, etc.) and covert (disinformation) means. Astroturfing may be undertaken by anything from an individual pushing one’s own personal agenda through to highly organized professional groups with financial backing from large corporations, non-profits, or activist organizations.

As a business and marketing consultant who spends considerable time in China, I get upset when I see marketing and PR terms not used the right way. One thing which is done very frequently in China, but whose terminology is not used correctly, is astroturfing. As a matter of fact, I have not even heard of a Chinese term for astroturfing, even though I have seen it in many forms all the time. In fact, a good deal of what the Internet is used for in China in the BBSes in China, is astroturfing in different forms.

I was upset when I saw the term astroturfing mixed up with censorship in this video interview with reference to censorship in China. My definition of censorship is when I have to use a VPN tunnel to get to content I cannot view in China, or because I cannot get my Feedburner RSS feeds because they are blocked by the GFW, or as Jeremy Goldkorn, publisher of Danwei chooses to call it, the Net Nanny.

The biggest difference between astroturfing and censorship: astroturfing is a PR term and censorship is a political term. Astroturfing is a PR tactic which can be used for either political or commercial ends; censorship is always used for political ends. Using censorship with reference to China is a politically charged term because many critics of Chinese government policy like to use it to satisfy their own political agendas. Other people are entitled to their own political views re Chinese government policy, just as I’m entitled to mine. Everybody has a right to their own opinions. What I do criticize is abuse of terminology in order to score political points when in fact what is being used is a PR tactic.

Paying bloggers and users of Twitter to shape public opinion about China is an astroturfing tactic. Let’s call it astroturfing and not call it censorship. Admittedly, the Chinese government has used astroturfing in a very clumsy fashion by paying bloggers directly for their blog posts and tweets. Rule No. 1 of astroturfing is “Don’t get caught doing it”. This means you should set up front organizations to do the work so that the important guys/government have plausible deniability. These front organizations have to be run by eloquent, expensive and intelligent opinion leaders who know what they are doing and what the whole objective is. The people they work with, and contract with, do not have to know.

Sure, it adds to your costs, but some things are more important than costs. That’s why this whole payoff of bloggers and tweets is so silly and let’s say it, downright stupid.

The real masters at the right way to do astroturfing are the Americans and American PR and lobbying firms. They set up enough “independent” organizations so that the astroturfing movements cannot be traced back to the government, the original sponsor. After all, that is the whole point of it. Government ministries, organizations and parties should never be directly involved in it.

These “independent” organizations, usually think tanks, then contract with the PR firms and coordinate very complex and expensive PR campaigns which are, well, astroturfing. The whole objective is to make it look independent for most people. These people are the audience, the people whose opinion you want to shape.

Astroturfing was used extensively in the aftermath of the revelations of torture re Abu Ghraib and Guantanamo in the US. Many Americans were sincerely shocked that the US military would use such interrogation techniques. In order to shape US public opinion, the Pentagon provided leading US media companies hired retired generals as “consultants” to talk on TV about the situation, and mitigate the political damage to the Bush administration. These consultants were paid for by the Pentagon. How it was done was revealed in an article on the New York Times.

If the Chinese government wants to be truly effective at winning the PR war with the western media, it has to allow different voices to speak up about China, and get past the very worn-out charges of “interfering in China’s internal affairs” or “hurting the feelings of the Chinese people”, which may have some appeal to not very bright people, but really turn off intelligent people. Part of the price of being considered a developed nation is to allow different discourse and opinions on an intelligent level. Moreover, this gives the Chinese leadership a better selection of policies to choose from. After all, that’s whole point of the exercise.

So let’s stop paying off bloggers and tweeters 50 Chinese yuancents or fen to shape public opinion. That’s the cheap and dumb way.

The Chinese government needs to stop thinking small and start thinking big in how it shapes not just Chinese public opinion, but western public opinion. Spend money and do it the right way with the right people.

Anything else is just an embarrassment.