The China Vortex

Gladiator movie poster

At the end of my previous post, where I painted a generally pessimistic picture of the near future, I mentioned that I would write about the businesses which would do well in this downturn.

In my opinion, they are bread and circuses.

During the decline of the Roman empire, the Roman emperors realized that in order to prevent uprisings, they needed to feed the people (bread), and to entertain them (circuses). Life was grim, ugly and short. People lived for the day. People were reduced to their most basic needs, food, sex and entertainment. Everything else was unnecessary, and most likely, did not do well as a business.

The most popular entertainment of the time in Rome were massively staged gladitorial spectacles which were fights to the death for the gladiators. When people were this miserable, they wanted to have power, if only for a moment, to see others fight to live. People were not happy, and they got pleasure and enjoyment out of what some would call sadistic entertainment (in happier times).

The Roman emperors provided a huge spectacle as an outlet for this frustration in the form of gladiator fights at the coliseum. Instead of trying to resist this angry urge, they saw that the only way out for them was to channel the urge away from them. The state rode this wave, and brought Hollywood production values and state funding to this entertainment to keep the sheeple happy. That is how they were able to extend the period of decline in the Roman Empire to 400 years instead of being overthrown much earlier.

Bread and circuses.

The times we live in will be very similar.

In China, where entertainment is already a large part of what makes up the Internet, there is already a very large entertainment component.

Historically, Chinese rulers have been experienced at putting down rebellions and uprisings, but when it came to entertainment for the masses, they could not hold a candle to the Roman emperors. On the other hand, they did not produce characters quite as twisted as Caligula and Nero either. The Roman emperors were in a league of their own.

Now, how to get state funding and production values for huge epic productions which recreate the smell, blood, excitement and drama of a real gladitorial spectacle as was captured in the movie Gladiator? Whoever can answer that question and can figure out how to bridge online games and the real world drama of life and death gladiator fights, creating a whole new experience, is in the money, not only in China, but globally.

Plus ca change, plus c’est la meme chose.

For the past five months, I have been researching about the feasibility of setting up an IAB (Interactive Advertising Bureau) in China. The IAB as a trade association was founded in the US in 1997, and has since spread to all major markets in North America and Europe where it helps to coordinate discussion and implementation of Internet advertising production standards and measurement standards for web analytics.

I have been invited as a guest of Web Analytics Wednesday to speak on the subject on Nov. 5 in Beijing. I plan to talk about what I have learned from talking to many digital companies and ad agencies, and about the progress which has been made so far. I also plan to include my own assessment of what is needed to make IAB successful in China.

If you are interested in this subject and have the time, I look forward to meeting you at the event.

UPDATE For those of you who are having trouble getting to the above link, it will be at 8PM Wednesday at Club Camp. You can get directions to Club Camp here.

What a difference a month makes!

Just a little more than a month ago, China was basking in the afterglow of the Beijing Olympics, and the US still had an investment banking sector. Now, all China news has been taken up with tainted milk scandal, and the US consumers have changed from spendthrift junk-buyers into wondering whether they will have enough money to buy Campbell’s soup. (Last Monday, when the Dow went down 777 points, Campbell Soup was the only stock to go up. Can you say dark days ahead?) At the same time, Americans have come close to openly rebelling against the Bush administration-backed Paulson plan to bail out the banking sector and create liquidity in credit markets.

In the meantime, economists and politicians are debating whether this is the beginning of a recession or depression. Let’s just say that it’s going to be bad.

In China, the bad has different roots, in how the dairy industry has been systematically thinning milk, then loading it up with melamine so that it doesn’t look protein-deficient (it is). In fact, the problem is systemic, and is not just limited to the dairy industry. This is something which runs throughout Chinese society on a wide systemic basis because local officials are judged only on quantitative results instead of quantitative and qualitative results.

Wall Street and China took different paths, but both ended up with the same sack of shit. The trouble is that this sack of shit affects the whole society in both the US and China, and the rest of the world.

Now, if the problems were not systemic, all you would have to do is hire a PR firm, and they would quickly put together a PR campaign, the public would gradually forget, and everybody would get back to their merry business.

But it’s not that simple.

Recessions/depressions are like forest fires; they destroy a lot of the accumulated undergrowth and excess, providing an opportunity for new growth. We are now going through such a forest fire. It is likely that it is only just beginning. But it is worth thinking about what are the new flora and fauna which will grow and flourish in the environment which comes afterwards.

Here are my thoughts:

• Transparency will be the rule instead of the exception. Instead of talking about quality, companies and government officials will need to show it.
• The Internet and modern IT will turn into a transparency enabler. Think of webcams in dairy processing and manufacturers’ plants in China which anyone can log into anytime. Think of US members of congress listing all the contributions they take and publishing their meeting calendars, live and online.
• For companies, proof of quality. This means that it won’t just be ads and PR. They will need to show how they create quality. A big question for service companies: “How do we show quality in what we do for our customers?”
• Creating quality is no longer a one-way communications process, it will be two-way. Consumers will challenge the companies and governments, and they better have good answers ready. Smart companies will think of ways to weave some of the criticisms into product/service input and incorporating it on a near real-time basis.
• We are witnesses to the crumbling and collapse of an old way of doing things, and the rise of a new way. Education systems all over the world have not prepared people for this, especially the business schools. If you are a newly-minted MBA, good luck!
• An awful lot of companies in China are not going to make it. Many of them don’t deserve to make it. But there will be refreshing new companies with new ideas and who are committed to quality and value. Most of them will come from the private sector. Keep your eyes on Zhejiang for new ideas, companies, products and services! In my opinion, Beijing and Shanghai are vastly overrated and are not truly representative of China. They are still like the Treaty Ports of old: they have enough Chinese to make westerners feel like that they are in China without having to make a major adjustment in lifestyle, and enough ministries and public buildings to make the Chinese officials feel comfortable and in control. The relentless drive to lopsided urbanization at the expense of the countryside which Yasheng Huang puts forward in his book Capitalism with Chinese Characteristics: Entrepreneurship and the State, is a view which is sometimes discussed among Chinese, but which most westerners are not aware of. China is just now beginning to pay the very high price of this lopsided development.
• There is going to be a lot of money to be made in helping the old companies make the transformation to the new value economy. Most of them won’t make it, but they are going to spend a lot of money trying. If you’re in change management and know how to market, you’re going to make a killing.

One of the fun things about China, and the Chinese Internet, is that new issues can pop up very quickly, and become major issues.

This has just happened with the issue of user privacy on the Internet. With more social network sites, and more users posting real information about themselves, along with contact information, etc. this has become a real issue.

I’m not going to offer a solution to this very complex issue. Instead, I’d like to bring up another issue: “How do you have a productive discussion, where all get a chance to contribute to the debate, get heard, and then come to some kind of agreement about a solution?”

Here is the problem. This issue flared up when many SNS sites started blocking Baidu’s spiders from crawling their sites. The official reason: to protect users’ privacy.

The problem is that there has been no discussion about what user privacy is. The definition of privacy is very different for a 12 year-old girl and her 40 year-old mother and, in turn, is very different for a 22 year-old gay man.

Each of them, or their parent/s, may have very different ideas of what constitutes user privacy. The gay man may not want to reveal his sexual orientation except for his closest male partner/s, and may not want anyone else, including family, to know. The same goes for religious affiliation, etc.

These are very real issues which need to be discussed and thrashed out in the open, and people need to be able to put forth their views for discussion. This is a vital and natural part of what constitutes a civil society, which is what the Chinese government supports and advocates.

Unfortunately, there is no clear mechanism for discussing a very complex issue like user privacy in China today.

Instead, we have companies coming out with thinly-disguised excuses about privacy, when in reality it looks more like a pissing match between companies over whose spiders can crawl over whose sites. Are the two groups going to come up with different, even opposing, ideas and definitions about what constitutes user privacy, and force people to choose one or the other? If that is the case, then it’s not really about user privacy, it’s about choosing between one camp or the other, with every user forced to make a choice.

But that isn’t what the Internet is all about. The Internet is all about empowering people so that they can make their own choices. The Internet is about pushing decisions to the edge, where people make their choices, and if they don’t like them, they can change them later on.

This is what is missing in China. Without this system or mechanism, there is just endless bickering and noise, and what should be a serious discussion with a well-thought conclusion, usually ends up in a lot of noise with the loudest shouters winning.

What is an important issue, usually ends inconclusively.

Or as the Chinese say 不了了之。

Chinese Internet users deserve something better.

As many of you already know, there are areas where the development of the Internet in South Korea has been influential in China, especially online gaming, which was really born there. Compared to China today though, the Internet in South Korea has much deeper penetration and is much more pervasive than in China. For most South Koreans, it would be unthinkable to live without the Internet and their mobile phones. Penetration across generations is much higher than in China.

Part of this is because the South Korean government in the late nineties decided to open up a huge amount of bandwidth and make it available to all South Koreans. Compare that to the US, China and most other countries, where the amount of bandwidth is much lower.

When this started in the late nineties, the Internet was still considered a young person’s thing, and most adult South Koreans still did not trust it for content, advertising and information. This is no longer the case.

I am looking for information on:

• What changes made the South Korean go from not trusting the Internet to gradually trusting the Internet? Were they laws, applications or events?
• Were there certain laws, applications or events which made the attitudes of certain generations of South Koreans change? What were they?
• Would any of these changes have been possible if the South Korean government did not open up bandwidth?
• How has the Internet and cheap, high-availability broadband fundamentally changed the society?

Look forward to hearing from you.

Thank you.

Victor Koo, CEO of Youku, recently wrote an article, Internet Measurement in China: How to Get Out of the Dark Ages, where he highlighted the major challenge for Internet companies in China: the lack of reliable metrics for performance measurement.

In the article he talks about how even some VCs in China still rely on Alexa for very basic measurement stats, when in fact, Alexa is not considered reliable.

Many American service providers do not measure audiences from Internet cafes, which as I have pointed out, are a major source of traffic from China. Since American software companies are not familiar with the audience profiles of what is now the largest national audience in the world, they do not break out Internet cafes into a separate category, which underlines how American software providers are out of touch with this very important market. (This Internet cafe trend may change as broadband becomes more available in households, but it definitely should be counted as a major separate category in any report which claims to cover the Chinese market.)

The situation is not helped by government-supported “big picture” reports by CNNIC which give too broad numbers on a national basis and support a government agenda, but do not provide any business insights. They are great grist for press releases and the politically-charged Chinese and western media, but that is about the only value they have.

What Victor Koo does not mention is that the lack of reliable independent statistics has a very real debilitating effect on the healthy growth of the Internet as a sector in China, and the revenue outlook for Internet startups. This is because independent metrics, statistics, standards and definitions are requirements for the global media business. In order for media buyers to make good media buys for their advertising clients, they need standard definitions and metrics on the quantitative side so that they can make better overall qualitative recommendations and decisions.

It’s a testament to the robustness and attraction of China’s economy that the Internet has been able to grow as fast and as far as it has without these independent numbers and stats, but it is also a tragedy that many dollars have not made it to China because of the comparative opacity of the market.

If this systemic bottleneck problem can be addressed, the volume of ad money which would go to Chinese online publishers would go up dramatically.

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.

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.

Several days ago, a different kind of earthquake happened in China in the telecoms field. Unlike the Sichuan earthquake which took so many lives and caused so much damage, this shakeup was not unexpected. It’s ramifications will be large, if not huge, and it’s worth going into some depth to get a deeper understanding of how this change will affect the development of mobile usage of the Internet in China.

Before leaving the Sichuan earthquake as a subject, I would like to point you to this excellent slideshow by CIC Data (h/t to Tangos Chan) which shows how China’s grassroots social media has helped in the disaster rescue and recovery process.

China’s New Telecom Landscape

The main points of the new joint interagency government announcement by the MII (Ministry of Information Industry), NDRC (National Development and Reform Commission) and Ministry of Finance (MOF) are phrased as an opinion and encouragement. (Note: When you get two government ministries and one super-ministry “encouraging” you this way, you do what you are encouraged to do, even if you are China Mobile and have the largest single-country number of subscribers in the world. After all, this is China, not the US, where big corporations tell Congress and the executive through lobbyists and lawyers what they want and are willing to do, and then sell it to the American people through the media as “being in the best interests of the people”.)

The main points are:

• China Telecom is “encouraged” to acquire the CDMA business of China Unicom
• China Unicom and China Netcom are encouraged to merge
• The basic telecom service of China Satellite should be merged into China Telecom
• China Tietong (part of the railways infrastructure and the third fixed line operator after China Unicom and China Netcom) is to become a wholly-owned subsidiary of China Mobile

All six operators (China Mobile, China Telecom, China Unicom, China Netcom, China Satellite and China Tietong) have been asked to separately submit their implementation plans to the relevant ministries where they will be encouraged (again) to reconcile their different plans and agree on a schedule. Once this is completed, the Chinese government will then announce the granting of the three 3G licenses and which operators they will go to.

Following the reorganization, there will be three companies left, which meshes perfectly with the number of 3G licenses to be granted by the government. There will be one license granted for each of the new 3G technologies: TD-SCDMA (China’s natively-developed standard), CDMA2000 and WCDMA. Current opinion is that China Mobile will get the TD-SCDMA license, with China Unicom and China Telecom getting the other two foreign technology licenses.

Reaction

The immediate reaction on the HKSE, where China Mobile, China Unicom, China Netcom and China Telecom are listed was unfavorable to China Mobile, the giant in the mobile sector in China. Goldman Sachs issued a sell rating on China Mobile.

You can bet that the six companies will be burning the midnight oil to complete and submit their implementation plans so that they can get the 3G licenses as soon as possible, which should be sometime within the next 3-6 months. Most likely it will not happen before the Beijing Olympics, even though the network infrastructure is there, simply because there is a lot of training and testing to be done.

My Take

This change marks the end of the first stage of the rollout of mobile phone services in China. While China has the largest single-country number of mobile subscribers, most people use mobile overwhelmingly only for voice and SMS services. From a business standpoint, China’s telecom industry has been in a wait-and-see mode for the past two years.

This second generation, or next stage of mobile services will be about a renewed rollout and introduction of more data services, and the more important metric for the operators will be ARPU (average revenue per user) instead of number of subscribers. So please, let’s stop talking about number of subscribers, and let’s talk about ARPU instead from now on.

ARPU will be the real metric to measure the performance of the three operators. I say “It’s about time!”

This change opens crack and opportunities for investment and new players, and gives more choices to Chinese consumers. China Mobile, the industry leader in mobile services, has continued to expand the number of subscribers, having the world’s largest number of subscribers in one country, with more than 500M. China Unicom has been playing catchup because it started as a CDMA service provider (as opposed to China Mobile’s GSM) and although it also later entered the GSM field. The small independent mobile operators such as Tom.com, Linktone and KongZhong have all languished because China Mobile was seen as the dominant player which wanted to completely dominate the platform and application-level services. While it would be a real challenge for those companies to claw their way back to health, venture capital and private equity firms can now look more favorably at the next generation of mobile services, which will no longer be as dependent on a single mobile provider, since there are now three choices available, and they will differentiate on the basis of how they cooperate with service providers and services they offer to Chinese consumers.

In order for Chinese startups to survive and prosper, they will increasingly differentiate themselves on their business and execution skills instead of just technology. Good management will be key.

It goes without saying that Apple’s iPhone will be the most high-profile beneficiary of the change, since it will have two other mobile operators to talk to besides just China Mobile. Instead of just having a loyal base of hacked iPhone users in China, Apple will have a chance to test its vision of the mobile Internet with Chinese users.

The major handset makers such as Nokia, Sony-Ericsson and Samsung will also want to test their application services among Chinese users, and will have greater chance of reaching them.

There are many opportunities in search and display advertising, and subscription-based services. Most of these opportunities are not infrastructure-related, but service- and tool-related. I will talk about some of these opportunities in the future.

While this is a short-term setback for China Mobile, it will ultimately help the company because instead of becoming a lazy monopolist offering bad services, it will have to compete on service. This will make the company more competitive when China starts planning seriously for 4G.

I give the plan an enthusiastic “thumbs-up”!

This is a good example of central planning working to help competitiveness, and in favor of consumers.

It would be nice if, ahem, other countries with large consumer markets, took a closer look at this move and how it helps competitiveness.