Georgetown IEMBA China Market Entry Report 2008

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Georgetown IEMBA China Market Entry Report 2008

  1. 1. GOING .CN 6 Challenges U.S. Web Firms Must Meet To Succeed In China September 12, 2008 Jamie Hammond Pavitar Juneja Matt Luxton Ben Newhart Pat Sheridan Raghav Vajjhala  2008, All Rights Reserved
  2. 2. ACKNOWLEDGEMENTS Our deepest thanks to Professor Ilkka Ronkainen and the Georgetown University McDonough School of Business; and to the representatives of the many firms that generously agreed to meet and speak with us: • OgilvyOne Worldwide • Procter & Gamble • Jun He Law Firm • University of Hong Kong Law School • Tencent • AOL China • Google China • Wanmo.com • Omniture • Webtrends • MRM Worldwide • CNNIC • UPS • Baidu • Nielsen • iResearch • Tudou • Spil Games • HDT • Guthy Renker • MHDirect.com • Web2Asia • Plus Eight Star • China Springboard
  3. 3. Table of Contents GOING .CN .....................................................................................................................................1 1. Introduction: Who This Report Is For ...............................................................................5 2. Executive Summary ..................................................................................................................6 2.1. Six Challenges You Must Meet to Succeed in China ......................................................... 6 3. Background .................................................................................................................................9 3.1. The Internet in China ................................................................................................................... 9 3.2. Advertising in China .................................................................................................................. 10 4. Analysis: The Six Big Challenges ...................................................................................... 12 4.1. Overcome Fear of Labor........................................................................................................... 12 4.2. The Government and the Legal System – Obey, Lobby, but Move Ahead: .......... 13 4.3. Start At Zero and Build Up to What Makes Sense.......................................................... 17 4.4. China’s Got The Most People Online – So What? ........................................................... 18 4.5. Deals are Person to Person, Bargained For, and You Buy What You Can See ... 20 4.6. The Chinese Internet Is What It Is -- It’s Not Going to Morph Into the U.S ......... 21 5. Final Thoughts ......................................................................................................................... 25 5.1. Get Going Now.............................................................................................................................. 25 5.2. Ask Even Deeper Questions First ......................................................................................... 25 APPENDICES ............................................................................................................................. 27 MEETING REPORTS................................................................................................................ 28 1. OgilvyOne Worldwide ........................................................................................................... 29 1.1. Summary ........................................................................................................................................ 29 1.2. Specifics .......................................................................................................................................... 29 2. Procter & Gamble (China) Ltd. ........................................................................................... 31 2.1. Summary ........................................................................................................................................ 31 2.2. Specifics .......................................................................................................................................... 31 3. Jun He Law Firm ...................................................................................................................... 33 3.1. Summary ........................................................................................................................................ 33 3.2. Specifics .......................................................................................................................................... 33 4. Dr. Hong Xue ............................................................................................................................. 36 4.1. Summary ........................................................................................................................................ 36 4.2. Specifics .......................................................................................................................................... 36 5. Tencent Technology Company Limited .......................................................................... 38 5.1. Summary ........................................................................................................................................ 38 5.2. Specifics .......................................................................................................................................... 38 5.3. Conclusion ..................................................................................................................................... 40 6. AOL China .................................................................................................................................. 41 6.1. Summary: ....................................................................................................................................... 41 6.2. Specifics .......................................................................................................................................... 41 7. Google China ............................................................................................................................. 43 7.1. Summary ........................................................................................................................................ 43 8. Web Analytics Dinner ........................................................................................................... 44 8.1. Summary ........................................................................................................................................ 44 8.2. Specifics .......................................................................................................................................... 44 9. CNNIC (China Internet Network Information Center) ............................................... 46
  4. 4. 9.1. Summary ........................................................................................................................................ 46 9.2. Specifics .......................................................................................................................................... 47 10. UPS, Official Olympics Sponsor ..................................................................................... 49 10.1. Summary ........................................................................................................................................ 50 10.2. Specifics .......................................................................................................................................... 50 11. Baidu ...................................................................................................................................... 53 11.1. Summary ........................................................................................................................................ 53 11.2. Conclusions ................................................................................................................................... 53 12. Nielsen Online ..................................................................................................................... 54 12.1. Summary ........................................................................................................................................ 54 13. iResearch Consulting Group .......................................................................................... 55 13.1. Summary ........................................................................................................................................ 55 13.2. Specifics .......................................................................................................................................... 55 14. Marc van der Chijs ............................................................................................................. 57 14.1. Summary ........................................................................................................................................ 57 14.2. Specifics .......................................................................................................................................... 57 15. Tao Li, COO of HDT ............................................................................................................ 59 15.1. Summary ........................................................................................................................................ 59 15.2. Specifics .......................................................................................................................................... 59 16. Direct Marketing Roundtable Hosted by Guthy-Renker Shanghai ................. 61 16.1. Summary ........................................................................................................................................ 61 16.2. Specifics .......................................................................................................................................... 61 17. China Springboard............................................................................................................. 63 17.1. 6/5/2008 Skype Interview Summary ................................................................................ 63 17.2. 8/1/2008 Dinner Summary ................................................................................................... 63 18. Conference Call with Kaiser Kuo, OgilvyOne ........................................................... 65 18.1. Summary ........................................................................................................................................ 65 TIMELINE OF ADVERTISING HISTORY IN CHINA ......................................................... 66 ADVERTISEMENT LAW OF THE PEOPLE’S REPUBLIC OF CHINA - 1995 .............. 72 PROJECT WEBSITE ................................................................................................................. 82 Table of Figures Figure 1 - Growth of Internet Users and .CN Domain Names in China ............................. 9 Figure 2 - Forecast of Online Advertising Spend in China ............................................... 10 Figure 3 - Online Advertising Spend by Industry ............................................................. 11 Figure 4 - Online Advertising Revenue by Company ....................................................... 20 Figure 5 - Historical Trends in Age Demographics for Chinese Internet Users ............... 24
  5. 5. 1. Introduction: Who This Report Is For To see what is right, and not to do it, is want of courage or of principle. -- Confucius You are based in the U.S. or outside of China, and oversee international/AsiaPac expansion for a U.S. online organization, whose revenue is derived primarily from advertising. You are either in, or are considering entering the Chinese Web market. You are trying to decide what kind of personnel, organization, systems, brands, and most importantly, what kinds of websites and corresponding ad sales you want to deploy in mainland China. You do not feel compelled to operate in China as you do in the U.S., or for that matter in the rest of the world. You acknowledge that winning in China requires a very different approach. Your goal entering China is to gain significant market share and profit. This means that you are open to empowering your local office in the ways it takes to win there. In the near and medium term, your brand, your return, and your corporate culture are all subject to sacrifice -- and you are willing to accept this to achieve your objective in the world’s largest country and biggest Internet audience. If this is not you – if you are not willing to make these moves, or you feel compelled to do a “cookie-cutter” online operation in China as you have done in the rest of the world, or you are not looking to win in China but rather just have a presence – then you do not need this report, as your course is largely charted. Our original intent in writing this paper was to focus solely on advertising models in China – which ones are succeeding, which are failing, and why. However, we realized that the access granted so generously to us by so many leading players, compelled us to take a broader look. We decided to focus on the most formidable challenges in entering this huge and exciting yet immature and maddening market. That said, you will find key background and lessons learned about the ad market throughout the report and Appendices. Page 5 of 82
  6. 6. 2. Executive Summary 2.1. Six Challenges You Must Meet to Succeed in China After six months of extensive research, interviews, visits to China’s major cities, and discussions with dozens of leading executives and analysts in the region, we have identified six main challenges that American firms must overcome to have a successful ad-supported online business in China. Please note that this is not a six-step recipe for success in China – in fact, very few if any U.S. Web firms have enjoyed significant success on the mainland to date– rather, these are six challenges that must be met on the path to success: 2.1.1. Overcome Fear of Labor China needs to create millions of new jobs per year to keep pace with its torrid growth. This need is infused into much of what you see in China, from government policies to the many employees found in any store or business. In the U.S. Web industry, automation is a virtue. But in China, it is jobs that are the virtue. For example, Google’s highly automated ad-buying system competes with Baidu and its hundreds of ad salespeople. Another example: Two leading Amazon.com-type players in China – Dangdang.com and Joyo.com (latter owned by Amazon) – both do much of their fulfillment through their own legions of “bicycle [now car] boys.” Having a lot of employees can mean better treatment from the government. Hiring a big workforce is considered a given; when asked for an automated feed of its content, one major Chinese media company told its American Web partner to simply hire a bunch of people to copy and paste its content onto the site daily, “like everyone else does.”1 2.1.2. Government: Obey, Lobby – But Move Ahead Understanding and having ties with governmental bodies in China is key. Much of how you handle China’s governmental and legal systems will depend on your specific business. Many people we spoke with referred to this area as important, but they were uncomfortable discussing it in great detail. Examples abound of the power of the government online – from the great Firewall, to licensing powers, to the shutting down of swaths of major sites on seemingly a whim. But many also said that moving ahead is important. Don’t wait around for the government to figure things out. It can only truly focus on a few major things at a time – and right now, online advertising is not really one of them. Even governmental bodies we spoke with inferred this to us. 2.1.3. Start at Zero, Build Up to What Makes Sense Here we refer to the key decisions on what kind of operation you will have in China. The concept is to make these decisions based solely on succeeding the Chinese market, rather than to have them already decided based on operations elsewhere in the world: • Your offering (guess what: your great American site may not work in China -- so look for what will work) 1 AOL China meeting, Beijing, July 31 2008 (notes in appendix) Page 6 of 82
  7. 7. • Your brand (yes, even the name you use needs to be questioned) • Your model (revenue, etc.) • Your systems (sales, HR, etc.) • Your leadership structure (autonomy…and very likely a JV) • Your customers (if you are there to serve a known customer, that’s one thing…) If you have no leeway in making these decisions, you may want to reconsider your decision to even enter the Chinese Web industry. 2.1.4. China Now Has the Largest Online Audience – So What? While China has now surpassed the United States in Internet audience, its advertising industry online is not much more than 5% the size of ours. When the ad revenues of the top handful of players are removed from the picture, what’s left amounts to less than 2% of the U.S. market. Ad models such as the traditional cost-per-thousand (CPM), upon which many media rely upon in the U.S., and even the phenomenal cost-per-click (CPC) which has driven Google to more than $16 billion in 2007 revenue, are underperforming in China relative to the U.S. (moreso CPM than CPC). In fact, the most robust models we found in China is the relatively rudimentary cost-per-time (CPT), where advertisers buy a fixed location on a site for certain period of time; as well as pay for performance, such as Baidu’s selling of natural search results. Don’t base your sales and revenue expectations on audience size. 2.1.5. Deals Are Person to Person, Bargained For, and You Buy What You Can See Spend just a few days as a tourist in China and you will learn these lessons. The trick is realizing that they apply not just at Beijing’s famous tourist shopping centers the Pearl Market and Silk Market, but in just about any market in China. • Chinese firms’ massive labor forces are not just a function of governmental policy and norms. It is also a function of the importance of personal relationships – guanxi – in Chinese business. People want to be able to put a face to a transaction – even online. • Buying what you can see: The aforementioned CPT buys are a good example. Since “there are no refunds in China,” buying what you can see is just a given. • Bargaining: American publishers that won’t go off the rate card, won’t provide standard discounting, or won’t haggle, are creating an impediment up front that could be insurmountable. 2.1.6. The Chinese Internet Is What It Is -- It’s Not Going to Morph Into the U.S. Many American firms tend to think that as the Chinese Internet matures, it will start to look more like the U.S. Internet. This is what we first believed as well. The truth is that, while the Chinese Internet may in many ways be immature, it will continue to operate Page 7 of 82
  8. 8. very differently from the U.S. Here are some examples of how the Chinese Internet differs from the U.S. Internet: • The Chinese Internet is cluttered: Maybe it’s the nature of the vastly more complex Chinese language, or just how media is consumed, but simple clean sites are not favored here. • It is more focused on entertainment/gaming: Most consumers go online not for serious reasons, but to escape. • It is chock full of rabid communities/BBS: Given what people know about freedom of speech in China, many would be surprised at how robust Chinese online communities can be. Are they regulated? Yes. Does the government intervene? They have been known to. But the largely anonymous BBS message boards (plus to some extent, user-generated content (UGC), and less so, social networking) are an essential part of understanding online in China. More on BBS in sections 4.6 and especially 4.6.1 below. • It is young: In the U.S., older generations eventually got online. That is unlikely to happen in China. Young people predominate, and only as they get older will demographics change significantly. That is why some online advertising will not take in China. • It is provincial: The central government, as aforementioned, has a great deal of power in China. But provincial governments are the more hands-on authorities, and dealing with them is key. They are more powerful than a state government in the U.S., for the most part. • It is without ad standards: Advertisers are not happy that ad standards are weak in China, as it costs real money to deploy a campaign in literally thousands of sizes. But the arrival of standards is not an eventuality. • It is mobile: Mobile in China is “a way of life….Your mobile number is your identity.” We heard such statements regularly from the executives we interviewed. But is mobile advertising taking off? • It is in cafes: Internet cafes are a big part of Chinese Web usership, and many of the trends discussed in this paper are influenced by this. But as broadband to the home increases, will this change? Page 8 of 82
  9. 9. 3. Background 3.1. The Internet in China2 The Internet in China began as an academic enterprise in the late 1980’s as a joint project between the CNPAC international access line in Beijing and University of Karlsruhe, Germany, known to the outside world as CANET3. The formation of the Ministry of Information Industry, or ‘Super-ministry’ in 1998, helped clear the way of competing regulatory interests in the telecommunications industry. According to data published by CNNIC, .CN domain name registrations have increased steadily since domain registration was turned over to accredited registrars in 2003. In addition to the domain registration turnover, the cost to register has been dropped to $1RMB, or $0.15 U.S. CNNIC defines critical mass for Internet penetration as 10%, and that was reached in 2006. As of 2008, China boasts over 300 million people online, up 50% or 90M users in 12 months, and topping the U.S. for most Internet users. This only represents about 20% overall penetration of the population, concentrating mostly on urban areas and people under 30. Government focus is still very much on expanding IP/telecom infrastructure to the rural areas and getting government agencies online.4 Current eGovernment initiatives still focus on information distribution with eGovernment transactions still way off. Figure 1 - Growth of Internet Users and .CN Domain Names in China 2 CNNIC meeting, Beijing, July 31, 2008 (notes in appendix) 3 NETWORKING IN THE PEOPLE'S REPUBLIC OF CHINA (PRC), Franklin F. Kuo, SRI International, http://www.ibiblio.org/pub/multimedia/pictures/asia/china/about-china-net 4 CNNIC Interview Page 9 of 82
  10. 10. 3.2. Advertising in China Advertising in China is a relatively new phenomenon, with the first advertisement being placed in the Tianjin Daily newspaper for Blue Sky toothpaste on January 4th, 1979. Today, the majority of advertising money is spent on traditional media, such as television, newspaper and magazines -- this despite the explosive growth of the Internet in China.5 As measured at the end of the second quarter of 2008, companies were spending only 3-4% of their total advertising budgets on digital ads.6 A number of reasons exist for this sluggish adoption of digital advertising in China, the most important of which are described in greater detail in the following sections. Even though digital media has not been widely adopted by advertisers, online advertising spend is expected to rise dramatically in the coming years. From $924M spent in online advertising in 2007, to a projected $1.4B in 2008 and $2B in 2009,7 the market for online advertising dollars is poised to explode: Figure 2 - Forecast of Online Advertising Spend in China Sina.com, one of the top Websites in China, recently reported that its online advertising revenue is growing 59% year-over-year, with advertising revenue in the second quarter of 2008 reaching $64.9M (USD), a 39% increase over the first quarter of 2008.8 In terms of who is spending this money, the following three industries lead the charge in online advertising spend: • Automotive (26%) • Computers / Information Technology (22%) 5 Interview with Sean Rach, Managing Director, OgilvyOne Worldwide, July 31, 2008 6 Interview with Rach; Time for China’s Web Advertising Industry to Grow Up?, Silicon Valley Insider, August 18, 2008, www.alleyinsider.com/2008/8/time-for-china-s-Web-advertising-industry-to-grow-up- 7 eMarketer, May 2008 8 Robust Chinese Internet Advertising Growth Pushes Sina.com Higher, China TechNews, August 7, 2008, www.chinatechnews.com/2008/08/07/7203-robust-chinese-Internet-advertising-growth-pushes-sinacom- higher/ Page 10 of 82
  11. 11. • Fast Moving Consumer Goods (FMCG) (11%)9 Other industries that are investing in online advertising include Communications, Entertainment, Retail, Auctions and Classifieds, Fashion, Finance, Real Estate, and Media. These industries comprised 92% of the total online advertising spend in 2006.10 Figure 3 - Online Advertising Spend by Industry 9 Interview with Michael Jiang, General Manager, Advertising Platform and Products, Tencent, July 31, 2008; Nielsen // NetRatings AdRelevance, China, July 2006. 10 Nielsen // NetRatings AdRelevance, China, July 2006. Page 11 of 82
  12. 12. 4. Analysis: The Six Big Challenges 4.1. Overcome Fear of Labor China has a labor resource surplus, and the official numbers from the Chinese government do not capture the true demand for work.11 That said, the government is very much focused on creating millions of new jobs per year, to help continue the nation’s epic economic growth, as well as to help prevent unrest (a paramount part of the government’s mission in many arenas). It encourages large workforces, incentivizes them, and looks favorably upon them. Foreign firms can rely on labor costs in China remaining much lower than those in U.S. While the U.S. average household income in 2005 was $48,00012, the Chinese average annual household income in 2006 was $2,47113. Even if household income doubles its increase over the last 10 years (survey results show 70% increase from 1997 to 2006, doubling that would be a 140% increase), the average annual household income in China would be $5,93114. With this surplus, the Chinese are open to the use of brute force labor to help them overcome challenges in a variety of skilled and unskilled settings: • Use a laborer with clippers to trim a lawn instead of hiring a lawn mower operator15. • Build networks of “bicycle boys” to deliver goods and receive payment for orders placed online. • Use teams to manually update online content instead of investing in automated data feeds and more costly technical staff. • Hire hundreds of salespeople to sell small text ads on search engines. American companies do not see mass labor as an advantage. Rather, American firms develop technology and modes of operation that inhibit or prevent consideration of increased labor as a solution when confronted with a lack of revenue growth, and systematically avoid exposure to increasing labor costs. Thus, American Web firms in China have been slow to shed the attitudes and habits associated with its domestic hiring practices, despite government and economic support to do so, and thus risk being unable to: • Take full financial advantage of the Chinese labor markets 11 http://www.tradingeconomics.com/Economics/Unemployment-rate.aspx?Symbol=CNY 12 http://www.census.gov/hhes/www/income/incomestats.html, Income, Poverty and Health Insurance in the United States: 2006 (P60-233) [PDF] 13 http://www.gallup.com/poll/102871/Chinese-Consumers-Trying-Hard-Make-Ends-Meet.aspx 14 http://www.gallup.com/poll/102871/Chinese-Consumers-Trying-Hard-Make-Ends-Meet.aspx 15 Witnessed by project team during travels in Shenzhen Page 12 of 82
  13. 13. • Mitigate the lack of technical infrastructure • Connect with new customers through expansion of customer service • Position their companies for favorable treatment from the Chinese government. • Compete with Chinese firms that have large staffs to serve their constituents. Several of the companies we spoke with – including Google China and Omniture – discussed both the difficulty in hiring enough people, and the difficulty in hiring people quickly enough. In the case of Google, its efforts to overtake dominant Baidu in Chinese search are hampered by its inability to have the kind of staff Baidu is able to retain.16 U.S. multinational corporations (MNCs) operating in China should not make the mistake of believing that as technology use grows more sophisticated, the need for large workforces will be obviated. For example, a company can either choose to wait for debit or credit card models to become the standard, or it can invest in manually processing cash on delivery (COD) model to get goods into the hands of paying customers. (Guthy- Renker in Shanghai reported that more than 95% of their sales come from COD). Another example: Automated customer service – voicemail menus, auto responding support emails – are unlikely to catch on much at all, given the value placed on person- to-person contact when it comes to commerce (discussed further in section 4.5 below). 4.2. The Government and the Legal System – Obey, Lobby, but Move Ahead17: As may be expected, China is a highly regulated society, and companies must jump through a number of hoops to do business in China. What may not be so obvious, however, is that even in the face of significant rules and regulations, great ambiguity exists in what these rules and regulations mean, and how they are enforced. Unlike the United States, where agencies often opine on how to comply with their rules, and decisions of appellate courts are binding in similar situations going forward, in China there are no definitive answers, and companies often have to “make it up as they go” and ask forgiveness later if necessary. Having close ties to influential government officials thus can be beneficial, particularly for online content providers who bear the risk of offending content sensors and being shut down.18 4.2.1. The Basics In order to do business in China, a company must have a Chinese legal presence. That is, a company must be incorporated in China, either through a Wholly Owned Foreign Entity 16 Google, Baidu and Web Analytics Meeting Reports, Appendix 17 Due to language barriers, much of this information is taken from personal interviews with members of the Jun He law firm, the X. J. Wang & Co. law firm, and Dr. Hong Xue, Professor of Law at Hong Kong University. Appropriate guidance from qualified Chinese legal counsel should be sought before entering the Chinese market to ensure compliance with applicable laws. 18 For U.S. based companies, such ties may interfere with compliance with U.S. law, such as the Foreign Corrupt Practices Act. Note that this report does not provide legal advice on compliance with any U.S. laws, including the FCPA. Page 13 of 82
  14. 14. (WOFE) owned by a non-Chinese parent company, or as a company incorporated, based and residing in China. Once legally established in country, a company must obtain the permission of one or more (depending on the nature of the business) government entities, both national and provincial, to actually do business. Importantly, the scope of these “licenses” dictates the permissible operations of the company. A company that wishes to expand its business beyond the originally granted licenses must, technically, receive permission to do so from the appropriate government authorities. Of course the expansion of a company’s operations is open to interpretation, as are the regulations and appropriate authorities that are related to a specific company. Often, then, Chinese companies will act first without seeking government feedback or approval, and ask forgiveness later if/when their business expansion is questioned by authorities. This “act first, ask permission later” mentality reflects the ambiguous, and at times, informal manner in which business is often conducted in China. This is discussed in greater detail below. In the case of digital content, permissions from a number of national Ministries, and perhaps provincial governments as well, will be required based upon the nature of the content of an online business. 19 Perhaps the most important permission for traditional “portal” companies is the license to republish news, which is granted by the Ministry of Information and Industry (MII). Being such a licensed Information Content Provider (ICP) permits a Website to publish news stories provided by the State Sponsored News Agency. Currently, only three Websites in China are licensed as an ICP – sina.com, sohu.com, and netease.com. Interestingly, each of these sites reportedly has strong ties to the Chinese national government. 20 See below for additional discussion on the value of having government ties and lobbying. The two biggest take-aways from this discussion are: • doing business as an online content provider can be difficult due to the vast array of permissions required – the pervasive view is that “the Internet is a dangerous toy”21 which makes receiving permissions (particularly through a WOFE) very difficult; and • any entity would be well served by retaining local legal counsel with corporate transactions experience, particularly with setting up WOFEs and digital content providers. 4.2.2. The Ambiguous Legal Landscape As mentioned above, the vast array of regulations on both the national and provincial levels make it difficult for companies to operate with certainty as to what is required. Many national laws are drafted in a manner that is open to great interpretation, and often provincial laws, which are supposed to be in harmony with national laws, can and are 19 Google’s history in this regard is interesting, and reflects the ambiguity inherent in the Chinese legal system. See below for more detail. 20 Sina.Com’s CEO, for example, is married to a daughter of the Chinese Prime Minister. “Chinese Wedding Pulls Back Veil Of Secrecy on Money-Power Unions,” Wall Street Journal, Oct 31, 2003. 21 Theresa De, Partner, Jun He Law Firm. Page 14 of 82
  15. 15. interpreted in a conflicting manner. Given this, companies often fear asking the government for an official position, because it may either not get an answer at all, or it may get an answer it doesn’t like. Thus, it is viewed as less risky to proceed without legal certainty and deal with the consequences later. Google China and the Tudou.com (a leading YouTube-type Website in China) provide two prominent examples of this attitude, and the potential consequences. According to Dr. Xue, instead of waiting to receive all necessary permissions to operate its google.cn Website, Google China instead purchased a small company which already had an online presence. Google simply rebranded it and was off and running. While technically permissible, the Chinese government was not pleased at Google skirting the official permission process, and purportedly issued negative press releases warning the Chinese population not to use Google.22 Tudou.com provides another interesting case study in this regard. In December 2007, China’s State Administration of Radio, Film and Television (SARFT) and the MII issued regulations related to online video Websites. Significantly, these regulations required companies to apply for an Online Audio-Visual Broadcasting License.23 It was widely believed that leading Websites such as Tudou.com, afraid of poking too much into these regulations, simply ignored them and continued operating. On March 7, 2008, tudou.com, which at the time was the largest of the video sharing Websites in China, mysteriously went blank.24 It has since applied for and received the appropriate license, and is operating once again. The Tudou.com situation underscores and interesting dynamic in China for online content providers of all types – the existence of what we call “the Great Firewall.” It is widely believed that the Chinese government maintains an ability to censor portions, or all, of any Websites hosted in mainland China,25 and it clearly controls access to non-China based Websites from the mainland. Recall the uproar from the media during the Olympics when, contrary to its commitment of “free and unfettered access” to the Internet for journalists, the Chinese government continued to block access to some 22 Interview with Dr. Xue, July 31, 2008. 23 SARFT, MII Co-Issue Online Video Regulation, Marbridge Daily, December 29, 2007; www.marbridgeconsulting.com/marbridgedaily/2007-12- 29/article/7063/sarft_mii_co_issue_online_video_regulation 24 Rumor: China’s Largest Video Site Tudou Shutdown?, Doron Vermaat blog, thenextWeb.org/2008/03/07/rumor-chinas-largest-video-site-tudou-shutdown. Marc van der Chijs, the founder of Tudou, disputes these claims when asked by us, saying, “There are always a lot of rumors about what's really happening in the video space in China (especially rumors created by the competition), and because there is so much venture capital invested in these sites foreign media pick it up quickly and make it look like real news. Tudou was not shut down by the government and it did not 'mysteriously' go blank. We actually even informed all our registered users in advance that we would be moving our servers and would close down temporarily.” Email Correspondence, 08/28/2008. 25 The techblog86 Website describes one instance where the Chinese government shut down a Website a mere 25 minutes after it came online. The Website was illegally broadcasting Olympic events. Chinese Authorities Zap Illegal Website in 25 Minutes, August 13, 2008, www.techblog86.com Page 15 of 82
  16. 16. Websites during the games.26 The tight government control means that, without notice, an online content provider could find its Website shut down for posting or hosting content that violates some law or is otherwise offensive to the Chinese government. In reaction to stern warnings not to permit negative posts about the Olympics during the Olympic games, at least one Website shut down portions of their sites where users could upload content rather than risk facing the wrath of the Chinese sensors.27 Given the difficult governmental terrain in China, government relations – what we might call lobbying – plays an important role. While some companies we spoke with were uncomfortable discussing this, it is clear that it is useful to have strong ties with the government to help minimize business interruptions. Sina’s ICP license is a good example of how close ties to government can, perhaps, assist in cutting through bureaucracy. UPS has two ex-government officials in its employ. The point from all this is that companies operating in China must be comfortable with unclear and confusing laws and regulations coupled with potentially significant government oversight. Often it is most efficient to simply use your best judgment, move ahead and seek forgiveness if questioned. At other times, it is useful to lobby, informally (yet legally), the government for proper guidance and special permissions. In both instances, however, companies run the risk of adverse government actions, and companies simply must be comfortable with and prepared for such a situation. 4.2.3. Laws Specifically Related to Advertising In 1994 the Chinese National Congress adopted the Advertisement Law of the People’s Republic of China was adopted in 1994, which became effective April 25, 1995. While not specific to online advertisements, this national law places many restrictions on advertisements, advertisers, advertising agents and advertising publishers. For example, advertisements in China cannot contain: • the national flag, national emblem, or use the national anthem; • words such as “state-level,” “highest-level” or “best”; or • any pornographic, superstitious, horrible, violent or ugly information.28 There are further restrictions on the claims that pharmaceutical ads can make.29 In addition, advertisements must also be truthful, and cannot be belittle the products or services of other producers or manufacturers.30 Importantly for advertising publishers, they must “examine and verify the contents of advertisements in accordance with laws 26 See, e.g., China Unblocks “Some” Internet Sites, CNN Website, August 1, 2008, cnn.com/2008/TECH/08/01/olympics.Internet.ap/ 27 Interview with Marc van der Chijs, July 31, 2008. 28 See generally, Chapter II, Art. 7. 29 Chapter II, Art. 8. 30 Chapter II, Art. 7. Page 16 of 82
  17. 17. and administrative regulations.”31 In other words, online content providers can, under the law, be held accountable for advertisements that they host that do not comply with the specifics prohibitions on advertisements, even though they had no hand in creating the advertisement itself. Online content providers typically mitigate this risk through the contracts they have with agencies or directly with the companies themselves where the content provider is indemnified for losses associated with non-compliant ads. Note, however, that a monetary remedy is of little comfort to a content provider whose Website is shut down for non-compliance. It is conceivable that the Chinese government could take such a drastic step in response to ads it feels are too risqué or that it feels are too political in nature. For this reason, online content providers should prepare to have a review process in place. As before, given the complexity of the law and the need for proper contracts, companies should seek the advice of competent local counsel with experience in business transactions and contract law. 4.3. Start At Zero and Build Up to What Makes Sense What kind of operation should you have in China? Make these decisions based solely on succeeding the Chinese market – question virtually every aspect of your operations -- rather than simply adopt decisions based on operations elsewhere in the world: 4.3.1. Branding & Market Positioning When UPS entered China, they exported three things about its marketing: the brand name, the color brown, and their focus on customer service. Everything else was reconsidered from the ground up to make operations in China work.32 While the recipe for success may change from company to company, this is the mentality that must exist from the beginning. Large MNCs entering new markets typically rely on leveraging the brand to establish dominance. Cultural differences, however, can greatly affect brand loyalty. The Chinese generally distrust foreign brands and will choose a local or regional firm over the foreign competitors. While companies like Google have developed overwhelming dominance in many parts of the world, in China they are squarely in the shadow of their local competitor, Baidu. In fact, many first-time customers still struggle with how to pronounce the word “Google.” 4.3.2. Leadership & Operation Systems When choosing the right executives to lead an overseas venture, companies often select those from within their ranks who can best export the company’s vision and culture. In China, however, it is wise to select someone who knows and understands the Chinese market best. In a culture where relationship building is the central focus of doing business, choosing not only a Chinese national, but one who is already a player in the 31 Chapter II, Art. 27. 32 UPS Meeting report, Appendix Page 17 of 82
  18. 18. industry culture, is highly recommended Executives running operations in China must also maintain a high level of autonomy in decision-making. The pace of business in China is fast and if leaders’ ability to react is handicapped by their parent organizations, they are not likely to survive very long. Some of the American firms we spoke with had important groups in China reporting not to their Chinese GM, but to the corresponding groups in the U.S. On a corporate level, a major joint venture must be considered – including ones where power is relinquished to a local partner. Some executives we spoke with believe this is the only way to truly succeed in the Chinese Internet, and point to Yahoo’s success with Alibaba as the prime example. 4.3.3. Revenue & Advertising Models A lot of Chinese online ad dollars are flowing to more rudimentary models such as cost per time (CPT). Publishers setting up shop will have a tough enough time attracting ad dollars – it will be that much harder if they refuse to accept that the success of more sophisticated models has been limited. The picture is brightening; but sites that want to win may need to launch with revenue models that look very different from those of the home office. More on online advertising can be found in section 4.4 below. 4.3.4. Consumers & Customers Who are you targeting? In China, the online customer landscape is quite different. In section 4.6, we discuss many of the key differences, and why one should not expect the landscape to eventually fall in line with that of the U.S. The kinds of advertisers and consumers you attract in other countries may not be who you can or should attract in China. Examples: The plurality of Chinese Internet café users form a unique set of attributes; and generally, older users are few and far between. All this is not to say that entering China to reach a predetermined set of users (example: a site about the oil industry that wants to reach Chinese in that industry) is a problem. But firms should not make assumptions about any audience in China; and firms that can, should look closely at whether a target different from its U.S. one may be best in the P.R.C. 4.4. China’s Got The Most People Online – So What? As China takes the number one spot in total number of online users, why aren’t the ad dollars following as quickly as one might expect? 4.4.1. Chinese Netizens Are Not Yet Focused on Transactions or Behaviors That Lead to Transactions, So SMBs Don’t Advertise as Much One key answer: Domestic consumption is not yet supporting the necessary competition among small and medium business (SMB) advertisers. Looking at typical user demographics and usage patterns presented in the recently released CNNIC quarterly report, we notice the prevailing Internet trends of personal entertainment (music/video), social communication (BBS message boards, instant messaging), and news. Users are still weaving the Internet into the fabric of Chinese everyday life. If 10% penetration was the tipping point for Web acceptance into the society, what then is the tipping point for Web consumerism? One estimate suggests once 40% penetration occurs, Web Page 18 of 82
  19. 19. consumerism will take off, and traditional media ad budgets will start to move online.33 But another factor is what the Chinese spend online is not money (which, in the aggregate, they don’t have), but time. Especially in second tier cities and rural areas, the perception is that everything online is free.34 To increase domestic buying power, the government is phasing in increases to the minimum wage to triple from current levels in three years.35 The government is focused on extending infrastructure to the rural areas and developing a plan for ipv6 adoption. Retail banking and credit card usage are gaining traction as well – however, alternative currencies such as Tencent’s QQ credits (sold in stores around China for use in Tencent’s massively popular QQ games) are popular and actually put the Chinese ahead of the U.S. in terms of adopting micropayments. 4.4.2. Major Ad Buyers are Focused on Brand Awareness For the reasons given above as well as other factors, major advertisers focus on image advertising online. While (as discussed below) much of their budgets go toward rudimentary ad models, the freedom that comes with not focusing on transactions is also allowing big players like UPS and Procter & Gamble to experiment in other online areas such as: • Video and user-generated content (UGC), including UPS’ video-submission contest for the Olympics campaign • Microsites (special market-specific promotional Websites to promote their product offerings, often in several dialects), which both UPS and P&G deploy • BBS message boards: P&G for one acknowledges that these community portals are the ‘battlefront in the online space’ for brand advertisers like them.36 Firms such as Nielsen are now offering a brand protection service that monitors BBS sites for negative postings and responds with positive spin if necessary.37 4.4.3. Advertisers Don’t Look Much Beyond Market Leaders and Basic Ad Models Online ad revenue in China is split among a small handful of firms. While exact numbers are unavailable, a look at the 10-Ks of the major players backs up this suggestion. This pie chart is a rough representation: 33 Mark Van der Chris, CEO Spill Group Asia, interview 34 ibid. 35 Wang Xiaochun, Shenzen Bureau of Trade and Industry, remarks, July 29, 2008 36 J. Alfonso (Pon) de Dios, Associate Director, Greater China Media Department, interview 37 Nielsen online interview Page 19 of 82
  20. 20. Figure 4 - Online Advertising Revenue by Company Data: Analysis International 2008 Here, the top 6 sites in China – Yahoo China, Google China, Tencent, Sohu, Sina, Baidu – account for a whopping 78% of all ad revenue in the first quarter of this year. Other estimates put the figure higher – even when not including Google (the only foreign-run one of the six). The 16% “Other” is spread across thousands of disparate second and third tier sites. Much of these dollars are spent on rudimentary ad models such as cost per time (CPT). Many advertisers rely on agencies with little or no experience online to manage campaigns for them and these firms have been slow to adopt sophisticated models, metrics or standards.38 This is the case even though risk taking among advertisers would not cost much, with ad rates as low as they are. 4.5. Deals are Person to Person, Bargained For, and You Buy What You Can See Trust-building is paramount in Chinese business. In many cases, the Chinese demand to work with those with whom they have a substantive relationship – this is the concept of “guanxi”. Though many nations have a similar dynamic, it presents a bigger barrier for outside firms in China. The right amount of guanxi is vital, and can seal a deal for a long time. Guanxi relies on face to face meetings, networking, socializing, and frequent contacts. Emails, presentations, and teleconferences can deliver business content but cannot close deals.39 Western companies accustomed to virtual deal-making and automation have to establish a significant and not short-term physical presence. 38 Alex Lee interview, China Springboard CEO 39 Cameron Cowan, Accounts Manager, Omniture, interview notes Page 20 of 82
  21. 21. While this universal Chinese-business theme applies directly to corporate constituents such as advertisers, it also applies indirectly to online customers. Online businesses must not assume they can rely on faceless – much less automated – sales and service. As discussed earlier, employing large labor forces plays a role here. Baidu employs hundreds of salespeople who deal in small text ads. Major Amazon-type players retain legions of deliverymen. The need for human contact becomes even more necessary when considering that in China, almost every transaction has a bargaining component. So publishers who adhere to a rigid ad-rate structure will have problems in China. And many agencies – especially large and large-volume ones -- make their margin on discounts, so even more is at stake for them if the publisher won’t go off the rate card. Doing this can be very difficult for foreign firms who don’t do it elsewhere; but as with relationship-building, bargaining is so ingrained in Chinese business culture that there is no way around it. The final leg in this stool is that the Chinese are hesitant to buy any goods they cannot see.40 One of the main ways this manifests itself in online advertising is the popularity of cost-per-time advertising. With CPT, the advertiser knows exactly where and when the ad will run. Even though models such as CPC and CPM can be much more effective, the need to buy what you can see still often prevails. Several of the companies with which we spoke mentioned the same example: An ad buyer will only buy an ad that he can reliably point his boss to when the boss visits the Website.41 4.6. The Chinese Internet Is What It Is -- It’s Not Going to Morph Into the U.S If the Chinese were simply a certain number of years behind the U.S. in Internet maturation, as many still believe, then some of the U.S. firms that got in early should be winning in China by now, and other firms could follow in their footsteps. Instead, there are no examples of U.S. market leaders in any online category in China. Instead, there exist many examples of user behavior in China that are not consistent with U.S. behavior: • Big Sites Are Cluttered – Popular Chinese portals contain significantly more links than their U.S. counterparts. For simple comparison, on Tencent’s qq.com, there are over 900 links. On aol.com, there are 240 links42. Even in Hong Kong, Web designers favor site layouts with large numbers of links for the Hong Kong users (this group would be most likely to favor U.S. Internet browsing habits because of the longer exposure to the Internet, however that is not the case)43. Chinese portal homepages can scroll on for seven or eight folds, intermixed with text and graphic 40 Guthy-Renker, Ogilvy, July 31, 2008 ( See Appendix) 41 Companies that mentioned this dynamic included Tencent, Ogilvy, Tudou, Plus Eight Star, China Springboard. (See Appendix) 42 Link count based on find and replace count of href tags from source html on home pages of qq.com and aol.com 43 Ogilvy trip report Page 21 of 82
  22. 22. banner ads throughout. The look is familiar to that of Chinese press, especially local newspapers. Currently, there is little or no appreciation for Western-style Web usability in China.44 Conventional wisdom does hold that improving the online user experience will increase traffic and ad revenue. But in China, there is a spirited difference of opinion as to whether “cleaner” sites will eventually prevail. Google China, for example, believes its look will win in the end. Not surprisingly, the dominant leader, Baidu, believes its look is ideal. Tao Li from HDT helped provide perspective on this approach: Building the systems and processes that identify and address what the Chinese respond to today is a much more valuable skill than predicting what they might prefer in the future. For example, if the Chinese Internet population responds to flashy pages heavy with links and videos, then online advertising should be flashier and less text oriented than what is provided in the U.S. Marc van der Chijs, a key player through both his founding role at Tudou and current leadership of Spil Games, has pointed out that advertisers must recognize this trend. • Users Are More Focused on Entertainment / Gaming – Multi-player online games, music, and video thrive more than serious, information- and transaction- oriented activities do on the Chinese Internet. While all activities are sure to grow in China, the former, escape-oriented ones are likely to remain in the lead. In addition, these areas often still run afoul of copyrights; unless a business model addresses the limited financial resources of the average Chinese consumer, it is unlikely that copyrights will be more respected.45 • Youth Will Remain Dominant -- There has yet to be and may never be meaningful adoption of the Internet among older generations in China. The value of online activity may be dependent on the career progression in terms of salary and power acquired by the current young lead generation of Internet users. More on this in section 4.6.2 below • Communities Can Be Rabid - BBS, UGC and to some extent social networking actually represent a plurality if not a majority of the ways that Chinese can strongly (and to some extent, freely) express themselves in any medium, not just online. Few major sites are without a BBS, and few major brands are not the subject of BBS discussion – discussions that can be extremely influential.46 More on BBS in section 4.6.1 directly below. • Provinces Are Paramount -- China does not represent one homogenous market space, but rather many unique niche markets. Thorough independent research of target markets is highly recommended prior to any large-scale investment. 44 Jenny Hoe, independent consultant, Web Analytics Roundtable 45 Interview with Marc van der Chijs and Direct Marketing Roundtable 46 Interview with Marc van der Chijs and Direct Marketing Roundtable Page 22 of 82
  23. 23. • Mobile Is Ubiquitous -- While there exists a general expectation that mobile usage will have a huge impact on the Chinese Internet, it is not as clear how soon that will happen or how companies will take advantage of the opportunity47. Similarly, it is not clear how the use of mobile may impact other trends in usage from cafés or with broadband. • Cybercafes Are Part of the Culture – While cybercafés have proliferated worldwide, in China a very large number of consumers rely on them for their primary Internet access. This makes things like targeted advertising very difficult to deploy, as the computers are essentially public. Cafes are not looked upon favorably by the government, and increasing broadband to the home (and higher-speed mobile, as just mentioned) might move cybercafes to a role closer to that of its role in the U.S., but this is not a given. • Ad standards? What Are Those? – This paper has touched on ad standards but just to be clear, here is a brief roundup of the situation: A campaign that includes the top 100 sites in China requires up to 7,000 different ad sizes to be cut.48 For all parties – advertisers, publishers and third parties such as agencies – this is far from ideal. But given the proliferation of cheap labor – including graphic designers – the pain is apparently not high enough for action. During our research, we found evidence of groups trying to propagate standards, but nothing has been successful to date. 4.6.1. BBS The most influential technology in China in terms of free expression of ideas is not a common Web technology. It is Discuz!, the software platform that powers 70% of all Chinese BBS49. When a U.S. user sees a Chinese BBS with the ability to accommodate flashy images, they may not recognize it based on the text heavy interface more commonly known to U.S. Internet users. As summarized by Gang Lu in the blog www.mobinode.com and documented by iResearch Consulting Group, “in 2007, In China around 36.3% users spend 1-3 hours on BBS, about 44.7% users spend 3-8 hours and even 15.1% users are on BBS for more than 8 hours a day. Over 60% of users will login at least 3 BBS more than 3 times each every week.” 80% of Chinese Websites operate their own BBS. However, based on examinations of Chinese BBS, the gap in design is not as far from the U.S. as is the case with gaming or portals. George Godula, founder of Web2Asia, pointed out the more aggressive companies seek to influence BBS listings to put their company in the best light; companies, aware of the influence of the BBS, can find ways to influence how comments are placed. It is also an acknowledged practice of the Chinese government to influence editing of the BBS. During the Olympics, the government communicated to site owners that negative BBS comments could prompt a shutdown of the site50. Many believe that the government and 47 Interview with Marc van der Chijs 48 Web Analytics Dinner, See Appendix 49 http://www.mobinode.com/2008/01/17/chinese-bbs-the-undiscovered-phenomenon-in-chinese-Internet/ 50 Interview with Marc van der Chijs Page 23 of 82
  24. 24. Carrefour worked together to quell protests outside Carrefour stores in China and that one main way it was done was to shut down BBS threads on the protests.51 These efforts are less an indication of the issues with BBS and more of an indication of the power and influence of the BBS. For a Chinese user, the opportunity to post an (anonymous) comment to BBS and influence a large audience can possess greater value than to send a comment back to an advertiser or portal owner directly. This incentive also exists for businesses. For example, Spil Games shut down their BBS to prevent competitors from logging Olympic related comments52. Because of the power of BBS, the opportunity to use them to shape opinions, and the relatively smaller gap in knowledge of BBS technology and design, U.S. MNCs would benefit from investment in a BBS strategy. 4.6.2. A Young at Heart Internet Nation To date, it has not appeared that older generations in China have adopted the Internet. Figure 5 - Historical Trends in Age Demographics for Chinese Internet Users While there are some changes in percentage shares in the age brackets younger than 30, those above have remained relatively static. A strategy based on expecting Internet users to “grow up” would appear risky given the demographic trends from CNNIC. Given these trends and the likelihood they will not change, U.S. Web firms may benefit by focusing on those that favor their strengths. For example, it may be difficult to create the type of dense sites or unique games the Chinese prefer, but BBS and youth marketing are well within the American wheelhouse. 51 Web Analytics Dinner, Appendix 52 Interview with Marc van der Chijs Page 24 of 82
  25. 25. 5. Final Thoughts The team’s recommendations are embedded in the six challenges that precede this section. The six challenges represent the key issues to consider before setting foot on the mainland. However, they do beg the unanswered question: Should American Web firms even enter China? We see two contrasting ways of looking at this question: 5.1. Get Going Now From major infrastructure to vast complexes, the Chinese are building at a pace unmatched in the world. A visit to any major city in China – for example, Shenzhen, which was a fishing village 25 years ago and is now bigger than any metro area in the U.S. except for New York – is proof enough of this. The West talks about how fast things change in our society, but in many ways we don’t hold a candle to China; for example, it took London as much time to just hold the public hearings about its vast new international terminal at Heathrow as it took Beijing to fully complete its even larger one.53 This pace of change can be seen online as well. It is often just a matter of weeks before a hot new startup spawns multiple copycat sites, for example. When we first began looking at the Chinese online ad market, we thought it was on a path similar to the U.S., and simply behind the U.S. by a number of years. American firms could wait until the market in China matured and then expect to do well. Indeed, some major American Web firms in China still believe precisely this. We no longer believe this, however.54 China will take its own path, and firms who want to succeed there will simply fall behind if they do not get involved now. Be smart how you enter, be willing to sacrifice, and be patient for profit – but if you are to enter, don’t let those things delay your entry. This is what we heard not only from Internet industry leaders, but also leaders in other industries we met with, from financial services to telecom to software.55 The message is clear: Go! 5.2. Ask Even Deeper Questions First Many in the West are of course dismayed by China’s approach to human rights, including freedom of speech. It may be inevitable for media firms in particular to feel compelled to grapple with this issue as they enter China. Everywhere in China you will find the word Harmonious and synonyms thereof, on buildings, businesses, even municipalities. Asian culture and religious history stress balance in mind, body, and spirit and Confucian ideals of harmony among people. Yet we witnessed explosive growth that often lacked these ideals. Other times, the growth seemed more like the opening ceremony of the Beijing Olympics: Executed by vast 53 Paul Goldberger, “Situation Terminal,” The New Yorker, April 21, 2008 54 Section 4.6 details many examples that support this view. 55 IEMBA-wide meetings in Hong Kong with Excel Technology and Citi; in Shenzhen with ZTE Page 25 of 82
  26. 26. numbers of people, yet tightly controlled by a few. But whether chaotic or controlled, individual rights in China are quickly given lower priority in the name of progress – whether it is a roadside neighborhood being walled off so that Olympic visitors won’t see it, or a BBS shut down to help a MNC withstand a corporate crisis. For online advertising, the real issue may be whether the professional class that upholds standards of business and codes of conduct will be empowered. From ad metrics, to intellectual property, to credit, to issues of censorship, online advertising requires not so much strong government policy as it does the power to police itself. Some would argue that the central government should be less wary of the professional class and embrace the ideal of harmony and balance so ingrained in its culture. So considering this reality, American Web firms need to confront themselves with the contrast between a native cultural value system which governs commerce and legal norms and frameworks, and those at play in China. It is one thing for a Western product brand to do well in China; for a service brand, dependent on something like advertising, is a whole other question. Will the physics at play in China ever allow success without causing PR problems back home? Is it your job to help change China? What output from a Chinese presence can be leveraged back to the global business? These are tough questions that pose perhaps a seventh and most difficult challenge to overcome. Page 26 of 82
  27. 27. APPENDICES Page 27 of 82
  28. 28. MEETING REPORTS Page 28 of 82
  29. 29. 1. OgilvyOne Worldwide 23rd Floor, The Center 99 Queens Road Central, Hong Kong www.ogilvy.com July 31, 2008 Participants: Sean Rach, Managing Director (sean.rach@ogilvy.com), Pavitar Juneja, Matt Luxton 1.1. Summary Sean Rach is the Managing Director for OgilvyOne Worldwide’s Hong Kong office. He provided interesting insights into the Hong Kong advertising market in general, and the online advertising environment specifically. 1.2. Specifics 1.2.1. The Online Advertising Space (Hong Kong) • Ogilvy’s preferred method for placing online ads is through Third Party Ad Servicers, such as Double Click. Double Click gives ad agencies access to a ton of data through “click tags” attached to each online ad, including which Websites are generating the most actions (clicks). o Ogilvy is then able to optimize the ad campaign based on the real time data. It is this powerful tool that makes online ads, in Sean’s mind, so powerful. • Advertisers, however, only spend 3% of their ad budget on digital media. This compares to 35% of digital consumption, illustrating a huge “confidence gap” among advertisers. • The dominant online ad model in HK is, as with PRC, a daily rate model (CPT). o Rach believes this is cultural – the boss wants to see the ad on the best Website on the specified day – not the lack of metrics on ad impressions. Page 29 of 82
  30. 30. o This is driven by historical ads in HK as well – television and print media have been dominant for so long, and this is the manner in which they are bought. o He also thinks ad agencies are partly to blame for CPT model dominance in that they tend to overwhelm their clients with information and statistics about the online ad space. He believes they need to make it simple to get their clients to understand the online space. • Rach thinks that PRC may be better off than HK in this regard since they don’t have the “bad habits” of HK. Advertising is a new thing there, and consumers are willing to accept ads in multiple forms. • Another problem in the HK online ad space is lack of standards across Websites. Each site has different requirements for the size of ads, which makes it very expensive for advertisers as well. • As for advice to U.S. content providers, his most important point is that cookie cutter models do not work. Just because it has worked in the U.S. doesn’t mean it will work in Asia. You have to be “locally relevant.” Page 30 of 82
  31. 31. 2. Procter & Gamble (China) Ltd. 27-33/F., Center Plaza 161 Linhexi Road, Tianhe District Guangzhou, Guangdong, P.R. China Post Code: 510620 August 1, 2008 Participants: J. Alfonso (Pon) de Dios, Associate Director, Greater China Media Department (dedios.JA@pg.com), Pavitar Juneja, Matt Luxton 2.1. Summary Procter & Gamble (PG) is a sophisticated advertiser, and is keenly focused on its consumers. It relies primarily on TV ads currently, but has created online trial campaigns that try to tap into China’s penchant for online communities and blogging. The two most striking points from our interview were (1) Pon’s surprise that CPT is used by others in the digital advertising space, and (2) his perspective that the success (or failure) of any Website is driven by locally relevant content. Without content that attracts appropriate consumers, FMCG (Fast Moving Consumer Goods) producers will not advertise. 2.2. Specifics • TV ads have made PG successful, and this is why PG spends most of its advertising budget on TV rather than digital. • Digital ad budgets are, however, escalating – Pon did not have the numbers with him – and he believes that they probably are not where they need to be. • PG focuses on creative digital ads and trial campaigns, and sees User Generated Content and Social Networking Sites as the battlefront in the online space. o PG is acutely aware of the Chinese trend toward online communities (UGC) and is focusing its online ad campaigns here. o One example was a PG Pampers Website where PG created a community for mothers to discuss baby care. This was hugely important to mothers, particularly Page 31 of 82
  32. 32. given China’s one child policy (i.e. no learning from past mistakes), and led to a big increase in Pampers sales. • PG does not have a good way to measure the ROI on its online ad campaigns. It is focused on engagement time, and so does NOT buy ads on a CPT basis. It is all CPC or CPA. Pon was surprised when we told him that others have said CPT is the dominant online ad model. • PG sees video as important, but more as a way for PG to advertise rather than as a medium on which to advertise (i.e. they are not advertising pre-roll or post-roll on tudo.com or 58.com or other Websites). • Bottom line for PG: they key for any Website is to create content that reaches PG’s consumers. Given China’s obsession with blogs / UGC / BBS, a simple portal doesn’t do it. You have to create features / communities that attract consumers. Page 32 of 82
  33. 33. 3. Jun He Law Firm Suite 2208, 22/F, Jardine House 1 Connaught Place Central, Hong Kong www.junhe.com July 30, 2008 Participants: Theresa De, Partner, Dennis S K Hu, Solicitor, Pauline N. Y. Chan, Solicitor, Pavitar Juneja, Matt Luxton 3.1. Summary • General restrictions on ad content that seem consistent with “common sense” approach • No laws exist that are specific to the online ad environment – PRC and courts are trying to adapt existing laws (IP and health) to online environment • U.S. companies that try to enter PRC market directly may face legal difficulties that domestic firms do not experience. 3.2. Specifics 3.2.1. Chinese Legislation Process • Laws that apply across the PRC (and, in theory, in Hong Kong and Macau) are passed by the National People’s Congress (the NPC), the equivalent of the United States Congress. • There are a number of Ministries, however, which are empowered to pass regulations and rules that have the binding effect of law. Examples of PRC Ministries include the Page 33 of 82
  34. 34. Ministry of Information, the Ministry of Foreign Exchange, and the Ministry of the Petroleum Industry. Multiple Ministries may pass regulations pertaining to a single law. • Provinces also often pass laws that apply within their boundaries. In theory, these laws are consistent with laws passed by the NPC, although this is not always so. 3.2.2. Advertising Laws • The NPC passed an Advertising Law in 1994, effective 1995, that applies to advertisements generally, regardless of the media for the ads. The text of the law is attached in the Appendices. o There is no national law directed specifically to online ads, although local Beijing authorities passed an online ad law in 2001. We were not able to get much information on the specifics of this law. • There are many requirements on what ads can and cannot contain, although there is not a lot of guidance (e.g. laws must be for the general good of society, cannot promote violence, cannot jeopardize social order, cannot include or reference national symbols (flag, song, etc.), cannot be injurious, must be truthful, etc.) • There are a number of other laws that may also apply to advertisements and advertisers, such as intellectual property laws, or Ministry of Health regulations on tobacco, drugs, etc., for example. • The Law provides for joint and severable liability among the parties (advertiser, agent, publisher) for compliance with the Law. This means that publishers, under the law, are required to ensure that advertisements are truthful, not injurious, etc. (see above on law requirements) even though they didn’t create the ads. o Firms try to shift this risk via contract where publishers require advertisers to rep and warrant that ads comply with the law and that advertisers / agents have proper permits to do business. • Penalties for non-compliance can includes fines, confiscation of ads, and possible criminal / civil liability 3.2.3. Doing Business in China • You must have a local legal entity in PRC to do business in China – a Wholly Owned Foreign Entity (WOFE), a JV, or a partnership of some sort. • You must apply for, at a minimum, a permit / license to do business in China. The entity that must provide the permit / license depends on the nature of the business and where it will be conducted. o A business that operates only in a single location must apply for permission from local regulating body. A company doing business throughout China likely has to apply to an NPC Ministry for a license / permit. Page 34 of 82
  35. 35. o Online Advertisement Publishers (Baidu, Tencent, etc.) must apply for permission to operate from the NPC (Ministry of Information?). Theresa and Dennis referred to these entities as “ISP”s. • Licenses reflect the scope of business that a firm conducts – you cannot conduct business that exceeds the scope of the applied for and approved license. • Licenses for ISPs are greatly scrutinized (and WOFEs have a hard time getting these) because the Internet is a “dangerous toy” o PRC government is concerned about scope and effect of Internet traffic Page 35 of 82
  36. 36. 4. Dr. Hong Xue The University of Hong Kong Faculty of Law August 1, 2008 (Teleconference) Participants: Dr. Hong Xue, Matt Luxton 4.1. Summary Dr. Xue is a law professor at the University of Hong Kong, and holds LLB, LLM and PhD degrees. She currently teaches a class on Information Technology Law in the People’s Republic of China, which has 4 primary areas of focus: Access, Privacy Protection, Online torts, and E-Commerce. Dr. Xue emphasized the importance of receiving government approval before you do business in China, and content driven Websites have additional burdens placed upon them due to the number of different agencies and ministries whose approval are required. The bottom line for her is that online entities face a complex legal system in PRC, and companies should hire competent local counsel to help them navigate this landscape. 4.2. Specifics • PRC laws related to Information Technology, in general, are very complicated. In 2000, the National People’s Congress issued regulations on Internet Services, which led to a host of rules promulgated by various Chinese Ministries, including the Ministry of Information and Industry (MII), the Ministry of Commerce, and the Ministry of Education. • Internet Service Providers, or ISPs (effectively content based Websites) may require up to 10 different approvals before they can start operating. o At the bottom of sina.com.cn, for example, you can find a link that shows the various department approvals Sina needs to operate and that demonstrates its compliance • The most important approval for ISPs is the one from the MII. Other agency permissions are determined based upon the content of the ISP. • Sites that contain pharmaceutical information, for example, need permission from the Ministry of Health • An additional permission from MII, the Information Content Provider (ICP) license, is required to publish news. An ICP is the most difficult permission to get, and currently only 3 Websites have permission to re-publish news that the state controlled news agency generates. These sites are sina.com.cn, sohu.com.cn, and netease.com.cn. • Regarding U.S. companies entering China, Dr. Xue feels that they have been unsuccessful for two reasons: Page 36 of 82
  37. 37. o Culture – U.S. based operations don’t appreciate Chinese demands for content o Government pressure – Google is a good example. When Google failed to receive its ICP, it “rented” one from a small site. The Government shut the site down, and also launched a media campaign against Google, actively encourage the population not to use Google. She feels this has had a huge effect on the success of Google’s china site. Page 37 of 82
  38. 38. 5. Tencent Technology Company Limited 8/F, Suite A TCL Tower Shenzhen Nanshan Hi-tech Park www.tencent.com July 31, 2008 Time: 2:00 PM Participants: Jiang, Michael, General Manager – Advertising Platform & Products, Matt Luxton, Pavitar Juneja (PJ) 5.1. Summary Matt and PJ met with Michael Jiang (center person in the picture) from Tencent Technology Company Limited to discuss advertisement models currently prevailing in the Peoples Republic of China (PRC) and its future trends. Michael was very helpful and informative about the PRC advertisement market both from the Advertiser and online Publisher standpoint. Overall the meeting was fruitful and provided good insight on the advertisement market trends and ad revenue models prevailing in the Peoples Republic of China (PRC). 5.2. Specifics 5.2.1. About the company: Tencent provide one-stop solution for the following capabilities: • Search Engine capability, Competitors – Baidu, Google • Portals, Competitors – CINA, SOHU • Gaming Page 38 of 82
  39. 39. • e-Commerce, Competitors – Dang Dang, Alibaba, eBay 5.2.2. Advertisement Industry in the Peoples Republic of China (PRC): • Following industries (in the order) are major online advertisers in the PRC o Automotive o IT Hardware o Real Estate o Fast Moving Consumer Goods (FMCG) o Apparel o Banking & Finance o Internet Service Providers o Gaming sites • Tencent provide online advertisement for low end brands like Gaming, Apparel and FMCG • Small to medium brand advertisements are on CPC model for revenue generation • High end brands like Automotive advertisements, big banners are on CPT, CPM model for revenue generation • For all major brands, number of clicks are monitored by the 3rd party like double click, Allyes • Number of page viewed is monitored by the Publishers • Post Click statistics has no standards and typically monitored by the Advertisers 5.2.3. Advertisement Future Trends in PRC • PRC advertisement industry is resistant to accept CPC, CPA models due to uncertainty in the revenue generation • Industry is embracing CPT, CPM models • CPC and CPA models will be used in the 2nd and 3rd tier advertisements • Video advertisements accompanied with the brand name will become more prevalent as Chinese market is less technology savvy. • Bandwidth is no issue and mobile users are increasing every day. Advertisement through mobile devices (like in Japan) will become popular • No future for just video sites like 58.com, tudo.com • Privacy will still remain a big issue in the near future • Social Networking Sites (SNS), YouTube and other sites which follow Facebook business model will have hard time in PRC Page 39 of 82
  40. 40. • Major change in the Social Network Sites (SNS) needed. Recommendation is to integrate online network with offline network • PRC government is flexible and industry will decide regulations and compliance with the law • Tencent expects its users to rise from 273 M to 300M by the end of this year 5.3. Conclusion • To be successful in PRC, Foreign Company must alliance with the local company. • Foreign company must provide power and authority to local people • CPM revenue model for online advertisement will remain most popular among high end brands • Low end brands are moving towards performance based models like CPT • Mobile and Online video for brand recognition will become popular Page 40 of 82
  41. 41. 6. AOL China TUSPark Headquarters Beijing July 31, 2008 Participants L to R: Lu Lu, Vice President, Technology, AOL; Dr. Norman Koo, VP & GM AOL China; Patrick Sheridan and Jamie Hammond. Not shown: Luke Shi, Assistant GM, AOL China. 6.1. Summary: Norm Koo runs AOL China, and Lu Lu runs the development team in China but is based in the U.S. where he also runs a major development team for some of AOL’s top Websites. Luke Shi is their right-hand man. We met with the three of them on a Thursday afternoon at AOL China’s offices, located in Tsinghua University Scientific Park (TUSPark), a building complex that houses many of the top American Web firms’ Chinese offices. The office and the entire TUSPark campus is dominated by early-twenties aged Chinese employees, many of whom graduated from Tsinghua or other nearby universities, and some of whom still live in dorms. This area, in the Northwest corner of greater Beijing, is the heart of China’s Silicon Valley. 6.2. Specifics Page 41 of 82
  42. 42. • In Spring 2008 AOL Taiwan and AOL Hong Kong launched. There is also a Chinese- language AOL portal targeting North American Chinese-speaking audience. There is as of yet no AOL.CN • They are curious to learn from our report the following: o Why have other American Web firms in China failed to meet expectations? o Should AOL consider doing something very different to succeed? o Is it necessary to have a joint venture to succeed here? Seems like every WOFE (wholly owned foreign entity) has failed…this is not to say that every JV has succeeded, because some have not. o In any case, what level of control does the local office need to have to succeed? • Here once again we heard anecdotes about the virtue of manual labor in China’s Web world: o When AOL called a local content partner asking for a content feed, the partner said “What feed? Just hire people to copy and paste our content like everyone else does.” o …Automation is everything in the U.S. online business…here it is seen as putting people out of work. o Dang Dang is another example – POD delivery service • Supergirl (Chinese Idol, basically) finale: 1.2 billion votes cast • One reason e-commerce hasn’t fully taken off yet is that refunds aren’t big in China – so you have to see what you are buying (hence Dang Dang service above). • It takes time for a foreign firm to win in China. Motorola has been here 20 years. Nokia a long time as well. • Most people we met with referred to the power and potential of mobile, as was the case in this meeting. Examples: SMS = IM here; your phone number being your identity…the aftermarket for premium numbers; phone bling. • As online grew in the U.S., older people did go online. Here that is not happening. Online is for the young. Page 42 of 82
  43. 43. 7. Google China Participants: Ann Wang, Online Sales and Operations Director, Adsense, Google Greater China, Dong P, Google Online Sales and Operations Director, Adwords, Google Greater China, James Hammond, Patrick Sheridan 7.1. Summary The Google Building might as well be located in Mountain View. Hip young staff meet visitors in the lobby front of the flat screen LCD projecting a 3d version of the Google Zeitgeist. Spacious cubes, a yoga room, and of course catered lunches all complete the Google aesthetic. We received a full tour of the Beijing facility, a dedicated meeting with senior managers, and lunch at the company cafeteria. Google feels well positioned for long term growth in China. They are currently focused on small to medium size enterprises (SME). They feel their product offerings are perceived as more complex by customers than those of major competitor Baidu, however, over time with increased competition the market will move in their direction as it has in the U.S. Global HR policies defined in Mountain View have a limiting effect in China ramping sales staff to compete with Baidu. A major challenge remains originating traffic to the Website and keeping traffic. Most Google China searches result in content hosted on Baidu. Google is partnering to embed its search bar in local portals as well as acquiring highly trafficked portals. In terms of content networks, Baidu was described as the ‘Head’ and Alimama as the ‘Tail’, meaning that Baidu takes the most high end premium content advertising and Alimama looks to extend its ad network reach into the smaller content players. Google maintains five offices in China: Hong Kong (sales), Taiwan [sales], Guanzhou [sales], Shanghai [engineering services], and Beijing [HQ, a bit of everything]. Page 43 of 82
  44. 44. 8. Web Analytics Dinner Lan Club Beijing July 30, 2008 Participants included: Benjamin Joffe, Managing Director, Plus Eight Star Ltd. (first on left); Nguyen Le, Vice President Product Strategy, Wanmo.com (to Ben’s left); Lin Juan, Senior Analyst, Wedge MKI (to Nguyen’s left); Florian Pihs, Data & Analytics Program Director, MRM Worldwide (first on right); Jennifer Hoe (to Patrick’s right); Darryl Su of Omniture China (two down from Jennifer); Yong Wu, GM, Webtrends; Apple Xu & Yimeng Ding, OgilvyOne Worldwide; Patrick Sheridan, Jamie Hammond. 8.1. Summary We arrived in Beijing from Hong Kong earlier in the day and headed downtown for dinner at this amazing Phillippe Starck-designed club, where one dish was more exotic than the next. Florian Pihs, who blogs at http://longmarch.chinalytics.com, set up this dinner and it was a great way to get started meeting Beijing online-professional community. Patrick and Jamie had several fruitful exchanges during an evening of wide-ranging conversation. 8.2. Specifics • Anecdote on the importance of BBS: After the Olympic torch relay problems in France, there were protests at Chinese Carrefours. The Chinese government “helped” Page 44 of 82
  45. 45. the company delete BBS conversations about Carrefour, and that helped squelch the protests as it cut off a key way of organizing them. • No reason why Google China couldn’t close the ‘language gap’ it suffers from with Baidu – but that doesn’t mean they can overcome Baidu. • Nielsen could use a better reputation in China -- and Comscore could use more of a reputation. • Most big advertisers are not spending enough in China to care about precise metrics (and the metrics is not driving more spending either)…but that is just a matter of time. • Omniture: Set to announce some major China deals. One of the challenges is hiring – takes too long to clear home office -- and with the pace of change in China combined with the lack of qualified people, that is even more of a problem. They do see the opportunity to take a more public metrics role in China, but not in their plans at this point. • Ad standards: IAB weak here at this point. T advertise on the top 100 sites, you have to cut six or seven thousand banners. Fortunately, graphic designers come cheap in China. (What we heard later in the trip is that the need for lots of manual work can actually serve as a virtue – automation is not the goal in many cases…the more people you hire, the more favorably you are looked upon by the government etc.) • Advertisers who buy three screens down on major portal home page do not get or do not care that their visibility is low. • Simplicity is not as valued in Chinese Web design…the dense pages of Sohu/Sina are much favored over the simplicity of a Google. • Several people during conversation quoted Alexa figures…a sign of weak metrics! • An innovative startup featured on TechCrunch will find in no time 3-4 copycats in China. • The aggregate of the CPT ads are $8 eCPM Page 45 of 82
  46. 46. 9. CNNIC (China Internet Network Information Center) Headquarters Northwest Beijing July 31, 2008 Participants L to R: Patrick Sheridan; Tan Yaling, International Business Development, CNNIC; Jamie Hammond; Li “Howard” Guanghao, Deputy Director International Business Development, CNNIC. 9.1. Summary CNNIC oversees China’s domain name registry and other fundamental aspects of the Chinese Internet on behalf of the Chinese government. The organization also publishes regular reports on the size, scope and key characteristics of the Chinese Internet. Page 46 of 82
  47. 47. Their offices are located near a building that houses the .CN servers, where the first email sent out of China was mailed 21 years ago saying, “across the Great Wall, we can reach every corner of the world.” (see picture at right). For us to start our first morning of meetings in Beijing getting a government outlook seemed like good timing. 9.2. Specifics • Online was up and running in China for a while before it was fully open to the Internet, in 1994 – albeit on very small pipe. • When dotcom bubble burst, Chinese Internet growth flagged for 4-5 years, just like in U.S.….2.0 helped bring it back, just like U.S. • Tencent QQ cards (Taobao aftermarket), game points at Internet cafes…big numbers. Alipay very strong, as is mobile payment. • June 2008 report shows Internet usership in China at 253mm -- biggest in the world. Up 43mm in 6 months and 91mm in a year - more than 50pct. • Critical mass was reached in the second half of 2006 when it hit the 10pct (of total Chinese population) point at 137m. • Registrations of .cn domains spiked around same time. 12mm now. was less than 2mm two years ago. Only 1 yuan to buy. • 80% of usership is broadband. • Telcos and cable compete for access, just like in U.S. • 28.9pct have accessed via mobile first half of year. 73mm mobile users. Speed seems to be picking up. but that includes notebook terminals. • Penetration of population stands at 19.1pct. 19 hrs /week online (goes up and down and then up). top apps: music, news, IM, video, search Page 47 of 82
  48. 48. • “Online advertising is in all of these applications, it is everywhere actually. online music, online news, even instant messaging. Popup windows also get advertising..it is almost everywhere. Sometimes this online advertising is regarded as malicious software because it pops up.” • Online video: 160mm viewers, better off than rest of Internet users. Movies/TV constitutes 86.3 pct of online video content...Olympics will boost this • Video sharing prevalent, mostly via IM • BBS not as strong as before, thanks to IM (which is also less monitored). • Generally: BBS college (and local) communities. IM personal. Email work • After top five apps, you then have: 6 email; 7 gaming (monetized, but not through ads); 8 blogs (have some ads); 9 BBS (some monetized with ads). • As alluded to above, BBS will decline as alternatives become more popular…that said it can be “hard to tell the difference between a blog and a BBS.” “One is person centralized and one is [geo or topic based] community centralized." • Online shopping 16.2 rmb 1h 08. Taobao (like eBay) dominant C2C commerce, 81.5pct market share. They don’t charge. Dang Dang (like Amazon) top B2C, then Joyo, totaling 60pct. These sites do advertise. • Baidu 74.5pct of search market share. Google "only" 14.3pct • Rural going up fast in growth pace. And only 7% penetration there. • They agreed with notion that one reason for delta in online ad market size between U.S. and China is that in China, advertisers cant reach older people online, unlike in U.S. where older have money...but eventually the under 30s will get older. and advertisers will go online more to reach them • Government can’t focus on everything at once. Focus is on connectivity and growth…things like ad standards might come later. Page 48 of 82
  49. 49. 10. UPS, Official Olympics Sponsor News Plaza Hotel Beijing July 31, 2008 Participants clockwise from left: Patrick Sheridan; Jamie Hammond; Joseph A Guerrisi, VP, Marketing, Asia Pacific Region, UPS; Sok , Communications Manager, U Page 49 of 82
  50. 50. 10.1. Summary We met with UPS on the night of their arrival in Beijing for Olympics month. We met at the News Plaza hotel, which they were to “own” for said month, hosting clients and executives during the games. This was part of their sponsorship of BOCOG, the Beijing organization hosting the Olympics. UPS as an official sponsor was “delivering the Olympics” -- handling transportation and logistics for the games, which allowed it to display – and advertise – its prowess in such areas to China. Above are images from an ad doing just this, taking up an entire wall at the Tiananmen Square subway station. 10.2. Specifics • In 2005, UPS was “really getting going” in China, having gotten out of its JV there post-WTO, to operate as a wholly owned entity. The Olympics pitch came at that time, and it was “perfect timing” in terms of their need to basically re-launch in the country in a big way. • UPS primarily interested in B2B and image marketing. • Asia Pacific region they run has three zones: o English speaking (NZ, AU, India) o China Page 50 of 82

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