China’s Internet Giants May Be Stuck There

Even before Google

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[GOOG  Loading...      ()   ] began threatening to shut down its search service in China, it was not fitting in.

Google and other major American Internet companies like Yahoo and eBay failed to gain significant traction in the Chinese market. And Facebook, Twitter and YouTube are blocked by the government.

Instead, the hottest companies in the world’s biggest Internet market have names like Baidu, Tencent and Alibaba — fast-growing local firms that are making huge profits. Post-Google, China’s Internet market could increasingly resemble a lucrative, walled-off bazaar, experts say. Those homegrown successes, however, could have trouble becoming global brands.

Liu Jin | AFP | Getty Images Young men play online games at an internet cafe in Beijing.

“If the Chinese government continues to favor domestic companies, those companies that reach critical mass could become phenomenally profitable,” said Gary Rieschel, founder of Qiming Ventures, an American venture capital firm with investments in China. “But it may be hard for those companies to become world class without outside competition.”

Still, the success of Chinese companies here can be measured by the numbers.

Revenue at Tencent, a kind of Internet conglomerate, jumped over 70 percent last year, to about $1.8 billion.

Baidu, a Google look-alike, has largely clobbered Google in China, despite giving up some ground in recent years. And Taobao.com, China’s huge e-commerce site, handled nearly $30 billion in transactions last year.

The story behind the success of these companies is a simple one, some analysts say. The young people who dominate Web use in China are not just searching for information; they’re searching for a lifestyle. They are passionate about downloading music, playing online games and engaging in social networking.

“Sixty percent of the Internet users here are under the age of 30,” said Richard Ji, an Internet analyst at Morgan Stanley. “In the U.S., it’s the other way around. And in the U.S. it’s about information. But in China, the No. 1 priority is entertainment.”

Experts say American companies have largely failed here because they don’t have local expertise, are too slow to adapt and don’t know how to deal with the Chinese government.

“Internet companies in China have to work so closely with the government,” said Xiao Qiang, of the China Internet project at the University of California, Berkeley. “And that means the government’s political agenda can become the company’s business agenda.”

The need to censor Web sites, for example, can overwhelm smaller companies, Mr. Xiao said. “This becomes a growing business cost. So often, small companies don’t develop.”

At this stage, analysts say the Web in China is less about innovation than about quickly delivering on the latest online trend.

“People here are quick to see trends, and to clone and innovate,” said William Bao Bean, a former Internet analyst who is now a partner at Softbank China & India Holdings. “If one company is doing well, other companies will quickly clone it and roll it out.”

No company is better at that than Tencent, which is based in the southern city of Shenzhen.

The company’s biggest weapon is a popular instant messaging service called QQ. Its 500 million active users give the company an advantage when it introduces new products and offerings, like online games.

Tencent was founded in 1998 by a group of friends that included Ma Huateng, also known as Pony, who is now its 38-year-old billionaire chief executive. With Tencent commanding a stock market value of $37.2 billion, the only global Internet companies that are worth more are Google ($173.7 billion) and Amazon ($57.2 billion).

But there are other Chinese powerhouses. Baidu, which dominates the market for search advertising in China, is expected to benefit from Google’s departure, even though its own search engine is heavily censored. (Microsoft’s search engine, Bing, which remains censored, could also gain users.)

Investors are clearly betting on Baidu’s future. Since January, when Google first announced that it might exit China, shares of Baidu have leapt 50 percent, adding $7 billion to the company’s market value.

One advantage local companies have is government protectionism. Because the Communist Party wants to maintain tight control over communication and the media, foreign Internet companies come under suspicion.

For instance, YouTube has been blocked inside the country for over a year, ever since a user uploaded a video that was said to show human rights violations in Tibet.

YouTube, which is owned by Google, had a large following here. But now online video in China is being championed by companies like Youku.com and Tudou.com. They may have dominated anyway, analysts say, but it certainly helps to have few big competitors.

And without competition here from Facebook, which has not yet tried to develop a site for the Chinese market, a social networking site called Kaixin001.com has managed to register over 70 million users.

But some experts say Google’s departure will leave Internet users here with fewer options, making the country’s Internet market less competitive and less open.

“The biggest loser is Netizens,” says Fang Xingdong, chief executive of Chinalabs.com, a research firm. “Google is a multilinguistic search engine, but Baidu is a Chinese-language one. Chinese information only occupies a small fraction of the Internet.”

Google was troubled by censors. And it’s clear that censors make some of the material on Baidu’s search engine look like the bulletin board of propaganda, with some links directed to People’s Daily, the Communist Party mouthpiece.

But Chinese Internet companies go along, despite some misgivings, sensing that the real money is in online fun and games. These seem to flourish despite repeated government crackdowns and warnings about Internet-addicted youth and illegal music downloads.

One question, though, is whether Google’s departure will prevent Chinese companies from developing alongside the world’s technology powerhouses.

“When the Chinese companies go outside of China, they will find that they fail to understand their competitors as well as they did when they were competing in China,” said Mr. Rieschel, founder of Qiming Ventures.

Of course, Chinese companies may just be happy staying home. With 400 million Internet users and growing, their own market is a substantial prize.

Bao Beibei contributed research from Shanghai.