The Rise of Baidu (That's Chinese for Google)

The Rise of Baidu (That's Chinese for Google) By DAVID BARBOZA BEIJING

IN the summer of 1998 at a picnic in Silicon Valley, Eric Xu, a

34-year-old biochemist, introduced his shy, reserved friend Robin Li to John Wu, then the head of Yahoo's search engine team.

Mr. Li, 30 at the time, was a frustrated staff engineer at Infoseek, an Internet search engine partly owned by Disney, a company whose fading commitment to Infoseek did not mesh with Mr. Li's ongoing passion for search. Like Disney, Mr. Wu and Yahoo were also losing interest in the business prospects of search, and Yahoo 'in a colossal corporate blunder' eventually outsourced all of its search functions to a little startup named Google.

Mr. Xu, who had called together some friends for a documentary he was making on Silicon Valley, thought the two search guys would hit it off. Mr. Wu says he exchanged greetings with Robin Li, but what most impressed him was that despite all of the pessimism surrounding search, Mr. Li remained undaunted.

"The people at Yahoo didn't think search was all that important, and so neither did I," says Mr. Wu, who is now the chief technology officer at the Chinese Internet company "But Robin, he seemed very determined to stick with it. And you have to admire what he accomplished."

Indeed. A year after the picnic, in 1999, Mr. Li founded his own search company in China, naming it Baidu (pronounced 'by-DOO'). Today, Baidu has a market value of $3 billion and operates the fourth-most trafficked Web site in the world. And Baidu is doing what no other Internet company has been able to do: clobbering Google and Yahoo in its home market.

While Baidu continues to gain market share in China 'and does so with a Web site that the Chinese government heavily censors and that gives priority to advertising rather than relevant search results' some analysts question whether Baidu can withstand competition from Google and Yahoo, which possess superior technology and global work forces.

But Baidu's evolution, and Mr. Li's journey as an entrepreneur, offer textbook examples of the payoffs and perils of doing business in China and suggest that Baidu may prove to be far more resilient than some analysts believe. China has a population of 1.3 billion, about 130 million of whom are Internet users, an online market second in size only to the American market. Because China is the world's fastest-growing major economy, analysts consider it the next great Internet battleground, with Baidu uniquely positioned to prosper from that competition.

In exchange for letting censors oversee its Web site, Baidu has sealed its dominance with support from the Chinese government, which regularly blocks Google here and imposes strict rules and censorship on other foreign Internet companies.

In addition, analysts say, entrepreneurs in China have a knack for pummeling American Internet giants. "The globally dominant U.S. Internet companies have failed to take the No. 1 market share position in any category," says Jason D. Brueschke, a Citigroup analyst, of the Chinese market. "And they came with more money and major brand names. And so there's something fundamentally different about this market."

So fundamentally different, Mr. Brueschke believes, that Baidu will retain its hammerlock on the Chinese search industry. "The real battle in the competitive landscape is not about who's No. 1, it's about who's going to be No. 2," he says.

Google, of course, will have none of this, stressing the independence of its search results and the international reach it offers users. "People want information and they want global information," says Kaifu Lee, the president of Google in China. "We can't be bought."

But Mr. Li says Baidu's model is working supremely well and that the company has built a loyal base of users who value its search capabilities. "At the end of the day, if a user finds relevant information, they'll come back," he says.

ON its corporate Web site, Baidu says that it takes its name from a Song Dynasty poem written several centuries ago that "compares the search for a retreating beauty amid chaotic glamour with the search for one's dream while confronted by life's many obstacles."

Mr. Li, born Li Yanhong in 1968 in what was then an impoverished city

200 miles southwest of Beijing, is familiar with life's obstacles. The fourth of five children, he grew up during China's brutal Cultural Revolution. Despite the oppression that surrounded him, he said he was always able to focus on stamp collecting, performing traditional opera and other interests, including, eventually, computers. He was bright enough to get into the country's most prestigious school, Beijing University, where he majored in library science and dabbled in computer science.

The government infamously cracked down on pro-democracy demonstrations in Tiananmen Square in 1989 when Mr. Li was a sophomore, causing his college campus to be shut down. Mr. Li is mum on the events that followed, saying only that he was apolitical. But he does say that a year later he started thinking of studying abroad and that by the time he graduated in 1991 he was ready to leave his homeland.

"China was a depressing place," he says. "I thought there was no hope."

He applied to the top three graduate programs in computer science in America, but did not get into any of them (perhaps, he says, because China was considered an also-ran in technology). "I blindly sent out 20 applications," he says. "SUNY Buffalo was the only program willing to give me a fellowship."

He enrolled at Buffalo planning to earn a Ph.D. in computer science but grew disillusioned with academia. He completed his master's degree in

1994 and then joined a New Jersey division of Dow Jones & Company, where he helped develop a software program for The Wall Street Journal's online edition. During that time, he also became enamored of the technology boom taking shape in Silicon Valley. He spent much of his time trying to solve one of the Internet industry?s earliest problems: sorting information.

A breakthrough came in 1996, he says, when he developed a search mechanism he called 'link analysis', which involved ranking the popularity of a Web site based on how many other Web sites had linked to it.

"The moment I created this thing I was very excited," he says. "I told my boss and pushed him. But he wasn't very excited." Soon after, he attended a computer conference in Silicon Valley and set up his own booth to demonstrate his search findings.

William I. Chang, then the chief technology officer at Infoseek, met Mr. Li at the conference and recruited him to oversee search engine development.

"Robin is possibly the single most brilliant and focused person I know," Mr. Chang says. "And his inventions, now widely adopted, are still the gold standards in Web search relevance."

After Disney acquired the small fraction of Infoseek stock it did not already own in 1999, it shifted the company's focus away from search and toward content, leading Mr. Li to form his own Internet company with Eric Xu, who had a Ph.D. in biochemistry and good contacts in Silicon Valley.

The partners raised $1.2 million from two Silicon Valley venture capital firms, Integrity Partners and Peninsula Capital, and with their seed money in hand flew to China and founded Baidu in a hotel room overlooking Beijing University's campus. Nine months later, in September 2000, two other venture capital firms, Draper Fisher Jurvetson and IDG Technology Venture, pumped another $10 million into the startup.

So it was that on the eve of the Internet bubble bursting in the United States, Baidu took off in China.

"When I came back I was prepared for a rough life," Mr. Li says. "It turns out it wasn't so bad."

Baidu started out offering search services to other Chinese portals before developing its own stand-alone search engine. Some members of Baidu's board of directors opposed the shift, saying it would turn customers into competitors. But Mr. Li said he sensed a shift in the market after watching the success of Overture, a company in Pasadena, Calif., that sold advertising space correlated with search results (which meant, for example, that ads for dental clinics might pop up next to search results for cavities).

"We were skeptical about search," says Scott Walchek, a partner at Integrity Partners and a member of Baidu's board. "But we weren't as smart as Robin. Robin said he had a unique opportunity to build a brand around search. And he was right."

In September 2001, Baidu began its own site

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which looked almost exactly like Google's no-frills home page. And even before Google did it, Baidu allowed advertisers to bid for ad space and then pay Baidu every time a customer clicked on an ad. Small and medium-size companies loved it, the site became deluged with traffic and Baidu turned a profit in 2004. By then, Mr. Li was pushing for an initial public offering in the United States, insisting it would be a huge branding event for a company that had come to be called "China's Google."

BAIDU went public on Aug. 5, 2005, at $27 a share. When trading ended that day, shares of Baidu closed at $122, up 354 percent, the biggest opening on Nasdaq since the dot-com peak in 2000. Suddenly, Baidu was a $4 billion company and Mr. Li held stock worth more than $900 million. But not everyone cheered. Many analysts said that by almost every measure Baidu?s stock was ridiculously over-valued. It eventually tumbled to as low as $44 before rebounding. On Friday, its shares closed up $3.03 in regular trading, to $87.75, giving the company a market capitalization of about $2.94 billion.

At the time of the I.P.O., some critics attacked Baidu's zealousness for ad revenues. They noted, for example, that a Baidu search for the word 'cancer' turned up ads for hospitals that paid for top spots in results rather than returning information on cancer itself. In comparison, Google and Yahoo more clearly separate ads from relevant search results by placing them on the right side of the page.

The company's revenue jumped 190 percent in the first half of this year, to $40.9 million; profit soared 550 percent, to $11.7 million. Baidu's Web site is drawing millions of young people eager to download music files, create blogs or search for pictures of China's '10 Most Beautiful Women.' While Baidu is growing fast, its revenue is still anemic compared with Google's, which is expected to top $7 billion this year.

Analysts say Baidu is playing to a different audience than Western Internet companies because the Chinese are far more interested in entertainment than news, books or car rental rates. "The fact is 70 percent of China's Internet users are under the age of 30," says Richard Ji, an analyst with Morgan Stanley. "Most of them are single, only children. They're looking for entertainment."

That may explain why China's dominant Internet companies are all entertainment focused, like Tencent (which hosts online communities and instant messaging) and Netease and Shanda (which are online gaming sites).

Yet no Internet company in China is growing as fast as Baidu, which had more than 50 percent of the pay-per-click market in the first half of year, up from a 37 percent share in the same period a year ago, and according to Analysys, a research firm in Beijing. Google and Yahoo both lost ground, with each company holding 16 percent pay-per-click shares for the first six months of 2006.

Still, Baidu faces significant challenges. The company?s stock is in the stratosphere, putting pressure on management to deliver knockout growth every quarter. Google?s shares closed up $5.90 Friday in regular trading, to $409.88, meaning investors pay a hefty $60 for every $1 of profit in the stock, far more than other Internet companies. But Baidu investors pay a whopping $190 for every $1 of profit.

Baidu also faces legal challenges, including lawsuits claiming it violates copyright laws on music files. Baidu has been sued over the issue, but continues to provide links to sites that offer music files. The company says it does not believe it should be held responsible for simply offering linking to other sites. In a country rampant with claims of click fraud, a Beijing hospital recently claimed that Baidu orchestrated a scheme in which a Baidu affiliate kept clicking on the hospital's ads to fatten the fees it had to pay Baidu. A Baidu spokeswoman says the company has not reviewed the case, but actively polices click fraud.

LOOMING on the horizon are Google and Yahoo. Google says it plans to spend hundreds of millions of dollars to compete in China, and Yahoo has merged its operations here with Chinese Internet behemoth

"Google is fierce," Morgan Stanley's Mr. Ji says. "And Alibaba has the best sales force. Baidu could get hurt on the technical side."

But the Chinese market is littered with the wreckage of American Internet companies that have failed to dominate here. In 2003, eBay bought the largest Chinese auction company and then lost market share. In 2004, Amazon bought the largest Chinese online merchandiser and then lost market share.

Now, the real fight begins. Google, which invested $5 million in Baidu just before its public offering last year, sold that stake for a hefty $60 million in June. And now, Google is building up a huge research team in Beijing, not far from Baidu's headquarters. But analysts say it won't be easy for Google.

"The American Internet giants are dominant in the U.S. and dominant in Europe," Mr. Brueschke at Citigroup says. "And then they come to China and fail. And so what I want to know is: What is Google going to do differently?"

For his part, Robin Li seems undaunted.

"Our traffic keeps increasing," he says confidently. "We're now the No.

1 Web site in China."

Copyright 2006 The New York Times Company

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