Google and China

Disclaimer in Danish: For et par uger siden skrev jeg denne synopsis som oplag for en senere mundtlig eksamen. Da opgaven er på engelsk og omhandler en aktuel begivenhed, synes jeg det kunne være spændende at lægge den online og se om den kunne trække noget trafik på grund af den søgevolumen som sagen skaber, især på engelsk. Derudover handler den om det jeg normalt plejer at skrive om her på bloggen, så den kan måske også være interessant at læse for nogen. Jeg vil selvfølgelig komme med en masse spændende tal for hvor meget trafik den trækker fra søgemaskinerne senere. Jeg håber du vil acceptere denne smule "spam", mod at få indsigt i resultatet af testen, tak :)

Problem statement

In January 2010 Google announced they would no longer censor their search results in the Chinese version of the search engine, even though they initially agreed to do just that in order to do business in China. According to Google they were never comfortable with censoring their search results, but they believed it was better than not being in China at all. The decision was made due to a series of attacks against Gmail accounts, Google e-mail service, aimed to harm human rights activists. The attacks came from China.

The objective of this paper is to analyze the economic consequences Google will be faced with, if they will be forced to stop their businesses in China by the Chinese government. Google has a very healthy business model and a high turnover and profit alone by their representation in the U.S. market, but China has grown in past years, and now has 404 million Internet users, the highest number in the world. A market this big, will be devastating to leave for any company, regardless of size. This paper will analyze what makes Google's business model work that great in the U.S. market and elucidate whether it can be transferred to the Chinese market with the same success rate. This includes an analysis of the advertising business in China, which plays a large role in Google's successful business model.

Background

In February 2006, at a hearing in the United States House of Representatives, Google made a statement explaining their motive with building operations in China, according to laws and regulations made by the Chinese government. Up until this point Google had only been accessible to the Chinese users through Google.com, a solution faced by certain issues. Google's business objective is to make the worlds information available to everyone, anywhere at all times. This mission is based on two fundamental commitments:

However, since 2002, Google had received emails from Chinese users saying that Google.com was inaccessible to them. Furthermore Google had noticed that certain search queries for political sensitive topics was filtered, so that Chinese users couldn't find information on the subject through Google.com. Another issue regarded that some users where redirected to local search engines when trying to reach Google.com. These issues meant that Google had a product in China that was not reliable enough to Google to be proud of. The filtered search results, and problems with inaccessibility meant that Google was unable to fulfill their business objective with the current solution. A part of the solution was to add a third pillar to their commitments regarding their objective:

In the Chinese situation this would mean building an operation in China, on the conditions demanded by the Chinese government. These conditions included agreement of self-censorship of their search results. Even though it is against their most basic values, because censorship is counter to making information available, this new approach had some great advantages. By launching a new product - Google.cn - according to the Chinese laws and regulations, Google could ensure that all Chinese users would be able to access their services. Being able to place servers in China would also mean faster and more reliable access to their services, another core objective of Google.

The only disadvantage of the new solution was that Google would have to censor a handful of political sensitive search queries, but due to the fact that the Chinese government already filters this information, the new solution wouldn't make this issue any worse than before. Google would altogether be able to offer a better product to the Chinese users, making more information available to them. Based on this, the conclusion was to build an operation in China, in according to the laws and regulations in China.

Google recognized that this was an imperfect solution, though a reasonable one, given the circumstances. Due to this, Google was aware that the begun a process towards a better solution for the Chinese users, and this was not the ultimate answer to the problem. Elliot Schrage, Vice President of Global communications, who made the statement, also says:

Looking ahead, we will carefully monitor conditions in China, including new laws and other restrictions on our services. If we determine that we are unable to achieve the objectives I've outlined above, we will not hesitate to reconsider our approach to China.

A new approach to China

On January 12th, Google made a press release on their official blog, announcing a new approach to China. As formerly mentioned, Google knew that the solution made in 2006 was imperfect, and was ready to make changes if necessary. In December 2009, Google became victim of a highly sophisticated cyber attack on their corporate infrastructure. The attack originated from China and was aimed at Gmail accounts (Google's mail service) of human rights activists. According to Google, only two accounts appeared to have been accessed, but further investigation showed that third parties have routinely accessed dozens of other accounts of advocates of human rights in China. As a result of these attacks and attempts to limit the freedom of speech on the Internet further, made Google make a drastic decisions to no longer censoring their search results in China. It is important to mention that Google doesn't remove the censoring from Google.cn, resulting in a breaking of the Chinese law. The solution was to redirect visitors at Google.cn to Google.com.hk – Google Hong Kong – where Google offer uncensored search results in Chinese. This solution is in many ways much like the solution used before 2006, before Google began building operations in China.

Why make this move?

The obvicious reason behind Google's move is, as they said themselves, that the situation, which always has been imperfect, is no longer the best solution for Google to meet their objectives of making information availably to everyone. Others mean that Google think the attacks was made by the Chinese government, and as a counterattack given the Chinese population the ability to find, share and discuss information about the Chinese government without being censured at all. Another possibility is that Google is losing market share in the Chinese search market to the Chinese search engine Baidu, and is using this as an excuse for this. Which one is it? To find out which of the above is more likely a series of analysis will be conducted. The paper starts by looking at the Google business model.

The Google business model

The business model Google has applied to be one of the most successful Internet companies and biggest brands worldwide is very unique. It revolves around their search engine, first launched at Google.com in September 1997. The search engine was build upon the same values that Google follows today, making all the worlds knowledge and information availably to everyone. To accomplish this the two founders Larry Page and Sergey Brin built a highly sophisticated search engine, which held many patented solutions in order to, organize the vast amount of rapidly increased data on the Internet. The first search engine showed to be far superior to everything else on the market, which resulted in a rapid growth for Google.

Generating turnover

Google first product or service, the search engine, was entirely free for users to use, so in order to turn Google into a profitable business AdWords was launched in October 2000. AdWords is an online advertising program, which enables other businesses to buy sponsored links on the search engine.

Illustration of sponsored links, AdWords, on a search engine result page.

Through an advanced bidding system Google could now present highly relevant advertisements to its users and offer great value for money to advertisers. AdWords instantly became a success for advertisers and a result generating huge turnover for Google. Already in 2000, Google generated a turnover of 19 million dollars, which increased to 86 million dollars in 2001. In 2003 the turnover broke the billion dollars barrier with a turnover of 1.47 billion dollars.

In 2003 Google expanded the advertising program with AdSense which made it possible for website owners to place ads from the AdWords program on their websites and receive a share of the revenue. Google had, through its search engine, a good knowledge about the contents of each website and therefore could choose ads of equal relevance to show on those websites. Those two advertising programs is today the backbone of Google financial foundation, generating 97% of Google's total turnover. Both programs were self-serviced which meant that it had the opportunity to scale without causing equally increasing costs.

In the fiscal year of 2009 the turnover had reached an amazing 23.65 billion dollars, 47 % of which was generated in The United States, which has about 227 million Internet users. Google's turnover created in The United States is 11.1 billion dollar, also meaning that for every one million Internet users Google's turnover is around 49 million dollar.

Growth strategy

Since 2000 Google have mainly used two different growth strategies. Because of the way their turnover could scale with the growth of the web, Google quickly created a solid financial foundation, which enabled them to acquire other companies. The advertising business can be seen as a cash cow because of the way it just keeps generating turnover without much involvement from Google as a result of the high amount of self-service in the way it is designed.

However, because of the unique business model that Google uses, there are some differences in the way their cash cow affects Google's other products. It may seem strange that Google is spending a lot of money on vertical integration through acquisitions of companies and horizontal on development of products which is not related to their core competency, the search engine, and is completely free for people to use. The reason for this is that these other products can contribute to and strengthen the cash cow, making it even more profitable.

One of the first products Google launched other than the search engine was Gmail, Google's online e-mail service. As mentioned earlier it was free, but I gave Google an opportunity to show even more ads to users, and since all the e-mails were located at Google's own servers they could analyze what a specific e-mail was about and present ads related to that subject, very useful to both users and advertisers.

Relevant ads presented to a user reading an email in Gmail.

Another product was Google Docs, which at first glance was a competitor to Microsoft Office, but since it was an online product it had another very important mission. If people are working online in their browser instead of in a separate application they are that much closer to one of Google many ads across the web. They can decide to do an Internet search on Google with AdWords ads, they can visit a website usingAdSense ads or they can login to Gmail and see ads in there as well. Suddenly these products became complimentary products to Google's advertising products, the more time a user spend in a browser window instead of desktop applications like Microsoft Office or an email client like Outlook, the more money Google will ultimately earn.

In May 2005 Google acquired Urchin, who made web analytics software. Google renamed the product to Google Analytics and made it free to everyone. Web analytics software is a very crucial part of running a successful Internet business, so by giving it to website owners for free they would be able to make improvements to their websites resulting in a more profitable business and because of that be able to spend more money on AdWords advertising, which meant more revenue to Google.

Today, Google basically only has one product, which generates turnover and a long line of supporting products, which contributes to that product/cash cow. Whether it is Google Maps, Google Mail, Google Docs, Google Analytics or Google Reader their mission is to contribute to the advertising business, which scales very well to whatever growth the other products and the search engine can create.

The Chinese Internet search market

China had 100 million Internet users in 2006, expected to reach 250 million in 2010, but it did in fact reach 404 million users, making it the world's largest Internet population. This makes China a very promising market, but also complex and challenging. One aspect that Google has to consider is how their business model fits into the Chinese market.

As the previous analysis showed Google only has one product that generates turnover, the advertising business, which performs very well in the western part of the world, namely in The United States. It is common knowledge that The US is a very capitalist market they practically invented most of the modern marketing and sales techniques used today. Anyone who has traveled or lived there will know that they are very used to a certain way of thinking, were everything is about money and consumption. Aggressive marketing campaigns and eager salesmen in stores is a natural part of everyday life. As a result of that they are used to being exposed to ads everywhere they are without taking much notice of them. But how will their business model perform if applied to a market where these things aren't as common and are commercial and ads may be frowned upon.

Another concern is market share. Google's potential turnover is linked to both the number of Internet users in a market and of course the market share. In Denmark Google has a dominating market share of 96 % and in The United States the market share is 72 %. To analyze the attractiveness of a market it is also important to know if the market share is nearly 100 % or maybe a vanishingly small fraction of the market.

Share of the Chinese search market

Baidu.com

Baidu.com is a Chinese search engine, tailored to the Chinese market. It was launched in 2000 and has gained market share mainly from Google up until 2009. It is the market leader in China today since Google announced that they would no longer censor their search results they have actually lost market share and Baidu.com has gained. In 2009 it did look like Google was about to become market leader but not anymore. In January when Google made its decision did however gain market share, which made experts believe that the market share were not the reason for the risky move by Google:

As seen on the illustration below, the color scheme used on the two search engines is pretty much the same, so there is no reason to believe that the design of Baidu.com is why most Chinese like to use that one instead of Google.

Comparison of the result page on Baidu.com and Google.com.hk

Maybe Google though it could be an advantage not to censor their search results like Baidu.com also is required to do. Maybe it could give them the edge to move past Baidu and become the market leader, so the hacking-story was just an excuse to remove the self-censorship. However some people says that the Chinese people don't really care about the censorship.

"The Chinese people don't wake up in the morning thinking: ?What did Dalai Lama say yesterday or how do we interpret Tiananmen Square today? They just want to use the Internet and all of its possibilities.", Doris Naisbitt

The Chinese people are much like all other people. They just want to use Facebook to socialize, see how their stocks are doing, at things like that, and those things can Baidu.com do just as good as Google can without the censorship.

The Chinese advertising business

As earlier mentioned, a key factor for how good a market might be for Google to operate in, is how the advertising business is doing, since it is Google core business to generate their turnover. To analyze how the advertising business in China is compared to The United States we take a look at the revenue creating per one million Internet users accounting for the differences in market share.

In 2009 Google's turnover in The United States was 11.1 billion dollar and there were 227 million Internet users. Google had 72 % market share, which would mean that the total market would be worth 15.4 billion dollar or 67,800,000 per one million Internet users.

In the second quarter of 2008 China had a total of 298 million Internet users and the total market revenue was 185 million dollar or only 620,000 dollar per one million Internet users. In the fourth quarter of 2007 the total revenue was 131.3 million dollar with 210 million Internet users, giving 624,000 dollar per one million Internet users.

It can be concluded that even though China has the world's largest Internet population it is not the largest advertising market, at least not in the search engines.

Google's revenue in China

China's Internet population is experiencing rapid growth these years and is now over 400 million users. With that in mind a revenue of 624,000 dollar per one million users is still a total market value of 252 million dollar a year. If Google is forced to leave China altogether they would, based on a 30 % market share be missing out on a 75,6 million dollar revenue in 2010 alone. David Drummond, Google's chief legal officer, also says that moving into China was never a financial move for Google and that the revenue from the business in China are quite small and that it will not have an effect on them if they are forced to leave China.

The number of Internet users would however properly grow even bigger during 2010, and JP Morgan says that their model suggests that Google will generate a revenue of 600 million dollar in 2010 in China. Even though that number was to be true it would still only represent 2 % of Google total expected revenue in 2010.

Weather Google is making this move because they have nothing to loose or they really stand firm on their principles it is certain that leaving the Chinese market will not have a noticeable effect on Google's financial situation.

Reasons for Google's market share

Even though there is were little difference in the design and color scheme between Baidu.com and Google there can be some other factors, which makes some people prefer Baidu.com to Google.

The success of a search engine is based a lot on it's ability to deliver relevant search results to the users. Google does a very good job of doing that in The United States and Europe, but might not be able to do that in China. One reason could be because of the language, which uses another alphabet than the one used in The Unites States. There could also be some social differences, which Baidu.com does a better job of taking into account, because it is an Chinese-based company.

The fact that Baidu.com is a Chinese search engine could result in a preference for it in favor of the foreign search engine that Google is.

As concluded in the analysis of Google's growth strategy and product mix, it uses a long line of product, which gives a synergy effect where each product contributes to the advertising products. Due to this, for Google to become the success they are in The United States and Europe, it is not enough just to make a Chinese search engine they also have to launch a line of supporting products. The search engine alone cant do the job of generating huge revenues.

Conclusion

When Google announced their new approach to China, they also mentioned that they were never comfortable with the self-censorship required to do business in China. Weather this is actually the real motive behind the decision or something else like lack of market share and a brave move to gain market share is unclear.

It is however very clear that even though China has the worlds largest Internet population, it only represents a small fraction of Google's worldwide revenue and that it would not have a significant effect on Google if they are forced to leave the Chinese search market.

The reason that China, in spite of 404 million Internet users, only represents about 2 % of Google's revenue can be found in multiple factors. First of all, the advertisement in search engines is not a big business as it is in The United States. Since the advertising business is Google's main source of revenue it is linked very closely to the success of Google's business altogether. Second, even though Google has a dominant market share in the European markets and in The United States they have only been able to gain 30-35 % market share in China. This could be because of a local preference for a Chinese search engine or lack of synergy effect between Google's search engine and all the complimentary products.

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