NQ Logic

Technology | Strategy | Consulting

Google vs. China

It all started with a blog entry written by David Drummond, (SVP, Corporate Development and Chief Legal Officer) on January 12 warning that Google and others large companies from the internet, finance, technology, media and chemical sectors have been recent victims of highly sophisticated and targeted cyber attacks. Google itself was targeted by hackers with the goal of obtaining information from Chinese human rights activists’ Gmail accounts.

Contextualizing these attacks under the broader umbrella of freedom of speech, Google decided that they will provide an unfiltered Chinese search results in response to the attack, acknowledging the consequences and contemplating "having to shut down Google.cn, and potentially [their] offices in China". Defending their cloud computing technology model, Google has decided instead to denounce publicly the confirmed China-based cyber-attacks, stating their stance, and moving the debate over values and human rights onto the far larger political stage instead.

Largely applauded by Western activist associations as "a bold and difficult step for Internet freedom in support of fundamental human rights" [Leslie Harris, president of the Center for Democracy & Technology], Google was backed in their fight by not only U.S. President Barack Obama who is "a big supporter of non-censorship", but also by Secretary of State Hillary Clinton who "looks to the Chinese government for an explanation". Clinton later on in a longer political speech about Internet Freedom reaffirmed that "censorship should not be in any way accepted by any company from anywhere", and that "consumers want to have confidence that the internet companies will act as responsible stewards of their own personal information" (exact same words that appeared few days later on the Google Official Blog).

More recently Google has decided to delay the introduction of two mobile phones in China, the world's largest mobile phone market with more than 700 million accounts, widening the gap even more with the Chinese authorities. Local media reported that some Google employees from the Chinese operation center were put on leave, while some staffs were denied access and others transferred to different offices in the Asia Pacific region. Most recently the attacks have been traced back to computers at two educational institutions in China, including one with close ties to the Chinese military, and Google close competitor Baidu.

Jiang Yu, a spokesperson for China's Ministry of Foreign Affairs responded that China "welcomes international Internet companies to do business in China in accordance with the law" and that "the Chinese government administers the Internet according to law and [China has] explicit stipulations over what content can be spread on the Internet". If the battle over the internet is forceful among the Chinese internet users between the pro-Google ("It’s not Google that’s withdrawing from China, it’s China that’s withdrawing from the world") and the anti-Google ("China doesn’t care"), the government is rather quieter on providing an official respond yet.

Google in China

When in February 2006 Google decided to open its Chinese operations and offer most of its services to the fastest growing internet market in the world, the Silicon Valley company made it clear that the company would stay there under certain conditions: disclosure to user when search was filtered, user privacy was protected and google.com was available. With these in mind, Google was entering the Chinese market with the intention of gaining sufficient market share by offering a superior technology and to ideally change later on, from within, the censorship concerns.

To justify the ideological leap between their own "Don’t be evil" mantra and Chinese censorship, Google executives at the time mentioned that their focus would be to help Chinese people first and foremost.

"We actually did an evil scale and decided not to serve at all was worse evil." – Google CEO Eric Schmidt on the company’s decision to offer a censored version of its search services in China, Jan. 30, 2006

In the year 2009, with the constant alterations of all Google services (YouTube, Google.com, Books, Gmail, Google Apps and Google Docs), China made it clear that Google should not expect a rational business environment in which to work. Despite the fact that Google managed to capture between 20% to 30% of the Chinese search engine market and shaping the market around a duopoly, the company is still a distant second to Baidu, a Chinese company that enjoys a close relationship with the government and its 60% to 80% of the search engine market share.

Google’s revenue in China, which is estimated to be anywhere from U$100 million to U$600 million out of a U$1 billion total estimated search engine market, represents a tiny fraction of Google’s entire revenue (less than 2%). But Google’s China revenue has been increasing steadily over the past few years, gaining traction with the more educated internet crowd, the business people and the expat communities.

More importantly Google is really focusing on the 600 million Chinese phone subscribers. Only a small fraction of these subscribers have access to the mobile internet today, but the market for smartphones in China is exploding, fueled by China Mobile and China Unicom 3G network expansions. With its recent acquisition of AdMob and the Android OS, Google has a unique and strong position in the mobile advertising business in which Baidu and Google both have about 26% of the mobile search engine market, estimated to be U$150 million in 2009.

The Internet Market in China

According to the China Internet Network Information Center (CINIC), the Chinese population of internet users reached 384 million at the end of 2009, putting it ahead of the United States as the world’s biggest internet country. One in five internet users in the world is living in China. Mandarin is the second most used language on the internet universe, behind English and its 478 million users around the world.

In 2009, the number of Chinese internet users grew by 86 million (29 % increase from 2008), and with 29% of China's 1.3 billion population online, the middle empire has still a lot of room to grow over the next few years. With 70% of its online population below 30 years old, the internet in China is a phenomenon dedicated to young, educated and urban individuals. It is not surprising that the top three online destinations are music sites (83.5%), news portals (80.1%) and search engines (73.3%). Access through mobile phones has risen by 120 million to in total 233 million, which represents approximately 61% of all internet users.

With such a large population of internet users and a production of over 600,000 engineers per year, China is becoming a place where hacking is now an unofficial full-time profession. Essentially targeted at collecting information from competitors and across borders, Chinese cyber attacks are becoming more sophisticated and skillfully executed. Attack on Google is one among many. Computer hacking is illegal in China. Even though last year Beijing introduced a law that makes hacking a crime with punishments up to seven years in prison, the law is very difficult to enforce just by the nature of the crime.

More than sixty internet regulations have been made by the Chinese government to regulate the internet. The Golden Shield Project, sometimes known outside of China as the Great Firewall of China, prevents Chinese internet users from accessing a list of sensitive websites outside the mainland borders. Chinese internet police, estimated to be more than 30,000 heads, is vigorously monitoring critical comments on BBS, forums, blogs, and major portals. Last June the government attempted to install "Green Dam" censorship software in every new computer. This software would deny access to sites with pornographic or politically sensitive content. The plan was postponed at the last minute after a backlash by Chinese internet users, computer makers and foreign governments, but will certainly be resumed by the Beijing authorities at a later time.

The internet in China is burgeoning on both the supply and the demand sides; there is a vast catalogue of English copycat websites translated in Mandarin and at the same time, the government closely controls not only what people have access to, but also what people are commenting on. It is in this peculiar context that every internet company there, Chinese or foreign, is evolving and competing for a slice of the next biggest internet market of today.

Other U.S. Tech Companies in China

All foreign internet companies in China have the same treatment as the domestic ones and are closely monitored by the Chinese government, but they also have been place under a lot of scrutinizes in their own countries by both government and consumers.

When in 2002, Yahoo! turned over the democratic activist Wang Xiaoning’s emails, the company was under severe pressure by Congress and the American press. After Mr. Wang was sentenced to ten years in prison, his wife sued Yahoo! under human rights laws in federal court in San Francisco. Since 2005, Yahoo! China is run by Alibaba, a Chinese internet company in which Yahoo! owns a 40% stake. When testifying before Congress in another dissident case in 2006, Michael Callahan (Yahoo!'s general counsel), explained that he could not even say how often Yahoo! provides information about its users to the authorities since the authorities are dealing directly with Alibaba and not Yahoo! China anymore, thus outsourcing not only operation but responsibilities as well. Nevertheless, a new level of tension between those two companies was reached recently when "Alibaba Group has communicated to Yahoo! that Yahoo!’s statement that it is ‘aligned’ with the position Google took was reckless, given the lack of facts in evidence," and pointing out that "Alibaba doesn’t share this view".

Apple has a different approach in China. Most of its manufacturing is done there where over 200,000 contractors (through Foxconn Electronics) are assembling almost all of Apple’s products, including the recently announced iPad. But the company has decided to not focus on the Chinese market where counterfeit iPhones, the prohibition of WiFi, the fear of downloading applications and the lack of credit card usage are major obstacles to the high-end Apple customer experience and business model. Despite being taxed at 17%, since the Chinese government considers Apple a foreign manufacturer even though all of their products are built in mainland China, the company has already sold 200,000 iPhone units in partnership with China Unicom. In 2008 a large public campaign against poor working conditions in Apple’s factories in China took the company by surprise and damaged the iconic brand image in the West. Even though Apple has since introduced a new regulation and monitoring procedures, doubts are still lingering.

Microsoft owns the desktop market in China, yet earns little money from it because 80% is illegally copied. Nonetheless, Microsoft is injecting millions of dollars in aid into China, on top of its annual operating expenses to help develop infrastructure for the software industry via joint ventures, academic research center and training facilities. Disassociating itself from Google, Microsoft has reportedly said that it has no plans to pull its operations out of China and that censorship is part of everyday business in the ICT business globally. "The U.S. is the most extreme when it comes to free speech," said Steve Ballmer, noting however that even the U.S. bans child pornography, while France bans internet access to Nazi pictures, refocusing Google’s challenges to a mere business decision rather than an ethical compromise.

"On a business level, that decision to censor... was a net negative" Sergey Brin, Google co-founder [27 Jan 2007]

Afraid to be turned into a Danone Case, many foreign companies are witnessing that their previous partners are changing into ambitious predators, and that their own expertise and technology is "coming back at them globally in the form of cut-price products from subsidized state-owned behemoths" to which GNI would have a hard time to propose a solution.

CasB (China as a Business)

The unique Chinese market is defined along the below four major characteristics:

Structural: The Chinese government does not allow direct foreign investment, but rather permits joint venture partnerships when a majority ownership is held by the Chinese company. This business practice helps to retain capital gain and investment within mainland China, but also favors technology skills and savoir faire transfer while keeping economic and job growth inside the country. The recent ban from investment in China's online game operations through setting up wholly owned enterprises, joint ventures and cooperatives is the latest example of a tightening potential foreign gain in the Chinese market.

Technical: Over the past 10 years the state-driven telecommunications industry has built sufficient network capacity to create a self-sufficient ecosystem around a Chinese private internet where supply and demand are locally driven by government incentives. With hundreds of thousands of engineers manufacturing all the devices and equipment for the rest of the world, China is not lacking any capacity and competence any time soon. The recent rumors, confirmed by Rod Beckstrom (ICANN CEO), who accuses China (and Russia) of developing alternative internet roots to separate from the rest of the internet, is an eloquent example of how China is technically advanced in applying its goal of building the ultimate Great Firewall.

Political: The multi-tiered Chinese government has also built sufficient technical capabilities to be able to monitor first, and control second, all conversations on the internet. China’s Golden Shield, developed with the help of Western corporations like Cisco, Siemens-Nokia and Nortel, is a virtualization of the political behavior that exist in mainland China where control and order have brought economic growth over the past 30 years. Censorship has been the Chinese way to keep "harmony" in the middle empire for decades. The government leaders are afraid that it could set a dangerous political precedent should they compromise on Google’s request, and will not therefore take the risk to loosen their tight control over the information flow.

Cultural: Chinese business behavior is essentially driven from relationships, local Chinese preferences, harmony built over time (as opposed to disruptive) and respect of public reputation ("losing face"). Any private or public misbehavior is severely punished with social rejection at least and annihilation at most. The way Google handled the crisis is breaking each and every cultural norms with an almost a certainty of not turning back. By threatening publicly and not using back channels for influence and communication, Google did not leave any room for negotiations or for the government to not lose face, with the only choice for them to reject this Google menace.

What’s Next?

Google is executing its exit strategy, leading the way to a new type of moral behavior when it comes to foreign businesses in China. Neither China nor Google can find a satisfying compromise that will allow both of them to manage their home reputations.

"We continue to follow their laws; we continue to offer censored results. But in a reasonably short time from now we will be making some changes there." Eric Shcmidt, Google CEO [25 Jan 2010]

Google’s business model is based on encouraging consumers everywhere to exchange personal data and store private information into the cloud, in return for some online advertising. This relationship is based on the fact that consumers entrust Google with their personal data. Any private data threat (like the cyber attack that happened to Google) is not an attack on consumers’ data but on Google’s business model itself, which is intolerable and unacceptable from the company’s standpoint.

To protect their current market and to avoid a meltdown of their cash-cow business, Google had to take a major step by withdrawing from an overexposed market like China. Unless the Chinese government can guarantee that Google would not be attacked again, Google will move out of China. At the same time the Chinese government cannot allow Google to be different from any other companies without creating a risky precedence that could impact their political stability.

Clearly Google will leave China, and will try to address the Chinese market from outside using different tools, and will be eventually blocked. Chinese internet companies will pick up the remaining market share. Chinese government will be strengthened from this episode. Google will ultimately turn this security breach into an ethical business dilemma, reinforcing its already-strong corporate brand perception around the world. Cyber attacks will continue in the world of internet. And with Google’s disclosure, other U.S. technology companies will have a harder time to explain why they are still doing business in China.

The true negative impact is that the growing Chinese internet community will be more isolated from the world, which is what Google came to change in the first place.

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