The Wall Street Journal-20080206-New Tune- Google Aims To Crack China With Music Push

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New Tune: Google Aims To Crack China With Music Push

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Two years after Google Inc. began a big push in China, Baidu.com Inc. continues to dominate the country's Internet search market, thanks in significant part to a controversial and legally risky offering: searches for free, unlicensed music downloads.

Now, Google is preparing a counterstrike, according to people close to the situation. The U.S. search giant is in the late planning stages of a joint venture with a Chinese online music company that would permit it to provide free -- licensed -- music downloads in China.

The service, which is likely to offer access to tunes from three global music companies as well as dozens of smaller players, could start in the next several weeks barring any last-minute hiccups. The music pact marks a turning point in Google's battle with Baidu to gain dominance in an Internet market that is soon expected to surpass the U.S. this year in number of users.

Baidu has proved a brash adversary for the much larger Google, leveraging its status as hometown champion in China to beat the U.S. Internet giant at its own game. From the start, Baidu has boasted that its knowledge of China and the Chinese language would give it a natural advantage over foreign rivals.

"We've been the No. 1 Web site in China for a number of years, and in fact we are the largest Web site outside of the U.S.," says Robin Li, Baidu's co-founder and chief executive. "When people get to know about the Internet, the first Web site they learn is about Baidu in China."

Google declined to comment on the China music plan. In the past, Google executives have made clear the company's determination to overtake Baidu. "We were late entering the China market, and we're catching up," Google Chief Executive Eric Schmidt said during a visit to Beijing last April. "Our investment is working and we will eventually be the leader."

A significant part of Baidu's success has been its music search service, which draws a sizable chunk of traffic -- at least 7% of its total -- to the site by facilitating easy access to free music. Baidu makes money by selling ads directly on its music pages. The free music also entices users to come back for other services, all of which helps the company sell advertisements.

But searches for unauthorized downloads have also made Baidu a target for music companies trying to protect their rights in a country where piracy has crippled the entertainment industry.

Google has not provided any unlicensed links to music products in China even though avoiding music has put the company at a disadvantage.

Google's new China strategy is widely viewed as a logical next step for digital music, but has until now been resisted by record labels, which feared further cheapening the perceived value of their products. Experimenting with such a system in China, where a legitimate music market is virtually nonexistent, could be a palatable entryway.

If the plan works, it could provide a road map for music industry offerings elsewhere in the world. Though piracy is more pervasive in China than in North America and Europe, it is a serious and growing challenge in those markets, which generate the lion's share of sales for the four global music companies.

The proposed venture goes directly after Baidu's music search audience, by offering high-quality music files embedded with a digital "watermark" that lets record labels track how often their songs are downloaded. The idea: Better-quality files will draw users away from unlicensed downloads, and give labels and search companies valuable data needed to make money from advertising, say people familiar with the plans.

"In principle, search engines provide search for people to access music more efficiently. In a broader way, that's a good thing," says Catherine Leung, general manager of Universal Music China. "It's the links and encouraging people to download illegal content that's a bad thing."

That's where the Google effort comes in. Vivendi SA's Universal Music and about 100 other foreign and domestic record labels have been working with Top100.cn, a Beijing-based Web site that currently sells licensed music downloads for 1 yuan (about 14 cents) each, and Google. Together, Top100.cn and Google would provide free MP3 downloads with value added services, people familiar with the plans say. The new search options, for example, promise to give users free access to a database of information about their favorite artists -- from concert listings to links to special ring tones.

Thus far, Universal is the only confirmed major label. Two others, EMI Group Ltd. and Sony BMG Music Entertainment -- a joint venture of Sony Corp. and Bertelsman AG -- are in talks to participate in the new service, say people familiar with the situation. (Both companies declined to comment.) Warner Music Group Corp. has also expressed some interest in the new venture.

The music companies stand to earn royalties via individual revenue- share models hammered out with Top100.cn and Google.

It isn't clear whether the deal would apply to the majors' entire catalogs, or just to their local repertoires. In China, some of the most popular, and pirated, songs are by local artists -- many who record for global music labels.

Paid download services like Apple Inc.'s iTunes Store have grown rapidly, but not nearly enough to offset a steep, eight-year decline in sales of CDs, which still account for about 90% of recorded-music sales at the major U.S. labels. Illegal music downloads outnumber paid downloads 20-to-1 world-wide, according to the International Federation of the Phonographic Industry.

In China, industry analysts estimate that 90% of China's 162 million Web users access pirated music from their computers every day. The music industry has made repeated attempts to stop Internet companies, including Baidu, from facilitating access to unlicensed music. But they've received mixed results from Chinese courts.

Mr. Li, a Chinese-born veteran of Silicon Valley, founded Baidu in January 2000 -- just over a year after Google was birthed in the U.S. -- as China's nascent Internet market was starting to catch fire. He credits Baidu's focus on the demands of users for its success, and says Baidu emphasizes service rather than what he calls "innovation for innovation's sake."

Google remains in second place with 26% of China's roughly $132 million in search-engine revenue in the fourth quarter of 2007. That compares with Baidu's 60.1%, according to Beijing research firm Analysys International.

Yahoo China occupies a distant third place with 9.6% of ad revenues. But it may become a more significant competitor if Microsoft Corp.'s $44.6 billion unsolicited bid for Yahoo is successful. As of now, the Chinese search site is operated by Alibaba Group, parent company of Hangzhou-based business-to-business site alibaba.com -- which is 39% owned by Yahoo.

Although Baidu is growing quickly, it still remains tiny compared with Google's global size. The Chinese company likely earned about $81 million in profit last year on $230 million in revenue, analysts estimate, compared with Google's $4.2 billion on $16.6 billion in revenue.In December, Baidu joined the Nasdaq 100 Index.

Baidu's home page is strikingly similar to Google's -- a search bar at the center of a mostly empty page -- as is its business model of selling ads tied to user searches. Baidu also offers an online encyclopedia in China called Baidupedia which, like Wikipedia, is an article database made up of user-generated content.

Baidu, like other Chinese Web companies, has employed tactics that are difficult or impossible for those foreign companies to follow. In Internet search, for example, Baidu openly embraces the Chinese government's regulation of free speech on China-hosted Web sites, while Google and others have struggled to balance those rules with Western opposition to censorship.

Google began providing a Chinese-language version of its search service in 2000, but it waited until 2005 to establish an operation in China. Executives at the company, whose motto is "Don't be evil," struggled with how to reconcile its principles with Beijing's limits on speech. In 2004, Google bought a small stake in Baidu for about $5 million, prompting speculation that it might try to acquire the Chinese search company.

But in May 2006, Google sold its stake (about 2% at the time), just as it was beginning a push of its own into the China market. Baidu went public in August 2005, raising $86.6 million ahead of a Nasdaq listing that saw its shares more than double on the first day.

That year, Baidu put out a video ad on the Web that cemented its reputation for being brash. In the commercial, a Chinese man dressed in imperial costume and armed with a calligraphy brush uses Chinese punctuation tricks to stump his tongue-tied foreign rival. The Chinese hero steals the female companion of the Caucasian character, who ends up spitting blood, then is left twitching on the ground as the crowd shouts, "Baidu knows Chinese best!"

By the time Google entered China in force in late 2005, Baidu's traffic had already grown quickly. Along the way, Internet analysts claim that Baidu enjoyed regulatory advantages in China. Google, meanwhile, experienced repeated interruptions to its service. At one point, Internet users who attempted to access Google's U.S. site in China were redirected to Baidu's search Web site. When Google launched a China-based Web site in early 2006, censoring politically-sensitive sites from its search results to comply with government rules, the move triggered outrage from critics in the U.S.

Baidu denies having any national leverage. "The only competitive advantage we have is we have a better understanding of Chinese users, of their preference of online behavior," says Mr. Li. "We do a better job on almost every aspect of the user experience on our Web site. It's not just a single product."

Still, the company's music search page has been the growth driver. At the time of its IPO, Baidu said music searches accounted for a fifth of its traffic. Government research, however, has reported that up to 55% of Baidu users go to the Web site to perform music downloads, many of which are unauthorized.

Leong Mayseey, regional director for the IFPI in Asia, estimates that music piracy in China costs the industry hundreds of millions of dollars a year.

Over the past couple of years, Baidu has tried to make peace with record labels by offering to share revenue from advertising it sells on music streaming in exchange for the right to advertise alongside the streaming songs. Mr. Li argues that such a model represents the future of digital music in China. "Digital music will be a large market, especially in China, and it's going to be an advertising- supported business," he says.

Some record label representatives agree. But so far only one multinational record label, EMI, has taken up Baidu's offer.

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Kevin J. Delaney contributed to this article.