Bears Stearns Report on the Chinese Online Game Market

A good initiation on the sector from the Antonio Tambunan, the new Bear Stearns Analyst covering the China game sector. He knows his stuff; he is a hardcore gamer.

His top pick is Netease, followed by The9. He downgrades Shanda.

Download bearstearnschina_online_games_1207_us.pdf
(Writen on 2005.12.09)

China's Online Gaming Craze

The mainland market for online games is set to surpass $2 billion by the end of the decade and beat out South Korea as king

By his own admission Zhao Songwei, 24, is logging far too many hours these days at a sprawling Internet Café in Shanghai. He spends four or five nights a week immersed in online fantasy and combat games such as The Legend of Mir II—The Three Heroes and World of Warcraft and has been known to go at it in grueling 24-hour stretches. He freely admits he has something of a gaming problem. "I think online games are definitely addictive," he said during a recent Monday morning session.

The Shanghai hotel employee just can't seem to resist the sheer entertainment value and escape from everyday worries that his virtual adventures deliver. At the moment, his current fixation in cyberspace is getting his adopted character in Warcraft (a nasty looking horned creature on a horse with pop-out eyes) some seriously nasty weaponry to go on a killing mission.

Other characters had better watch their backs. "My level in World of Warcraft is 60, the highest in the game," says Zhao, who looks more like a skinny high school student than a predator.

PASSING SOUTH KOREA. Zhao represents an extreme dimension of China's current online gaming craze. Yet make no mistake: Chinese youth are proving to be some of the most committed and driven gamers on the planet. And the stupendous growth of the online, interactive game market in China continues to astound analysts.

The market for fantasy and adventure multiple role-playing games shot up 54%, to $460 million in 2005, and is on track to reach $2.1 billion by the end of the decade, figures research firm IDC. China is expected to surpass tech-happy South Korea next year as Asia's biggest gaming market.

For Chinese Net companies such as Shanda Interactive Entertainment (SNDA), the kingpin of online gaming, and portal companies that also compete in this segment such as NetEase.com (NTES), this market offers huge long-term potential. And the reason seems to go beyond the obvious point about China's sheer market size, though an Internet user base of 120 million (and growing fast) doesn't hurt a bit.

FEROCIOUSLY COMPETITIVE. The quality of Chinese games is fast-improving, and there may be something to the idea that multiple-participant online gaming appeals to the collectivist spirit of mainlanders. "Players have interactive relations and they work together to accomplish missions," says Shanda spokesman Zhuge Hui. "This ensures the demand of online games" in China, he says.

That said, the Chinese online gaming business is ferociously competitive and going through a period of disruptive change. Valuations of Chinese Internet stocks have taken a beating in recent months. The Chinese government and state-run cellular carrier China Mobile are tightening up billing practices and content fees for such things as downloadable games and ringtones. That has cast a pall over the entire Net sector.

On top of that, the business model for online gaming is changing, notes Jun-Fwu Chin, a senior analyst and online gaming specialist with IDC Malaysia. The current trend among online game purveyors is to reduce or entirely eliminate fees to play games to build up a bigger stable of users.

But now companies are hoping to rake in even more revenues by charging for things like weapons and ammo and other virtual goods needed to advance various games. Companies "are switching to a model with revenues generated by the sale of virtual items," he says.

A DISNEY INTEREST. That is probably a smart move long-term, but right now it is costing companies like Shanda dearly. Its first-quarter profits fell 95%, to $1.47 million, as it saw a slide in online subscriptions and increased competition from Chinese rivals such as NetEase.com. Yet Shanda Chairman and founder Chen Tianqiao thinks building up a huge online consumer base will pay off big eventually, not only in the sale of virtual goods but also music and online movies to the legions of gaming fans attracted to its site.

Even so, few would deny the long-term potential of Chinese online gaming—and it is getting noticed in the U.S. In May, Walt Disney's (DIS) Internet unit struck a deal with Shanda to distribute and operate games based on Disney's hottest animated characters.

Meanwhile, a fantasy online game that the National Basketball Assn. rolled out last October called NBA High Scorers' Challenge, in which gamers play the role of a general manager responsible for setting salaries and team rosters, attracted 200,000 registered users at the league's Chinese Web site NBA.com/china, which is powered by Sohu.com.

"It has had an incredible response," says Mark Fischer, vice-president and managing director of NBA China. And a downloadable mobile phone version of the game developed by Shanghai-based Mtone Wireless has also been a hit.

SUPER GROWTH. Yet the real show for Chinese companies is to improve the quality of locally-developed games. Right now, South Korean game developers rule with about a 45% share of the online games in operation in China. Nexon, a Korean online game company, offers games through operators in China, and one called Crazy Arcade BnB (for Bomb and Bubble) which goes under the name Paopaotang in Chinese, has an incredible following of 130 million registered users.

However, Chinese game developers are starting to come on strong with well-designed games of their own. "Some Chinese companies have become pretty competitive," says Calvin Yoo, director in charge of international business development at Nexon, though he thinks the market is growing so fast that Korean game designing outfits will continue to thrive.

Chinese Internet players have a big incentive to develop smash hits of their own, given the $117.4 million in royalty payments the Korean game developers hauled in during 2005 from the mainland. That is why companies like NetEase are pushing hard to generate hits internally.

ON THE PHONE. A good example of that is Westward Journey Online II, which is based on the famous Chinese novel Journey to the West and a film adaptation of that classic tale by Hong Kong actor and film director Stephen Chow Sing Chi. Its visual style draws heavily from traditional Chinese paintings, and is one of the most popular games among those developed inside China. This game has attracted more than 83 million registered users.

Big numbers and huge potential will continue to drive interest in Chinese online gaming. There is serious money to be made by mainland hosting sites and local and foreign game developers. And there will be interesting challenges for a mobile handset-based game when 3G, high-speed telephony arrives in 2007 or 2008. All this will provide more than enough virtual entertainment for hard-core gamers like Zhao.

China moves to zap online game addiction

China on Tuesday introduced an “anti-online game addiction system” intended to protect players from the mental and physical perils of spending too much time in front of computers.

The system, which will encourage players to play less by cutting the benefits they gain in online games, is to be implemented by local internet companies that have signed a code of conduct drawn up by China's press and publications administration.

The move reflects fears about the social impact of popular “multiplayer online role-playing games” which have been blamed for encouraging sloth, truancy and even murder.

An estimated 25m Chinese play online role-playing games. These allow players to interact as characters ranging from warrior heroes to powerful magicians in vast virtual environments.

However, communist groups and newspapers have highlighted reports that many players are addicted to the games.

Under the new standard, up to three hours of play is considered “healthy” - and more than five to be “unhealthy”.

The anti-addiction system cuts in-game benefits to players after three hours. For most games this will mean awarding fewer “experience points” to fantasy characters and reducing the value of virtual goods such as magic weapons that they acquire.

After five hours online, players will be subjected every 15 minutes to the warning: “You have entered unhealthy game time, please go offline immediately to rest. If you do not your health will be damaged and the benefits you can win will be cut to zero.“

Leading games companies have agreed to the system to head off the threat of stricter regulation.

China's online games market is expected to grow 65 per cent to $633m this year, and will be the world's largest by 2006, according to CSFB, the investment bank. .

Such growth has won high valuations for Nasdaq-listed Chinese online games companies such as Shanda Interactive and Netease, which have promised to implement the system by late October.

Why Lenovo-IBM is a tough sell

Two years ago, I got an inside look at operations at Lenovo Group, the Chinese computing giant that is forming a joint venture with IBM to sell PCs worldwide.

Military marching music blared out of loudspeakers that ringed the corporate headquarters. It was 2 p.m., the beginning of the mandatory afternoon exercise break for the assembly line employees. "Here it is," I thought, "the legendary willpower and unity of Chinese organizations." I expected to see employees popping off jumping jacks while wielding soldering guns.

Instead, the workers mingled around a courtyard, smoked cigarettes and in general seemed impervious to the motivational siren songs broadcast by upper management. It warmed my heart--people truly are the same everywhere you go.

Formerly known as Legend, Lenovo has consistently been predicted to become one of the first companies from China to go worldwide. It sells some PCs in Europe, but to date its operations have mostly stayed in China.

The pending deal with IBM will make those global plans will materialize overnight. Under the terms, Lenovo will buy the PC unit, but IBM will lend it its name and make Lenovo a preferred provider. Pulling such a deal off, however, would be fraught with difficulty.

First, let's take a look at the factors in Lenovo's favor. For one thing, the company often behaves more like a Western corporation than an Asian conglomerate, adapting rapidly to changing circumstances.

Founded in 1984 by researchers from the Chinese Academy of Sciences, Legend first existed as a distributor in China of PCs from overseas. It subsequently moved into making PCs, consumer electronics, printers, storage and, more recently, supercomputers. It also has its own retail stores in China.

Lenovo has shown an uncanny ability to extract expertise from its many technological partnerships. It learned how to make PCs from AST Research and Acer, two of its distribution customers. Lenovo subsequently stopped distributing both brands. In 2001, America Online and Lenovo invested $100 million in a joint venture to develop online properties. Lenovo has since bought out AOL's interest at a discount.

Just as importantly, the company knows it can't simply rely on latent nationalism or local low-cost manufacturing to woo customers in China. When it began to lose market share to multinationals like Dell in the first part of the year, Lenovo immediately cut prices.

In addition, technology giants such as Samsung and Acer have paved the way for broad acceptance of manufacturers from Asia.

But here's the snag: Samsung, Sony and Acer sell to consumers and small businesses. IBM sells notebooks and desktops to big companies, and corporate computing doesn't travel easily across borders.

Fujitsu Siemens Computers is the fourth-largest PC maker in the world, but good luck finding any of its products in the United States: The company sells its boxes in Europe and Asia. Samsung bought AST and tried to break into North America a few years back, but the effort floundered.

The problem is that corporate customers want a safe, predictable and fairly inexpensive choice. Selling corporate America on a new technology is like giving your dad the latest fashions at Christmas: Chances are he'll be back in his jogging suit in two weeks. Advanced Micro Devices makes chips that win awards, but they don't end up in business desktops, because the Intel processors the IT managers have tested work just fine.

And IBM customers are the most conservative of the lot. They know they can call Armonk, N.Y., and get answers pronto if something goes wrong. Yes, IBM outsources laptop and desktop manufacturing--but it is Big Blue itself that has to answer for the products.

How comfortable are business customers going to be with a joint venture owned mostly by a company based 10 time zones away? More likely, they'd rather call Round Rock, Texas, home of Dell. In addition, IBM will likely be uneasy about having its brand name of products coming out of a group it does not fully control.

Another problem stems from the nature of joint ventures. They usually don't work. Typically, one company has to become a passive partner (AMD and Fujitsu's flash venture Spansion), or direct competition between partners has to be an extremely remote possibility (EMC and Dell), for a venture to have a chance of success.

IBM and Lenovo are going to have to exchange customer lists and let the one perform a service that it used to do itself. A lot of trust will be required. Remember how people worried whether the Hewlett-Packard culture would mesh with Compaq's. Here, the cultural gulf is a lot wider and, to top it off, the two parties will literally not speak the same language. The new Lenovo will consist of roughly half English speakers and half Mandarin speakers.

As the old saying goes, no one ever got fired for buying IBM. But no one ever got hired for buying Lenovo.

A culture of overwork exacts an extreme price

Thousands of Chinese are literally being worked to death. Huawei, previously seen as a model company, is now a symbol of the overwork phenomenon. One of its star employees, 25-year-old software engineer Hu Xinyu, died suddenly May 28 after nearly a month of overtime work.


At China's biggest telecoms maker, every new employee is issued with a mattress. The reason? So they can grab a nap beneath their desks, day or night, when they succumb to exhaustion from their endless working hours.

The frenetic work habits of the 40,000 employees of Huawei Technologies have become known as the "mattress culture" -- and it's a prime example of the intense pressures that kill up to one million Chinese workers every year.

Until recently, China was proud of its mattress culture. The employees of Huawei were icons of the tireless zeal that transformed China into the "workshop of the world."

Many worked for months without a day off, sleeping in their offices at night so they could keep working as soon as they awoke.

But there is mounting concern about the toll of death and illness from overwork. Experts estimate that 600,000 to one million Chinese workers are dying from it every year.

Huawei, previously seen as a model company, is now a symbol of the overwork phenomenon. One of its star employees, 25-year-old software engineer Hu Xinyu, died suddenly May 28 after nearly a month of overtime work.

He was a former athlete and sports enthusiast, yet he became so exhausted at the company that he often slept at his office instead of going home.

His death has helped ignite a national debate about the culture of excessive work. The Chinese media have documented a growing number of deaths caused by overwork, and Chinese websites and Internet forums have questioned the national economic model.

"Working is important, but it can't be more important than life," one young office worker said in a website debate about Mr. Hu's death.

Almost all sectors of Chinese society, from manual labourers to intellectuals, are prone to overwork. In the past five years, for example, 135 professors and other scholars in Beijing have died prematurely as a result of overwork, according to media reports. Their average age was just 53.

Another report concluded that the life expectancy of intellectuals in Shanghai has dropped by five years in the past decade. And a survey of 2,600 high-tech workers in Beijing found that 84 per cent were unhappy with their excessive workload and nearly 90 per cent were worried about the impact on their health.

"People are starting to look at the human cost of China's phenomenal growth rate," said Robin Munro, research director at China Labour Bulletin, a labour-rights organization based in Hong Kong.

"Many Chinese people are beginning to question whether their society is benefiting from this relentless drive for great-power status. When you have up to a million people dropping dead from overwork, it's a calamitous situation.

"These are the kinds of shocking numbers you might expect from a disease epidemic. It's an awful indictment of the work culture in China and the pressures on ordinary people."

Under Chinese law, he noted, workers are prohibited from working more than 36 hours of overtime a month. Yet this limit is routinely exceeded in most export-oriented manufacturing industries.

"It's the mentality of a slave-labour camp," Mr. Munro said. "The entire work culture is distorted. There's so much emphasis on making money in China, and working extraordinary hours is seen as the way to do it."

Even the state-owned propaganda newspaper, People's Daily, has criticized the amount of overwork, which it blames partly on the rising unemployment rate and the 14 million jobless people in the country.

"With the growing numbers of people ready to take their places, few workers are willing to turn down overtime," the newspaper said in an editorial last month.

One of the most poignant cases was the story of Gan Hongying, a 35-year-old worker in a garment factory in southern China.

Desperate to raise money for her husband and two young children, she worked 22 hours of overtime in a four-day period this spring. She began to complain of dizziness and headaches, and she talked constantly of how she needed to sleep.

On May 30, after more than 54 hours of work over four days, she died suddenly. Her last words to her sister were: "I am so tired. Give me the key to your home, I want to have a rest."

After her death, a local newspaper investigated and found that the garment factory had routinely forced its employees to work overtime.

If the workers failed to finish their orders, the factory gate was sometimes locked to keep them inside, and they were threatened with a loss of pay.

The investigation found that 70 per cent of factories in the Pearl River delta of southern China, where Ms. Gan worked, had required its employees to work more than the legal maximum of overtime every week.

Beijing's Balancing Act

Mao Zedong dispersed China's industry in the 1950s so that his young Communist regime would be less vulnerable to attack. The loss of any one part of China would not then prove economically disastrous, he reasoned. He would be able to retreat to any part of the country, if necessary, and still have the means to supply his army.

This move left China with a lopsided economy, especially its state-owned sector, and has added a unique regional dimension to the restructuring that would anyway be occurring to state-run industries going through the sort of changes that China has been experiencing since Deng Xiaoping set off down the path of economic reform in the late 1970s.

Though it might cause Mao to turn in his grave, private enterprise now accounts for the majority of economic output in China. It is more efficient and faster-growing than the state sector. It is not constrained by being an anchor industrial employer in places where it often has no natural advantages.

Private companies in China remain small--agriculture, wholesale and retail distribution and construction are dominated by thousands of small family firms--and they face considerable barriers to growth; access to markets and capital still depends greatly on connections. They are, though, on the whole profitable.

The state sector, composed of about 150,000 state-owned enterprises, is a different story. These firms are often big and unprofitable. An study by the Organization for Economic Cooperation and Development (OECD) based on data from 2003 found that they wrung half the productivity from twice the capital.

State enterprise assets represent about 85% of China's gross domestic product, about three times higher than in even the most state-dominated Western European economies, France and Italy, and well above the rate typical in economies making the transition from developing to developed.

Not all are hopeless basket cases. Productivity and profitability are improving surely, if slowly. The return on equity at state industrial firms rose from 3.4% in 1998 to 10.2% in 2003, according to the OECD study. That is short of the private sector's 14.4%, but still passable.

However, the best performance is concentrated in the largest 20% or so of state enterprises. They tend to be the ones that Beijing is using to drive development across the economy in the industries that are the boiler rooms of growth: energy ( PetroChina), banking ( Bank of China), utilities ( Huaneng Power), chemicals ( Sinopec), heavy industry ( Baoshan Iron & Steel), telecommunications ( China Telecom) and transport ( Air China).

Beijing's industrial policy for its state-owned enterprises is two-pronged: to develop national champions that can compete in world markets, and to ease the strain the basket cases impose on the national treasury.

Except at the top end (the companies that make our list of China's largest companies), even China's biggest companies are not so sizable by world standards. Only 14 make the list of the world's 500 largest companies by sales, of which eight are state-owned.

Hence, a policy emphasis on achieving economies of scale and scope. Since the late 1980s, informal links between large enterprises have been formalized through merger and consolidation. That has distilled 120 industrial groups identified as national A-list companies, with a further 2,300 similarly preferred companies at provincial and city levels.

The national champions have been given more decision-making and financial autonomy and priority in the allocation of state-controlled resources, including investment and capital.

They have been encouraged to create research centers (even China's biggest companies devote only 1% of sales to research and development, on average--compared to 5% in the West) and develop their foreign trade. They have also been earmarked for stock-market listings.

They were initially given protective tariff support, although that is being removed in line with China's World Trade Organization entry obligations.

Beijing is also trying to pull off a delicate balancing act: imposing the disciplines of the market on management while keeping policy control of its national and local champions firmly in trusted hands. This has led to the creation of a hybrid group structure, not dissimilar to the industrial groupings that underpinned Japan Inc.

Under this model, a holding company, run by politically appointed managers, controls a network of associated operating companies via controlling or minority shareholdings. One or more of the associated companies may be selected as the vehicle for a public listing on a stock exchange; others of the associated companies may be designated to absorb a large amount of the group's underperforming assets.

A side benefit of this structure is that it has created national industrial networks that circumvent the local protectionism and vested interests that are a legacy of Mao's industrial policy. That, in turn, has eased Beijing's way toward meeting its WTO market-opening obligations.

Since 2003, supervision of the very largest state-owned companies in China has fallen to the State-owned Assets Supervision and Administration Commission (SASAC), a high-level commission whose writ runs to about 180 companies. It has set an internal target of having 50 Chinese companies, including state-owned ones, among the largest 500 companies by sales in the world by 2015.

To this end, it recently linked the salaries and bonuses of the presidents of 30 of the biggest state-owned enterprises, including China National Offshore Oil (nyse: CEO - news - people ), to the profitability of their companies.

More M&A can be expected in the state sector as China seeks to create more big companies that can compete internationally. Yet perversely, Beijing will try to do this while tightening its hold on the sector rather than loosening it.

China Surpasses U.S. In Internet Use

Chinese Internet users spend nearly two billion hours online each week, while the U.S. audience logs on for 129 million hours per week.

That's the bombshell Dr. Charles Zhang, chairman and CEO of Sohu.com (nasdaq: SOHU - news - people ), dropped last month after ringing the opening bell at the Nasdaq, a milestone for a Beijing-based company.

Zhang reported that, according to his internal research, Chinese Internet users numbered over 150 million--and possibly up to 200 million--and Sohu.com, including all of their properties, was in the top five most trafficked sites in the world. Nielsen NetRatings, which doesn't have statistics for China, reports that the U.S. had 154 million active users in January 2006. This means that China, if Zhang is correct, is at or above the U.S. in the number of Internet users and that these users stay connected far longer each time.

How could the milestone of China surpassing the U.S. in Internet users have gone so unremarked? It turns out that it isn't that easy collecting data on over a billion people in a country as vast as China, where most people are not connected by phone lines.

The China Internet Network Information Center (CNNIC) reports that the number of active Chinese Internet users was 111 million by Dec. 31, 2005, up from 94 million a year earlier. And over the past two years, it has been growing at a steady rate of 18%. However, according to Zhang, the CNNIC polling is conducted by calling fixed line phones. "Young people do not use fixed line phones. They all have mobile phones," Zhang said, explaining why he believes the CNNIC is reporting lower-than-accurate numbers.

Even if we assume that China is still behind the U.S. in terms of users, China definitely wins in another critical area. One of the most valued metrics of Internet usage (especially for advertisers) is time spent online. Chinese users average 15.9 hours per week, while Yahoo! (nasdaq: YHOO - news - people ), the most popular Internet site in the U.S., can only get its users to stick around for less than one hour per week (216.5 minutes per month according to ComScore Media Metrix). That's 1.765 billion hours per week online in China, compared with 129 million hours per week online in the U.S.

What's up with all that time online? This is the first time in Chinese history that the nation has been connected. As Zhang explains, "People log onto the Internet and Sohu.com because, in China, there is no Forbes, Reuters or The Washington Post. Print media was all state-controlled and official, and the Internet filled this void." Indeed, according to the CNNIC, 67.9% of online use in China is spent devouring news, more than searching (65.7%) and e-mailing (64.7%). By contrast, only 3% of Yahoo!'s U.S. traffic clicks over to news.*

Moreover, China has a lot more room to grow than the U.S. While roughly half of the U.S. population is actively using the Internet, just 11.7% of the Chinese population is currently plugged in.

Internet Users In China

Source: China Internet Network Information Center, CNNIC.net

There are 400 million cell phone users in China, with over 6.1 million mobile users connecting online.** As cell phones increasingly become the connection of choice, you can expect China, which is a generation ahead of the U.S. in mobile technology, to lead the world in mobile Internet-access growth. And everything will hit hyperdrive over the next two years, as the country ramps up to host the summer Olympics, which are being held in Beijing in 2008.

So why is Sohu.com the hottest site on the Web these days, when Baidu.com (nasdaq: BIDU - news - people ) is the better known brand in the U.S.? Sohu.com is up 40% this year, while Baidu.com, the blazing IPO of last summer, has lost 9% since January and is down 63% from its 52-week high.

While Sohu.com, Sina.com and Baidu.com are all in the top ten of most popular global Internet site--above Amazon.com (nasdaq: AMZN - news - people ) and AOL--Sohu.com has twice the revenue and three times the net profit of Baidu.com. And Sohu.com is the official Web site for the 2008 Beijing Olympics. Additionally, Sohu.com was the first publicly traded Chinese company, alongside Sina.com, to adopt Sarbanes-Oxley accounting standards, which speaks well of the management team of Zhang and CFO Carol Yu.

Sohu.com

Charles Zhang is not afraid of heights. Recently, Zhang, 39, the founder of Chinese Internet portal Sohu.com was clinging to the face of Mount Everest, 6,666 m above sea level. That's high but nothing compared with the altitude of his company's stock price. On July 10, Sohu shares closed at $38.25 on NASDAQ--a gain of 245% since April 1. More impressive, Sohu shares are worth 36 times their value during the dark days of the Internet bust, when they traded for less than $1.

Sohu, which started in 1996 as the first Chinese-language search engine, surprised critics by turning profitable in the third quarter of last year. For the second quarter of 2003, it posted a stunning $7.5 million profit on $19.3 million in revenue. But the climb has not always been smooth. During the shake-out following the dotcom crash, shareholders questioned the company's heavy dependence on banner-ad revenue. Hostile board members and disgruntled investors wanted professional management to replace him. Zhang says his nonconfrontational style helped him hold on, but the experience "was the worst sort of psychological torture." Short-messaging service, which helped the company turn around and generated total revenues of $750 million in China last year, now accounts for 48% of Sohu's revenues.

Zhang, who holds a Ph.D. in physics from M.I.T., sees parallels between his recent attempt to scale Everest and his near death business experience: "The temperature was subzero, with winds threatening to blow my tent over, and I was constantly out of breath. But as bad as it was, I'd sooner do it all again than repeat what I went through after the bubble burst." Is he out to climb more mountains? Undoubtedly; he's not afraid of heights. --By Kaiser Kuo/Chengdu

China's Web Watchers

Nothing in Zheng Yichun's upbringing foreshadowed his landing in a political prison. His English-speaking father interrogated captured American G.I.s during the Korean War, and as a teenager two decades later, Zheng led his middle school's Communist Youth League. Only when the reform era hit China in the 1980s did the aspiring poet have what his family calls an "awakening." China's leaders were corrupt and tyrannical, he said, and he would fight them with words. Yet despite the provocative title of his self-published 2002 collection of poems, The Era of Brainwashing, his work went mostly unnoticed. If not for the Internet, Zheng, now 57, might still sit in his mildewed sixth-floor walk-up near the Manchurian city of Dalian, surrounded by bookshelves of Russian literature, tapping verse onto his Legend computer.

But Zheng also shared his thoughts on overseas Chinese-language websites. China's one-party system is "the root of all evil," he wrote in an essay that was one of 63 signed articles he posted on dajiyuan.com, a website popular among Chinese intellectuals. Even though Web surfers in China can't normally access dajiyuan.com;it's among a long list of sites blacklisted by government censors;police arrested Zheng last December on charges of inciting subversion. On Sept. 22, he was sentenced to seven years in prison. Beijing had once again sent a stern message to Chinese who dared to use the Internet to express their political opinions. "Zheng's arrest served as a warning to people like me," said Yang Chunguang, another Dalian-based writer critical of Beijing, shortly before Zheng's sentencing. "I e-mailed dajiyuan.com asking it to take down the things I had posted."

A decade ago, the Internet was hailed as a breakthrough technology for promoting freedom and democracy because its pervasive reach would make it impossible for repressive regimes to control free speech and the flow of information within their borders. The Chinese government has proven this to be wishful thinking. Employing much of the same information-screening and filtering technology used worldwide to combat pornography and spammers, Beijing has built a Great Firewall of China that restricts viewing of scores of foreign websites (such as those for Amnesty International and numerous news sites); the government has also deployed tens of thousands of Internet police to investigate online crimes, including political offenses. While some tech-savvy surfers can find ways through the firewall and past Web police monitors, the vast majority of China's 100-million online population will search in vain for Mandarin equivalents of the Drudge Report, blog screeds and independent journalism that define free online speech in most of the world. A recent study by Harvard Law School's Berkman Center for Internet & Society concluded that "China's Internet filtering regime is the most sophisticated effort of its kind in the world."

But as Zheng's arrest shows, China's taming of the Internet depends more on old-fashioned muscle than on new technology. Above all, Beijing maintains control by instilling the fear in Web scribes and online businesses that they are being watched—and that, if they cross the line, they are risking their investment, their business, even their freedom. The threat is real: Human Rights Watch estimates that 60 Chinese are serving prison sentences for Internet-based political crimes, and Beijing frequently closes down websites operating on Chinese soil whose owners allow controversial postings.

Indeed, far from loosening up, Beijing is intensifying its scrutiny of the Web. Last week, the State Council released even more stringent regulations—aimed at online forums, blogs and wireless SMS messaging—that bar postings of news that goes against "national security and the public interest." The latest clampdown continues a campaign that started almost 10 years ago when China began building its own version of the World Wide Web. It was relatively simple to keep tabs, with authorities quickly learning to program off-the-shelf network routers—the switches that zip data around the Internet—to block offending Web addresses. Then, in 2000, Beijing spelled out its strict Internet philosophy: State Council Order No. 292 barred nine types of content from websites, online bulletin boards and chat rooms, including anything that might "harm the dignity and interests of the state" or "disturb social order." The government has also made it difficult to maintain anonymity. The majority of Chinese go online at cybercafés, and in order to rent computer time users must register with their national ID numbers. Cybercafé employees watch what their customers are viewing, keep logs of sites visited and share that information with local Internet police departments, which have been set up in more than 700 cities and provinces.

Perhaps most important, the 2000 decree held content providers responsible for information published on their sites. The result: knowing they were being watched, all but the bravest Web users played it safe. "The best censorship is self-censorship, and China relies on solid work by the secret police to make people censor themselves and keep the Internet under control," says Xiao Qiang, director of the China Internet Project at the University of California, Berkeley journalism school.

Beijing's control of the Internet is bolstered by its success at enlisting the aid of foreign companies such as Microsoft, Google and Yahoo!, all of which run online operations on the mainland. The fast- growing China market is key to their global strategies, and they are loath to antagonize their host nation. Yahoo!'s China operation was widely criticized last month for turning over information to the police that helped send journalist Shi Tao to prison for 10 years (Shi had posted a list of topics that Chinese newspapers were forbidden to cover, including the anniversary of the 1989 Tiananmen massacre). Yahoo! officials said they had no choice but to abide by the "laws, regulations and customs" of countries where it does business. It isn't alone in its sensitivity to local customs: Microsoft's MSN portal blocks the Chinese words for "democracy" and "freedom" from the blogs it hosts, while Google omits banned websites from its search results.

Likewise, mainland Internet companies have become virtual appendages of the government censorship apparatus, employing their own human monitors to ensure their sites remain free of banned content. China's leading blog host, Bokee, which just received $10 million in foreign investment, employs 10 full-time inspectors to keep an eye on postings and to delete those that might anger Beijing. "You have to know where the pressure lines are," says a monitor at Xici Hutong, a site where Chinese journalists share ideas. He says he removes pornography, which is illegal in China, as well as personal slander and "political things." One of China's two biggest portals, Sohu.com, routinely talks with government regulators about what topics to add to the forbidden list. "China is undergoing a huge experiment in its transition to a free society," explains Charles Zhang, Sohu's CEO. "We need to be responsible to see that reforms go steady and stable."

Beijing deals harshly with those who test the rules. One site run by students at China's top school, Peking University, was "the epicenter of political sensitivity," says a former manager there. Its name, Yitahutu, meant "a big fat mess," and its 300,000 registered users often posted critiques of China's one-party system. In July 2004, someone posted an article by a Hong Kong researcher claiming that the Communist Party's approval rating was lower than 20%. Officials from the Party's Central Discipline Inspection Commission arrived at the website's office to remove the article. In its place, they substituted dozens of comments written by party propagandists masquerading as ordinary web users critical of Yitahutu. "Without the Communist Party," read one, "the good times would end." Two months later, the site was shut down. The closure order said it had "disseminated political rumors." Since then, cities around China have created teams of Internet propagandists to pose as citizens and post comments supporting the party.

Still, determined Chinese web surfers manage to tunnel through today's firewall with the help of software that guides them to overseas "proxy servers," computers that enable them to fetch and view banned content. Activists smuggle proxy software into China and pass it hand-to-hand on flash memory devices. "It's really cat and mouse," says Bill Xia, president of U.S.-based Dynamic Internet Technology, whose product bounces users among many proxy servers, making it hard to track the surfer's identity.

On a recent afternoon, a Chinese reporter in Beijing used one of these programs to watch a video of the Tiananmen massacre on his IBM ThinkPad. "See that boy facing down a line of tanks?" he says. "I'd heard about that." In most countries, this ability to track down elusive information is now little more than a mundane miracle of modern technology. In China, this unconstrained curiosity remains a perilous threat;to both the browser and Beijing. With reporting by With reporting by Sonja Steptoe/Los Angeles

Research fraud rampant in China

A Chinese study found that 60 percent of PhD candidates admitted to plagiarism, bribery.

	CHEAT: In 2003, Chen Jin held up what was supposed to be a breakthrough Chinese chip - now exposed as a fraud.

EIJING – The stunning revelation of fraud and fakery in the heart of China's R&D industry has vindicated a feisty set of scholars who are gaining traction in exposing a culture of fraud and corruption in China's colleges.

Just days ago authorities revealed that the Hanxin digital signal chip, a so-called "Chinese chip" designed to enhance home-grown computer technology, is not an original. Chen Jin, "father of the Chinese chip," evidently used a product from a foreign firm to win a lucrative bid in 2003 - ironically, to spearhead a much publicized patriotic national drive to create a Chinese super microchip.

For scientists and researchers in China, the Chen case, while embarrassing, is all too typical. Other fraud cases are coming to light that reveal a deeply ingrained habit of plagiarism, falsification, and corruption - widely recognized, but not widely policed or punished in Chinese universities.

It also arrives in the midst of growing concerns about the nature and character of native firms, of exports, and of the contributions to technology and scholarship by China around the world. What has been an irritating and somewhat comical issue about pirated DVDs - has now morphed into a fuller-scale complaint about high-tech intellectual property rights violations. The American Chamber of Commerce Tuesday issues a tough "white paper" on piracy violations and practices in China.

Last week nearly 120 Chinese scientists living in the US wrote an open letter of concern to Ministry of Science officials, arguing that standards of research in China have dipped to such lows, that the country's reputation is on the line. Ironically, the desire to boost China's research reputation, and the pressure that puts on scientists, is partly fueling the corner-cutting.

A recent Ministry of Science study of 180 PhD candidates in China found that 60 percent admitted plagiarizing, and the same percentage admitted paying bribes to get their work published.

"The actual situation might be worse than that, particularly in the area of social sciences," says Fang Zhouzi, a biochemist who splits his time between California and Beijing, and runs a website that has detailed more than 500 cases of serious academic fraud in China.

Mr. Fang is one of the feistiest whistle-blowers - wellknown and also feared in Chinese academic circles. Fang, whose real name is Fang Shi-min, is an Old Testament angel of vengeance when it comes to lying and cheating, and his work has led to a number of high-level fraud exposures and dismissals in the academic world.

His investigations have exposed:

• Yang Jingan of Hefei Industry University, who was expelled from the communist party after Fang disclosed plagiarized essays from foreign academic journals;

• Liu Hui, dean of the Medical School of Tsinghua University, who was dismissed after Fang found that Liu falsely claimed to have been director of medical research at New York University;

• Yang Jie, dean of biology at Tongji University in Shanghai, who was dismissed after admitting to having a falsified résumé.

In the computer chip case, it was an assistant that exposed Mr. Chen. Evidently fearful of being implicated in what was proving a fruitless mission, the assistant posted on Jan. 17 an exposé on the Xinhua bulletin board.

On May 12, Shanghai's Jiaotong University, where Chen is based, stated the Hanxin, or "Chinese heart chip," was a DSP 56800E, by Motorola. The University promptly fired Chen. The chip on display in Shanghai at the festive 2003 chip launch, attended by top officials, was a painted piece of metal, it was revealed.

Yet Fang and other fraud-busters say such public disgracings are the exception, not the rule. They argue that the culture of plagiarism continues mainly because corruption runs to the upper levels of the institutions of higher learning, and efforts to expose it are throttled.

Take the case of Wei Yuquan. Mr. Wei is vice president of Sichuan University as well as an immunologist and a member of the Chinese Academy of Sciences. A recent article by Mr. Wei describing an experiment to treat cancer cells was billed as groundbreaking. Yet when Si Lu Sheng, a relatively obscure older pathologist from central China, reviewed the article, something stuck in his craw. Mr. Si asked Mr. Wei for simple verification. But Wei refused to present basic evidence, discuss methods, or even present receipts for lab purchases of special white mice. Yet on the basis of the article, Wei received a $60,000 grant from China's National Life Science and Nature fund - big money for professors here, some of whom make only $350 a month.

Si was flabbergasted. Nearing retirement, and with little to lose, he started a small campaign to expose what he felt was cheating, he told the Monitor.

Wei visited Si several times to talk him out of his campaign. Si was offered a lucrative research project. But Si wasn't biting. So, a different kind of pressure was exerted - Si got harassing phone calls and his wife was pressured at her job. In the end, the university backed its vice president. But no substantive evidence of the veracity of the medical test has been forthcoming.

"I got involved to warn younger scholars of the harm of falsifying research," Si says. "The faking is obvious, everyone knows it. But no one dares to talk about it, since the university president declared the work was acceptable. When the senior leaders at the university ordered the discussion to be closed, it was."

So Si sent a set of letters and the case to Fang's website.

A Sichuan University spokesman contacted Monday said that, "There is no clear line between academic corruption and academic disputes. People who are fighting against corruption are not reliable and do so to make a name. We should let the leaders of the university decide."

"What we need is to actually punish those who commit fraud, to kick them out," says Tsinghua University engineering professor Zhou Nanyuan, who does research in the area of science fraud. "So far we only have an oral commitment to police this, from our university leaders. The problem is that many violators remain, even after they are exposed."

"The higher the position a cheater occupies, the easier for him to avoid investigation and punishment," Fang told the Monitor.

The increase in science-related fraud contributes to the exposure of corruption, since science tends to be a performance-driven discipline where verification is part of the accepted process, experts here say.

Still, Si says that serious science review mechanisms are lacking. The science magazine editors that first published the article were chosen by seniority rather than professional capability, Si says.

Party members loyal to the school have far greater say in the review process than a more knowledgeable, but less senior, figures. Since grants are state funds, few on the review boards are willing to stick their necks out and rebut serious scientific claims - especially for grant proposals that appear under titles like "national research."

Useful Chinese Online Tools List

Here is a list of some popular Chinese online tools.:

Business Social Bookmarking: 365key

Notes: 1tie.cn

Social Networking: Wealink

email: Netease Mail

Feed Tool: Feedsky (previous post here)

RSS Reader: Zhuaxia (profile)

Online Storage: Mofile

Social Groups: Douban(profile)

Podcasting: Toodou (profile)

Online Image Editor: IEPS(IE Only)

Photo Album: Yupoo

Survey: 51tou

Spreedsheet: EditGrid (profile)

OpenID: OpenID.cn

Videosharing: UUME

Blog Hosting: Baidu Space

Social Networking: UUZone

Search: Baidu

Digg: Diglog

The World's Top Websites - Yahoo number 1, China moving up

I took a look at the top websites in the world according to Alexa. You might be surprised by what I found. Here is the current top 10 in terms of traffic:

1. Yahoo!

2. Microsoft Network (MSN)

3. Google

4. Yahoo! Japan

5. Baidu.com

6. sina.com

7. EBay

8. Passport.net

9. sohu.com

10. 163.com

Yahoo's dominance in Web traffic and reach comes through loud and clear, but perhaps more importantly this data proves that China is a huge Web market. There are 4 Chinese websites in the top 10 globally, compared to 5 US sites. The top 10 Chinese websites are in the top 35 globally, second only to the US in terms of Web presence.

Update: QQ.com is moving up very fast.

Is Web 2.0 a native language to the Chinese?

Rebecca MacKinnon has been at the Chinese Blogger Conference and has come away from it wondering if "Web2.0 is potentially a very Chinese thing." She explained:

"One of the most important words in the Chinese language is “guanxi.” It means “relationship.” Whatever you think about the term “Web2.0”, the point is that social networking and relationship-building are at the core of today’s most exciting web innovations. The Chinese happen to be the most natural and skilled social networkers on earth."

Censorship is an issue in China of course and Rebecca outlined some practical measures to work around that, in her thought-provoking post. And I loved how Rebecca ended her post:

"Another thing about this story: it’s not so much about what the internet is “bringing” to the Chinese, or how the internet is coming in as an outside force and “changing China.” The real story is about how Chinese users are taking the connectivity, tools and applications, internalizing them, and making them their own."

China Web2.0 Review

Here's a site to keep an eye on - an English language blog about Web 2.0 in China:

"China Web2.0 Review is a blog dedicated to track and review web2.0 development in China. We will profile and review web2.0 applications, products, services and business in China, and track the buzz about web2.0 in China?s internet industry as well."

China Web2.0 Review has an interesting post about FeedSky, which is like China's answer to Feedburner (although more than that, according to the post).

Hat-tip Rex Chung for the link. It's great to see what's happening outside Silicon Valley and I hope to discover more international Web 2.0 blogs.

Top Web Apps in China

China is next in my series on top international Web apps. If you haven't been following, the other countries I've profiled so far have been Germany, Holland, Poland, Korea, United Kingdom, Russia and Spain. As this series has gone on, the comments have become as important as the posts - perhaps moreso. I'm hoping this post about China's Web application market is no exception, because China is (obviously) a huge country and one blog post can't hope to cover it all. So I encourage people from China who may read this, or people who are familiar with the Chinese Web, to contribute your thoughts in the comments here - and add web apps to the list.

I have to thank several people for the information in this post: In particular Tangos Chan, who runs the excellent China Web 2.0 Review blog, and Benjamin Joffe - CEO of Asian Internet consultancy Plus Eight Star Ltd and co-founder of Mobile Monday Beijing. Also thanks to Chang W. Kim, who introduced me to Tangos and Benjamin! Sam Flemming of Chinese research company CIC Data and Micah Sittig from Shanghai also contacted me with their thoughts.

Overview of China market

Let's start with an overview of Chinese web apps. Benjamin Joffe said "there is basically at least one Chinese equivalent for every single US web2.0 service that is more than 2 months old." Here are some other characteristics of the China web scene, suggested by Tangos Chan and with further comments from Benjamin...

Big companies still dominate the market

Tangos says that so far there are no outstanding small startups that have successfully gained the attention of ordinary internet users. For example, in the blog hosting market Blogcn, Bokee and Blogbus were among the first movers. But after big companies Sina, Sohu and Baidu entered the scene, they won market share quickly [see short profiles of these companies below]

Benjamin adds that no Chinese startup that stays a startup for long - "basically they grow to over 100 staff and get their first million $ round of financing fairly quickly, or disappear."

Chinese startups often copy the Silicon Valley model

Tangos: "Sometimes, just a copycat even without any change."

Benjamin: "True enough in a first step, but as usually more than one company does this, it eventually results in tough competition to differentiate and gather/lock in users as quickly as possible. Some are making use of China's unique characteristics in terms of mobile penetration, labor cost, cheap logistics and lack of credit cards."

M&A is rare in the China market - or is it?

Tangos says M&A is rare in the China market, which makes it more difficult for China's startups to raise funding and find an exit.

Benjamin has different information from an M&A consultancy firm: "there has been over $500M worth of M&A in 2005, which is huge for a country with a GDP/capita well below 1/10th of the Western developed world. But he says that "most of the M&A occur in the wireless space" and there are "several hundreds, if not thousands" of companies competing in this wireless space.

Tangos agrees that China's mobile sector has more innovation than the Web sector, because of the high penetration rate of mobile handsets and highly developed short message, ringtone and ringback tone services. He said that in the general Web sector the big companies - Sina, Sohu, Baidu, Netease, etc. - seldom acquire startups, unlike what usually happens in Silicon Valley. In China the bigcos "just build new services by themselves."

So looks like both Tangos and Benjamin are right - M&A is relatively rare in general web apps, but common in the wireless space.

Regulation is a potential risk for Chinese startups

Tangos: "for instance, SARFT (State Administration of Radio, Film and Television) recently announced plans to regulate the online video market."

Benjamin: "I would also mention the regulations in the mobile space (as many Internet portals derive revenues from mobile phones). Sanctions and new rules for getting subscribers all impact the content providers' businesses. You can have a look at the change in their stock price around mid-July to see the impact of China Mobile new regulations."

Foreign companies find it difficult to compete

Tangos says that language barriers, difference in culture and government policies and regulations make it difficult for foreign companies to compete in China's market.

Benjamin totally agrees - he says "it is almost a national sport to show how foreign those companies are." He mentions a viral video by Baidu making fun of a foreigner, representing Google (explanation here). Benjamin also thinks US Internet giants are suffering from many shortcomings in China:

"...lack of understanding of local netizens' tastes, weakness in Chinese language software treatment, slow reactions. The only one doing fairly good in China is Google. Yahoo and Amazon bought their way in, and web 2.0 US companies are all concept-copied and adapted by local players."

Top China Web Apps

Baidu is the leading Chinese language search engine. It's the 4th ranked website in the world in Alexa's rankings - putting it only behind Yahoo, MSN and Google on a global scale. According to Wikipedia, the Chinese word "Baidu" translates to "hundreds of 'degree-level'" in English. It has an index of over 740 million web pages, 80 million images and 10 million multimedia files. Baidu.com had its initial public offering (IPO) on 5 August 2005. It also offers blogs and other services similar to the US Internet giants.

Sina is is the largest Chinese-language web portal (news, entertainment, email, search, etc), so similar in a way to Yahoo. Alexa ranks Sina as the 7th biggest web property in the world, just behind MySpace. It's said to have 94.8 million registered users and more than 10 million active users engaged in their fee-based services, with an estimated 3 billion page views every day [source: Wikipedia].

Sohu is a "mass portal and leading online media destination" [source: Wikipedia]. It's ranked 12 globally by Wikipedia.

Benjamin told me that Sina, Sohu and Baidu are all listed on US Nasdaq and each is valued at over $500M. And those are just 3 of the more familiar names to english-speaking Web people. China is such a big player now on the Web that they have 4 companies in Alexa's top 10 web properties in the world (Baidu, qq.com, sina.com, 163.com). The US has 5 in the top 10 and Japan 1.

Other China Web 2.0 apps

There is already a 'web 2.0 logo' display of China web apps, at internetdigital.org (in list format here). So for this post Tangos has come up with his personal list of favorites. Feel free to add yours in the comments, along with reasons why. Here's Tangos' list:

• Douban: One of the choice of Business 2.0's "Web 2.0 Around the World "; my profile for it


• Podlook: A Chinese podcast directory (profile).


• Dianping: Local business review and search service, some introduction here.


• Wealink: business social networking service.


• zhuaxia: online rss reader similar to rojo (profile).


• Sohu Blog: blog service by Sohu, a popular internet portal site, just upgrade to allow users to add various widgets into their blogs.


• iephotoshop: online image editor, very powerful, but IE only.


• Feedsky: an analog of Feedburner in China.


• Editgrid: Online spreadsheet (profile).


• Maxthon: a IE based browser.


• City8: online map service with local real view (profile).


• eDushi: online 3D map service.


• Qihoo: BBS and blog search and aggregrator. (disclaimer: Tangos is currently an employee of Qihoo)


• wretch.cc: Taiwan-based blog and photo album service.


• 8box.cn: music discovering and sharing service (an interview with its founder).

China Web blogs and news

• China Web 2.0 Review blog (this has been on my RSS subs ever since it started in Nov 05)


• mobilemonday beijing


• web20asia.com


• Virtual China


• Sam Flemming's blog

I'm sure there are other interesting english language blogs about China Web that I've missed, so please mention them in the comments.

Thanks again Tangos and Benjamin for the fascinating information. China is obviously a very important part of the Web and its influence will only get bigger over the coming years, particularly in mobile one suspects.