After New Regulations in China, What's Ahead for Baidu?

Rules on Search Ads Will Hit Short-Term Revenues, but There Are Upsides

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People walk past a Baidu Inc. logo displayed in the reception area of the company's headquarters in Beijing, China.
People walk past a Baidu Inc. logo displayed in the reception area of the company's headquarters in Beijing, China. Credit: Qilai Shen/Bloomberg

Digital advertising has exploded in China, the world's No. 2 ad market, with spending on online ads increasing five-fold in five years. Chinese search giant Baidu has been a big beneficiary of that growth. In terms of global search revenues, Baidu is second only to Google. And like Google, it's used income from search to fund ambitious projects, from driverless cars to artificial intelligence.

But Baidu has hit some speed bumps lately – and its troubles are largely because of a search ad. A university student with cancer wrote a long personal story online about seeing a promoted search result on Baidu for an expensive alternative medical treatment, describing how his family borrowed money to pay for it.

The student, Wei Zexi, died, and his post went viral, with some commenters accusing Baidu of sacrificing the public's health in pursuit of ad money from unreliable healthcare providers. (Healthcare ads have been a big source of revenue for Baidu.)

There were repercussions. The latest was that internet regulators this weekend ordered Baidu and other Chinese search engines to provide results that are "objective, fair and authoritative;" to limit the number of search ads on a page; to make it clear when results are sponsored; and to check advertisers' qualifications. In a country with tight control over online expression, the Cyberspace Administration of China also said search engine results shouldn't run counter to the interests of the state or the public. Baidu has agreed to cooperate to "uphold a healthy Internet environment." Acting on regulators' orders, it already put into place some of the new rules weeks ago.

How will the new rules affect Baidu's users, its advertisers and its revenues?

A common user complaint about Baidu has been that people don't understand which results are organic and which are paid for. Over time, it has grown easier to tell; now paid results are shaded pink and marked with a small "promotion" tag. They're also limited in number too, to 30% of a page.

Robin Li, Baidu's founder, wrote in a letter to employees last month that Baidu would prioritize user experience from now on. He promised to "reexamine the business model of every single Baidu product" from that angle.

Yu Xue, senior analyst at IDC China, points out that Mr. Li also wants to improve the mechanism for user feedback and protect user rights. Mr. Xue is optimistic about the new regulations; he says the direction things are heading will be good for marketers too.

First, though, there will be some adjustments for advertisers to get used to.

Prince Zhang, chief digital officer for IPG Mediabrands China, says Baidu will now have to examine the licenses and claims of ad providers in many industries, which could slow the process for getting approvals.

Advertisers will have a harder time maintaining visibility, since there are fewer search ad positions available. On the other hand, the new rules mean "more opportunities in content marketing and search engine optimization," he said. "Obviously, organic search results have more chance to drive traffic now."

Baidu was projected to take in 8.8% of search revenues globally last year, second only to Google, at 55%, according to eMarketer. (Google closed down its search engine in mainland China six years ago amid censorship concerns.) Baidu, Alibaba and Tencent are the key players in China's fast-growing online advertising industry, projected to hit $40.8 billion this year, according to GroupM, up from $7.7 billion five years ago.

Baidu, which was called out by regulators weeks ago, in mid-June cut its revenue forecast for the second quarter to between $2.81 billion and $2.82 billion from $3.12 billion to $3.19 billion.

Shelleen Shum, forecasting analyst at eMarketer, predicts Baidu's search revenue will be affected in the short term but normalize down the road. "The clearer marking of sponsored links and reduction in ads per page may lead to a better user experience and more sustainable growth," she wrote in an email.

To diversity its revenues, Baidu has been making big investments in services linking the offline and online world, such as platforms for ordering takeout. But search is still its bread and butter, and Ms. Shum expects it to remain so for the near future.

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