If Facebook Could Enter China, Here Are Some Of The Hurdles

Editor’s note: Henry Fong is CEO of Yodo1. Yodo1 is a market entry specialist and full service technology provider helping Western game developers successfully gain traction in the China mobile games market.

Mark Zuckerberg’s visit to China back in December 2011 created a storm of speculation on whether Facebook was preparing for a full scale entry into the most populous country in the world. Photos of Zuckerberg visiting Sina’s headquarters in Beijing, leaked by a Sina employee and reports of him meeting with other major Chinese Internet companies such as Baidu and Alibaba have further fueled rumors that Facebook is looking for a local partner to facilitate its China entry.

Putting aside the rumors and speculation, there is little doubt that Facebook is looking for a way to enter the China market and the real questions lie not in the “if,” but rather the “how,” “when” and whether Facebook will be able to make a success of their China market entry when countless other western Internet juggernauts have bruised and battered themselves against the Great firewall of China.

License and Registration Number Please…

For Internet companies, the “rules” for playing in the China market are many and varied, the most basic of which includes the acquisition of an ICP (Internet Content Provider) license which only a local Chinese company can obtain. There are many ways and mechanisms via which Western companies can obtain this license, or at least obtain the rights to use it, the most popular of which is in the form of a set of Variable Interest Entity (VIE) agreements and structures. This mechanism is used by most of the local Chinese Internet companies that are listed overseas (hence making them non-local companies) and a good article explaining how VIE’s work in detail can be found here, compliments of the China Accounting Blog.

Besides the ICP, a broad based Social Network platform such as Facebook will require a whole bundle of other licenses based on different core functionality including but not limited to a Network Culture Operation License, which is required for all gaming platform operators. Also needed, an Internet Publication License, a requirement for video and photo sharing services, Payment Service Operator license required for Facebook’s credits service and likely dozens of other licenses from a multitude of different government departments including:

• General Administration of Press and Publication (GAPP)
• People’s Bank of China (PBoC)
• Ministry of Culture of the PRC
• The Information Office of the State Council of PRC
• The State Administration of Radio Film and Television
• The Ministry of Information Industry

To put things into perspective, here’s an example of the licenses that were obtained by a video broadcasting company operating in China and the scope of services provided by them is but a fraction of the services available on the Facebook platform.

Rewriting the Book of China Entry or Same Book Different Chapter?

Facebook’s formidable war chest of cash and equity value from their impending IPO provides alternatives for obtaining the relevant operating licenses through acquisition of local Chinese companies that already have them. However, this seemingly obvious path to a quicker China entry poses many other challenges, and one look at the trail of failed market entries by other leading Western Internet companies certainly paints an unfavorable picture.

To provide perspective, let’s take a look at the China eCommerce space to get a feel of the challenges for leading Western players entering into China. eBay and Amazon have both tried their hand at the buy vs build approach to enter the market thru their respective acquisitions of Eachnet and Joyo.  Amazon’s entry into China though unimpressive, can be categorized as a “success” on relative measures if you compare them against that of eBay, arguably the most high profile and widely published “failed” China entry in the Internet space. After eBay’s 2003 acquisition of EachNet, then the leading B2C provider in China, eBay successfully eroded EachNet’s user base and leadership position into a blip on the radar screen and handed China’s B2C market to Jack Ma’s Taobao. This market has now grown over 100 times in transaction volume since eBay’s initial entry in 2003.

The reasons for eBay’s China failure are many and varied, but there are a number of relevant chapters from “eBay’s book of disasters” that Facebook can learn from in hopes of avoiding a similar fate. Chief among eBay’s fatal errors is that they failed to understand what the Chinese consumer really wanted from a B2C service, focusing instead on replicating their global model that had proven successful in Western markets to the Chinese community who’s shopping behavior, culture, product needs and purchasing power were extremely different to that of their Western counterparts.  Concurrently, Jack Ma launched his B2C offensive with Taobao, a services that provided free listings with content and navigation tailored to the tastes of the local consumer. Today, Taobao is by far the dominant player in the B2C space and processes 79% of China’s online transaction value.

Fight for Past or Fight for the Future?  Some Food for thought for Zuckerberg.

Some would argue that the war for dominance of Social Networking in China has already been fought and won, with major players such as Tencent, Sina and RenRen each claiming a significant slice of the Social Networking market, each leading in terms of specific demographics, features or access methods. The challenge for Facebook is that its broad platform of functionality competes directly and extensively with each of the above existing leaders in the market, though less so with Sina whose primary social asset is the Sina weibo services which is more competitive to a Twitter offering than a Facebook.

Before deciding how Facebook should enter the Chinese market, a more relevant consideration for Zuckerberg is what markets does Facebook want to compete on in China. Given the plethora of regulatory challenges and the steep learning curve that the company is likely to face, it might make more sense for Facebook to choose a new battle ground that has yet to see an entrenched player in the market, but is significant enough that success in this area would provide a significant footprint for Facebook to leverage its other services into the region.

One such market that might make sense for Facebook to target is the market for smartphone services. China already has the largest install base of smartphone handsets in the world with an estimated 100m units and projected doubling of unit shipments by the end of 2012. The battle for this rapidly growing access method has already started with Sina and Tencent duking it out via their respective mobile Weibo (microblogging) services and RenRen’s initiative to expand their traditional Social and gaming services onto the smartphone platforms.  Facebook’s recent acquisition of Instagram provides an opportunity to leverage the app’s popularity among Chinese users as a potential route for a broader Facebook market entry in a way that is relatively non-threatening to Instagram’s Chinese partners such as Sina, whose social features are well integrated into the Chinese version of the app.

At a macro level, the opportunity to dominant China’s smartphone market is HUGE, much bigger than what Instagram can provide today and potentially dwarfing the existing web-based social networking market in the coming years. Facebook and other players in the market have an opportunity against a limited time window to make a significant impact in this space where mobile social networking, smartphone payment methods, gaming and a number of other billion dollar plus markets are still in its infancy. What’s more, the smartphone platform war is an area that Facebook has yet to make a significant impact on in its home markets. The Chinese market can be a great way to experiment with new mobile services and business models quickly and cheaply in a market where there is only upside potential for Facebook.