Silicon Hutong

Speak, Baidu, Speak.

High School Library, ISB

Misspending my virtual youth

0928 hrs.

Lonnie Hodge, who I would fairly say is something of a fan of Baidu, takes the search company's CEO Robin Li to task over his failure to show up to do his keynote at last month's ad:tech confab in Shanghai, ostensibly for a "sore throat." Most of the attendees to whom I spoke shared varying degrees of pique that Li didn't show up, and Hodge in particular sees this as emblematic of Baidu's disdain for Cluetrain-style engagement:

Baidu, or any company, would do well to join the party (not that one...) and join in on the many conversations, those that honor AND those that harangue, which can only make us better business people, more responsible netizens, and decent global citizens.

The Credibility Problem

Baidu has had its share of problems of late, extending from allegations about driving traffic through - and cashing in on - illegal music downloads to growing questions about the validity of its organic search results (given Baidu's apparent willingness to hawk those results to the highest bidder.)

These problems are not purely academic or legal. There is a small but growing negative buzz about Baidu among Chinese users and in the local media, some of it focusing on non-issues, but a growing amount questioning the value of a search engine that compromises its organic search results by prioritizing paid listings.

The Search Problem

That's not going to help things with advertisers. I am starting to hear from companies who have until now devoted their search advertising budgets to Baidu that Google has made huge strides in its search algorithms, and that search ad results on Google were improving quickly. One advertiser I spoke to said that at the end of 2007 Baidu had 100% of their search ad budget. They now have 90%, and that will drop precipitously in 2009.

None of that would be too worrisome if we could believe that Baidu was totally focused on improving its core product. Unfortunately, Baidu has chosen this moment to focus time, attention, and resources on becoming a diversified online conglomerate, venturing into e-commerce, e-payments, and other resource-intensive business in an effort to keep users on its site once they land there.

Leave aside the fact that they are creating enemies where they could be creating partners - or friendly acquisition targets. To diversify into businesses that are so far from your core, that are less brand extensions than leaps into completely new industries, all when you are facing fundamental issues running your core business looks less like wisdom than hubris.

(Unless, of course, this is the first phase of an effort for Baidu to abandon search over the long term. Hmm.

But we digress.)

Unless Baidu can demonstrate to advertisers that it is improving its search product faster that Google is, that it continues to deliver better and more meaningful search results, and that the company can do all of this while pursuing credible efforts in online TV, e-commerce, and whatever else it wants to do, the advertising cash from the big spenders is going to start to leak away.

The Communication Problem

What this all comes down to is a failure to communicate.

Whether comfortable admitting it or not, Baidu has always been seen as "Google with Chinese Characteristics." What Baidu needs to recognize is that China's characteristics - and specifically her Internet users - are evolving.

More of the nation's online populace is turning to online search as a pathway to seek truth from facts, not find stealth ads from snake-oil salesmen hidden among - or above - genuinely helpful information. Wall Street may be pushing for monetization, but the demand from Chinese consumers is for credibility, trust, and results they can believe in. Sincere testaments of devotion to such ideals and a few sackings are a good start, but it will not be enough: Baidu has to do more to balance the disparate demands of investors, advertisers, and users.

The history of the Internet is littered with the corpses of great search engines that were popular, then failed, and with dominant players that were challenged by Google and then imploded.

Baidu has had a dominant position in China, but to this observer it is starting to look like all Baidu has is its dominant position. It does not appear credible, it does not appear focused, and it does not look like a particularly good partner for for other online companies and a partner of declining value for advertisers.

Yet I give Baidu the benefit of the doubt. I assume it is a good company, just slightly unguided. As such, they need to prove they are on track.

• They need to engage with advertisers and their agencies at every opportunity, both collectively and individually.

• They need to focus on search, and if they want to get into e-commerce, for heaven's sakes go out and buy something, don't try to build it.

• And finally, they need to remember that consumer loyalty in China is ephemeral, and that if they do not engage, their user base can evaporate as quickly as it was built.

I have to believe that this is what their PR agency is telling them. But I also suspect that the lawyers are saying something else.

The lawyers are wrong. This is one of those times when silence is not golden, it is poison.

UPDATE: Check Paul Denlinger's excellent post on the matter at China Vortex. Paul looks at the BIDU's problems from an ad sales perspective. Not pretty.

We're from the FDA. We're here to help.

In the Hutong

Scoffing at pessimism

1952 hrs.

Richard over at AsiaBizBlog (just blogrolled - not sure what took me so long) is less than impressed with the idea that the FDA will open an office in China. He believes, not without justification, that the office will be a non-factor in the effort to improve the quality of China's exports of non-farm foods, medicines, and medical devices.

Watching the Watchers

I tend to agree. Unless the FDA is prepared to seriously staff-up its efforts, even getting deep access to factories (by no means a given, as Richard points out) will not be enough to regulate the immense and growing flow of consumables out of China and into the U.S.

Where they will help, though, is in certifying and monitoring third-party inspectors, and anything else they can do to help promulgate a quality-control system based on commercial standards and contractual requirements rather than government regulation and inspection.

There are already a decent number of enterprises and organizations engaged in product inspections in China, ranging from massive companies like the SGS Group, to entrepreneurial operations like David Dayton's Silk Road International, to religious purity inspectors like the Orthodox Union. What is missing is a guardian to watch the guardians, and the FDA would likely be better off spending its time on that effort, and on requiring U.S. importers to show proof of inspection by one of these outfits.

I suspect that over time they will get this (if they don't already), and that the noises that made by the Secretary of Health and Human Services suggesting his A-Team of eight inspectors were going to personally clean up the collective act of China's factories were, in fact, nothing more than spin for the home audience.

A Reason to Believe

Richard also noted that the Foreign Ministry is already publicly prevailing on the U.S. to accept certificates issued by the Chinese quality inspection department on goods to be exported to the United States.

It would serve us all well to remember that for a long period after the U.S. discovered a few cases of Mad Cow disease in American beef, the Chinese authorities refused to accept any beef approved by the United States Department of Agriculture until such time as PRC regulators could be convinced that the U.S. system had taken appropriate action to eliminate the danger, and the USDA approval was once again credible.

In the wake of an ongoing sequence of quality issues that have killed and injured far more people than Mad Cow ever did, China needs to appreciate that rebuilding the credibility of its certification authorities will likewise be a process, one that I expect the new FDA offices could assist by observing and providing feedback on the Chinese certification process.

If, however, the FDA receives something less than the full cooperation of Chinese factories and authorities, U.S. acceptance of any Chinese government certification will be a long time coming - even if this gets turned into a political football between Beijing and Washington.

Why Land Reform is a Tech Opportunity

In the Hutong

There's something about a high-fiber snack...

16:23 hrs.

In the flurry of news about plans to reform land use in China, much of the coverages focuses on the new potential for Chinese farmers to either pay to farm the land of others, or to indeed expand their own plots by renting more land, thus building scale and offering the greater potential for profit. I think a lot of people noted this, and after checking to ensure that neither Monsanto, John Deere, nor DuPont was in their stock portfolio, dutifully forgot it.

There is, however, more to this story.

Not Your Father's Land Reform

While the idea of land reform gets folks in the agriculture business dreaming about China's vast farmlands changing from a patchwork of tiny plots to a more orderly quilt of massive farms, that dream is both unlikely and overrated. The omnivorous Tom Barnett notes an important point Callum MacLeod makes in his article in USA Today:

"China is the opposite of the USA, which has an abundance of capital and land. In China, labor is abundant, but it is short of land and rural capital, [said Li PIng, of the Seattle-based Rural Development Institute.]

In short, don't count on Hebei starting to look like the upper San Joaquin Valley anytime soon.

But let's take a closer look at Li's point.

• China has abundant labor. Yes, and that is not likely to go away soon, massive urbanization notwithstanding. America has under 6 million people living and working on farms. China has around 700 million. You could literally cut China's farm population by 90% and still have too many farmers to replicate the efficiencies of U.S. farms.

• China is short of land. Yes, and that is not likely to change anytime soon, either, unless China plans to invade and cultivate the Siberian steppes. Whether taken as a ratio of land under cultivation to the total national land mass, or as a ration of arable land to population, Chinese agriculture is land-deficient.

• China is short of rural capital. Yes, it is now. This, however, unlike the previous two conditions, can change. And therein lies the real opportunity behind China's land reform.

AgriBusiness with Chinese Characteristics

Regardless of how much you change China's agricultural land use rights, you're always going to have too many people cultivating too little land, which means that the future of Chinese agriculture is not about vast wheat fields or free-range beef ranching. You have to find another model.

At the most basic level, this means that China's farms will find prosperity with crops that demand a great deal of human attention, and that will capture market prices that will allow farmers to compensate their workers accordingly. But more labor working fewer valuable plants is only half of the answer. There is a shortage of water available to farmers in a growing proportion of the country. Air pollution, soil degraded by poor irrigation practices, and lousy infrastructure still hamper the industry.

At the same time, consumer demand for higher value farm products means that for most farmers their real opportunities lie with crops they are not accustomed to cultivating. With some exceptions, China's successful farmer of the future will be a small- or medium-sized agribusiness focusing on high-value cash crops or horticulture (flowers and foliage.)

So when Li Ping talks about rural capital, we need to think beyond cash: China's farmers also need equipment to address environmental and infrastructure challenges, as well as the know-how to get the most out of whatever size plots of land they can cobble together under land reform. Which, in turn, means that land reform is the first step to liberating the value of Chinese farmland, rather than the last.

Chinese AgTech

I would love to say that technology is a panacea that will clear up all of these challenges, but if I did, I'd be wrong. Nonetheless, there is a growing range of opportunities for technology to help turn the more entrepreneurial of China's farmers into agribusinessmen. Just a few of these include:

* Drip irrigation: China's shortage of fresh water is already bad, and it is going to get worse. Chinese farms will only be sustainable if they use exactly as much water (and fertilizer, and nutrients) as they need, and no more. Drip irrigation is the best, most practical solution today. As aeroponic techniques develop beyond space travel and dorm-room cultivation of cannabis sattiva, they may eventually supplement drip irrigation, but likely only for specialized applications.

* Greenhouses and Nurseries: beyond the vagaries of pests and weather, the challenges of China's environment is likely to drive the production of cash crops - not just flowers - into greenhouses. We see a lot of this around major cities and in centers like Kunming, but expect this to expand. This involves more than just covered farmlands: it also means temperature monitors and controls, irrigation systems, air-quality management systems, and harvesting.

* mAgriculture: few Chinese farmers can afford laptops, but many more can afford mobile phones to monitor their crops, the weather, and market prices, as well as to take orders, capture opportunities to sell at higher prices, and make payments on supplies and micro-loans. Farmers will need inexpensive yet rugged and waterproof handsets with large buttons, long battery life, and possibly even solar charging capability. They will also need easy-to-use service bundles to include information access and mobile banking.

* Training: there is just no way to get millions of farmers into schools. Raising skill levels in new crops, new tools, and agricultural economics is going to involve a combination of traditional low-tech methods and some experimental efforts in using remote training via satellite TV and possibly the Internet.

* Finance: once you have the land, you need the cash to develop it and to finance your first crop. Traditional methods of agricultural banking in China, including banks and farm co-operatives, won't be enough. Micro-finance, in all of its forms, can be most economically administered using technology. That doesn't mean a computer on every farm, but it does mean loan officers in rural areas equipped with at least hand-helds to help manage payments and collections.

These only touch the surface, and there will be specific opportunities around specialized crops, but you get the point. As we slide gently into global recession, technology firms have an opportunity with Chinese land reform to begin developing - or at least researching - how to deliver products to help solve some of the challenges implicit in China's next green revolution.

The ARJ-21 and China's Long, Slow Climb to the Skies

In the Hutong

No place else I'd rather be

1158 hrs.

Covering this year's Zhuhai Air Show, The Economist takes a look at China's first domestically-produced jetliner, the AVIC1 Commercial Aircraft Corporation's ARJ-21, and on the eve of the regional jet's maiden test flight takes a moment to consider its commercial prospects. Their verdict: don't count China out.

Many foreign analysts doubt that Western airlines will ever be prepared to buy Chinese aircraft. But, as in other fields, China is playing a long game.

Much of the debate about the ARJ-21 thus far has centered around two issues: first, whether the ARJ-21 will attract buyers beyond the Chinese airlines who are compelled to purchase it (and GE, who is making a pile selling engines for the jet); and second, whether China will ever develop a globally competitive civil aviation industry.

Both questions miss the point. What is most important about the ARJ-21 is the lessons it teaches us about the process China goes through to catch up with the rest of the world in technical, complex, high-value industries.

Watch Process, not Product

If you look at all of the technical sectors in which China has built commercially viable businesses, you can discern a clear process by which the nation's industrial policy kick-starts these efforts. In the case of cars, computers, mobile phones, and now commercial jetliners, the pattern is dependably consistent. Let's call it the Four C Model.

First, comes what I call the "capability" phase. the government typically announces a national project to build its own version of an technical product. It turns to a government research institute or a similar organization, which in turn pulls together the team from across the nation's universities and enterprises. Eventually they manage to produce a one or more prototypes, but there is no real possibility of commercializing the product.

Upon review of the initial prototypes and the development process, typically a range of issues is identified that prevented the commercialization of the product. As a result, during the next "collaborate" phase, China sets up an enterprise to build the product using foreign designs, components, and know-how. The result is not quite commercially viable, and may only sell to local customers because of tariffs, tax-breaks, or other subsidies that make the local product appealing to local customers.

Next comes the "component" phase, when a local company creates its own design or modifies another, and many of the parts, but key, mission-critical components come from overseas. In this phase the product is adequate and by most measures comparable to foreign products, but with no track record only the most adventurous foreign customers are ready to trust the product.

Finally, all of the technical kinks are worked out, there are several Chinese companies involved in the effort, and with a demonstrable track record behind it, China is ready to go head-to-head with global companies. This is the "competitor" phase, and it usually marked by brisk sales and the beginnings of a true competitive advantage.

Not Quite a Competitor

In the case of the ARJ, China's effort to build its own jetliner has reached the "component" phase, and it has taken 35 years to get this far.

In the early 1970s, China began a project to prove to the world it was capable of making its own jetliner. the result was the now almost-forgotten Shanghai Y-10, which was as close to a clone of the Boeing 707 that the nation could produce in the late 1970s. Two prototypes were produced. They flew in the early 1980s. China made its point. And the jets never saw commercial service: they were essentially flying monuments to China's aspirations. This was the "capability" phase.

Not long after, China got involved in negotiations with McDonnell-Douglas Aircraft for a joint-venture to assemble their MD-80 class jets in Shanghai. The JV went through brutal political turbulence and costly delays, and in the end the venture sold only a fraction of the jets it had hoped. McDonnell-Douglas was sent packing, but China was left with an entire generation of aircraft engineers, a lot of very helpful tooling, and the groundwork to take the next step. Thus ended the "collaborate" phase.

After nearly a decade of thinking, planning, proposals, and counter-proposals, and even another shot at collaborating with other Asian aspirants, China launched the ARJ-21 (Asian Regional Jet - 21st Century) project. This is the "component" phase, and at this point China is serving as re-designer (the jet is basically a shortened MD-80, or DC-9, with a new wing design from Russia), project manager, and system integrator.

Tough Room

China's aviation policy-makers and industrialists knew the ARJ-21 would be playing in the most competitive end of the civil aviation pool. The regional jet field is dominated by Canada's Bombardier, with its CRJ series, and Brazil's EMBRAER, with its ERJ series, both of whom have complete lines of aircraft, global technical support, and who built their business on solid reputations for making dependable aircraft.

Three very old names in the aviation industry, British Aerospace, Dornier, and Fairchild, have already been driven out of the aircraft manufacturing business after losing out to Bombardier and EMBRAER, and Boeing's 717 was squeezed out of its market niche with a plane strikingly similar to the ARJ-21. Four other very old names in the aviation industry, Antonov, Tupolev, Sukhoi, and Mitsubishi are all getting ready to pounce on the ARJ-21's markets with brand new regional jets of their own.

So there is not much hope for the ARJ-21 beyond China. And prospects inside of China are not that great, either.

Fat Planes Wanted

The idea behind a regional jet is that you have flights under two hours duration connecting cities under 1,800 kilometers or 1,100 miles apart where you cannot economically fill, say, a Boeing 737, or where the field might be a little short for a small jetliner.

In China, however, the problem is that we have a limited number of airports, a limited amount of airspace, and a whole lot of people who want to fly. There will be some market for regional jets, but in the medium to long term China needs larger jets that make the best possible use of the limited resources in Chinese aviation (i.e., concrete and airspace) to move the maximum number of passengers at the lowest possible cost.

Finally, let's not forget that perhaps the most serious competitor to regional jets in China doesn't even fly. China is in the early phases of a madness for high-speed intercity rail transport. The threat posed by trains as fast as Japan's Shinkansen and France's TGV is most serious to the shorter air routes served by the ARJ. As the price of jet fuel goes up (and, despite current trends, it surely will), that threat grows all the more critical.

Back to our Model

There are other issues, such as a total cost of ownership for the ARJ-21s that are going to be higher than carriers are being let to expect. With all factors in consideration, the ARJ-21 faces some roaring headwinds.

But again, what is important is not the plane itself, but where China's jetliner manufacturing industry will be after the ARJ-21. And here is where it starts to get really interesting.

Just as the ARJ-21 goes into full production, Airbus will be completing its A320 assembly plant in Tianjin. Between the two, China will for the first time have two factories cranking out airliners. The benefits to the industry will be enormous. China will have created overnight a workforce of engineers, machinists, and all of the other specialties involved in aircraft assembly.

In short, by 2014, the groundwork will be in place for China to make the next jump, and the ARJ-21 team will have had five years learning what it takes to support an airliner in the field, sometimes even in the most challenging locations.

What is more, right about that time, Boeing and Airbus will be under pressure from their customers around the world to develop successors to their single-aisle jetliners in the 110-170 passenger range. Both have made it so far by updating and extending their 737 and A320 lines. Five years from now, that may not be enough.

At that point, the door will open for China to enter the fray with its own design, and they will have the benefit of being able to work with the world of suppliers and subcontractors - both in China and overseas - that Boeing and Airbus have helped create. And with Boeing and Airbus forced to contend with powerful unions determined to secure for their members a comfortable American or European middle-class lifestyle, China may well offer a nice cost advantage as well.

All things being equal, then, China may well be able to compete in the small airliner market by 2020.

A Lesson, not a Product

Again, though, this makes the ARJ-21 a stepping-stone, not the destination itself. As such, the success or failure of the ARJ-21 project cannot be measured solely on the basis of aircraft sold. Rather, it must be judged on its by-products, on the extent to which it prepares the nation's aerospace industry to take the next, all-important step and become a global competitor.

AdAgeChina: Obama, China, and Public Diplomacy

In the Hutong

Using music to tame The Beast

1145 hrs.

AdAgeChina.com just posted my Viewpoint article on Obama and public diplomacy. My core point:

If Obama is to keep his hard choices from backfiring with China, he must make his case to both the Chinese government and the Chinese people.

And make no mistake, Obama will need China. One only need look at the issues the new president will face to see how important the help of the PRC will be to his success. At the very least, China will be essential in forging a global energy and environmental regime, bringing security to Central Asia, ensuring that Russia remains integrated in the global system, midwifing North Korea's return to that system (and perhaps its peaceful re-unification with South Korea), and, of course, resolving the current global financial crisis and forming new system to both nurture and regulate international finance.

Conventional diplomacy will form a part of the effort to enlist that support, but it will not be enough. Instead, Obama and his team will need to undertake an unparalleled effort of public diplomacy, and one that shuns the tools and tactics of the Cold War for strategies, approaches, and messages more appropriate to a world rendered naked by the Internet.

It's up on the site now, available to subscribers only. If you're interested in the discussion, let me know. I'm thinking about re-crafting the article into 1 or two expanded blog posts.

China 2.0 Tour: It Doesn't Get Much Better

Jingshun Road, Inbound

Adjusting to a more social life offline

1745 hrs.

If you haven't been following the China 2.0 Tour online via Twitter (#china20), you should really check out the site and the linked blogs of all of the participants. They are leaving Beijing tonight and heading for Shanghai to continue their tour.

I have had the opportunity to both run and to take part in many immersion programs seeking to help executives and others learn about China from the ground up. This one was ambitions in both scope and participants: audiences do not get much tougher than a roomful of high-profile bloggers.

But this program went off so well I told The China Business Network's Christine Lu that they need to make programs like this a regular offering to organizations, individuals, and businesses who really want a crash course in the China you do not see on CNN or read about in the papers.

I'm not accustomed to doing plugs here, but if they ever get around to offering such immersion programs, they would be well worth looking into. The kinds of people you meet, the range of perspectives you get, and most important the insights you take away are phenomenal. I fancy myself something of a China specialist and was participating as such, but I probably learned almost as much as the China "n00bs" on the tour.

A Clear-Eyed Look Ahead

The Parking Lot of the Heqiao Building

Smog smog blow away, go light on Tianjin today

1007 hrs.

The shelf life of a good China book, especially one that covers business, is short. The pace of change in China is so brutal as to render the best tomes obsolete all to quickly, and often before they even reach the bookshelf.

So when finally sat down to read James Kynge's China Shakes the World last week, I was concerned that I had waited past the book's prime to imbibe its insights.

I needn't have worried.

A clear-eyed look forward

James has been in China for 27 years, but the tone of the book is one of humility. He approaches his subject - the economic rise of China and what it means for Chinese and for the rest of us - as a student, and he takes us along on his journey of discovery.

Thus unlike most books about China, China Shakes the World looks forward rather than back, using the past and an acute understanding of what drives China and its people to attempt to draw some faint lines into the future. The picture he paints is not always comfortable, but he resists the temptation of weaker writers to lapse into alarmism or make sweeping generalizations. His head remains calm throughout, and this makes his conclusions all the more disturbing because they cannot be dismissed.

When the going gets tough

What I treasured most about the book was the distilled insights that he gently placed throughout. My favorite - and, given the times, the most relevant - was his observation that reform moves forward in China at a brisk pace when the nation faces severe challenges, and when times are good the pace of reform slows, stops, and sometimes reverses.

Generalizations are always suspect in China, and it it has been my experience that when dislocations are severe regulation on media actually increases. That said, a review of the historical record bears James out, and if the Hu/Wen administration remains true to form, the next major policy initiative to address the current economic crisis (after the current round of Keynesian pump-priming) may be a liberalization in foreign investment policy.

(As such, this is a very good time for companies operating in highly-regulated industries and the associations that represent them to begin crafting the economic case for greater liberalization, because the opportunity to drive change will come quickly.)

A must-read

Once again, I have yet to read the single book that provides the key to understanding China, despite a quarter-century of looking. When China Shakes the World, however, should be at the top of your reading list of books that offer precious insight into where China is going and how we should prepare for it.

Digital Video and the Coming Showdown with Broadcast

The floor of the CASBAA Dome, West Kowloon, Hong Kong

All the TV people are dressed like bankers

1320 hrs.

Just finished my panel at CASBAA 2008 on "Strategies for a Post-Olympic China." It's humbling to be on a stage with people like Gehua Senior V-P Li Danyang, Terry Mak from Celestial Pictures, Peter Schloss from BroadWebAsia, Paul Wang of CSM, and to have Cosmedia Group CEO Tony Tse moderate. These may not be household names, but they should be, because each of them has helped lay the foundation for China's media future by building companies that are testing the edge of what is politically acceptable and commercially viable.

But enough gushing.

We have seen the future, and it is Youku

We were all positive about the prospects for online video companies like Tudou and Youku in China, and not just because the issue of SARFT licenses has been so recently cleared up. What I said I though was exciting about online video is that the medium actually offers the first viable opening for foreign film and television into China on something other than constricted official channels or on pirated DVD. If the video site owners are smart, as their revenues begin to grow, they will cut deals with content owners. Content owners, for their part, will cut deals (probably revenue sharing) with the video sites.

Peter Shloss, whose company is actually deeply invested in one such site, told the audience "I'm ready to license now."

The audience, clearly moved (or taken aback) by our passion and relative unanimity, used their wireless voting devices to confirm that they saw online video as the most interesting media opportunity in China in the coming three years.

All good stuff. Very exciting. A win for all. Mostly. Because all of this is predicated on three issues:

1. Perfecting the advertising model with better measurement and business models tweaked to prevent things like click fraud; or finding another approach;

2. Convincing the content owners that this is a wise thing for them to do with their expensive programming;

And the one I kicked in:

3. Managing the eventual showdown with traditional broadcasters. Because the reckoning is coming, and it is coming right soon.

Gunfight at the Tudou Corral

Up until now, neither the government nor the broadcasters have seen new media generally and online video in particular as a threat to the traditional TV business in China. Revenues have been small, television ad income has continued to grow, and the people watching those videos had little spending power. Let them have their little games, the broadcasters seemed to say, we have Real Business to do.

But there is another meme growing quietly in the wings of this conference, and Paul Wang hinted at it during our panel. The Annual CCTV advertising auction is coming in two weeks, and three people I have spoken to in the last 24 hours all agree that this auction will break CCTV's winning streak. If this year's take (for 2009) beats last year's (for 2008), it won't be by much. Whether it's the post-Olympic hangover, a growing fear, uncertainty, and doubt spurting forth from the world's financial markets, or something more fundamental and tectonic is the only question.

My bet is on the "fundamental and tectonic." Which takes us to online video.

The most interesting part of the semi-annual CNNIC report is not the big headline number of how many Internet users China has, but the demographic profiles of those people. For a long time, the overwhelming majority of regular Internet users in the PRC have been of university age or younger, and they didn't have much to spend. But recent reports from CNNIC make it clear that this is slowly starting to change. As those people who used the Internet growing up are graduating from college, getting jobs, and looking for ways to spend their loose change, the "Internet generation" is turning into a very interesting target audience for a lot of advertisers, and not just the ones selling computer gear.

This demographic shift is happening at a time when many advertisers - including but not limited to the multinational corporations - are starting to worry about what they are getting for their money. Add to this picture the curtain of fiscal conservatism that is descending on marketing officers as a result of the global financial crisis, and suddenly advertising on television no longer looks like the automatic slam-dunk it did at the height of the Olympics.

Here is my scenario: either this year, next year, or in 2010 the results of the CCTV advertising auction are bad - so bad that they cannot be hidden. We're talking like a 10-15% decline, or maybe worse. Meantime, Youku, Tudou, et al are starting to rake it in. They've concluded content licensing deals, they've fixed (or kind of fixed) the measurement issues, and there are upwards of 300 million users online.

At that point, it is not going to take long for CCTV and its fellow broadcasters throughout China to add things up. They will turn to the State Administration for Radio, Film and Television and to the Publicity (propaganda) Committee of the Party, making the case that these private online companies are not only hurting their business, but, worse, doing damage to the ability of broadcasters to serve their propaganda/social administration function for the state.

At that point, the government's options become fairly clear: restrict the online video sites, let the broadcasters run whatever content they want, or force some kind of accommodation between the two sides (i.e., compel each of the sites to take on a state broadcaster as a part or majority shareholder.)

Don't Go Down that Dusty Street

China's broadcasters wield tremendous political power, (for all the expected reasons and for many others that we won't go into here,) and they will not go gently into a future where they cater primarily to people who cannot afford an Internet connection. There is just not enough money in it.

The wise thing to do for the online video companies is to recognize - right now - the danger implicit in their own success, and start working to prevent that showdown. But I'm not optimistic. These companies are so focused on the plentiful immediate challenges to their prosperity and existence that they can't worry about an over-the-horizon threat.

On the other hand, that's exactly what Boards of Directors are supposed to be for. Once they get done lecturing their management about how important it is to make money, the next topic on the list should be about how to avoid getting sat on.

CASBAA is proving that Asia is not a place

In the VIP Room, CASBAA Dome, Hong Kong

I knew I should have had lunch...or even breakfast

1445 hrs.

Much of the discussion in the opening panel this morning was a focus on how Asia is such a superb market in the face of the changes happening around the world today. I agree with that halfway, but I was amazed at the number of longtime residents of Hong Kong, Singapore, China, India, and other territories in this region who still consider Asia to be a single market.

I'm note sure we can consider China a single market, much less all of Asia.

I'm not just being pedantic

The danger implicit in thinking about Asia as a single market is not that we here in the region might start believing it, but that people sitting in New York, London, or Los Angeles might start believing it, and may start acting on that assumption. It is wrong on the same level that thinking of The Americas - from the Yukon to Tierra del Fuego - is all one market. And I would argue there is more cultural commonality between North America and Latin America than there is among Asian nations.

The problem with this thinking becomes evident when you have a satellite broadcaster trying to run a channel around Asia. There are so many different sets of political and cultural sensitivities around the region that if you want to sell your channel around the region, you need to edit your channel using the standards of the most conservative culture in the region (or what the assembled broadcasters here call "the lowest common denominator.")

Imagine, for example, having to broadcast The Sopranos, or the movie "The Big Lebowski" across the region. In several markets in Asia, the f-word is verboten, even on pay-TV and late at night. If you strip the F-word from those works, you may clean them up, but you remove a level of authenticity from the material that is going to anger viewers elsewhere in the region.

But if you frame Asia as a region, you have a hard time caring. What's important is that you are in as much of Asia as possible, not that you are creating a localized experience for everyone you reach. It obscures the real challenges and the most rewarding opportunities.

Brands are Global, Content is Local

Alex Arena from PCCW had the quote of the day this morning when he said that "all content is local." Heads nodded around the room. Which mystified me. Because if we all agree that all content is local, why do continue to frame our businesses in terms of supra-local entities that are driven by global imperatives (cover Asia) rather than local opportunities (what is happening in India?)

The record speaks for itself. The successful global broadcasters (and online companies) in Asia approach the region as a convenient geographical cluster of diverse markets. This keeps the focus on using the regional organization to support local marketing efforts, rather than trying to push a generic Asian service on 2.5 billion very non-generic Asians.

Stat of the Week: China Internet User Update

The floor of the CASBAA Dome, West Kowloon, Hong Kong

Waiting for the Asian Pay-TV Panel

1426 hrs.

The statistic of the week came out of my panel this morning at CASBAA. According to Li Danyang, senior Vice President of Beijing Gehua Cultural Development Group, China's Internet has now surpassed 280 million users.

The country loves numbers, so I'm betting that the CNNIC January report puts us right around 300 million users.

So update your fact sheets, and prepare to update them again in two months.

By the way, If I hear the word "monetize" one more time, I am going to have a myocardial infarction.

Another reason the long tail doesn't exist in Chinese music

Beneath Kerry Center Beijing

I love the smell of fresh paint in the evening

1625 hrs.

Beijing music promoter Ed Peto posted a superb article on OUTdustry a few days ago that dissected the way the Chinese music business develops hot new artists.

They don't.

A&R, Chinese Style

They use homemade monitoring systems to identify the songs that are getting the most play and illegal downloads on the Internet. When they see that they already have a hit on their hands, they swoop in, sign the artist, and promote the hell out of the ringtones.

Ed believes, with some justification, that this has led to the homogenization of music in China. We don't have a host of genres, sub-genres, and the like. What we have is millions of people all listening to the same straight-up-the-middle stuff. Ed sees a bad moon rising:

"What has resulted is a kind of echo-chamber effect, in which only the low common denominator, crowd-approved pop music is fed back into the network through these curated bottlenecks. The priority of the Chinese labels is to please the network and make it into these bottlenecks, not push musical boundaries forward, as failure to make it into these top strata of recognition brings with it a hefty price. As one of the only other major sources of industry income, brands focus the bulk of their sponsorship monies on the highly viable hit artists, compounding the relatively anonymous non-chartees to further suffering."

Ed makes a convincing case, and no doubt this "echo-chamber" has a lot to do with the vast differences between the Chinese and foreign music industries. And the part of me that believes that a healthy diversity of acts and a great talent scout (known in the biz as an artists and repertoire, or A&R guy) is the key to success in the music business wants to believe he is right.

I'm not gonna try it...

But the not-so-hidden hand of opportunistic moguls is not the only factor at work in China. First, it is essential to step back and understand the consumer behavior on a wider stage. China is an insanely referential culture, which means that people - especially young people - make consumer choices of all types in large part because of the social implications of those choices. You pick your music, your phones, your clothes, your shoes, your hairstyle, and make dozens of other choices in an effort to be a part of a group.

Making choices outside of the set "norm" in your peer group is risky behavior. At best, you will be the recipient of some serious ribbing, and at worst you will be shunned for making an errant choice.

Not too long ago, I asked my nephew why he used a certain brand of mobile phone. He told me "sure, I hate the way it looks. The quality sucks. But everyone else in my dorm owns the same phone, and if I go and buy another brand, people will give me a hard time. Worse, if it doesn't work, I look like an idiot in front of everyone."

Thus it is with music. Young people - insecure beasts in any culture - are in China constrained more by fear of being wrong than by discomfort with conformity.

Too young to know

Second, some historical perspective is in order. If you have seen the movie School of Rock with Jack Black, you might remember a blackboard diagram his character drew laying out the evolution of rock music. If you don't remember, click this for a fast look.

Done? Good. I'll continue.

What you will notice is that the diverse, multi-genred and sub-genred American music scene was by no means always thus. In fact, if you go back as recently as the 1940s, popular American music was a pretty monotone place. Classical, jazz, ragtime, big band (swing), and country was about as diverse as it got. Any given city had maybe half a dozen radio stations, and there was a lot of sameness in the programming.

Sounds like China today, huh?

Back to the U.S. in mid-century. Pop music grew up in the 1950s, folk came to the fore, country began to diversify, and rock-and-roll hip-thrusted onto the scene. Sometime between 1955 and 1963, an explosion in diversity and variety took place, both feeding and being fed by a generational shift and political and social change. Nearly a half century later, we have as many types of music as there were popular acts when my parents were kids.

A little perspective is in order. China's music business is young, China's youth culture is just beginning to evolve into the socially sanctioned "rebellious period" we know of in the west.

And remember - China is but three decades removed from the largest spasm of enforced social conformity in the history of the human race, the Great Proletarian Cultural Revolution. For centuries, if not millennia, you excelled in Chinese society by being redder than red or more Confucian than Confucius. The rebellion, the urge to non-conformity, thinking in a way that deviates from the norm has not been beaten or bred out of the Chinese, but it is going to be a while before young people allow those urges to bloom enough that being different will be cool. And it is the coolness of difference that nurtures diversity of tastes and behavior.

It is against such a background that true musical diversity will bloom. And when that happens - just as it happened in the west - the suits in the music business will have no choice but to follow.

The Dragon's Longer Tail

The change could start literally at any time. The early signs of it are there - not least of which was 25,000 young Chinese singing along with Linkin Park at the top of their lungs in Shanghai last year, plus a growing club scene, and the falling cost of composing, producing, and uploading your own music.

What China needs more of is Ed Peto. I'm not calling on the nation to clone one passionate Englishman. Rather, I think the time is quite near when a small but passionate group of young Chinese and foreigners are going to kick the Chinese music scene into serious overdrive.

China's rich music heritage meets the world's music meets a quarter of a billion kids who just wanna have fun.

The mind reels.

IPR Protection: Beyond Law and Enforcement

In the Hutong

Sore from power-walking

1635 hrs.

In conducting my technology and intellectual property rights (IPR) panel with the Notre Dame Medoza b-school students last week, I realized in the midst of Eric Priest's comments that the problem of IPR protection in China was too often painted as a two-dimensional issue.

Laws, cops, and jails

The first dimension is law, or the extent that China has on its books the statutes, treaties, regulations, and administrative procedures to protect patents, trademarks, and copyrights. I'm no lawyer, but I defer to the three attorneys on my panel (two of whom were Ph.Ds) who seemed to agree that the legal structure to protect intellectual property rights is in place in China.

The second dimension (and the one that gets all of the attention) is enforcement. Okay, China, the world seems to say, you have all of these wonderful laws to protect intellectual property of all kinds. So why are companies, individuals, and institutions violating these laws everywhere in China with seeming impunity?

And here we have the problem. The lawyers, organizations, and government negotiators fighting to protect intellectual property rights in China are focused on getting more cops to shut down more factories, arrest more people, jail them longer, fine them more, and prove to the rest of the population that messing with intellectual property law is a ticket to jail. They use that old logic "kill one to save a hundred."

As much as it might enrage some of those defenders of intellectual property rights to say this, there are not enough cops, jails, or judges in China to end the problem purely by judicial means. (In fact, I'd suggest that even in the most developed societies, the tools of enforcement were only ever meant to be used in the relatively rare cases of overt, commercial violation of patent, copyright, and trademark laws.) And there never will be.

The Law is Not Enough

Eric Priest, one of my co-panelists at the Notre Dame seminar, is a trained lawyer with two law degrees, and even he is impatient with those who leave the IPR to their attorneys:

"Both domestic and international entertainment companies have tried the litigation path in China with little success. Major Chinese search engines like Baidu.com and Yahoo.cn have deep pockets and are far and away the most popular channel for accessing free music files online in China, so they were natural targets for contributory infringement suits. But murky legal issues (Baidu won on appeal because the court found it only aggregated links to content but did not in fact serve the content itself, while Yahoo.cn was found iable for infringement under similar circumstances) and notoriously low damages for infringement available under Chinese law have left copyright owners with little recourse, and emboldened internet companies to continue to conspicuously serve up free, unlicensed content."

Eric suggests that the better approach is to create business models that ensure compensation for the artists and labels as well as the company profiting from their distribution. In the paper he lays out three potential business models that could be used in China. Without doubt, new models need to be created, tested, revised, and perfected, and therein lies a major part of the opportunity.

The problem with the model approach is that any new model hoping for adoption must deliver a experience that is superior for the consumer to the model it is replacing. A painful number of models fall short of that promise. Some of the largest companies in the world have failed to deliver a superior book-reading experience on a mobile device, and the jury is still out on Amazon's geographically limited (and still expensive) Kindle. Conversely, home video has taken off because it offers an experience that is in many ways superior to the cinema. And iTunes turned music downloads into a mainstream experience.

In China, technologists cannot stop at creating business models that satisfy the music supply chain: they have to offer something that is so much superior to free music that people will be willing to pay for it. And then the people will need to be sold. Ask Steve Jobs: even the best experiences in the world don't sell themselves. For all of its virtues, Apple had to market the hell out of the iTunes experience to drive uptake beyond an initial core of users. Success for any business model will require a greater effort still.

Win their hearts and minds and their wallets will follow

Which brings us to my point. As much as lawyers may wish us to believe that law and enforcement should be adequate, as much as engineers may wish us to believe that technology offers a silver bullet, as much as entrepreneurs believe that smart models are the solution, they are all ignoring one more important piece:

Compliance. Voluntary compliance.

I'll put that in short words: people have to want to do the right thing. Then you have to give them an opportunity (business model.) Then you have to make non-compliance inconvenient (DRM, or something better that replaces it). Then you have to make breaking the law downright costly (laws/cops/courts/jails/fines). You need every element in that chain if IPR is ever to have any value. Because you can put all of the technical and legal solutions in place that you want, but until you have convinced the consumer that compliance is in his best interest, too, he or she will find ways around it.

You make it personal. You make it meaningful. You make a civic and more importantly a social virtue out of compliance. You make that individual feel like he or she is doing something important every time they lay cash down for something they could get for free. No. I will not do that. It's not right.

Is doing that going to be easy? Absolutely not. This is what management texts refer to as "a big, hairy-assed goal." But the industry uses the size of the task to justify not undertaking it. They tell themselves "it is too hard. You cannot change Chinese culture, and anyway it is easier and cheaper to hire more lawyers and get our industry associations to talk smack about the Chinese government in congressional hearings."

Yes, it will be a long, difficult, and costly process, but so is the current effort to push for enforcement. The industry has spent millions pushing for better laws in China. It is spending tens of millions on enforcement and litigation. How much is it spending on getting people to want to pay for something they are used to getting for free?

It may take a generation or more to change the way people behave. But it can be done, and it must be done if artists - songwriters, composers, and performers - are ever to have a trade in China, and if the music business as a whole is ever to thrive.

And the time to get started is now, if not sooner.

PRC IPR for MBAs

Starbucks Pinnacle Plaza

Sucking Indian Summerbreeze

1354 hrs.

Last week I had the opportunity to moderating a panel on technology and intellectual property rights in China for a group of MBA students from the University of Notre Dame's Medoza College of Business.

Lawyer, Lawyer, Lawyer, Me

The panel was made up of myself and three speakers, all of whom were accomplished attorneys. I have to admit to being worried about that before getting there, but it turned into probably the most dynamic public discussion I've heard on the topic in ages. We never got sucked into a China-bash, but kept things focused on how you protect your IPR in the face of "what it is" in China.

All three speakers acknowledged that after three decades and an China's IPR laws are in place, so James Luo from Bird & Bird dove into why enforcement in China is possible but not easy. James is a great speaker, and a nimble opponent when questioned. I tried to corner him with a question about how collusion between local IPR violators and enforcement authorities undermines efforts, and he dodged the bullet with grace and humor.

The other full-time attorney on the panel, Ray Moroney of Rouse & Co., focused on prevention as the best cure, underscoring that IPR protection begins long before your business arrives in China. Of all of the foreign IPR attorneys I've met, Ray is perhaps the most commercially-minded of the bunch. He told the group that you cannot come to China with a fixed business model around your IPR - you have to think creatively. I'd rate him as more than just an attorney, but a true counselor on the subject.

The third speaker was Eric Priest who, while an attorney by training, has given up on the practice of law to actually dive into business. He is involved in a couple of ventures, notably Noank Media, a global music licensing concern. Eric is one of a growing breed of what I would call merchant-scholars, people who combine serious intellectual pursuits with entrepreneurial tendencies. Eric actually put the whole discussion in a broad business context, explaining that China does not have just one intellectual property problem, but several.

The Takeaways

The underlying messages that the students took from the hourlong program (just before they jumped on buses to go look at the problem firsthand in Zhonguancun and the Silk Market) confounded the impressions they had taken from the media at home, to wit:

• The IPR problem in China is much more complex - and nuanced - than it is often presented by western media and the various industry players and lobbyists for whom this is the issue;

• You have to think creatively about solving your IPR issues: lobbying, factory raids, and lawsuits alone do not an IPR strategy make. You have to rethink your business models, your business structure, and your entire regime for protecting proprietary information when coming to China;

• The players in China's IPR debates are not oblivious to the cracks occurring in America's vaunted intellectual property protection regime. Debates over patent trolling, overly-aggressive enforcement of copyrights, the effects of technology, and the free and open culture movement* are watched and noted with interest; and, of course

• Intellectual property protection in China will make only limited progress until local enterprises and institutions are suffering from counterfeits and piracy at least as much as foreigners are. In the meantime, Hu Jintao probably does not wake up every morning worried about IPR issues.

No surprises for the initiated, to be sure, but one more indicator that much of the problem in the fight over intellectual property comes from the way executives, pundits, and policy-makers abroad perceive and frame the problem.

I walked away with a few other conclusions, but that's the subject of another post.

The Students

The 46-odd students in the group were primarily executives working with some of the largest firms in the U.S. After a few days in China it was pretty clear that they were reaching that stage of sensory and mental overload as they tried to absorb it all. At the same time, I didn't see the distant stares that usually accompany such whirlwind immersions. These students were all really jazzed about China and wanted more.

If I were a cynical person, I would suggest that any MBA student looking at the prospects for a robust US job market after graduation would be wise to be interested and enthusiastic about opportunities overseas. But it was not like that. It was more like they sensed something in the air - opportunity, maybe, or post-Olympic optimism, or perhaps that hum that you feel more than you hear when you land in China.

I suspect most of them will be back, and soon.

*(I will resist the temptation to create an acronym around "free and open culture movement" for fear of pronunciation issues)

Searching for China's Soul of innovation

In the Hutong

Peace through superior keyboards

1702 hrs.

In the wake of the global financial crisis, thoughtful people are starting to think about what the U.S. is going to use as a growth engine, now that housing, stock markets, and arcane financial instruments are out as alternatives. It did not take long in these discussions for some bright people to suggest that America needs to innovate its way back to greatness.

Yankee Ingenuity, Jia You!

Leaving aside for a moment that innovation and creativity in finance got the United States - and the world - into this problem in the first place, betting the future of any nation on its collective ability to come up with a whole lot of "new and useful" things in the space of an economic cycle seems to be a bit of a Hail Mary play. Industrial policy, regardless of how light or heavy the hand that applies it, has never been all that useful as a driver of innovation. Even corporations that spend billions on research and development wind up with very few useful innovations (look at the pharmaceutical industry), and many companies fail to capitalize on those they get as a result, for a myriad of reasons. (The case of Xerox Palo Alto Research Center and the graphical computer user interface is one notable example.)

There is simply too much serendipity in the innovative process to foment it efficiently. Even when you put really smart and creative people together with the facilities they need to innovate, the entire effort devolves into a numbers game. Throw enough brains together for long enough, the thinking goes, and something good is bound to come out of it all.

What America has going for it, of course, is momentum. Coming off of a national tradition for invention that began with Benjamin Franklin and Eli Whitney, somewhere just before World War II American inventiveness reached critical mass - literally and figuratively. Simultaneous discoveries and inventions across fields like physics, chemistry, aerospace, and electronics met mass production, marketing, mass prosperity and Keynesian economics. The resulting boom has carried the U.S. for seven decades - why should it not continue?

Sure, the government may be dysfunctional, Wall Street shell-shocked, and consumers in hock to their hairlines, but by gum, Americans still know how to come up with new stuff, make it cheap, and market the heck out of it. There's hope for the Yanks yet.

Waiting for China to Start Innovating Again

The unspoken assumption here is that nobody else is anywhere near as good at that stuff than the Americans. Which is part of the reason the words "Chinese innovation" scares Americans.

It would be unfair to forget that a lot of companies hear those very words and think "in China, innovation is really imitation." There is plenty of truth in that, and that thinking keeps a lot of intellectual property attorneys and trade negotiators well fed, clothed, and housed.

But the real pachyderm on the porch, the question that so many in the innovative industries will not allow themselves to ask, is "what if Chinese companies got it together and started to innovate? Then what?"

Questions like this are part of what is driving a wider audience to learn more about the life and work of Dr. Joseph Needham. A Cambridge master and biochemist, Needham spent much of his life and career compiling a history of Chinese science. He was an avowed sinophile, and as such much of his effort centered around an effort to prove that China before the Qing dynasty was the cradle of many of the world's major innovations up to that time.

The underlying theme of his work was to disprove the chauvinistic hypothesis that Chinese as a race were capable of imitation but not innovation. In the main, he documented and catalogued Chinese innovations in an effort to demonstrate that the West - and the Industrial Revolution it birthed in the 19th Century - owed a massive debt to Chinese innovations.

(The Chinese innovation I heard about all the time when growing up was a metallurgical technique called the Lost Wax process of investment casting. My father's foundry in California used that process in the 1960s and 1970s to make parts for turbochargers, airliners, golf clubs and medical implants. He was as proud of the heritage of the system as he was of its results. "Gee, Dave how do you make such amazing products?" "Ancient Chinese secret," he said with an enigmatic smile. But we digress.)

The real pity about Needham's work is that he spent so much time focused on what the Chinese invented and when they invented it that he had no time to figure out why the Chinese were such prolific innovators when they were, and how things changed to make that stop. This may have been because Needham was a monomaniac, or simply because he wasn't a trained historian. Either way, it leaves us with proof that the Chinese can be great inventors, but without the historic perspective on what it will take to revive that latent spirit.

Innovation with Chinese Characteristics

Yet he points us in a compelling direction. So much of what is written about China and innovation today, whether by foreign or Chinese observers, is patronizingly prescriptive. If China wants to innovate, it must imitate - it must recreate the conditions that exist in high-tech hothouses of Silicon Valley, Boston's Route 128 corridor, Austin, and Seattle. There is some truth in that, but there seems something unnatural about trying to graft San Jose onto Shanghai, or Federal Way onto Tianjin.

Needham's work, on the other hand, hints at another road to an innovative future, one that is Chinese in origin, not Western. Perhaps the answer for China is to search for an answer to the independent innovation challenge in its own history, applying foreign lessons where appropriate.

What was it about those times that fostered innovation? Was it cultural? Was it economic? Was it political? Was it invasion or civil war that fed China's inventiveness, or was it the luxury of peace and prosperity? Was the assimilation of some foreign culture the spark that set off periods of creative flowering, or did cultural homogeneity drive it?

These questions, and others like them, are the markers that will take us the next mile down the road that Joseph Needham walked, and will likely give us a better idea of when and how China will challenge America for innovation leadership.

In the meantime, I'm betting on Silicon Valley for green technology innovations, not China. But that's another post.

No Mas Kaptial

In the Hutong

Listening to the dulcet tones of the jackhammer

1554 hrs.

Rocker-writer-marketer Kaiser Kuo quotes me generously in Ogilvy China Digital Watch on the prospects for venture-funded Chinese Web 2.0 startups who are staring down the gullet of the Global Financial Kraken. What prompted Kaiser's article was Sequoia Capital General Partner Michael Mortiz' come-to-Yeshua talk with the CEOs of his portfolio companies last week, letting them know that it is time to get religious about revenues and profits.

(Nota bene, I expect that this is not the first time said entrepreneurs have heard this refrain from Moritz. Indeed, I wonder how much Moritz and his Menlo Park neighbors really see capital to be a problem, and how much they are taking a singular opportunity to use the FUD-whip to great effect. I figure it is a bit of both.)

Mortiz' comments and those of his partners at the meeting are here. I suspect - as, I believe, does Kaiser - that there are a lot of similar conversations taking place in cold-sweat enfragranced boardrooms in the world's financial capitals.

The dragon in the outhouse is how much this all applies to companies in China. Or, more accurately, whether investors will see China as an exception to the thick cloud cover over the world's financial markets, and thus keep the cash flowing into China.

Kaiser and I agree that things are going to get tight for the time being. While the Hutong is far removed from both Silicon Valley and Wall Street, the picture we are getting is that Wall Street is still trying to keep liquid, unwind some arcane financial instruments, clean up the subprime mess, and lobby Washington for more help as the water rises. Everyone else is either hunting for carrion in the wreckage or hunkering down for the next round of bad news. "Flight to safety" seems to be the order of the day, not "what the hell, Frank, let's pump another couple hundred million of our cash into some cool stuff in China."

The key question is how long this will all last.

My bet is that the longer the downturn goes - and the longer that U.S. and European investors stick with conservative investments - the louder the capital sucking sound from China's online and technology ventures. With less offshore venture capital chasing Chinese investments, valuations will come down, and at some point those valuations will reach a point where local capital will start to get interested. The business cycles in China are fast, but I figure if local ventures face an extended capital drought - say, 18 months or more - we are going to see a flowering of China's domestic venture capital business.

RMB funds will come from a variety of sources, including large investment houses, state-owned banks, and possibly even purpose-built policy banks created by the government to funnel a modest chunk of China's US$2 trillion capital reserves to local ventures. All of this would dovetail nicely with China's commitment to independent innovation, and with what Paul Denlinger expects will be a tsunami of government cash into neo-Keynesian infrastructure spending across the countryside.

This is a golden opportunity for China to build a robust venture capital industry with Chinese characteristics.