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The money trail

Research houses, financial analysts and advertisers have paid little heed to the precarious foundations of Baidu’s success. The government body, the China Internet Network Information Center (CNNIC), has said that “MP3 search is the primary boosting factor for Baidu’s high growth”. With the large number of users attracted to all this free music, users simply stay on and continue to use Baidu.

Ironically, a significant portion of Baidu’s institutional shareholders and mutual fund investors are American companies, including blue chip investors such as US investment companies like Morgan Stanley, JP Morgan, Fidelity and Goldman Sachs. Leading Western brands like Motorola, Adidas, and Lancome have also profited by advertising on Baidu’s infringing activity. Both investors and advertisers seem oblivious to the misappropriation of musical assets while the money rolls in.

Has Baidu been entirely open with Wall Street? While Baidu’s regulatory filings in the US refer to its litigation with music companies, they don’t hint at the full extent of its music operation: or its precarious nature.

In its SEC filings, Baidu acknowledges that “a significant portion of our traffic is generated by users of our MP3 search service.” Baidu also refers to the “deep linking” lawsuits in China, and the threat to the entire business posed by having to close MP3 search.

“These results provide new data and suggest new insights into the extent of Baidu’s violation of copyright,” John Kennedy chief executive of the sound recording rights group IFPI, told us.

“Baidu is quite simply the biggest infringer of music copyrights in China, generating huge revenues by deliberately providing access to illegal music. It is as big a problem for China as it is for copyright holders. Baidu stands out as a champion of old-style copyright abuse just at the moment when China is intending to champion fair trade, respect for intellectual property and a new home-grown creative economy.”

We put the following questions to Baidu’s financial PR agency Ogilvy:

• Is management aware that that many MP3 files listed in MP3 Search are only available through Baidu?
• Is management aware that the movement of these files is co-ordinated in response to infringement requests to ensure they are always available to Baidu users?
• Is it official management policy to downgrade search results returning legal, licensed MP3 searches and MP3 files outside Baidu?
• Given the importance of this information in ongoing litigation — should this not be fully disclosed to investors?

Ogilvy has not responded.

Baidu reported total revenues of US$240m in 2007, a 108 per cent increase over the previous year, and revenues of $82m in Q1 of 2008, which showed another 108 per cent increase over the corresponding period in 2007. Q2 revenues announced last month show Baidu hitting US$100m in Q2, up 87 per cent year-on-year.

The web economy that isn’t

Defiance of creators’ rights in order to build up a web audience will sound familiar to Western readers. As it becomes apparent that the much vaunted “Web 2.0 economy” is failing to deliver sustainable, wealth-creating businesses, startups are increasingly turning to music, the surefire way of attracting “attention”, making the calculation that the obligation to pay creators is optional. It’s the same dynamic we’ve seen here, but on a giant scale.

IFPI sounded a confident note to us that the rights of musicians and budding music entrepreneurs will eventually be respected.

“I’m confident that the law will eventually catch up with Baidu,” said Kennedy, “with the company paying out huge compensation claims”.

IFPI takes some encouragement that pressure is building on Baidu from the indigenous Chinese music industry, and hopes US investors can take notice.

“[Investors] have good reason to question their association with a company that is not only cynically expanding its business on the back of copyright infringement, but which is also likely to be found liable for the massive damage it is causing,” he told us.

Yet recently, EMI announced it was withdrawing from China, selling its stake in EMI Taiwan, Typhoon and Hong Kong’s Gold Label Entertainment. The British music company had earlier closed offices in Thailand and Singapore and is reducing its business, but it is not a vote of confidence that the world’s biggest internet audience can be monetized.

Baidu has already effectively reduced the price of music in China to zero. Last week, Google China responded with a legal, fully licensed MP3 Search engine supported by advertising. Both streaming and song downloads (192kbps, no DRM) are free. (The site is at www.google.cn/music, but inaccessible outside China). Google’s partner for the service, Top100.cn, scrapped its own download service to make way for the new venture. Labels are skeptical.

In addition, a study just published by the MCPS-PRS Alliance into the Radiohead experiment suggested that free might not be enough. (See Millions chose torrents over Radiohead’s own site — survey). “Fans” flocked to the familiar P2P torrent trackers. Can rivals hope to change the habits of Baidu users now accustomed to an uninterrupted flow of unlicensed music?

The fate of the unloved music business in China today may seem remote here. But it begs the question: does economic activity from music have to be destroyed, just so Web 2.0 survives? ®

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