From...

January 19, 1999
Web posted at: 12:13 p.m. EST (1713 GMT)

by James Ryan

(IDG) -- Guanxi. In China, it means connections. And in the recent past very little got accomplished in the People's Republic - at least not on any grand scale - without it. The signs of free enterprise are everywhere, but much of the economy is still under the heavy thumb of government bureaucrats. Guanxi helps grease the moribund wheels of decaying state machinery.

But guanxi can cut both ways. In politically volatile China, today's fruitful alliance can become tomorrow's crushing liability. And thanks to the country's burgeoning free market, there is now another way to get things done - with capital.

Those two approaches - old and new - are personified by Edward Zeng and Wang Zhidong, two young Chinese entrepreneurs. Both are visionary, both are extremely ambitious, and both are hell-bent on building global e-commerce dynasties before the age of 40.

But Zeng, 35, a onetime government economist with a master's from the University of Toronto, is more old-school. He has attracted a modest amount of Western investment capital, but his strength comes from his high-powered government connections - guanxi. His company, Unicom-Sparkice, a joint venture with China Unicom, the country's second-largest phone company, has grown from two to 200 employees in two years and is expanding into Internet telephony, business-to-business data services, ISP services, Web design, e-commerce, debit payment and a chain of Internet cafes.

Wang, 31, an electrical engineer by training, hasn't bothered much with guanxi. "As the Chinese government becomes increasingly normalized," he says, "guanxi is becoming less and less important." In 1997, his Beijing software company, Stone Rich Sight, received a round of $6.5 million in U.S. venture capital from Walden International Group and Robertson Stephens.

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Last June, Wang shifted his entire focus to the Internet. It was an easy decision: Software piracy in China is rampant. Besides, SRS' Web site was already receiving more than 1 million page views per day, making it one of the most trafficked Chinese-language sites in the world.

Then in November, SRS merged with Cupertino, Calif.-based Sinanet.com, which had become the most popular portal for nonmainland or "global" Chinese under the direction of Taiwanese-born CEO Daniel Chiang. Now known as Sina, the combined sites have more traffic than any other competitor in the Chinese-language market.

Despite 20 years of economic reforms, most Chinese firms remain in government hands, and the state keeps a tight rein on private entrepreneurs. Nowhere is this more true than in the Internet sector, which party hard-liners view as a social, political and security time bomb. Their biggest fear? Easy access to pornography and antigovernment information, especially anything pro-Taiwan or pro-Tibet. The Ministry of Public Security enforces a strict code of conduct governing content, chat rooms and e-mail, and blocks access to offending sites.

China's Internet customer base is small: 1.2 million, or roughly one in 1,000 residents. Chinanet, a service of China Telecom, the state telephone agency, directly controls 80 percent of ISP traffic and licenses out the remaining 20 percent to private ISPs, most of which are based in high-traffic urban areas. Although connections can be unreliable at times, the Chinese government has made significant investment in Internet infrastructure. At the same time, apart from security edicts, the state has lagged in the formulation of general rules governing Internet commerce. This has created openings for crafty entrepreneurs but also a certain amount of wariness and insecurity. No one knows what the landscape will look like once laws are passed.

While the government has been selling off its smaller, less successful enterprises in telecommunications and media, it has hung on to the larger, more profitable ones. Most are controlled by political appointees more interested in personal gain and increasing their guanxi than turning a profit. China's economy remains a tug-of-war between this powerful state sector and emerging private enterprises.

Western-style Internet commerce is not thriving. Less than 2 percent of the total population owns computers, and a similar proportion holds credit cards. The vast majority of Chinese live in rural areas, subsisting on the equivalent of $200 a year. Furthermore, because of the U.S. ban on advanced encryption technology, the security of financial transactions over the Net remains in question, especially given Chinese wariness about any transaction that is not cash. To make matters worse, consumer spending in China is currently in a slump, thanks to both the Asian crisis and uncertainty over the direction of government spending and layoffs.

Now the upside: The Chinese appear to be quick studies of Western consumer ways. Flip on a television in Beijing today and you're just as likely to tune in to a home-shopping channel or an infomercial hawking toilet seats as a news program about wheat production. Urban Chinese have adopted cell phones and pagers in a big way.

The growing consumer appetite for technology in China has spawned its very own high-tech center, Beijing's bustling Zhongguancun district, crowded with small hardware and software firms, including Zeng's Unicom-Sparkice and Wang's Sina. Like its foreign counterparts, Zhongguancun has sprouted around nearby engineering breeding grounds, such as Beijing and Quinhua universities. Only 20 years ago, much of the land in this area was devoted to farming.

On Baishiqiao Road, home of discount computer retailers and software start-ups, hordes of bicyclists and pedestrians waltz with beat-up taxis and mule carts loaded with bricks. Trishaws carry teetering stacks of computer monitors. Around the corner, vendors hawk pirated software and every imaginable chip and computer part, spread edge-to-edge on sheets along the sidewalk. For the right price, they'll build you a desktop on the spot.

Pioneers such as Zeng and Wang forge ahead, confident that their government will recognize the importance of the Internet to China's emergence as a global economic force, as well as continue to allow "controlled entrepreneurship." And while they wait for the domestic market to expand, they have turned their attention to the 3 billion potential customers outside China clamoring for Chinese-made goods.

Waiting in Edward Zeng's Unicom-Sparkice conference room when he arrives for work this November morning are three serious-looking men from the State Planning Commission. They're here to discuss economic projections and employment issues. Zeng, dressed casually in jeans, a light-blue work shirt and a bulky wool sweater, serves as Internet advisor to several ministries, churning out one or two policy papers a month. He estimates that he spends roughly one-third of his time and energy courting the favor of officialdom. "I would like to spend more," he says with a rueful smile.

The son of a doctor and an architect, Zeng became a rising star within the State Planning Commission, the government agency that formulates economic policy, after earning his M.B.A. from Qinghua University. Ten years ago, a few days after the student uprising at Tiananmen Square, he hopped a flight from Japan, where he was on official business to Canada, to accept a fellowship at the University of Toronto. "I decided it was not a time to work in the government but to train in the West," he says with diplomatic tact.

With $5 in his pocket when he stepped off the plane, he subsisted by selling T-shirts on the street. He also pulled a tourist rickshaw for tips; his first night on the job he paid $30 to rent the rickshaw and earned $5. It was a valuable lesson in capitalism. Better to own the means of production.

Zeng earned a second master's degree in finance from the University of Toronto, worked briefly for the Canadian government and established several joint ventures before founding Sparkice, a small Canadian company that dabbled in several industries, including television and the Internet.

Two years ago, he paired with China Unicom, China's largest private phone company, to form Unicom-Sparkice and build an Internet company. They each own a 45 percent share, with U.S. entrepreneur Bill Melton, the CEO of CyberCash, owning the remaining 10 percent.

Zeng has been able to parlay his personal relationships with Communist Party officials into a number of lucrative concessions. Unicom-Sparkice, for example, is one of two Chinese entities to receive the green light for Internet telephony. (The other is the formidable state-run phone giant, China Telecom.)

Even more potentially lucrative, Zeng has been granted permission to develop a debit payment system in cooperation with the state-run Bank of China and Virginia-based CyberCash. Many believe this will be essential to developing an e-commerce market in China. In one scenario, consumers or merchants could make cash payments at one of Zeng's Internet cafes, money that would then be routed through the Bank of China to pay the merchant at the other end. In another scenario, cash accounts at the bank could be debited electronically.

"The people don't trust credit cards; they like cash," Zeng explains. "We are [offering] the only other online payment solution in China." If he can resolve the currency convertibility issues and get the debit system in place, possibly by the end of this year, Zeng would have a "potential gold mine," says one envious executive at a major U.S. Internet company.

Adds CyberCash's Melton, who personally has invested "a few million dollars" in Unicom-Sparkice, "this isn't about whether people in Beijing want to chat with people in Tianjin, but how many people in Beijing are going to be marketing their goods to anybody in the world who wants them. Today, almost everything has a 'Made in China' stamp on it. You can do the math."

Zeng's cafes have become the Internet darlings of the Western media; last July even President Clinton visited one. Zeng charges customers about $4 an hour to surf the Web (half that for students). Zeng also brings in income as an ISP, charging a $35 set-up fee and then about $6 dollars a month for e-mail service. Zeng says access fees, including cafe rental fees, provide roughly 60 percent of revenues, with another 20 percent coming from advertising, and most of the remainder from e-commerce activities. Advertisers, he says, include Compaq, AT&T, Oracle and a local paging company.

Zeng has launched several other enterprises to help tap the global market. Among the most publicized (and most questioned) is his plan to set up a chain of 100 Internet cafes around China. Since he opened the first of a dozen cafes two years ago, more than a thousand have sprung up around the nation, he says. If he can attract the capital, he hopes to buy up the best of these and sell Unicom-Sparkice franchises.

Zeng believes his cafes will play a role in educating Chinese consumers. Already, he has used them to woo technophobic government bureaucrats, many of whom are in their 50s or 60s. "It's a great concept, particularly for China," says Eric J. Gerritsen, VP for international business development at Lycos, and a regular visitor to China. "It seems to address the need for a little extra hand-holding and a clearinghouse for e-commerce."

Cafe users are diverse, says Zeng, ranging from "students to grandmothers to Party officials." On this day, most Internet cafe visitors appear to be using it to check their Hotmail accounts. Among them is a 24-year-old Beijing University student, Liu Die Hua. "Mostly we send e-mail to our foreign friends," says Liu. "But buying things is very promising. I think we will buy things in the near future."

Another of Zeng's big ideas is a suite of business-to-business services dubbed Dragon Pulse and ChinaRep. For a fee, ChinaRep offers background and contact information for industrial firms in China. Subscribers pay $49.95 per search or an annual rate. Using data from China's Bureau of Statistics - guanxi again - Zeng claims to have 1 million businesses cataloged. However, since the software only spits out the top 100 firms in 39 different industrial categories (there is also a region-by-region search), the number of businesses accessible is actually less than 10,000. Still, for a foreign firm that wants to manufacture in China, it could be an inexpensive and time-saving tool.

ChinaRep will also create and host a company's Chinese-language Web page for as little as $650. "The idea is to become an industrial gateway for foreigners," he explains.

On one wall of Zeng's high-ceilinged, low-tech office is a map of the world. That's the one Zeng is looking at now. What does he see? Hordes of non-Chinese customers waiting to buy Chinese-made products, thousands of Western firms lining up to use China-based manufacturing facilities, and, yes, a billion Chinese aspiring to Western standards of consumption. It's all in your perspective.

"Eighty percent of Christmas gifts come from China," he says, smiling. One has the sense he's used this line on Western guests before.

Because of his fertile mind and a tendency to pursue multiple projects simultaneously, critics have accused Zeng of being unfocused, fickle and, in the case of his Internet cafes, wildly misguided. Others say he is more interested in being a "player" in the New China than in running a successful business. His believers, however, seem to outnumber his detractors.

"Edward's a creative, aggressive, well-connected young man with a vision," says CyberCash's Melton. "I've spent my life investing in people like that, and it's paid me very handsomely to do so."

In contrast to Edward Zeng's low-key, somewhat distracted charm, Wang Zhidong has an intense, focused, no-nonsense demeanor. His modern, Western-style offices are in the rented wing of a private school building on the edge of Zhongguancun. The son of schoolteachers, he grew up poor in a small town in rural Guandong province with a love for computers - machines that he had never seen but only read about. After winning a rare opportunity to study engineering at Beijing University, he emerged as something of a programming prodigy. Graduating into post-Tiananmen China, he put his faith in the free market.

His first job was with the for-profit, university-affiliated Beijing Founder Group, designing Chinese-language applications for Windows. At age 24, with two partners, he founded his first software company, Suntendy. Two years later, after a falling-out with his partners, he started a second company that attracted the attention of Hong Kong investor Duan Yong Ji. With half a million dollars in capital, they formed Stone Rich Sight. Their most popular product, a Chinese-language overlay for Windows called RichWin, sold 800,000 copies. Despite such success, Wang and SRS remain virtually unknown outside China - especially when compared to promotion-savvy Zeng.

Regarding guanxi, Wang has taken a pragmatic approach that reflects the transitional nature of the economy. "It's dangerous to rely too heavily on relationships in volatile power structures," says Wang's CFO, Mark Fagan, an American who serves as Sina's investor liaison and chief media troubleshooter. "There is far more risk today in allying yourself politically with someone in the government, than in just pursuing the private-enterprise profit motive."

To attract more foreign capital to China, Wang believes, Communist Party officials know they must foster a climate in which businessmen like him can continue to prosper, with or without the right connections. Wang's strategy has been to form partnerships with content providers, including state media enterprises. That way Wang can, in effect, piggyback on his partners' guanxi without exposing himself to political risk. Wang also points out that his company is located in a special technology development zone, which he says provides the company with "a degree of policy support and protection." China has successfully established similar experimental zones elsewhere in the country, such as near the southern border with Hong Kong, where capitalism is freer.

Not that Sina can afford to completely ignore traditional power relationships. Before merging with the pro-Taiwan Sinanet, for example, Wang floated the potentially explosive plan with both his government contacts and content providers. "We did a lot of homework," recalls Fagan. "And it's not like our job is over. This is going to be a really interesting balancing act."

Media in Hong Kong and Taiwan portray the merger as the takeover of a pro-Taiwan Internet company by a pro-People's Republic mainland firm. Some Chinese officials probably saw it from the reverse perspective. Sinanet has long been viewed as unfriendly to the Chinese government, as evidenced by the fact that its home page is blocked much of the time.

"If you don't have solid connections, [doing business in China] can be very tough and very dangerous," warns Derek Ling, who until last month was Sinanet's VP and general manager for China. "But if you establish the right guanxi you can do things there that you could never do in the outside world."

Because the merger is so new, Sina is still trying to sort out its direction. To avoid running afoul of Chinese government content restrictions, for the time being, Sina will maintain separate portals for its mainland Chinese, U.S., Taiwanese and Hong Kong markets. The plan is to build locally oriented, full-service Chinese-language portals that combine the search index features of Yahoo with the content and services of AOL.

The U.S. portal, for example, currently provides news, Dow Jones stock quotes, e-mail, shopping, a search engine, advertising and links to other Chinese-language sites. For the China site, Wang is currently negotiating with a variety of mainland content providers - magazines, newspapers, television stations and other media. At some point in the future, he hopes to charge subscription fees for access. Ultimately, the sites will host e-commerce and Internet telephony.

In the immediate future, the bulk of revenue will come from advertising, mostly from global operations, primarily U.S. and Taiwan-based; the Chinese Internet ad market is still in its infancy. Ongoing revenues from RichWin should also provide some operating capital.

Wang hopes to raise between $20 million and $30 million from foreign investors over the next year. Half of that will be spent on branding. Says Fagan: "Our goal is to capture the real estate."

While bureaucrats have taken a wait-and-see policy toward much of the high-tech free enterprise in Zhongguancun, the Ministry of Public Security is keeping a close watch over the Internet. In addition to blocking offending sites, the MPS has issued sweeping Internet security controls. ISP users, for example, must sign a contract vowing they will not "read, copy and spread information or pornography that will harm the nation or society."

In late November, three men were arrested for forming an opposition political party. Among the charges were that they had used the Internet to send documents abroad. And a Shanghai resident was recently arrested for supplying 30,000 e-mail addresses to a U.S. Web site the Chinese government had deemed unfriendly. Wang and Zeng purposely steer clear of controversial subject matter. Theirs is an economic, not a political or cultural, agenda. "We are very progovernment," says Zeng.

And the Chinese government is pro-Zeng. Visitors to Sparkice are invariably treated to company fliers displaying the signatures of Prime Minister Zhu Long Ji and President Jiang Zemin (alongside those of Bill and Hillary Clinton). In China, such signature collections function as endorsements of talismanic import.

Wang, too, has taken a conciliatory approach to the state security apparatus. At its own expense, SRS has hired 30 monitors to guard against use of its chat rooms for antigovernment activities. The monitors file reports that are passed on to state security. It is also assumed that state security personnel drop in on chat rooms unannounced. Given the fear of government reprisals, most customers are "self-policing," says Fagan.

The Internet, of course, defies such controls. Anyone who enters a Sparkice cafe and plunks down 30 rinminbe for the first hour can, just like anyone outside China, easily gain information on banned personalities from the Dalai Lama to Pamela Anderson. Even blocked sites can be reached via proxy server or by using a URL deeper in a site. "From my cafe you can read anything you want," Zeng proclaims with a sly smile. "They've tried [blocking offending sites] before, and it doesn't work."

Balanced against security concerns is the need to aid China's economy. International Data Corp. estimates e-commerce in China could approach $2 billion by the end of 2002. "The heads of some traditional sectors are not aware of the importance of the Internet to economic development," says Wang. "However, the situation is improving as they see the Internet being applied successfully in other sectors."

Things will get even more interesting as China completes its current consolidation of media and telecommunications ministries into one central Ministry of Industry and Information. "How that all plays out over the next year or so is very important, particularly to joint-venture equity structures," says Lycos' Eric Gerritsen. China, he points out, has 300,000 ailing state enterprises. "Imagine if just one ailing state enterprise is bailed out by the Web. From the political point of view, you have a very powerful success story."

In addition to difficulties particular to China, Wang and Zeng face challenges familiar to Westerners: attracting investment capital and hiring qualified employees. Talented programmers and engineers are in short supply and have limited company loyalty. Experienced management is even harder to come by, especially those versed in both Chinese and global markets. "There are not many talented managers, and opportunities to get management training are scarce," says Wang. "We need to nurture this more." He took on the role of SRS' general manager because he "could not find anybody qualified for the position."

Many of Zeng's key positions are occupied by foreigners, whom he must pay "international rates," he says. His head of international marketing is a young man from Morocco, his CFO is a Chinese American from California and his marketing manager is a Canadian. Likewise, Wang has hired Anglo-American Fagan as his CFO to make the company more appealing to Western investors, although the rest of his staff is ethnic Chinese.

As for financial partners, Zeng and Wang must also look abroad. Chinese capitalists cannot comprehend the spending ways of Internet start-ups, in which branding, market share and traffic come ahead of profits. "People in China don't understand Internet economics," says Zeng, who is looking for more investors like Bill Melton.

Sina and Unicom-Sparkice aren't alone in vying for a chunk of the Chinese-language portal market. Among their competitors are Yahoo Chinese, launched last May by Chinese-speaking founder Jerry Yang, with big guns IBM, Motorola and the Cathay Pacific airline as sponsors; the homegrown Sohoo directory, founded by Charles Zhang; and Hong Kong-based China Internet Corp., which has partnered with Netscape and Xinhua, the Chinese government's news agency.

CIC has raised $25 million and signed deals with America Online and Sun Microsystems. Lycos is expected to announce a strategic partnership with a non-mainland Chinese portal in the coming weeks, and Infoseek will soon announce a new partner to help tackle the Chinese market. Powerful U.S. portal firms could have easier access to capital as well as internal resources, which would help steamroll smaller, less well-financed local competitors.

But Zeng says he isn't worried about competition. "The market is very big," he says. "Even if you have 10 competitors, you still have a very big piece of pie."

China by the numbers

Total Population: 1.2 billion, 75 percent (900 million) in rural areas Internet Use: 0.1 percent of total population (1.2 million) in June 1998, expected to reach 7 million by 2001 Credit Card Holders: 1 to 2 percent of total population, but 33 percent of urban residents Telephone Penetration: Will reach 11 percent in 2000

IDC says PC sales are growing by 25 to 30 percent a year; 1999 PC sales will be 4.9 million.

ALL THE MODERN CONVENIENCES
Pagers	62 percent
Bathtubs	24 percent
Personal Computers	16 percent
Mobile phones	32 percent
Laser-disc players	19 percent
DVD players	3 percent

Source: Grey Advertising