Baidu's Ad Business Is in Crisis, But the Problem Isn't Just Baidu — Or Just Advertising

One company's ad revenue is another company's marketing budget. How advertising does says a lot about the wider economy.

In two trading days Baidu's stock fell 23.5%, wiping out $12.6 billion in market value and dropping the company below JD.com and Meituan. "BAT," an acronym that stopped fitting the facts years ago, is now firmly in the past.

It started last Thursday night, when Baidu reported its first quarterly loss since going public in 2005. The cliff-edge drop in the share price showed how unprepared investors were for the collapse. In the same quarter last year Baidu made 6.694 billion yuan in net profit, which Robin Li credited to the new "feed" ads inside the Baidu app. This year the whole company lost 327 million yuan.

A few weeks before Baidu's loss, Tencent — long seen as the company that took Baidu's voice on the Chinese internet — reported its own results. WeChat still has a staggering 1.1 billion users, but Tencent's advertising business has clearly begun to slow as well.

And Google, the company Baidu has always tried to imitate and whose profits are still enormous, took its worst hit in seven years in late April, briefly losing $100 billion in market value — also because ad sales were growing more slowly.

What went wrong?

Digital advertising has finished its move from the PC to the phone, everywhere. That is Baidu's main crisis

Baidu lost money because ad revenue growth slowed to 3.2% while marketing costs kept climbing.

Ad revenue growth has been slowing since 2018 even as costs rose. The growth rate of Baidu's marketing and traffic-acquisition spending has gone up every quarter since the second quarter of 2018, from 33% then to 71% this quarter.

On last week's earnings call, Baidu CEO Robin Li gave three reasons:

• Sharper competition in digital advertising
• Advertising regulation aimed at particular industries
• Changes in the wider economy

The first is a crisis peculiar to Baidu as the industry's former leader.

People have been discussing the competition Baidu faces for years — we named Baidu our Disrupted Company of the Year at the end of 2015. Its problem is that nearly all of its ad revenue comes from search, and search no longer matters as much.

In a July 2015 interview with the American business publication Re/Code, Robin Li said: "We realize a lot of companies are building their own apps — they no longer let us index their content, and they are giving consumers a very good service. If users in the mobile era spend a lot of their time outside of search, we have a problem. If a user goes straight to an app to get a service, they no longer need search, because search only gives you information."

In the early days of the internet, reading the news or using a service meant typing in a web address. Not many people bothered to memorize addresses; it was easier to type a few words into a search box, since the keyboard was always right there. The search returned a screen of links, more than half of them ads most of the time. Those ads were Baidu's revenue.

To be fair, Baidu's search has always been better than its Chinese rivals'. Google's forced exit in 2010 did not make Sogou or 360. Baidu alone still controls more than 80% of the Chinese search market, with every rival holding a single-digit share. For the foreseeable future, no company looks able to unseat it there.

But once people started reaching for a phone instead of a PC, Baidu stopped deciding what most of them saw and used. Apps you open with one tap replaced search engines and web pages as the daily door into internet services.

As WeChat, Toutiao, Alipay, Douyin, and Taobao became the door to their own territories, and people on the subway scrolled Moments or killed time on Douyin and Toutiao instead of searching and reading web pages, the advertising moved with them.

Toutiao is the example everyone reaches for: in 2018 Toutiao and Douyin together took in nearly 50 billion yuan in ad revenue, close to half of Baidu's.

Short video and feeds are new sources of revenue Baidu is also pushing hard, but the gap has already opened. On the earnings call Robin Li said 174 million people open the Baidu app each day and Haokan Video has 22 million daily users. Douyin, by comparison, announced at a February event that it had passed 250 million daily users. Weibo has more than 200 million a day, and WeChat passed 1 billion long ago. In feed advertising, a service with fewer users who spend less time in it simply has fewer slots to sell.

In Beijing, Shanghai, and Shenzhen, several conferences a week, large and small, are devoted to working the traffic on Douyin and Kuaishou. That is where the traffic has collected, and founders, talent agencies, and service providers trade notes there on how to catch the moment while short video and feeds are still growing fast.

Search was just as noisy ten years ago, when it was starting out.

This is not Baidu's problem alone. Google watched PC advertising collapse over the past year too.

Figures from the third-party measurement firm Merkle show Google's mobile ads still grew 46% in 2018, faster than the year before. PC and tablet ads grew 2%.

In the first quarter of 2019, slowing ad revenue dragged down Google's overall growth and produced its weakest revenue increase in three years. Slower ad revenue growth means Google's traffic is no longer growing fast enough to make up for falling ad prices.

Beyond the PC, Google CFO Ruth Porat told the earnings call that recent changes at YouTube had slowed the growth in ad clicks. Last quarter Google's clicks grew 39%, 20 percentage points less than a year earlier, while the price of a click fell sharply, by 19% — YouTube ads usually cost more than search ads. Porat gave no specific YouTube figures, and Google's results do not break out mobile, video, or other categories.

At the Google Marketing Live conference in the middle of this month, Google launched a series of new mobile ad products, a sign that it has started taking feed advertising seriously.

In the same difficult quarter for Google, Facebook's ad revenue grew 26% year on year to $14.9 billion. Mobile ad revenue within that grew 30% to $13.9 billion, with Instagram as the main source of the growth.

The global pattern is visible in all of this: digital is passing traditional media, and mobile is passing the desktop.

Baidu started its feed in 2017, giving people news to read inside the app. As a place to put advertising, though, Baidu can no longer really be compared with Toutiao. Li said 178 million people opened the Baidu app each day in the first quarter and 22 million opened short videos on their phones. Toutiao had 106 million, Douyin 250 million. Even Weibo, at 200 million a day, is ahead of Baidu.

The number of users, and the number of ads those users see and click each day, decides a platform's ad revenue. In the mobile era Baidu is nowhere near being China's most important advertising channel.

At the same time regulation is everywhere, hitting healthcare, gaming, and financial ads alike

For years Baidu's ad revenue has come mainly from retail e-commerce, healthcare, franchise services, and financial services.

Healthcare, and healthcare e-commerce within it, is one of the few Chinese industries still booming. Tmall's pharmacy channel did 59.5 billion yuan in gross merchandise value in 2018, and consumer health categories such as medical aesthetics, physical exams, vaccines, and dental care grew more than 140%. The health mall run by Ping An Good Doctor grew its 2018 gross merchandise value by almost 80%.

Hospitals have long favored Baidu, because it is still the main channel through which people look for treatment and medicine. Shandong Kaichuang Group is Baidu's second-largest ad agency and one of the few listed companies among them; the large clients it discloses each year are almost all private hospitals, and a single hospital can place more than 10 million yuan of advertising on Baidu through it.

On the earnings call Robin Li said that regulation, along with Baidu's own medical rules, had led it to move the landing pages for healthcare ads onto Baidu's own platform. His CFO, Herman Yu, said on the same call that the effect would be harsher next quarter.

"We switched most of our healthcare advertisers at the end of the first quarter," Yu said. "When you change the [ad] pages, users often need time to get used to them, and conversion rates take a while to recover."

To get around review, most medicine and health-supplement ads have for years used a "double jump": the first page, the one the ad in the home feed opens, is compliant, while the page it jumps to next carries what medical advertising has always been full of — "clinical experts" and "patients telling their own stories," good at persuading people to buy, and not compliant.

Last March and again last December, the Haidian branch of Beijing's Administration for Industry and Commerce fined Toutiao, both times for illegal medical advertising.

In other words, once Baidu followed the stricter rules on medical advertising, it could no longer get users to click the ads and buy medical products and services. Pressed by analysts on whether medical advertising would recover in the third quarter, Yu said he could not give an accurate forecast.

Regulation is not confined to healthcare, and its effects are not confined to Baidu. Momo president Wang Li said on the company's March earnings call that the freeze on new game licenses had hit Momo's related business directly. The same decline shows up in Tencent's and NetEase's results: unable to launch enough games, both cut their game marketing budgets.

In financial services, the closure of the insurance regulator, deleveraging in asset management, and the wave of collapsing peer-to-peer lenders took an entire industry's advertising with them.

China's whole ad market has just had its steepest fall in 11 years. The problem is bigger than channels shifting or one industry being regulated

Advertising is one of the main ways a company spends money to grow its business. When business goes badly and a company cannot create new revenue, it has to cut costs instead, and layoffs and smaller ad budgets are the usual tools.

That is the problem in front of China's ad market now. It is not only television, print, and other traditional media that have been hit; growth is slowing across every medium, and elevator poster ads are the only format still growing in double digits.

Figures from CTR Media Intelligence show the ad market shrank 11.2% in the first quarter of 2019 — the steepest fall in 11 years, and the first time a first-quarter decline has reached double digits.

CTR's survey of advertisers shows only 33% plan to raise their budgets this year, the lowest share in a decade. The shares planning to hold budgets steady and to cut them are both the second-highest in ten years.

On the earnings call Robin Li pointed to the economy, saying ad spending had not bounced back after Chinese New Year the way it usually does. "Even though the Chinese government has introduced a number of policies to stimulate the economy," he said, "given the current macro environment, stricter government regulation of content, the pullback in venture capital and other factors, we think the advertising business will face a harder environment in the near term."

Pony Ma takes the same view and named the industries. On Tencent's earnings call he said: "Advertising revenue was affected by the macro economy, particularly in cars, property, and internet services. Internet companies are often very large without being profitable, and a lot of O2O companies and internet startups have chosen this moment to cut their spending."

The industries that buy most of the advertising are not very different in China and the United States.

The top five in the U.S. are retail, cars, finance, telecom, and consumer goods.

Figures from CTR Market Research show that the five industries spending most across all media in 2018 were post and telecommunications, beverages, pharmaceuticals, food, and commercial and business services. Most were falling; the few still growing were beverages, food, and commercial services. In the first quarter of this year, food spending grew 11.8% while the other four fell by more than 20%.

That is because nearly all of the big industries are shrinking.

In 2018 Chinese car sales fell for the first time in 30 years. The China Passenger Car Association put the drop at 5.8% for the year. In the first three months of 2019 it widened to 10.5%.

Carmakers' ad budgets show it. Not one of the country's ten largest carmakers increased the growth rate of its sales spending.

Property developers are in the same position. After sales climbed to 300 billion yuan a year in 2016 and 500 billion yuan in 2017, all three of China's biggest developers — Country Garden, Evergrande, and Vanke — stalled in 2018.

Chinese developers all run on heavy debt, so slower sales mean a cash-flow crisis, and each has been slowing its sales spending to save money. Country Garden and Vanke both saw selling-expense growth slow in 2018. Evergrande, which grew the least of the three, raised selling expenses by only 7.68%.

In the first quarter of this year Evergrande discounted homes to collect cash faster, Country Garden was reported to be planning large-scale staff changes, and Vanke chairman Yu Liang, in an internal speech on February 25, again used the phrase “stay alive”. Things look only worse.

Internet companies became big advertisers over the past few years. They are cutting too

CTR's review of the first-quarter ad market shows that all-media ad spending by the so-called "post and telecommunications industry" — mostly websites and mobile products, a quaint way to draw the boundary — fell 24.3% in the first quarter of 2019.

Part of that is gaming companies cutting costs, seen most directly at Tencent, which cut 4.2 billion yuan of selling expenses in the first quarter, more than 20%.

Cutting that 4.2 billion lifted Tencent's profit, but it is bad news for the ad industry: Tencent has no physical business, so cutting selling expenses is essentially cutting advertising.

The other half of it, as Pony Ma said, is that there are fewer startups left with money to burn on advertising.

The years when mobile advertising boomed were also the years when one wave of startups after another burned cash to buy growth, from the O2O rush of 2013 and 2014 to the bike-sharing craze of 2016 and 2017. However long each of them lasted, some of the money always went into ads. Focus Media's elevator screens played Pinduoduo and Luckin Coffee videos for months at a stretch.

Now that some industries have disappeared, a great many companies have failed, and another batch has gone public and had to disclose its finances, far fewer companies can keep burning money on advertising without counting the cost.

Food was the only industry whose ad spending rose last quarter, while e-commerce platforms' ad revenue kept growing fast.

In the end the only thing left to count on is consumption, and whatever can stimulate it. But how much potential does consumption still have?

Charts by Feng Xiuxia and Gong Fangyi

Cover image from ROBIN WORRALL on Unsplash