Chapter 1: Loosing from the Starting Line

Chapter 2: To Invest More or Not

Local competitors did not give Yahoo opportunities to catch up. The only way to get ahead of competitors was through acquisition. After China entered WTO, the regulation for foreign investments to enter Internet industry was somewhat loosened. The door for Yahoo to buy in was opened.

In 2003, Yahoo came out of the shade of the first Internet bubble with the leadership of new CEO, Terry Semel. Yahoo started to focus on search engine business and began their worldwide competition with Google. The successful acquisition of Taiwan portal, Kimo.com, helped Jerry Yang make up his mind to look for a local partner in China. He hoped that Yahoo China's embarrassing situation in the past four years could be changed via a successful acquisition.

At that time, Baidu and 3721 were on Yang's radar screen. (Translator: See Part 1 - Introduction for 3721. And Baidu was the company later known as the Google of China.) Between the two, 3721 better suited Yang's appetite. According to sources closed to the deal at that time, though Baidu had good technology, its founder, Robin Li had higher hope for an IPO. His price for Yahoo was 150 million USD, while 3721's Zhou Hongyi asked for 120 million USD.

What Yang saw valuable was that 3721 had already become very profitable. 3721's revenue in 2003 was 200 million RMB and profit was 60 million RMB. And 3721's customer base was very attractive to Yahoo's future development. 3721 had 450 thousand small and mid sized enterprise customers. This matched Yahoo's global vision for potential future services  - search, e-commerce, broadband services, enterprise mail services, enterprise instant messaging, competitor analysis, etc. More importantly, after being rebuffed by the money market again and again, Zhou was much less intended to go public then Li. Or in other words, he was more willing to be bought.

History made Yang and Zhou came together happily. However years later, according to some Internet analysts, Yang's attitude toward China market at that time was still wait-and-see. And he still did not trust local management. In the market condition at that time, these factors determined that this partnership would be doomed. What only surprised everyone was how fast the departure came.

A Wavering Jerry Yang

According to Zhou, 3721 was not worth of 120 million USD. It was Alibaba and Ma Yun's acquisition intent raised 3721's valuation. In November 2003, Yahoo China announced the 120 million USD acquisition of 3721.

Another episode of the deal was that it was not easy for Zhou to get the money in its full amount. He had to satisfy several Yang's conditions.

According to the agreement, acquisition would complete in two years. Yahoo would pay 50% of the full amount at the beginning. The rest would be contingent upon the profitability of Yahoo China under Zhou's leadership. The agreement required Yahoo China to make 10 million USD profit in the first year to be able to get another 25%. The remaining 25% would require Yahoo China to make 25 million USD profit in the second year.

On March 22 of 2004, full of confidence, Zhou Hongyi, CEO of 3721 became Yahoo China's CEO. However at that time, what Yahoo China had was just a skin - the Yahoo brand. Everything needed to be rebuilt. And the foremost important problem in front of Zhou was: money!

Yahoo China never had a clear vision. To achieve longer term development or to make profit right away was never clearly defined by Yahoo headquarter. In Zhou's view, Yahoo's strong search engine business overseas had very little value in China. Therefore it was enormous pressure to associate Yahoo China's performance measure with the second half of the 120 million dollar investment. While in Yahoo headquarter’ view, if the investment had been in one shot, it would be hard to control Yahoo China's profitability and to motivate Zhou. According to Qi Xiangdong, a former VP of Yahoo China, Yahoo even could deliberately setup barriers for Zhou to meet the performance measure, therefore to reduce the cost of the acquisition.

"Don't think village leader is not leader"

(Translator: There are 8 billion rural populations in China. Villages are still the smallest social units among them. And Village leader is the lowest management level in Chinese society.)

The lofty Zhou once said: "Yahoo China will become the best search engine in China! We have only one competitor, Google."

However, in addition to inadequate investment from the headquarter; the internal development of Yahoo China was also behind the pace of the China Internet industry. Bringing into Yahoo his 200-people team, Zhou started reform in Yahoo China immediately and heavily. He had three major goals: to internationalize Chinese web surfing (Translator: not sure what this means), to localize Yahoo search technology, and to heavily promote Yahoo mail in China.

In addition, Yahoo China started tackling ecommerce, instant messaging, search, and email service. On June 8th, Yahoo launched a new version of its IM software, Yahoo Messenger 6.0 Chinese Edition. On June 21st, Yahoo China's independent search site, YiSou (Translator: Uni-search translated into English.), was launched. On July 26, Yahoo China was the first to expand its mail box quota to 1G.

Zhou’s philosophy was to focus. He killed several content channels that Yahoo had not been good at in the past. Targeting white-collars, he heavily promoted topics such as real estate, automobile, entertainment, and sports. Zhou ignored Yahoo headquarter’ firm belief on being a portal site. He put limited resources into mail and search. His radical attitude won him a name of "Yahoo Barbarian". Different vision on Yahoo's future became a time bomb between Zhou and Yahoo headquarter.

When upper level discordance started to emerge, merger between the employees of the two companies was not smooth either. Some opinion was that rather than saying that Yahoo China acquired 3721, it was indeed 3721 with 200 employee acquired Yahoo China with 50 people. And it was a fact that Yahoo China's employee moved from Huarun Building to Heqiao Building, where 3721 was located.

Because of enormous performance pressure, Zhou could not care less about the rumor on who bought who. He understood acquisition failure often came from the failure of merging different company’s cultures. Zhou was determined to solve the problem with his own way. He intended to wash out Yahoo China's intrinsic bureaucracy as a multi-national company, with a startup culture of "Forge ahead, run forward and quick response". Strong-minded Zhou believed company should motivate people with culture, not procedures.

To be able to quickly merge employees from two companies together, Zhou spent huge amount money to fly the entire company to Sanya, Hainan province (Translator: An island city in South China sea with a Hawaii like setting.) for a one-week team building event. To be able to really win his people's heart, Zhou used the most 'Chinese' way of relationship building - drinking alcohol with former employees of Yahoo China. "That was not a gentlemen style tasting. It was 'no-drunk-no-back'" Zhou recalled. In the end, Zhou got drunk, fell into a swimming pool and lost two teeth.

All of the above paid back nicely. Yahoo China became profitable in 2004 with 40 million USD revenue and 10 million profit. Zhou's effort made the industry feel the influence of this Internet giant again. In Zhou's own words "Don't think village leader is not leader!"

Seemingly Yahoo China gradually found its direction. However, behind that transient success, the conflict between Zhou and Yahoo headquarter was getting worse.

A Doomed Partnership

During Zhou's first year, Yahoo headquarter supported him fully. And Jerry Yang turned a blind eye to Zhou's "barbarian behavior".

For instance, Zhou did not get along with Yahoo China's senior management of finance, HR, and legal – those who did not support him. He directly asked the headquarter to replace them, headquarter agreed. Without getting a quick enough approval from the headquarter, Zhou decided by himself to not heavily promote search any more on Yahoo China homepage, instead, he launched an independent search portal "YiSou". Because this was not agreed upon by headquarter, Zhou allocated 3721's money rather than from Yahoo China as this project's early investment. Yahoo acquiesced again. However, Zhou still felt being restricted by Yahoo headquarter.

"After getting into Yahoo, we became their employees and entered their bureaucratic system. There were a dozen layers above me. I was at the lowest level. There was even no way to have dialogue with him on an equal footing. Don't even mention about strategy. My task was to meet his numbers every quarter. We built YiSou, 1G mailbox voluntarily, with entrepreneurs’ motivations. We acted before reporting. The company grew from 200 people to 600, only with 3721's resources." Zhou complained to IT Time.

The reason why Yahoo supported Zhou's "barbarian actions" was that Yahoo China met their 2004 numbers. However, on top of what had been recognized in year one, Jerry Yang set a higher bar for Yahoo China to meet in 2005: overcome Baidu to become the number one search engine, and a significant expansion of Yahoo mail’s user base.

However Yahoo headquarter did not allocate additional investment to support the raised performance measure. This meant the new development had to be supported by Yahoo China's profit. Of course Zhou would not agree on this arrangement. He strongly requested Yahoo headquarter to increase budget. With a wavering China strategy, Jerry Yang could not approve Zhou's requests. The conflicts between Zhou and headquarter were gradually becoming publicly visible after Yahoo's fiscal year budgeting process.

Yahoo started their fiscal year budgeting process in June or July. Zhou realized that the budget for the new fiscal year did not have cash investment in China market. He wasn't very much agitated at that time, because the budget would be finalized in December. However, after Yahoo China launched 1G mailbox in July 2004, they did not make any big moves. This time point coincided with the time when budgeting process started. Zhou started to watch, though he was still hopeful.

In December, there was no sign that the budget would get changed. In early 2005, Zhou started a series of negotiations with Yahoo. According to Zhou, he proposed two alternatives during the negotiation: The first, acquisition condition would remain unchanged, but Yahoo needed to allocate some additional investment for the long term development of mail and search service; or the second, agreement would end early with an acquisition valuation lower than the initial price. Yahoo headquarter disapproved both proposals.

Yahoo gave Zhou another proposal: Zhou and his team would stay with the company; Zhou's share would be paid according to the original agreement; however Zhou should not interfere Yahoo acquiring other stock holders' shares. (Translator: not very sure about this translation.) This time it was Zhou who disagreed.

The intense negotiation lasted five months. One Yahoo employee later recalled, once after an intense dispute with the headquarter over long distance call, Zhou shattered his office's glasses. Yahoo China's business was adversely impacted by this situation. There was virtually no new development in the first half of 2005. Management team only spent time arranging their own businesses. Some even went vacation trips together. Employees were aimless and even panic.

Indeed what Zhou asked for was somewhat reasonable. After intense discussion among Jerry Yang and other Yahoo top executives, the board agreed long term development should be the goal for Yahoo China. And they agreed to invest 5 million USD in addition to the 120 million acquisition. However, by May 2005, China Internet market had made remarkable change again. For instance, sdo.com (Translator: One major game developer in China.) became the biggest share holder of Sina; and Netease quietly strengthened their content offerings. For Yahoo, more competition emerged.

Five million USD was far from enough for Yahoo China to reach its goal. According to some industry experts "Internet acquisitions today were all in the range of ten million USD. Yahoo China's money could not buy anyone - they could only develop internally. Obviously that would be too slow."

The final result was that Zhou quitted and the acquisition agreement ended prematurely. In total, Yahoo paid 3721 share holders 90 million USD. And 3721 belonged to Yahoo China. Zhou confirmed that he would leave Yahoo China on August 31.

Seemingly found its direction, Yahoo China let its promising future slipped away because of the hesitance from the headquarter about whether to invest more or now. While at the same time, Sina, Sohu, Netease and other portals were getting wildly profitable via wireless value added services.