Tech

Tim Culpan is a technology columnist for Bloomberg Gadfly. He previously covered technology for Bloomberg News.

At first, Terry Gou didn't think he had a serious problem. Six years ago, after three of the 800,000 workers he employed at Foxconn Technology Group in southern China committed suicide, Gou was feeling guilty, but not entirely responsible.

Baidu's Robin Li may be experiencing a similar set of mixed emotions. A user of the search business Li built died of cancer after seeking an alternative treatment that was advertised on the search engine and proved ineffective. The victim, his family, netizens, the media and the government have all blamed the company.

Unhealthy News
Baidu's shares took a hit after regulators and state media started probing accusations that its search engine directed consumers to unauthorized cancer treatments
Source: Bloomberg

If there's good news for Li, and for Baidu's customers and investors, it's that he seems to have learned within weeks what it took Gou months to understand: The facts are irrelevant.

That Foxconn's suicide rate, even at its peak, was far lower than the national average was just as irrelevant back then as the fact that Baidu neither caused, nor claimed to cure, a young man's rare form of cancer this year.

Yet it didn't take long for Chinese state media, which often functions as a government mouthpiece, to excoriate Foxconn for its working conditions and pay rates. From there, it was only a matter of time before the government would leverage the outcry and have Foxconn raise wages, and then embrace national policies that included decentralizing from the rich southern cities and creating jobs in poorer inland regions.

For Baidu, which is accused of introducing a cancer patient to unauthorized treatment via its search engine, the China Daily laid out the issue clearly in a May 1 commentary:

"The controversy falls on allowing companies who pay more to appear high on search result rankings, even when such companies may not be qualified to provide the service." 

With Baidu's business model so solidly based around auctioning off placements in its search results, the implications were clear, and the shareholder reaction brutal. The stock dropped 7.9 percent the day after that commentary, and is down 13 percent since then.

That the controversy surrounds health-care advertising is particularly troubling, because that's a large and lucrative market for Baidu.

After a swift investigation by China's Internet regulator, Baidu agreed on Monday to limit sponsored posts and set up a fraud-fighting fund. 

The China Daily followed up, saying in an editorial:

"Other changes can be expected both in the practices of the internet industry, and in the rapidly growing, though at times messy, medical services contracted by public hospitals to private practitioners."

It would be easy to conclude that these changes will be bad for Baidu, just as boosting wages and moving inland might have hurt Foxconn. Yet a rise in both profit margins and shares of Hon Hai, Foxconn's Taipei-listed flagship, bely that analysis and hint at a path for Baidu.

Foxconn Fights Back
Shares of Hon Hai recovered after suicides prompted wage rises and a move toward inland China
Source: Bloomberg

In both cases, the targeted company is the largest in its sector, and thus the leading choice for clients. While Foxconn soon had to start sharing more Apple orders with rivals, its size allowed the company to carry the burden of wage increases and inland expansion better than smaller manufacturers, and even pass those costs on to customers.

Foxconn went further, boosting automation and increasing employee training, resulting in better margins and deeper engagement with clients.

Gentle Rebound
Operating margins at Foxconn flagship Hon Hai were already falling before wage rises and new factories boosted costs following suicides, but they've since rebounded
Source Bloomberg

Li also recognized the need to clean up the quality of what Baidu does actually display. ``If we lose the support of users, we lose hold of our values, and Baidu will truly go bankrupt in just 30 days!" Reuters cited Li as saying in a letter to employees this week, imploring them to put values before profit. ``It's the long-term way!"

While values before profit might sound like an emotional outburst, it makes economic sense. Baidu cutting the size of its ad inventory to fit with new restrictions won't in itself reduce the number of advertisers wanting to participate. Rather, it will make the available slots rarer, and so more valuable. 

At the same time, it's likely to make Baidu's product more credible and spur consumers and advertisers to place greater value on the search engine, even if some of the dodgier advertisers have to be cut off.

When that happens, Baidu's investors may be happy that Li learned a Foxconn-sized lesson.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tim Culpan in Taipei at tculpan1@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net