Tech

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

Baidu claims its troubles with medical and health-care advertising are a temporary problem, and business will improve once regulations are figured out and advertisers return. That seems like a logical analysis.

Shares of China's biggest internet search engine dropped as much as 8.9 percent in extended trading after Baidu cut its revenue forecast for the second quarter because of the regulatory restrictions, and that's a logical response too.

Band-Aid
Baidu's stock took a hit after investigations into its medical and health-care advertising, and fell again as the impact on sales became more evident
Source: Bloomberg

It all came to a head last month when regulators, and China's state media, started pointing the finger at Baidu after one of its search-engine users died of cancer. The patient had used Baidu to find alternative therapies, which ultimately proved ineffective. Baidu was widely criticized, and quickly moved to clean up its advertising amid the investigation.

The fact regulatory issues may be short-lived, and that better-quality advertisers should return once the dust settles, doesn't change the reality that there are fundamental problems with Baidu's business model.

For a start, medical and health care accounts for a large slice of its overall revenue:

"Over half of our medical customers temporarily reduced or delayed spend on our platform while awaiting clarification of regulatory requirements," founder and CEO Robin Li told investors during a conference call Tuesday morning in Beijing.

The events of last month resulted in Baidu's second-quarter sales forecast being trimmed by 10 to 12 percent. Considering half the three-month period had already passed before the incident, its impact on revenue can be extrapolated to as high as 20 to 24 percent.

Li says "over half" -- but not all -- customers wound back spending, so it could be surmised that the category's contribution to sales is well in excess of 24 percent. Baidu's investor-relations team declined to provide a breakdown by sector.

Regardless, any amount over about 15 percent -- a not unusually high figure in the advertising business -- means a fair degree of reliance on one product category.

Another problem for Baidu is that compared to Google, its ad results and its search results are barely distinguishable. That's because of Baidu's pay-for-placement program, which, according to its own regulatory filing, is a core tenet of its business model. Cleaning up its medical and health-care search ads, therefore, will likely make Baidu's remaining ad inventory more valuable.

Sales Strength
Baidu's pay-for-placement ads have helped to drive revenue in past years, yet regulatory scrutiny could risk that business model
Source: Bloomberg

But that leads to a third problem, and one that will require more than a Band-Aid to fix. Once Baidu's health-care business is cleaned up, a host of new landmines await. Financial ads are another big part of its business, and Chinese consumers are just as eager to discover hot new investment targets as they are cancer therapies. Then there's food delivery, education, transportation and construction -- all industries where scandals could pop up at any time.

Chief Financial Officer Jennifer Li acknowledged as much in Tuesday's call, noting that Baidu is becoming more proactive amid "shortages of rules and regulations" in emerging sectors.

While such an approach is laudable, doing so under the company's existing pay-for-placement model, where organic and paid ads remain indistinct, seems more like a game of whack-a-mole than any meaningful revision of its business model.

Describing Baidu's troubles as temporary may be wishful thinking at best.

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:
Katrina Nicholas at knicholas2@bloomberg.net