Baidu is facing a hard time boosting its bottom line -- the 34 percent plunge in net income for the second quarter was the fourth decline in 18 months.
Tougher rules on placement of ads for medical and financial services have crimped growth, and founder and CEO Robin Li told investors Friday it could take another three quarters before revenue recovers.
But the challenges of regulation and ad sales are masking a deeper problem that's hurting Baidu's bottom line. Traffic acquisition costs have climbed almost ninefold since early 2012 -- outpacing revenue growth -- and are now the internet search engine's second-largest line item behind sales, general and administrative expenses.
So the company that proudly trumps its technology and is boldly marching toward an era of self-driving cars and artificial intelligence now spends more money attracting eyeballs than it does on research and development.
If there's a lesson in the importance of R&D, take a look at Apple. Bloomberg View columnist Leonid Bershidsky this week pointed out that the iPhone maker now spends less on R&D than Samsung or Alphabet (aka Google), noting that Samsung's earnings growth remains robust while Apple just posted its second straight drop in net income.
For nine consecutive quarters, Baidu cited increased promotions through its hao123 internet directory service as one of the reasons for the jump in traffic acquisition costs. Ironically, given this week's fire sale of Yahoo assets, hao123, which was founded in 1999, was described as being similar to Yahoo! Directory when it was bought by Baidu in 2004.
The fact Baidu spends more money to drag users to services such as a decade-old web directory than it does on next-generation technology says a lot about Li's strategic priorities. And remember that it was Li himself who attempted to spin off the company's unprofitable but nascent video-streaming service when that's one of the few business models able to continually extract profits from online content.
I understand Li's predicament: without eyeballs, Baidu's portfolio of web properties is worthless. Yet spending to get those eyeballs is hurting Baidu's future. Traffic acquisition costs increased 38 percent year-on-year last quarter while R&D declined 9.1 percent, having recorded its first-ever cut in spending the prior period.
With traffic acquisition costs now equal to 15.9 percent of revenue -- double four years ago -- it's clear weak profit growth can't just be blamed on regulatory problems. What's also important to remember is that such spending doesn't buy long-term loyalty, whereas developing must-have technologies makes a company's products sticky and irreplaceable.
During an interview I did with Li in Beijing last year, he bemoaned the fact that investors didn't understand China's coming boom in non-search internet services. It was an understandable complaint, and his call for shareholders to be patient as Baidu transformed sounded reasonable.
And yet sacrificing the long-term future of R&D investment to prop up traffic at a 20th century website doesn't seem like Li's heeding that call.
If Li isn't listening to his own advice, one wonders why investors should.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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