Caught in the Chinese Web

NEW YORK (TheStreet) -- A few months ago, when Facebook was rumored to be close to a deal with Baidu (BIDU) about setting up a joint venture.

At the time, I said I thought that it was a smart move on the part of Facebook (although the rumors of the day then said it was something that Mark Zuckerberg was insisting on over objections by Sheryl Sandberg). I remember a friend of mine, Bill Bishop, an American venture investor based in Beijing, was very skeptical at the time of such a deal working out. Bill pointed out then on his blog how many American Internet JVs had driven on the rocks of China over the last 5 years.

I was reminded of Bill's thoughts last week when I watched an interview of Qunar co-founder, Fritz Demopoulos, who recently sold his Chinese travel business to Baidu.

Fritz is a German, who got his MBA in the U.S., and then promptly went to China. He started two companies over there in the last 10 years. He has a unique perspective on the country and what it takes to succeed there.

Fritz says flat out in the interview that he doesn't think that any U.S. internet company will ever be successful in China through a JV.

His reasoning was pretty simple. Even six years ago, China's infrastructure was pretty immature vs. the U.S. Remember that was the time when Jack Ma sold 40% of his company for $1 billion to Yahoo! ( YHOO). Baidu and Tencent were early days. Sina ( SINA) was a boring AOL ( AOL)-type company.

When big U.S. brands came to China -- whether MySpace or Google ( GOOG) -- they brought capital, know-how and coolness.

That Was Then

Today, things are much different in China. The market is flooded with capital. Any private company with a decent business plan can come up with some money.

There is tremendous technical talent available and it is much cheaper than in the U.S. It is getting a little competitive for the best talent in Beijing, Shanghai and Shenzhen but the costs are still far lower than the U.S. and the supply is very high.

Know-how is not really an advantage either for U.S. firms. Quite often, they know nothing about how to win in China. They assume their model, which made them successful in the U.S., can be simply grafted on to China. But it can't. Ask eBay ( EBAY) that turned tail and ran after getting beaten badly by Alibaba Group's Taobao. Ask MySpace China. Ask Groupon how their joint venture is going in China.

In fact, what seems to hurt the American companies the most in China is their over-confidence and laziness.

Is there a coolness advantage for American firms? Maybe. In the Facebook example, there might be some validity to that. Many Chinese have lots of friends outside of China they want to connect with and who are likely already on Facebook. It is unlikely that many of them are going to set up accounts on Sina Weibo or RenRen ( RENN). Therefore, if Facebook was to strike a JV with Baidu, I'm sure there would be many Chinese who would be interested because of the coolness factor.

Facebook's Chances

But keep in mind that the Facebook JV in China might be a very different experience than what you and I think of as Facebook today. Facebook and Baidu would have to jump through many hoops to convince the Chinese government that this JV would meet the standards set by the government. That would mean much stricter controls over expression than what exist today on Facebook.

It appears that Mark Zuckerberg has no problem accepting such limitations. But how would the Chinese users react? They might be so disappointed with the watered-down version of Facebook compared to what they expected that they might decide that the RenRen homegrown version is acceptable enough to keep using.

And don't forget the difficult aspects of making a JV work between two high-powered corporate partners even when there's not cultural differences. Baidu -- who has been very successful in the Chinese market -- would likely have strong views for Facebook on how to succeed in China. Facebook might chafe at being told how to be social by a company that's never been all that successful in social itself.

And then there are all the regulatory requirements to contend with in China. Google came to China and ended up doing quite well in search -- simply because the quality of its search was quite good compared to Baidu. Yet, Google left China because its co-founders couldn't accept dealing with the onerous regulatory requirements.

Yahoo!'s Lessons

The most successful American in China in the last 10 years -- arguably, of course -- is Yahoo! But that wasn't a JV. Yahoo! was lucky enough to back the right horse in Jack Ma of Alibaba. They got a heck of deal in taking 40% of his company for $1 billion (with Jack's consent of course). But even in this success, Yahoo! has found out that success in China can come at a cost.

Jack Ma removed the profitable Alipay unit from the ownership of Yahoo! earlier this year. After Ma had received some assessments that Alipay could be worth $30 billion if it was a public entity, he opted to compensate Yahoo! and Softbank (owners of 70% of Alibaba Group) $50 million for Alipay with a potential earn-out for the Group owners with a cap of $6 billion. Ma and his Alibaba Group management team decided to take on the rest of the upside to Alipay.

American Internet firms should JV at their own risk in China.

At the time of publication, Eric Jackson was long YHOO, SINA and Tencent.

Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.

Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.

He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.

You can contact Eric by emailing him at eric.jackson@thestreet.com.

More from Technology

For Amazon, Fox's Regional Sports Networks Spell a Unique Opportunity

For Amazon, Fox's Regional Sports Networks Spell a Unique Opportunity

Facebook Is Experiencing Outages, Stock Rallies Anyway

Facebook Is Experiencing Outages, Stock Rallies Anyway

FAANG Anxiety Roars Back as Investors Search for a Bottom

FAANG Anxiety Roars Back as Investors Search for a Bottom

Jim Cramer's Advice for Investors During a Bear Market

Jim Cramer's Advice for Investors During a Bear Market

Nvidia Stock Falls Another 12%

Nvidia Stock Falls Another 12%