A Great Leap Forward?

As legend chairman Liu Chuanzhi prepared to sign last week’s Internet deal with AOL Time Warner, he jokingly made a show of trembling hands to confidants. His gesture had a serious undertone. The $200 million agreement between these two strong-willed partners makes both sides nervous. Eighteen months in the making, it links behemoth AOL, the most visible symbol of American new media prowess, with Legend, a government-nurtured start-up that has grown to become China’s most successful computer maker.

Although China still hasn’t joined the World Trade Organization, this deal can be viewed as a WTO walk-up, a signal of what life might be like once China becomes a member. Upon entry, China has agreed to open its Internet market to foreign participation, making possible previously unthinkable arrangements like the AOL-Legend link. And for the communist officials who run China, you can’t get much more foreign than AOL Time Warner, a $40 billion company with a broad array of interests in the Internet, movies, cable and publicationsnone of which hews to a government line. “This is a classic example of the importance of the WTO to company decision-making,” says Matthew McGarvey, an Internet analyst at International Data Corp. in Beijing. “The deal is basically an intention by two debutantes to engage long term. To what degree it will be carried out is yet to be seen.”

If it works, the venture could introduce a new Internet business model to China, one that combines content with services like chat and instant messaging, as well as online access. For AOL, which already has a presence in 17 countries, the venture is its most ambitious in Asia. China is potentially the world’s largest Internet market, but so far Net companies aren’t finding it profitable. The partners haven’t ruled out buying a controlling stake in one of the country’s troubled portals. But for now, the idea is that Legend’s PCs will be sold Internet-ready for the home market, with easy-to-follow instructions to get buyers quickly up on AOL’s trademark services. To help attract Chinese surfers, the partners plan to offer 12 months of free Internet service with every computer before moving to a monthly subscription modela challenge in China since consumers are used to pay-per-minute Internet access.

AOL could scarcely have found a more muscular partner in China than Legend. The computer maker dominates the country’s home-PC market, with a 40% share. (Sales totaled $2.2 billion last year.) Legend’s chief financial officer, Mary Ma, the company’s main negotiator on the deal, says the Chinese firm initiated the courtship. Legend, she says, was convinced that, with the WTO’s open market pending, it needed a sophisticated foreign partner to help differeniate itself in the market.

One underlying question for AOL is how an Internet company dedicated to the free flow of information can operate in a tightly controlled country. Beijing routinely blocks websites, including this magazine’s, that report on what’s happening in China, and it is intensifying a campaign against cybercafEs, closing down almost 2,000 in the past few weeks. AOL’s CEO Gerald Levin, who flew to Beijing for the announcement, stressed in a press conference that the company’s commitment to editorial independence applies “to the journalistic enterprises within our company from TIME magazine to CNN,” while AOL’s communications service “respects the cultures and the different regulations in each country.” A Legend executive notes cheerfully that AOL’s filtering software, used in the U.S. by parents to keeps kids from accessing pornography, will be useful for keeping out “the political things.”

Despite the culture clash, the partners hammered out the basic framework for the venture at their first formal meeting, a whirlwind visit by Legend’s top executives to AOL’s Dulles, Virginia headquarters in June 2000. They decided almost immediately that it would be an equal partnership, according to Legend CEO Yang Yuanqing. (To comply with current China law, Legend will have a 51% stake.) The partners also quickly agreed on a business model that would combine Legend’s hardware and AOL’s Internet services. “There were problems throughout the negotiations,” concedes Yang. “But from the beginning, both sides had a clear direction.”

The deal ratchets up the pressure for China’s struggling former Internet darlings such as Sohu, Netease and Sina to find powerful foreign partners of their own. Even as they cope with serious internal troubles, executives from Sina and Netease shared a table at the AOL-Legend celebratory banquet in Beijing, which struck some as a symbolic wake for China’s early homegrown Internet businesses. Now all will be watching to see if this new venture can figure out what those ventures never could: how to make money.