The past few months have been confusing for companies trying to invest in Chinese Internet ventures.

In September, Wu Jichuan, China’s Minister of Information Technology, stated that foreign companies are barred from participating in the operation of Internet service providers and Internet content providers in China.

But in December, during an interview with The Wall Street Journal, Wu said that foreign entities must receive official approval from the Chinese government before investing in Chinese Internet sites.

China is also poised to become a member of the World Trade Organization later this year. If that happens, China would have to loosen its restrictions on the telecommunications market.

So what should you do if you’re interested in tapping into the vast Chinese market? Wait until the Chinese government offers greater clarity on its telecommunications industry or court the Chinese like other foreign companies have? If China is granted entry into the WTO, what opportunities will this give outside investors?
This two-part series will look at China’s stance on foreign investment in the Internet market and the current participation levels by foreign investors. In part 2, we’ll examine the role of foreign telecommunications companies in China.
Growth potential
The potential for businesses that invest in China is staggering. Since 1994, when the Chinese government established its first Internet connection, the number of Chinese online has grown to 10 million, according to Scott Savitt, editor of Beijing Scene, an online Chinese-English magazine.

A study by the International Data Corporation puts the number of Chinese online at 27 million by 2001 and predicts e-commerce transactions in China to soar to $4 billion by 2003.

Who’s online?
A survey conducted by the China Internet Network Information Center and translated by Virtual, an online publication that covers China, found that out of more than 52,000 responses, most Chinese Internet users, 39.9 percent, are between the ages of 21 and 25.

The number of people using the Internet between the ages of 21 and 35 is more than 78 percent. And 85 percent of Chinese Internet users are men.

The survey also found that nearly half of Internet users, 48 percent, were college-educated and were relatively well off by Chinese standards.

The survey also found that 84 percent of users acquired news online. Other information Internet users looked for included: software and hardware, 68 percent; online books, 52 percent; leisure and entertainment, 47 percent; science and educational, 41 percent; financial and security, 26 percent; and trade and commerce, 21 percent.

Who wants in?
For foreign companies that understand the demographics, it’s hard to deny the possibilities of the Chinese market, said Jeannette Noyse, an analyst with International Data Corporation.

“There are all sorts of equipment and service providers who are anxious to participate in the market,” she said. “There’s a lot of people who are interested in financing from the West, but they want some control. And that’s what China doesn’t want to give them.”

In the past, companies have worked around government restrictions by financing long-term equipment leasing and having some indirect investing, Noyse said. However, there hasn’t been as much investment in ISPs in China.

“That has been fairly controlled, and that’s where they’re anxious to get in and invest, but they’ve had a difficult time,” she said.

China and the WTO
Ultimately, the future of foreign investment rests with China’s membership in the WTO. Under the terms of an agreement reached between China and the U.S. in November, foreign companies would be allowed to invest up to 49 percent in Internet Content Providers and Internet Service Providers in China.

The deal still faces several hurdles: the U.S. Congress has to change China’s trade standing to Normal Trade Status. China must also reach trade agreements with both the European Union and Canada. The WTO then has the final say.

A “brutal” market…
Despite its potential, China is a difficult arena, said Steven Schwankert, director of China Operations for Virtual China and former president of

Generally, the Chinese partner gains the technological and managerial expertise of the foreign partner while the foreign partner has a chance to tap into the “fabled” profits of the Chinese market, Schwankert said. For a company to succeed, it must be able to produce a product that China can’t produce on its own.

“It’s brutal,” he said. “There are too many stories about companies that lost basically everything because their joint-venture partner backed out of their agreement once they learned what they needed to know to produce the same product on their own.”

…that has attracted investors
Despite China’s confusing stance on foreign investment in the Internet, many businesses have gone ahead and quietly set up shop in the hopes that further agreements will clarify the rules.

Jonathan Landreth, executive business editor for Virtual, said that such investment reflects the impatience of Western businesses with the Chinese government.

“A lot of Western companies, many of which are in Silicon Valley, already have Chinese operations in Beijing, but they don’t announce that,” Landreth said. “They’re just waiting for the regulations to be more clearly laid out before they say, ‘Oh yeah, we’ve got a Beijing office.’”

Or, as Schwankert puts it: “In China, it’s better to ask for forgiveness than permission.”

Who’s taken the plunge?
Plenty of foreign companies invested in the Internet last year. One of the most high-profile investments happened when Goldman Sachs, Chase Capital and several other venture funds invested in, the most popular Chinese- and English-language Web site in China.

In July, Hong-Kong-based , of which about 8 percent is owned by America Online, saw foreign investors buying shares during its IPO, and, in late September, Yahoo launched a venture in Beijing with Founder, a Chinese computer maker.

During the same month, Intel gained an equity stake in , an ISP based in China.

Even after Wu’s comments, December saw Pacific Century Cyberworks announcing a $60 million joint venture with NetCel to provide e-commerce service in China. And both Red Hat and LinuxOne —two Linux vendors—announced they would be releasing Chinese versions of Linux.

Landreth said it was no coincidence that the deal between PCCW and NetCel took place after the publication of Wu’s interview with The Wall Street Journal.

“The December interview made it appear as though China was prepared to at least discuss out in the open regulations about foreign investment in the Internet,” Landreth said. “It’s pretty uplifting news for those who are trying to get in.”

Some companies that have already invested are taking a wait-and-see attitude.

Dow Jones and Co, which publishes The Wall Street Journal, owns a percentage in

In response to a question submitted by TechRepublic to Dow Jones on how foreign companies feel about their Chinese investments, the company said, “we are awaiting the resolution of the internal Chinese government debate so that we can make sure that we comply with all Chinese laws and regulations. The details of how the Internet industry will be regulated—and which Chinese ministries will handle various parts of the regulations—still remains to be sorted out.”

Recent developments
Despite the risks, several foreign-funded Web sites have announced their launch since Jan. 1, according to Virtual China. The sites include those backed by Australia’s NewTel , China Digital Group, based in California, , created by a Denver-based software developer. , based in San Diego, is also developing a Chinese site.
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