Baidu (NASDAQ:BIDU), the tech giant that owns China's top search engine, shed nearly 20% of its market value this year as its core advertising business stopped growing. The economic slowdown in China, competition from other platforms, and tighter government regulations for the fintech, gaming, and healthcare industries all caused advertisers to buy fewer ads on Baidu.

However, Baidu continued to expand into other markets, including cloud services, driverless cars, mini-programs, AI, voice search, and smart speakers. Within those newer businesses, smart speakers became a major growth engine for Baidu over the past year.

Alibaba (NYSE:BABA) led China's smart speaker market last year, but Baidu surpassed Alibaba in total shipments this year. Baidu shipped 11.5 million smart speakers in the first three quarters of 2019, according to Canalys, while Alibaba shipped 11.2 million speakers. Let's discuss the three reasons Baidu is overtaking Alibaba in this high-growth market.

Baidu's Xiaodu Zaijia smart screen.

Image source: Baidu.

1. DuerOS

Baidu launched its first voice assistant, DuerOS, four years ago. Like Amazon's (NASDAQ:AMZN) Alexa, DuerOS accesses a growing list of services like online search, delivery, ride-hailing, and streaming media. It now runs on mobile devices, connected cars, home appliances, and smart speakers, thanks to dozens of partners that integrate the OS into their hardware devices.

The expansion of DuerOS, along with the launch of Baidu's first-party Xiaodu smart speakers, boosted the platform's total number of users from 100 million last August to 400 million in July. Last quarter, Baidu revealed that monthly voice queries on DuerOS had more than quadrupled annually to 4.2 billion.

The growth of DuerOS attracts customers in the same way as "Alexa-enabled" devices attract shoppers in America -- consumers who are already tethered to one voice ecosystem will likely buy additional devices to expand its reach across their homes.

Alibaba's Tmall Genie smart speaker also links to its voice assistant AliGenie. However, that assistant is more often used to buy products from Alibaba's e-commerce marketplaces instead of accessing a wider range of services like DuerOS. Alibaba doesn't regularly disclose its total number of AliGenie users or voice queries.

2. A more cohesive ecosystem

Baidu still controls 63% of China's online search market, according to StatCounter. It also owns the country's top mapping service, Baidu Maps, which can be accessed via DuerOS. Voice queries on Maps notably doubled year-over-year last quarter.

Baidu also has a growing ecosystem of Mini Programs -- which access external services like ride-hailing, deliveries, and more -- within its mobile app. Last quarter, daily active users on its mobile app rose 25% annually to 189 million, while monthly active users for its mini-programs grew 157% annually to 290 million.

Alibaba's mobile search engine Shenma only controls 7% of China's search market. Alibaba-backed AliPay also offers mini-programs in its mobile payments app, but it's unclear if it reaches more users than Baidu. Earlier this year, AliPay claimed that over 230 million people used its apps daily.

Baidu's mobile app and AliPay are both integrated with their respective voice assistants. However, Baidu's leading position in online search and maps -- along with DuerOS' expansion across first- and third-party hardware devices -- arguably give it an edge against Alibaba's commerce-oriented services.

Baidu's Xiaodu Zaijia smart screen.

Image source: Baidu.

3. Low prices and aggressive marketing

Baidu acquired smart speaker maker Raven Tech in early 2017. It launched its first Raven smart speaker in late 2017, but shoppers scoffed at its initial price of 1,699 yuan ($243).

Baidu went back to the drawing board and launched its much cheaper Xiaodu speakers last year. It priced its basic model at 249 yuan ($36) but often sold it for just 89 yuan ($13) during promotions. That cheap speaker sparked an aggressive price war between Baidu and Alibaba, but the latest market share figures indicate that Baidu is holding its ground.

Baidu stuck with big promotions for its newer devices, including its Xiaodu Zajia smart screen, which was priced at 599 yuan ($86) but launched at just 299 yuan ($43). Baidu is clearly selling these speakers at losses to gain market share, just as Amazon repeatedly offers big discounts on its Echo devices to lock in users.

However, Baidu's new Xiaodu Smart Display X8, which costs 599 yuan, recently launched without a discount -- which indicates that it could finally stop subsidizing its speaker sales as it overtakes Alibaba.

The key takeaways

Baidu generates less than 1% of its revenue from smart speakers, and the business is still likely operating at a loss. However, the speaker gives it a valuable foothold in a growing market and expands its search ecosystem well beyond PCs and mobile devices. Alibaba will likely remain a fierce rival in this market, but there's probably plenty of room for both companies to grow without stepping on each other's toes.