Baidu (NASDAQ:BIDU) has entered into the type of symbiotic business relationship that I love to see from companies I own shares of. It recently announced a partnership with Amazon.com (NASDAQ:AMZN) that would make its search engine the default option for Amazon Kindles sold in China. The deal is also rumored to include cooperation between the two giants on search services, distribution, and video content. This agreement is low risk and provides significant potential upside for both businesses while strengthening a relationship that may become even more critical in the decade to come.
China is a tough nut to crack
The success of China's own companies shows how hard it's been for foreign competitors to get a foothold, much less a dominant position, in the country. Alphabet's Google has become the nearly ubiquitous search platform in most of the developed world. But Baidu, a Chinese company, has managed to largely stave off foreign competition to maintain a healthy lead in domestic search engine market share.
Google has been rumored to be returning to China in a Shanghai Free-Trade Zone and surely has its sights set on becoming more relevant in the world's largest Internet market. The Chinese government, which has a great deal of control in determining access for foreign countries, surely has interest in seeing one of its own prosper against a foreign concern. Amazon can use this situation to get deeply embedded in Chinese economic life by offering Baidu a better chance to fend off Google.
A small entree is generally all Amazon has needed to succeed in the past, and I think this is true for China as well. Baidu will make it easier for Amazon to get its reasonably priced tablets (around $78) into the hands of millions of Chinese consumers. The first point of contact with these consumers may not pay dividends for many years, but Amazon is playing the long game. It will continue to invest in its China business, slowly present more compelling reasons to become an Amazon customer, and try to erode the market and mind share of its largest competitor.
Nice to rib Google
Amazon and Alphabet are two of only a small handful of significant players in Web hosting services. Amazon's AWS business has already become a multibillion-dollar business, with enviable margins to boot. We are poised to see more intense competition emerge between these two and others such as Microsoft and IBM in the coming years.
A strong Google presence in China will make Alphabet a more difficult competitor to deal with in areas where Amazon already does (or has plans to) go head-to-head. Google's dominance appears to be absolute in the United States, most of Western Europe, and highly developed Asian countries such as Japan and South Korea. While there will be small opportunities for Baidu to take market share elsewhere, such as India and Brazil, its future seems predominantly tied to China. If Amazon can help and prevent Google from landing the biggest jewel on the crown, it would be a win-win partnership between Seattle and Beijing.
Search dominance is Baidu's backbone
Baidu already understands that its long-term future doesn't lie exclusively in online search. Online-to-offline business, or O2O, which the company recently designated as "Transaction Services," is the largest growth opportunity according to CEO Robin Li.
The company is investing aggressively in these new initiatives. Laundry, movie tickets, restaurant reservations, and takeout require thousands of local partnerships. This drain of time and money is reflected in the recent hit to Baidu's bottom line, which caused traders to bid down the stock to around $135 in late September.
It's possible that Google will eventually overtake Baidu as the main search provider in China. I still like Baidu's chances, but this is a possibility its shareholders should nevertheless consider. If this happens, it will be important that Baidu's Transaction Services is already up and running, profitable, and harder to disrupt than the legacy search business. Being the default search engine on Amazon's tablets may help this become reality. If not, the downside from this partnership is almost nil, and I commend Li for fostering this relationship.
Optionality is key for both businesses
Part of the reason I like Amazon and Baidu so much is the amount of optionality, or different directions they can take, baked into both companies. We've already seen Amazon's move from online bookseller, to seller of just about everything, AWS, and whatever else is coming down the pike in the decades to come. Baidu is already one of China's great businesses and is in the process of morphing and somewhat self-disrupting so that it may continue to be an even bigger and better business 10, 20, or 30 years from now. It's difficult to model the future prospects for companies like this, but the rewards for patient shareholders could be substantial.
James Sullivan owns shares of Amazon.com and Baidu. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, and Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.