What can a business do when a tightening of government policy hits its industry hard? Zhou Xin, chairman of New York Stock Exchange-listed real estate services company E-House China, sees such a time in the real estate industry as an opportunity for strategic reevaluation. On April 23, E-House announced that its merger with China Real Estate Information Corporation (CRIC) had been completed, with the latter delisting from the Nasdaq and becoming an E-House subsidiary.

CRIC had been established jointly by E-House and the well-known web portal SINA in October 2009 through a spin-off of E-House and SINA units. E-House China had revenue of US$400 million in 2011, while CRIC had revenue of US$240 million. With the merger, SINA became E-House's biggest shareholder, with 25% of shares.

In an exclusive interview with China Knowledge at Wharton, Zhou talked about the strategic considerations behind the merger, the O2O (online to offline) model in real estate e-commerce and the huge potential for integration between the Internet and the offline economy.

An edited transcript of the conversation follows.

China Knowledge at Wharton : The real estate market has gone through a tough stage owing to tightening policies in recent years. How do you view the past, present and future of the real estate industry?

Zhou Xin: In the last decade, the real estate industry experienced rapid growth, thanks to China's opening policy, the government's housing reform policy from the late 1990s, and especially the fast pace of urbanization and Chinese people's demand to raise their living standards. Consolidation is needed to balance such rapid development. Therefore, this round of controlling policies was expected from the macro level. I believe the issues will be resolved during the industry's next development stage. Recently, real estate prices have declined, and their staying low for consolidation will be the trend for the next few years. It will be hard for the market to pick up due to tightening pressure from the government, which has clearly expressed its determination to control the property market. However, it is also hard for prices to fall, as local governments face severe challenges of loss in land auctions and high relocation costs. For this year, the property market faces pressure to move upward and a lack of incentive to go downward.

Going forward, urbanization and rural-to-urban migration will remain the major theme for China's economy, and people will continue to pursue higher living standards, especially improvements in housing. Therefore, real estate will continue to be an important engine for China's growth.

China Knowledge at Wharton : You have said that industry flux is an opportunity to reevaluate strategies. How do you deal with major changes in the macro environment as an entrepreneur?

Zhou: As an entrepreneur, the primary concern is to survive. After that, you will always have opportunities to think about the next strategic step. An entrepreneur always needs to have a sense of crisis.

Generally speaking, when a company is going full speed, you are enjoying the strategy premium of the past. For example, Apple today is consuming the corporate strategic premium that Steve Jobs left behind. In a time of rapid growth in the business, an entrepreneur usually is too busy to think about potential challenges and new strategies. But when market conditions are not so good, how would you achieve the next strategy premium if you didn't think hard, prepare and adjust today?

China Knowledge at Wharton : E-House was listed on the New York Stock Exchange in 2007, and in October 2009 E-House and SINA spun off their real estate business units to form CRIC and list it on the Nasdaq. At the end of last year, E-House announced the merger with CRIC, with the deal completed recently, and CRIC became an E-House subsidiary. What was your thinking behind the listing of the two companies, and the recent delisting and merger?

Zhou: I have a few personal understandings of capital. First is to listen to the opinions of experts, for example Neil Shen [the Sequoia Capital board member who invested in E-House] and Charles Chao [SINA's CEO]. On the other hand, capital is intended to serve corporate strategy.

E-House's listing in the United States was a landmark for the company to position itself in brand-building and capital-raising. CRIC's listing was to combine our database with SINA's Internet service. The recent merger is to integrate our business in the real estate industry and to follow the trend of performance-based advertising and channel marketing. It is an important step for E-House to transform to a real estate e-commerce platform that integrates both online and offline service.

In my view, capital is a tool, and an initial public offering is a means instead of a goal. I don't consider myself to be particularly sharp in the capital market. I only see the capital market from a CEO's point of view. First, we must come up with a corporate development strategy, and then make financing decisions centered on that strategy.

China Knowledge at Wharton : E-House China is a rare case of a traditional real estate agency with an Internet gene. You not only jointly established CRIC with SINA, you also formed a strategic partnership with Baidu, China's dominant search engine. E-House also launched the property transaction platform eju.comlast year, and opened the platform to developers and other property agencies as Eju Online Union. How should we view the concepts of the real estate online to offline platform and the relationship between the traditional agency and the Internet platform?

Zhou: I want to ask two questions first: What is the relationship between the online and offline economy? And what is the relationship between e-commerce and the offline business model?

The first question I answered back in 1999 during the Internet boom. I was discussing this with [Sohu CEO] Charles Zhang in a forum in Shanghai. He said the Internet was a portal and I said it was a tool — the offline economy is the safe harbor of the Internet industry.

For the second question: In China in the last decade there has been a phenomenon where e-commerce usually sells niche and discount products, which led to the wrong impression that the Internet and traditional industries can be isolated in their development. For an online startup, the first step is to build a website. The second step is to buy traffic with a large investment in online ads and customer acquisition. People rarely mention the third step, which is to integrate online and offline businesses. The result is, after years of development, e-commerce companies like Taobao [China's largest e-commerce company, with 70% of market share] and 360Buy [with 20% of market share] have found that there was a critical link disconnected, which is logistics and the distribution system. That's why 360Buy is making a heavy investment in a logistics system when it's still running at a loss.

Let's now look at traditional companies. Traditional companies are envious of the rapid growth of Internet firms. Taobao sold 3.36 billion yuan (US$527 million) of goods during the November 11 promotion day last year, much bigger than the volume a midsize retailer gets in a year. That's why many retailers hope to develop e-commerce. There was a CEO of a retail company who invested a few hundred million in building an e-commerce site that ended in failure. Why? Because there was no traffic to visit its website. At the moment, the cost for an e-commerce company to attract a new customer is about 200 yuan (US$31). I joked to [the retail company CEO] that it would work better to give [out cash to each] person at the entrance of the mall. To build a website is easy, but where do you get the traffic?

The development of E-House in recent years made me realize that we have walked a path where online meets offline. Online sales for property is actually the hardest among all niches, because real estate is big, immovable property; it takes a long time for customers to make a decision, and the transaction target is big. There are other issues involved, such as credibility.

However, the organization of E-House has its unique advantages. First is low traffic acquisition cost. SINA is our biggest shareholder now. Through investment or strategic cooperation, we have controlled the traffic entrance of real estate channels for both SINA and Baidu [the dominant players in portal, micro-blog and search platforms]. Second, our cooperation with SINA [house.sina.com.cn] is an independent real estate information platform itself. Apart from advertisement, it can help channel traffic to other platforms. Third, all I need to do now is build a transaction platform for the real estate business, where users can conduct a series of activities such as making appointments, touring the house, making contracts and payment. This is the positioning of eju.com.

Looking at our offline business, we already have sufficient resources in the real estate business such as an operating center, a call center and an activity center, including the online union of first-hand and second-hand property resources we have built up recently.

Last is the "distribution sector" in e-commerce. In my understanding, it is our offline agency business. Real estate can't move, so we need salespeople to deliver and complete the transaction in an offline office.

From the above organization, E-House has all the elements from online and offline real estate sales. So why don't we connect all these dots and do an O2O business model? That's my strategy.

China Knowledge at Wharton :   How do we evaluate whether this O2O model is successful?

Zhou: Complete integration of online and offline. For example, the offline business can get more traffic, information and resources from the online platform, and in turn can provide better service to online users. The two platforms can be totally combined. That's why I decisively pursued the merger of these two listed companies. After the merger, the main business model of E-House became very clear. Online is the traffic portal, transaction guidance and e-commerce platform. Offline is the channel and sales. That's the O2O model of real estate. This business model of E-House is also a valuable case study from the perspective of business model research.

China Knowledge at Wharton   What are the challenges at the operational and management levels, and how do you deal with them?

Zhou: After the strategic layout is completed, we need to get down to details. To connect all the links means you have to build each link well enough beforehand. This is not simply one plus one, but a complicated process of business integration. Execution is the key.

The merger of the two companies means strategic adjustment. A tough macro environment for the property market offers us precious timing to build every link solid and well. For E-House, strategy always has to be made beforehand, and tactics are to build up solid execution.

China Knowledge at Wharton   Noah Wealth Management, a fund company in China, recently announced that it will jointly establish a "Top 50" real estate fund with E-House, partnering with the top 50 developers. How do you see the future of this fund?

Zhou: E-House will follow the theme of "one body, two wings" in developing our businesses. The "one body" is the main business of online-offline integration; "two wings" refers to CRIC's property development data system service and our extended houseware sales platform and financial service. The former includes the platform on SINA [jiaju.sina.com.cn] and www.jiaju.com, which has over 100 million yuan (US$16 million) in annual sales. The financial service E-House Capital is an investment fund started after E-House's IPO in 2007, which has invested in upstream and downstream companies with several companies filing for IPOs this year.

At the same time, we work with developers for innovative financing projects. This year's plan is to align some developers and work with Noah Wealth Management to establish the Top 50 Property Fund. These are all initiatives in the financial sector and part of the value chain. It's not our major business and we are experimenting with a slow pace.

China Knowledge at Wharton  Last year, the e-commerce industry in China peaked in terms of private financing. A lot of private capital flew into the sector, but the competition is homogeneous. How do you see the growth of the Internet industry, especially e-commerce?

Zhou: It's no doubt that the development of the Internet is changing the world and our life. But I still believe that the future of e-commerce is to integrate online with the offline economy. When these two penetrate each other and are integrated well together it is real commerce, and an important development model for China's economy.