Web 2.0 — a term referring to a second generation of Internet services that allows people to share information online in new ways — is taking hold in China, whose online population topped 123 million as of June 2006, up 19.4% from the same period a year ago. China Knowledge at Wharton interviewed investors and entrepreneurs for their insights into what Web 2.0 stands for, what difference it will make in Internet-related businesses and what its future is in China.

Fisher Zhang, a partner in Ceyuan Ventures, a venture fund company specializing in high technology, looks at Web 2.0 as a business opportunity, not as a “concept” or a “fad.” “We don’t follow concepts,” he says. “We focus on the business. [It doesn’t matter] if you are Web 1.0, Web 2.0 or what. We invest in companies that can generate revenue or have the potential to become [viable] businesses in the future.”

His company, which oversees a $120 million fund in China, invested in a typical Web 2.0 site — douban.com — this July. Ceyuan Ventures is not alone. In a country where the average online surfer spends 16.5 hours on the Internet per week, according to China Internet Network Information Center (CINIC), it’s common to see venture capitalists pumping millions of dollars into China’s virtual world with the expectation of huge returns. For example, Oak Pacific Interactive, a company that manages seven online communities or social network websites in which Web 2.0 is fully embedded, received $48 million from a consortium of investors, including General Atlantic and Doll Capital Management, in March 2006.

In the first half of 2006, VC investment on the Chinese mainland reached US$772 million, according to zero2IPO, a Beijing-based venture capital research company. The number is up 128% year-on-year, with Internet-related projects accounting for 36% of the total.

“It’s perhaps the first time in Asian private equity industry history that you have two big emerging markets — China and India — that are growing at such a speed and attracting capital into the market”, says Kathleen Ng, managing director at Center of Asia Private Equity Research. “You have big markets that are drawing a huge pool of money from the investors.”

Tao Zhang is one of the players on this stage. After graduating from Wharton in 2002, he started his own dining guide site — dianping.com — and attracted venture capital from the Sequoia Fund earlier this year. “When we got started, there was no conception of Web 2.0 either in the U.S. or in China.” He listed three examples that inspired his company’s entrepreneurial idea: Amazon.com, whose success is partly attributed to its vast and high-quality book reviews; Wikipedia, which convinced him that collective intelligence is not inferior to individual experts’ intelligence; and “ZagatSurvey”, a well-known guide to restaurant reviews and ratings in the U.S. “One to two years later, we realized that dianping.com is just one of those typical Web 2.0 companies,” he says.

Understanding Web 2.0

“Companies that succeed will create applications that learn from their users, using an architecture of participation to build a commanding advantage, not just in the software interface, but in the richness of the shared data,” said Tim O’Reilly, chief executive of tech publisher O’Reilly Media Inc., in a report one year ago that tried to define Web 2.0.

Even he didn’t find it an easy term to define, turning to an analogy for help: “Like many important concepts, Web 2.0 doesn’t have a hard boundary, but rather, a gravitational core. You can visualize web 2.0 as a set of principles and practices that tie together a veritable solar system of sites that demonstrate some or all of those principles at a varying distance from that core.”

Another way to describe Web 2.0 is as the next generation of the World Wide Web that is attempting to build a web-based computing platform with easy-to-create services that will replace what desktop software does today. Kendall Whitehouse, senior director of information technology at Wharton, says future development of the web largely depends on which company’s application program interfaces (APIs) become the standard. APIs are a set of routines, protocols and tools for building software applications. “One reason Microsoft is so concerned about Google is the battle to control the APIs for future web development,” says Whitehouse. “If Google becomes the platform for Web 2.0 development, it would go to the core of Microsoft’s historical advantage.”

What’s interesting about the API bake-off, he adds, is that while Google gets most of the attention, other companies such as Amazon and Salesforce.com have made their APIs available in order to hasten the development of web services Yahoo is also an emerging player.

According to Fisher Zhang, Web 2.0 is “a model for interaction in which user participation is reinforced. Typical examples are blogs and social network sites. However, this concept adds nothing new to the original implications of the Internet at the time of its birth. The concept has to do only with form.”

Tao Zhang of dianping.com echoes some of the views above. “Web 2.0 is not new. In my view, it’s a natural extension of Web 1.0. For example, Bulletin Board System (BBS), a computer system used as an information source and forum for a particular interest group, has existed on the web for a long time. Many online services have elements of Web 2.0. For example, both eBay’s transactions and the popular online forum on Ctrip (the biggest online tourism service provider in China) have very typical 2.0 elements.

“Actually, every time an important concept has been formed, there have already been many activities that have taken place in advance,” he adds. “These new things, like blogs and wikipedia, were all emerging on the horizon [and coming together in] a tipping point. They converged into a new concept and Web 2.0 came into play.”

The Tough Survival Game

Venture capitalists are constantly looking to invest in start-ups that will one day grow into wildly successful companies. But the question is: When?

“We don’t know,” says Fisher Zhang. “We invest in companies with the potential to be able to create their market in the future. These Web 2.0 companies are still in a very early stage.” Consider blog sites, he says. “Their revenues basically rely on ads. BlogChina and Blogcn, two prominent blog sites in China, were expected to stand out, but it just hasn’t happened yet.” The reasons, he contends, lie in the fact that those traditional so called Web 1.0 portal giants are catching up very fast. With their huge user base and sound financial backup, it’s difficult for pure Web 2.0 companies to get their share of ad budgets. Total revenues for Internet businesses in China account for $300 million to $400 million, much smaller than in the U.S., which makes the environment for them more difficult.

Charles Zhang, the outspoken CEO of Sohu.com, one of the big three portals in China, says in statements published on his site that blogs and all the other small Web 2.0 companies are destined to be beaten by the big portals. “Whatever Web 2.0 is trying to do now, we can do it much better any time.” Even Ding Lei, the usually media-shy CEO of 163.com, another one of the big three, makes the same claim. He suggests that Internet companies should focus on the very basic nature of the business and work to better serve consumers’ needs rather than claiming they are 2.0 or 3.0.

The revenue structures of Chinese online companies rely mainly on three things, according to sources. Among them are SMS (Short Message Service), ads and online games. But some entrepreneurs have been trying to bypass advertising and make their revenue sources more in line with the spirit of Web 2.0.

Shalin Wu, the founder and CEO of teeta.com, a personal portal service community company, says that his secret of performing better than his peers lies in the fact that his company designed everything with the mobile platform and his team is more familiar with mobile business. “Looking into the future, we don’t want to rely on ads to generate our revenues. We are trying to explore some unique business models through a typical Web 2.0 approach.”

Jason Tian, founder of online dating web site baihe.com, says revenue will come from members who are willing to pay for its matchmaking services. But he admitted that the company is still mulling over more specific services to enhance its attractiveness. Baihe’s registered members already exceed six million, he adds.

As for Tao Zhang, “We are a bridging platform between restaurants and consumers.” He is confident he can establish his model of local search serving metropolitan customers. “Ctrip.com is in the tourism business; 51job.com stands for the recruitment service; we are going the way of local search.” Although not profitable yet, he claimed the company will break even next year.

The Real Difference

“It will take three to five years for those Web 2.0 companies to learn their lessons. Now is the time to adjust,” says Fisher Zhang. “Looking forward, we have [placed our bets] on China’s mobile Internet service. With a mobile user base of between 300 million and 400 million, it’s going to be a huge market. 1.0 or 2.0 doesn’t mean too much for us. We are looking for break-through technology with great potential.

Tao Zhang illustrates his understanding of the difference between Web 1.0 and 2.0 by referring to his mobile phone. “Ten years ago, you saw those big heavy Motorola mobile phones and people were still very happy and proud to have them. Today, if you are going to sell a mobile phone, you have to offer very distinct design and functions with it. Customers today are much more demanding.

“The same thing happens with online service. Online users will be savvier and more demanding of the products or services you deliver,” he adds. “The difference between Web 1.0 and 2.0 is not the difference between business models. It’s the difference between business operation — in other words, the site design, user interface design, customer service and information collection approach…. Big portals in China — those with overwhelming listings of information and advertisements, like Sina.com — will eventually be phased out. It will be just a matter of time.”