INTERNET: Hospital Gives Baidu Headaches, Qihoo Checks Out

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Bottom line: A hospital scandal surrounding Baidu could shave as much as another 3-5 percent off its stock over the next week, but will fade afterwards and have relatively little longer term impact.

Hospital scandal continues to rock Baidu

A scandal involving exaggerated claims by one of its advertisers continues to consume Internet search leader Baidu (Nasdaq: BIDU), which has fired a top executive in response to a story that has wiped out $6 billion from its market value. At the same time, Qihoo’s (NYSE: QIHU) rival search engine has announced it will no longer do business with hospitals like the one at the center of the scandal, nor with other sellers of medical products and services.

The government has taken the unusual step of assembling inter-agency task forces to investigate the case involving a young cancer patient who claimed he was misled by both Baidu and the Second Hospital of Beijing Armed Police Force. (Chinese article) As the scandal picked up momentum late last week, media are reporting that Baidu fired vice president Wang Zhan for harming the company.(Chinese article)

To say that Wang Zhan is a scapegoat in this case seems like a major understatement, since the accusations leveled against Baidu by the now-deceased Wang Zexi are a central part of the company’s advertising strategy and one reason it is so profitable. That strategy sees Baidu auction the best spots on its search results to the highest bidder, even though Internet users aren’t clearly informed of that process.

As a result, users like the victim in this story, 21-year-old student Wang Zexi, often believe the high spots go to results that are best suited to their queries, and put more trust in results that appear high on the list. That deception is worsened by the rampant exaggerated and often false claims made by Chinese hospitals, medical device and drug companies, resulting in cases like Wang’s.

I won’t repeat details of that case since I already wrote about it yesterday (previous post), but instead will recap some of the latest details as the story unfolds. At this point Baidu has gone into 24-hour crisis mode, in a bid to stem a flood of negative publicity that has caused its stock to drop 10 percent in the last 2 sessions and could have a serious impact on its business.

That’s because hospitals and other medical companies are one of its largest advertising groups. Baidu’s shares tumbled 15 percent last year during an unrelated dispute with the nation’s largest hospital group, as one analyst estimated that members of the Putian Healthcare Industry Chamber of Commerce could account for as much as 15 percent of the company’s search revenue. (previous post)

Internal Memo

In its latest response to the crisis, Baidu has issued an internal memo to employees explaining that the hospital at the center of the crisis was reputable in the past, and adding that it is continuing to cooperate with the investigation. (Chinese article) Exaggerated claims like the one in this case are quite common in China’s freewheeling and extremely competitive healthcare market, and the reality is that it’s very difficult for a company like Baidu to verify that all ads on its system are true.

That reality is leading the PR-savvy Qihoo to proclaim its search service will no longer do business with anyone selling medical products or services to consumers. (Chinese article) Qihoo announced the move in an open letter to its users, and not surprisingly cited the Wang Zexi case as a reason behind its decision.

While Qihoo’s move is obviously quite opportunistic, I do have to commend the company for ending its relationship with this problematic group of advertisers. Of course it probably wasn’t a difficult decision for Qihoo since the company is still struggling to monetize its popular but relatively cash-poor search service. I doubt Baidu will take similar action, and I stand by my earlier prediction that this scandal should quietly die down over the next week or two with only minimal impact to the company’s business.

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