The Challenges of Launching a Start-up in China: Dorm99.

com

Case Brief:

The case is about the challenges for starting business in China faced by two entrepreneurs
fresh from MBA with a good business plan, but limited knowledge about the business and
political environment of China. Ken Pao and Bill Li met in 2004 during their first year at the
Harvard Business School. They remained close and eventually decided to become business
partners, because each professed a devotion to pursuing an entrepreneurial career in China.

Li was a native-born Chinese who grew up in Beijing and received Bachelor’s and Master’s
degrees from the University of Pennsylvania. He gained work experience at Oracle, Goldman
Sachs and Alcatel before attending HBS. On the other hand, Pao was an American-born
Chinese who had travelled and worked in China. He was an experienced entrepreneur who
had co-founded two previous businesses after graduating from UCLA. Li’s background
provided the partnership with operational experience and strength in technology, as well as
his personal relationships in Chinese Bureaucracy. Pao brought to the partnership his
expertise and past experience in financing and managing small businesses. With a
complementary set of skills on the table, Li and Pao brainstormed different venture ideas,
after deciding not sit for on-campus recruiting.

Knowing that they wanted to pursue a venture in China, the two founders spent the summer
of 2005 immersed in the country. Pao travelled throughout China to understand the business
environment, especially for the internet. Li joined IDG Ventures, a venture capital firm in
Beijing to learn and understand about funding start-ups in China and how VCs evaluated
projects.

The business model was to develop a social networking website. Encouraged by how
successful Facebook and Myspace.com had been in the U.S., the founders felt that the
Chinese market was ripe for a new entrant. The business model they planned depended on
advertising for its revenues, much like the U.S. companies. The founders developed the
venture during their second-year at HBS and made it the focus of an independent study
course.

By March 2006 after missing the initial launch date of mid-February 2006, the founders
launched a beta site that they had completely self-funded. With minimal advertising, the site
acquired 15,000 users by the end of the month. By April, the founders raised a total initial

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investment of US$200,000, a majority coming from Zero2IPO Partners, a China-based

venture capital firm.

At the heart of a social networking business model was the need to gain new users. Since
their target market was the college student population, the founders partnered with
ChinaStart-up.com to develop a customer acquisition plan. ChinaStart-up.com was a Chinese
web portal that had been granted the exclusive right by the Ministry of Education (MOE) to
publish via its website the scores of the national College English Test (CET). The exam was
the only national standardized test that college students took to certify their English
proficiency. Dorm99 partnered with ChinaStart-up.com to gain access to its target segment of
college students. While ChinaStart-up.com provided on individual scores, Dorm99 planned to
offer the students the ability to access their test percentile rankings, a statistic never before
calculated nor presented to students in China. Dorm99 created a simple process to acquire
these users. A student would log into ChinaStart-up.com for his test score and from there
through an advertisement of Dorm99.com the test taker could retrieve their percentile ranking
nationally or by school. Since percentile ranking was a new statistic available to students and
an interesting new measure, the founders estimated a response of upto 2 million users.
Furthermore, this anticipated response rate was significant because it determined whether or
not Dorm99 would get additional VC funding. The venture firms they had met with advised
them that if the website could meet these registration numbers, then it would be a solid proof
of concept that would lead to new capital.

After months of setting up the program, preparing its back-end technology and front-end
website, the team was ready for launch. On the morning of the program the company had no
traffic to their site. Panicked, the team investigated all issues and realized that there was a
break in the links connecting its site to ChinaStart-up.com. The team quickly fixed the
problem and registrations soon came in. Within hours Dorm99 had acquired over 100,000
registered users. Then, at 2pm, ChinaStart-up.com called and told them they had to shut down
the website.

The MOE ordered Dorm99 immediately to stop disclosing the percentile information. The
ministry expressed that the data provided was too much information. The fact that percentile
ranking had never before been released was not because the MOE could not do so but
because it deliberately chose not to do so because they did not want to create a definite
“pass/fail” line for the test. The accessibility of this information pushed the MOE in a corner

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and in response it ordered a shutdown of Dorm99’s page. Having no other choice, Dorm99
complied.

The hard work the team put into its technology and marketing plans was wiped away in
moments. They thought about everything in preparing for this launch.

· Technologically— the site was working perfectly.

· Coordination with ChinaStart-up.com was smooth.
· Marketing was executed well, and deals were prepared.
· However, they did not anticipate the government intervention,

Unfortunately, no Plan B was prepared because it was felt that the company was offering its
target market truly valuable information. Yet, despite their level of experience in China, their
connections to high-level Chinese officials, and their partnership with a seasoned local
Internet company that had an exclusive six-year relationship with the MOE, the founders did
not anticipate that the Chinese government would want to withhold information that was
clearly demanded by the students. Dejected, the founders looked forward, to the options that
were available to them to make the venture a success.

Business Environment of China:

Undoubtedly, the general business environment in China is very inviting. This can be
explained from the high growth rate of Chinese economy over the years. The attractive
business environment of China is further strengthened by the fact that the Chinese
government is doing everything in its power to continue to improve the investment climate
for foreign companies by, among other things, continually spending large amounts of money
on the improvement of the infrastructure. But, the main challenge for the companies is, that
China has a communist Government which exercises direct control over almost all the
sectors. This is much more prominent in the media sector which covers the Internet, where all
the networks are owned and regulated by the government. China Education and Research
Network (CERNET) is largest national academic Internet backbone, it provides network
connection, .edu.cn domain name and IP address assignment, and educational and research
resources and super computing services. The government keeps a tab on the activities
undertaken on the internet and maintains a strict censorship to check on the spread of
information on the internet. This was seen in the case where Dorm99.com was shut down

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twice by the MOE over the release of information that the company thought would be useful
for the students but according to the MOE was creating a “Pass/Fail” line. Despite the fact
that the business line of Dorm99.com was to bring student close to each other by providing
them a social platform to interact, the government did not allow them to publish the
information without its approval. The government gave them new ideas for their website,
after defining how it wants them to operate.

China is very much a relationship society, where long-term, carefully nurtured relationships
are tremendously important. Even after being shut down by MOE twice in its launch
program, the founders knew that maintaining a relationship with the government authority
that oversaw their target market was still extremely valuable and the company was given new
opportunities, wholly unrelated to their original business line, but equal or more lucrative.
The new opportunities came through the relationship within the MOE. The contact presented
Dorm99 with a unique opportunity in online gaming, the opportunity was to deliver online
games to college student by developing an exclusive relationship with Ministry of
Education’s National Student Sports Association (NSSA), which was a “for-profit”
department within the MOE and providing online games through CERNET controlled college
internet network. With little exposure to generating commercial projects, the department
leaders were eager to find a partner to help it gain operational experience and more
importantly to help it earn revenue.

Business Opportunity to Opt for:

Although all the option are equally lucrative and will be beneficial in the long run the most
viable opportunity to opt for immediately would be Online Gaming as it will help the
company to tap the customer base it had originally planned for, i.e. college students and also
make up for all the investment and start making profits from the second year. The other
options while being attractive are not promising short-term solution with the long-term
solution that they already have, the credit bureau information gathering had their customers
as banks, the candidate verification for college recruiter had recruiters as their customers and
although, Test-result analysis had students as their customers, but the profits margins in this
line would be low and students will only log in to their website around results and exams, not
every day. The investors have given them milestones to reach which include developing a
clear-cut marketing plan that would encourage current subscribers to log in to Dorm99.com

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on a daily basis and would need to continue to grow their subscriber base. Through online
gaming they can link the online gaming to Dorm99.com and make online gaming available to
members of Dorm99 at some discounted price, by linking Dorm99.com to online gaming
they can ensure that the current subscriber log in everyday for any new messages or deals for
online gaming and they can also grow their subscriber base. In the coming years when
Dorm99.com becomes a hit among the students they can start working on the other ventures
given to them. The first one being test-result analysis as that is related to their original idea of
providing the scores to students, then they can look in for candidate verification for college
recruiter and credit bureau information gathering simultaneously, these two ventures are good
in the sense that by providing information for the students to recruiters and banks they can
earn money for the information they provide for each student. Dorm99.com took-off well in
an environment where most of the companies struggle and has a promising future ahead, just
by working on their strategy and the new ventures options available to them, it can surely
succeed.

Online Gaming Financial Projections–Dorm99 Projections

2007 2008 2009 2010 2011
(in RMB 000s)

Total Revenues 9,309 95,860 2,89,721 5,74,010 9,11,328

Business tax -465 -4,793 -14,486 -28,701 -45,566

Net Revenues 8,843 91,067 2,75,235 5,45,310 8,65,762

Cost of Revenues
Royalty Fees to the
Ministry of Education's -931 -9,586 -28,972 -57,401 -91,133
Sports Association
Server Leasing and
-5,518 -16,555 -33,110 -55,184 -66,220
Maintenance Fees
Software Licensing Fees -1,862 -19,172 -57,944 -1,14,802 -1,82,266
Distribution Channel Fees -465 -4,793 -14,486 -28,701 -45,566

Total Cost of Revenues -8,776 -50,106 -1,34,513 -2,56,087 -3,85,185

Gross Profit Margin 67 40,961 1,40,723 2,89,222 4,80,577

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Gross Profit Margin % 0.72% 42.73% 48.57% 50.39% 52.73%

OPEX

Sales and Marketing -5,818 -11,983 -20,174 -39,971 -63,459

Product Development -5,818 -11,983 -18,108 -29,066 -46,146
General and
-2,909 -6,367 -19,243 -38,125 -60,530
Administrative

Total Operating
-14,545 -30,332 -57,525 -1,07,161 -1,70,135
Expenses

Total OPEX % -156.25% -31.64% -19.86% -18.67% -18.67%

Dorm99 Net Profit -14,478 10,629 83,198 1,82,061 3,10,442

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