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After Sohu.com Inc. (NASDAQ:SOHU) reported strong 4Q10 earnings, some investors expressed concerns about the company's fast-growing search engine Sogou.com. The concerns have centered around Sogou's receiving significant revenue from C2C e-commerce website Taobao.com, which is owned by Sogou's 16%-owner Alibaba Group (OTC:ALBCF). These investors believed that Sogou generated the Taobao-related revenue because of its relationship with Alibaba, not because of its own service quality. The underlining logic is that Sogou did not deserve Taobao's ad spending, and it would not have done well in Q4 without Alibaba's support. I believe such concerns are unnecessary. Here are the reasons:

If Taobao did not buy these ad slots, Sogou may still be able to fill the slots with other advertisers' ads. In Sogou's search result pages, Taobao's pay-per-click ads have occupied certain ad slots because Taobao has outbid other advertisers in the auctions. If Taobao did not make those bids, other advertisers may still bid for those slots, and Sogou may still generate revenues from the slots. It's like if one potential buyer quits an auction, the sale may still be completed. In other words, Taobao's purchase of certain ad slots does not mean these ad slots are not attractive to other advertisers. In fact, the big presence of non-Taobao advertisers on Sogou.com can be easily verified by doing searches on Sogou for popular Chinese keywords "Stock", "Cell Phone", "Computer", etc. This situation resembles the well-known trade-off between Baidu's (NASDAQ:BIDU) Box Computing revenues and pay-per-click revenues: Box Computing partners have taken valuable ad slots previously occupied by pay-per-click ads, but this does not mean Baidu's pay-per-click ads have become less attractive to advertisers.
Taobao's purchase of ads on Sogou.com was neither incidental nor nonrecurring. It is based on well-founded long-term rationales, and ultimately results from e-commerce's heavy reliance on search engines and the competition between Taobao and Baidu. According to industry experts, Chinese e-commerce Websites typically generate about one third of traffic from search engines. Despite such heavy reliance on search traffic, in September 2008, Taobao started blocking Baidu search engine from crawling Taobao.com for merchant and product information. Taobao made the move to defend its market share against Baidu's upcoming C2C service Youa.com, and more profoundly, to prevent Taobao users from forming the habit of searching on Baidu.com for online merchants and products. After blocking Baidu, Taobao needs to look for other search engines as sources of traffic. Among major non-Baidu search engines, Alibaba finally decided to invest in Sogou, partly because Sohu was very committed to building the Sogou brand, and partly because the other companies were not suitable: Google's (NASDAQ:GOOG) status was unstable in China since March 2010; Soso's owner Tencent (OTCPK:TCEHY) operates Paipai.com, a direct competitor to Taobao; NetEase's (NASDAQ:NTES) Youdao had too little market share. The fact that Sogou's technology is not the best in China does not mean that Taobao should not choose it as a partner. I expect Sogou to continue benefiting from the China e-commerce competitive landscape in the next several years.
Source: Sohu: Taobao-Related Revenue Worries Overblown

Additional disclosure: My virtual investment portfolio has a long position in NTES.