分类：EN

By Edward Tse and Bill Russo
17 Sep, 2018

Despite the simmering trade tensions, China announced on April 17th to scrap a two-decades-old limit on foreign ownership of automotive ventures by 2022. While unsettling some state-owned car manufacturers who worry about emerging competition, the plan unveils tremendous opportunities for foreign corporate investors to fully leverage the advantage of China’s market size and growth. Earlier in April, the country had also lifted ownership cap on banking and financial sectors.

President Xi Jinping described the measures as part of a “new phase of opening up” which has its roots back in the 1970s. For a long time, foreign multinational corporations (MNCs) complain about a lack of market access in China and ask for reciprocity. They argue that China’s regulatory and industrial policies confer unfair advantages on Chinese companies, represent forced technology transfer and penalize foreign companies. In reality, China has been liberalizing its sectors for non-state Chinese companies and foreign companies gradually over the past decades. Many previously closed sectors were opened, either entirely or partially. Though not every sector is now open, the trend and direction are pretty clear.

Is the golden era for MNCs in China over? Pundits take examples of companies such as Best Buy, Home Depot and PepsiCo, which have had to make “strategic retreat” from China’s market. PepsiCo, for instance, sold its bottling business in China in 2011 to the Taiwanese company Tingyi Holding, which has a broad distribution network across China.

Source: Internet

The answer lies in how foreign MNCs approach the China market. They tend to copy-and-paste their strategy approach that has worked, perhaps for decades, in their home markets, assuming that it must also work elsewhere in the world. However, coming out from a planned economy at the end of the 1970s, China is a highly complicated and fast-evolving environment. This market context makes the “cookie-cutter business model transfer” approach not always appropriate.

However, China’s environment is not entirely without patterns. Through years, China has found its own development model: at the top, the central government plans the direction of the country. At the grass-roots level, entrepreneurship is thriving and driving economic growth often through innovations. In the middle, local governments compete and sometimes collaborate in clusters of cities within regions. This three-layered model, though not perfect, has indeed enabled China’s tremendous economic growth for the past four decades and offered major resilience for continued growth.

China’s innovations, in particular, are picking up with unforeseen speed and intensity. With “Made in China 2025” outlining China’s roadmap to becoming the world’s leader in high-tech, China is now already the second-largest spender on research and development and accounts for 21% of the world’s total, according to the US National Science Foundation. From the grass-roots level, patents, trademarks and industrial design soared in recent years. World Intellectual Property Organization reported that China contributed to 98% of global growth in patent filings, more than the combined total of US, Japan, Korea and Europe.

While China’s innovation is taking place with speed and intensity, MNCs have largely been a bystander. For long, China was known as a “copycat nation” and admittedly, for a long time, copycatting was blatant. However, innovations, largely business model innovations driven by China’s entrepreneurs have emerged with unprecedented speed, ever since technologies such as the wireless Internet became prevalent in China. Most MNCs were not even aware of this phenomenon because they didn’t believe the Chinese could be that innovative, and they did not really mix themselves into the Chinese business ecosystems.

Source: Internet

This lack of awareness is a key reason why MNCs have not captured the full potential that China offers. The “core competency” mindset from western corporate management drives foreign CEOs to not take risks and cling to what they are (supposedly) good at, often missing out on new opportunities to learn from Chinese consumers and companies. On the other hand, China’s leading entrepreneurial companies are good at identifying emerging market opportunities and are often willing to “jump over” to capture the new opportunities, even if they don’t have all the required capabilities to compete in the new conditions. They would often make up the capability gap through a combination of self-building and leveraging partnerships in the ecosystem.

Another reason why MNCs didn’t “get it” is that they see China as one of the many markets in the world, albeit often a very important market, but few put China at the core of their global development strategy. As much, they position their managers in China merely as operational or administrative people. Without an in-depth understanding of the China context, decision-makers from faraway global headquarters often find it difficult to stay informed of China’s innovations and to take full advantage of them. Or worse, they think they know and make decisions on that basis while in actuality they don’t (or at least not enough).

Lessons can be learned from multinational drug companies that are already bleeding talent to China startups. Zhi Hong, an 11-year veteran of GlaxoSmithKline, who led the company’s infectious diseases business, launched Brii Biosciences which raised $260 million from investors including Sequoia Capital. Dr. Xiaobin Wu, former China manager of Pfizer, left for a local cancer drug developer, BeiGene, where he sees opportunities for indigenous innovations for patients in China.

First, their strategy requires a thorough understanding of the China context which is evolving in a peculiar and multidimensional manner. Instead of using a linear, incremental approach at micro business levels, which is common at MNCs, they should focus on, or at least start with, the big picture and capture changes that can be abrupt and rapid.

Second, because these changes can be abrupt and rapid, MNCs should shorten their decision-making process, thus becoming more sensitive to innovations happening at the grass-roots level. Compared with the complex layers of management at MNCs, the dynamics at China’s new start-ups are very nimble and the decision-making is very fast. MNCs should therefore draw inspiration and create more agile organizations.

Third, the speed of development, uniqueness, complexity and strategic importance of China require foreign MNCs to fully embrace China as the core of their global strategy and organization, not just as one of many markets. Foreign multinationals should also train their China managers to be thought leaders and place them at senior levels as well as empower them with appropriate decision rights and resources.

There are cases of MNCs capturing significant value from China’s innovations. Earlier examples include Telstra, an Australian telecommunication and media company. Though its core business in China is restricted by foreign participation rules, it turned to invest in China’s online automotive advertising platform Autohome and made a handsome profit. Insiders estimated Telstra profited well over US$ one billion in well less than 10 years. Lately, Coca-Cola China ventured into the yogurt business with an investment in Beijing Lepur to tap the growing demand for health products and consumption trade-up. Lepur, a premium yogurt startup, is one of China’s fastest-growing brands.

Source: Internet

The golden era for foreign MNCs in China is not over. But to capture the rightful potential that China offers to them, foreign companies have to step up their game through more innovations, as well as better disruptive strategies supported by the right organizations and driven by the right leadership under a new and empowered global governance. Participating in China’s innovations in a full-fledged manner gives foreign companies a much better chance to succeed.

A major potential is emerging in Sino-foreign collaborative innovations (“co-innovation”). While China needs access to breakthrough technologies from global innovation hubs such as North America, Europe and Israel, top global technology firms also need a market that allows innovations to scale up. One of the most progressive markets with a vibrant digital economy, China is an ideal place to deploy and scale up new technologies.

To catch up with the new rules of games, foreign MNCs must accelerate by joining or even creating their own innovations ecosystems. Thriving or failing in China depends on whether they can strategically anticipate and capture the opportunities and handle the challenges. After all, it goes back to companies’ own mindset and awareness.

About the authors
Dr. Edward Tse
Founder and CEO, Gao Feng Advisory Company
Dr. Edward Tse is founder and CEO of Gao Feng Advisory Company. A pioneer in China’s management consulting industry, Dr. Tse built and ran the Greater China operations of two leading international management consulting firms for a period of 20 years. He has consulted to hundreds of companies – both headquartered in and outside of China – on all critical aspects of business in China and China for the world. He also consulted to the Chinese government on strategies, state-owned enterprise reform and Chinese companies going overseas. He is the author of over 200 articles and four books including both award-winning The China Strategy (2010) and China’s Disruptors (2015) (Chinese version «创业家精神»).
Email: edward.tse@gaofengadv.com

Bill Russo
Managing Director and the Automotive Practice leader
Gao Feng Advisory Company
Bill Russo is Managing Director and the Automotive Practice leader at Gao Feng Advisory Company based in Shanghai. With 15 years as an Automotive executive, including over 14 years of experience in China and Asia, Mr. Russo has worked with numerous multi-national and local Chinese firms in the formulation and implementation of their global market and product strategies. He was previously Vice President of Chrysler North East Asia, where he managed the business operations for the Greater China and South Korea markets. Prior to this, Mr. Russo was Head of Product & Business Strategy for Chrysler. He also has nearly 12 years of experience in the electronics and IT industry, having worked at IBM Corporation as a manufacturing and systems engineer, and formerly served as Vice President of Corporate Development at Harman International.
Email: bill.russo@gaofengadv.com

 

The following is an edited excerpt from China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies are Changing the Rules of Business by Edward Tse. The excerpt was provided by Portfolio Publishing.

In a quarter of a century Huawei has made itself the world’s biggest manufacturer of telecom-network equipment, rivaled only by Sweden’s Ericsson.

Huawei’s founder, Ren Zhengfei, was born in 1944 in southwest China’s Guizhou province, one of the country’s poorest regions. Ren attended university, studying engineering, and then joined the People’s Liberation Army to work on military-related technologies.

He left the army in the early 1980s as part of a round of military downsizing, moving to Shenzhen to start his own business. After a few false starts, he used 21,000 yuan of his own savings (then worth about $5,600) to set up Huawei in 1987. Initially, Huawei’s main source of revenue came from selling office telecom equipment imported from Hong Kong.

By 1990, it had acquired enough resources to open its first research laboratory. Two years later, the company launched its first digital switch, the core piece of equipment at the heart of any telecom network, which directs signals to and from callers. China at that time had just embarked on a massive telecom rollout; within less than 10 years, the country went from having no private telephones to acquiring first a nationwide fixed-line network and then multiple mobile ones.

The big winners for most of this period were the international equipment makers – Siemens, Alcatel, Nokia, Motorola, Ericsson, and Nortel – all of whom found ready customers in the provincial arms of the country’s big telecom services providers: China Telecom, China Mobile, and China Unicom.

These companies’ best Chinese customers were in the richer provinces and cities of the east coast, from Guangdong in the south to Beijing and Tianjin in the north, where buyers preferred to get their hands on the more advanced equipment offered by the international vendors.

But a government rule saying that all provinces had to buy equipment from at least two suppliers opened the door for Huawei to become the second provider in poorer, inland regions. Orders were small at first, which allowed Huawei’s engineers to gain experience at both installing equipment and seeing how what they made measured up against the systems from the international suppliers.

Driven by Ren’s insistence that Huawei continually upgrade its products’ quality through research and development, and supported by a government eager to see indigenous equipment makers displace foreign companies, the company’s footprint grew. The performance of its switches still lagged that of its competitors, but cheaper prices compensated for the gap. Able to undercut foreign companies on price and out-compete Chinese state-owned companies on quality, Ren began to find buyers in richer coastal provinces.

In 1997, Huawei stretched across the border immediately to Shenzhen’s south to secure its first international deal, a contract with Hong Kong operator Hutchison Telecom. Within eight years, as it extended sales first across Asia, then Africa and Latin America, and finally into Europe, Huawei’s overseas revenues were greater than its domestic ones. To ensure it secured deals, Ren insisted that his sales staff always submit bids below those of competitors – typically, by 5 to 15 percent, according to a report by Wharton Business School.

From the start, there was also another side to Huawei’s business: regardless of a customer’s size, the company would always be willing to come in and look for ways of improving the operations of its clients. During the golden era of telecom growth through the 1990s until the dotcom collapse, this approach was very different from that of the big international vendors, whose main focus was developing cutting-edge technology which they could then sell to fast-growing telecom operators.

Their preference was for selling entire systems to big companies, and they had little interest in selling to smaller businesses, especially those in poorer markets.

Huawei, in contrast, was happy to work with such customers, focusing on their often prosaic needs. It developed smaller, more power-efficient mobile base stations that allowed operators to reduce their electricity and rental bills. The company honed its ability to integrate its equipment with existing systems.

And, perhaps most important, it rapidly expanded the number of its R&D staff, hiring thousands of computer programmers and software-engineering graduates fresh from university, and putting them to work figuring out ways in which operators could run their networks more efficiently.

Today, Huawei is China’s biggest private exporter, with two-thirds of its $39 billion in revenues coming from overseas. It sells to markets in almost every part of the world, with the glaring exception of the United States, where its sales have been restricted to a handful of small mobile operators, largely due to national security concerns in Washington. Unsubstantiated allegations that the company is an agent of the Chinese government, however, serve as a smoke screen to hide Huawei’s significance.

It has shown how innovation, instead of calling for a string of groundbreaking products, can also be about finding ways of supplying and supporting an appropriate version of a product to secondary-market players. Serving customers in China’s lower-tier regions and other less-developed countries, then working with smaller players in developed markets, allowed Huawei to gain footholds and experience without having to go head-to-head with the big European and American equipment makers.

Instead, accompanied by a constant push to narrow the technological gap on its rivals, it could focus on growth through stealth by eroding their market share in areas they usually regarded as of secondary importance. As it grew in scale, Huawei’s consistently cheaper prices also had the effect of commoditizing the telecom-equipment sector, in the process reducing its competitors’ profits.

While its rivals could still win contracts where technological prowess mattered, less frequently could they win them where operators simply wanted their networks extended or upgraded in a routine manner. Along the way, Huawei has gradually transformed the world’s telecom-equipment market into something resembling China, where what counted was being able to offer constant incremental improvements in technology, features tailored to meet the precise needs of cost-conscious operators with no extra frills, and always at a price a little better than anyone else’s. Year by year, other companies merged or exited the industry, as Huawei relentlessly forced margins downward.

By 2012, it had established itself as the world’s biggest network-infrastructure vendor, with Ericsson its only remaining serious rival, and second only to Cisco in the router and switching market.

On March 15th, 2018, Gao Feng Advisory Company’s CEO Edward Tse was invited by Asia Society Switzerland to discuss China’s innovations in business. We would like to express our gratitude to Mr. Ernst Bärtschi, chairman of the Board of Directors of Conzzeta AG, for initializing the concept of this event and for orchestrating its organization. We would also like to thank the event’s host, Ms. Eunice Zehnder-Lai, member of the Board of Directors, Asia Society Switzerland, for leading the conversation.

Ms. Eunice Zehnder-Lai (EZL): Thank you, Mr. Bärtschi. Innovation is a very timely topic for all of us. Technology seems to be influencing all parts of our lives. China, as a topic, is also very relevant. Having said that, innovation in China may not come as the most intuitive topic. To many, the image of China is that of a socialist, planned economy and as a copycat nation. Not long ago, a lot of people were afraid of forming joint ventures with China, that they will steal your intellectual property, that they’re very good at making imitation and fake products, selling them at a fraction of the price and ruining your market. Suddenly, China has become a global leader in innovation. They’re one of the leaders in cashless payments, in drones, in many areas of e-commerce, and in facial recognition. How did that happen so quickly? If you count the number of unicorns in China, it is catching up with the US very quickly. If we look into history, at the end of the Cultural Revolution in the 1970s, Deng Xiaoping took over and inherited a big mess. His job was to turn the country around and he made certain decisions that really set the backdrop for this mass entrepreneurialism and grassroots innovation. Could you give us a little bit of color on the backdrop?

Edward Tse (ET): First of all, thank you. Thanks to Asia Society Switzerland for the invitation and to Mr. Bärtschi for your arrangement which is really wonderful, and Eunice for your being our host this afternoon.

I’m very privileged and I hope I can share with you some of my views and experiences. Having worked in China for over 25 years by now at some of the top and biggest consulting firms, first with the Boston Consulting Group, and later with Booz Allen Hamilton (later known as Booz & Company), I was fortunate to have helped a large number of companies, foreign and Chinese – including SOEs and private sector companies — over the years to help them develop their business and strategies.

Developing the right kind of strategy for China needs consideration of the China context. Without that consideration, the strategy would mostly fail. You cannot just copy and paste the strategy approaches that you take in Europe or in America or wherever and expect that to work in China. Sometimes it works but most often, it doesn’t because the context is very different.

Eunice, your question is very good. Many people are surprised by the speed and intensity of the changes in China. However, all of these happened for a reason.

The biggest near-term game-changer in Chinese history is the Cultural Revolution which left the Chinese disillusioned. When that was over, Deng Xiaoping returned to power. He decided to be pragmatic and tried something different: allowing entrepreneurship to come back to China.

Back at that time, the Chinese people were clueless about business because they had no exposure to the notion of business under a planned economy. However, we Chinese were innately very entrepreneurial in history. For centuries, the Chinese were trading with the Europeans, Indians and Arabs over the Silk Road. And we traded with our neighbors. It was just totally and artificially stopped by that aberration in the first 30 years of the PRC. However, after Deng lifted the ceiling, entrepreneurship started growing fast.

EZL: When we think about Chinese companies’ entrepreneurship, there are three companies that always come to mind: the “BAT” – Baidu, Alibaba and Tencent. And every time we see them, they seem to be going into a new business. And they seem to be growing horizontally in their ecosystems. Whereas in the West, the managers are taught to focus, to find out what your strengths are and what your core competency is. Do not deviate from what you’re good at, because the market will penalize you for it. It doesn’t seem to be the same in China. Why is that?

ET: You’re right. It is about management science. When I first joined consulting 30 years ago, I was in the US and was taught there were only two ways to think about business strategy. One is to form conglomerates, meaning collections of different kinds of businesses but on a random basis. The other way is to focus based on a company’s core competencies, i.e., what you are good at.

In fact, since around the 80’s, conglomeration was not considered as a good thing by the western capital market. The notion of “focusing on what you are good at” as an outgrowth of the “core competence” concept became the mainstream strategy thinking in the West till even now.

The rise of China and the prevalence of technology, in particular the creation of smart devices, have provided the context for the rapid emergence of companies like BAT. The Chinese really embrace the Internet, particularly wireless internet and its associated features like social media.

In China, while there are some companies that are conglomerates and there are some that are core competence focused, the fastest-growing companies grow by “multiple-jumping”: jump when they see new opportunities, even though they may not have all the capabilities needed to operate in the new opportunities space. They will make up for the capability gaps along the way either by themselves or through collaborations with other companies, or both. These companies may focus on their existing core competencies at first, but when they see the opportunities showing up in what we call the S-curve manner, they will try to catch these new opportunities even if they don’t have all the capabilities needed to run the new business. Managers in Western multinational companies don’t necessarily see these new upcoming opportunities in China. Even if their local managers tell them there are opportunities, most of them will revert back to a core competence focus, thinking, “if I try to stretch, I will be accused of being not focused.”

 

On the opposite, the Chinese entrepreneurs are highly driven to grab these new opportunities. If they lack the capabilities to do so, they would collaborate with partners thereby building ecosystems. Companies like BAT have developed into not just one but multiple ecosystems, turning into mega ecosystems. Today Alibaba and Tencent are already in the world’s top five by market capitalization.

By the way, leading U.S. tech companies like Google and Amazon have also grown through “multiple jumping”.

EZL: In all these mobility companies, they don’t really see themselves as transportation companies. They see themselves as data gatherers. The value is really in the data they have from having twenty million rides a day.

ET: That’s exactly right. The Chinese entrepreneurs have discovered this without knowing it actually. With the command of large user databases, they feel they can crisscross over industry boundaries. They can go into industries that they were not in before. So they can do multiple jumping.

Meituan-Dianping, the popular food delivery app, has 400 million active users in China and offers fast and convenient service. With that database, they look at mobility services as a good business to enter into. The leading mobility services company in China is a company called Didi Chuxing. Didi competed with Uber for a while until Uber pulled out from China. Didi didn’t look at the auto OEMs as competitors because they lived in different spaces – mobility solution and car manufacturing respectively. But this is not the case with Meituan-Dianping, who as a food delivery provider, has a large active user database. When Meituan announced that they would go into mobility service solutions, Didi was concerned that real competition and a real war would start. This is how competition is being defined in China’s digital space.

EZL: What other advantages do the Chinese have if you look at the very successful companies in China that are truly innovative? Do you see a common thread that goes through all of them? What are the typical characteristics of these companies compared to what you see in the West?

ET: It all started with the mindset and the leadership. In the West, companies tend to focus based on their core competencies. That is the response to a general slowdown of the economy in the 80’s and the early 90’s after the “go go years” of the conglomerates in the previous decades. So the academics and the consulting firms came up with a theory to try to explain that, which became the mainstream thinking in the West and it still is nowadays.

The Chinese came from a very different context. In the 80’s, coming out of the Cultural Revolution, they were experimenting with businesses, but had little clue because the notion of “business” didn’t even exist in China’s planned economy. Thereafter China has grown in a very different era and much faster. When opportunities came with the prevalence of technology, Chinese entrepreneurs began to develop a new and different mindset. This mindset is epitomized by the willingness to take risks and to capture new opportunities before the opportunities fully manifest themselves. Technology is a key enabler for developing new business models and new capabilities. Examples of this include not only BAT but also many others such as Ping An, Xiaomi, Geely, etc. Ping An, for example, has evolved from an insurance company into a major horizontal ecosystem. Peter Ma, its chairman, is now trying to benchmark the company against Google and Amazon.

EZL: What insight and learning would you have for our audience here? Not everybody here is involved in business in China. And even if they’re in business in China, it’s not a hundred percent in China. One could say, “Okay, all these great things are happening in China. How is it going to affect me?” How should we think about the threats and challenges of these new business models in China to the West? That’s number one. Number two are these context questions that you said about why these entrepreneurs are so successful in China, having a fast-growing market, having government support, having a lot of data, having hungry people because of their pain points that we don’t have in Switzerland. It’s a good life here and there is little competition. So what can we learn from innovation in general that is transferable to Europe?

ET: Of course, to what extent China affects you depends on your individual conditions. Some of you may be doing business with China and so China has a lot of implications for you. Some are not doing anything with China but are looking. Some may have nothing to do with China. But the Chinese may knock on your door anytime and you should be prepared for it.

China is on the verge of a new generational rise that will last for some prolonged period. Entrepreneurship and innovation are an important underpinning for that. Entrepreneurship cuts across many parts of China, and young people are going after their own dreams and pursuits. They aspire to be the next Mark Zuckerberg or Bill Gates or Jack Ma. Though only a very small percentage will succeed, a small percentage of a big number is still a big number.

Some of these young people realize that if they can be successful in China, they have a good chance of being successful in other parts of the world. I cannot predict exactly who they may be, but I know the mentality: the first step is to become number one in China; the second step is to go out to the world. The world is becoming more and more connected through technology, and globalization will prevail more than isolation.

EZL: Thank you very much.

About the host and guest

Ms. Eunice Zehnder-Lai is CEO of IPM (Institut für Persönlichkeitsorientiertes Management). Previously, she was in the financial services industry for 20 years with LGT Capital Partners, Goldman Sachs and Merrill Lynch in New York, London, Hong Kong and Switzerland. She also worked for Procter & Gamble in marketing and brand management as well as for Booz & Co. in strategy consulting. Eunice is also a member of the Board of Directors of DKSH (since March 2018), Geberit Group (since 2017) and Asia Society Switzerland (since 2016). She holds a Masters of Business Administration from Harvard Business School and a Bachelor of Arts degree from Harvard University.

Dr. Edward Tse is founder and CEO of Gao Feng Advisory Company. A pioneer in China’s management consulting industry, Dr. Tse built and ran the Greater China operations of two leading international management consulting firms for a period of 20 years. He has consulted to hundreds of companies – both headquartered in and outside of China – on all critical aspects of business in China and China for the world. He also consulted to the Chinese government on strategies, state-owned enterprise reform and Chinese companies going overseas. He is the author of over 200 articles and four books including both award-winning The China Strategy (2010) and China’s Disruptors (2015) (Chinese version «创业家精神»).

About Asia Society Switzerland

Asia Society Switzerland is an independent Swiss foundation, which is a member of the global Asia Society family. Founded in 1956 in New York, Asia Society has developed into a thought leader on Asian issues, and a vibrant community of decision makers around the world.

As the first Center in Europe, Asia Society Switzerland – founded in 2016 – provides a unique opportunity to become part of this global community, and to contribute to a meaningful dialogue that could shape our future. Asia Society Switzerland is committed to exploring Asia’s role in a multilateral world and to advancing the dialogue and strengthening partnerships among individuals and institutions in Switzerland and Asia.

About Gao Feng

Gao Feng Advisory Company (www.gaofengadv.com) is a pre-eminent strategy and management consulting firm with roots in China coupled with global vision, capabilities, and a broad resources network. We help our clients address and solve their toughest business and management issues — issues that arise in the current fast-changing, complicated and ambiguous operating environment. We commit to putting our clients’ interest first and foremost. We are objective and we view our client engagements as long-term relationships rather than one-off projects. We not only help our clients “formulate” the solutions but also assist in implementation, often hand-in-hand. We believe in teaming and working together to add value and contribute to problem solving for our clients, from the most junior to the most senior.

Our senior team is made up of seasoned consultants previously at leading management consulting firms and/or ex-top executives at large corporations. We believe this combination of management theory and operational experience would deliver the most benefit to our clients.

Our name Gao Feng is taken from the Song Dynasty Chinese proverb Gao Feng Liang Jie. Gao Feng denotes noble character while Liang Jie refers to a sharp sense of integrity. We believe that this principle lies at the core of management consulting – a truly trustworthy partner who will help clients tackle their toughest issues.

Reporting By Matthew Miller; Editing by Philip McClellan
CHANNEL NEWSASIA | March 16, 2018

China’s HNA, Shedding Debt Overseas, Is Still Hainan’s Hometown Champion

Hundreds of workers pour concrete as tower cranes swing overhead at the building site where a giant skyscraper is set to soar above the palm-fringed streets of this tropical Chinese city.

HAIKOU, China: Hundreds of workers pour concrete as tower cranes swing overhead at the building site where a giant skyscraper is set to soar above the palm-fringed streets of this tropical Chinese city.

The building is the first of two towers that will serve as the gateway to a 200-hectare new central business district in downtown Haikou, capital of the island-province of Hainan in southern China.

The project is being constructed by HNA Group , the widely scrutinized and highly leveraged aviation-to-financial services conglomerate that got its start in Hainan 25 years ago as a regional airline with just two aircraft.

But HNA is now looking to shed at least some of its sprawling interests in the huge 100 billion yuan (US$15.84 billion) business district, as it has done with many of the interests the company has amassed in a US$50 billion global spending spree.

HNA is currently in talks with potential “strategic partners” for parts of the development, which a range of investors also have stakes in, according to sources familiar with the situation, even as it prepares to re-organize its operations and shrink its workforce.

The search for investors in HNA’s hometown underlines the difficulties the company is facing as it struggles under the weight of the debt it racked up during its rapid expansion.
HNA told major bank creditors in January that it faced a potential cash shortfall of at least 15 billion yuan in the first quarter.

In the last two months, HNA has sold more than US$6 billion in prime real estate in Australia, New York and Hong Kong, while selling shares in Deutsche Bank , Park Hotels & Resorts , and Hilton Grand Vacations Inc .

On Monday, HNA Infrastructure Investment Group , one of the key developers of the Haikou business district, said it would sell a Hainan-based property company and logistics unit to Sunac China , a real estate developer, for 1.9 billion yuan.

When asked for comment on the stake sales, the company said in a statement that “HNA is always looking for trusted partners”.

The master plan for the Haikou business district includes 23 office buildings, residential compounds, and a massive luxury shopping mall. The first of the Haikou Twin Towers, 94-floors high, is scheduled to open in 2020, and will include a St. Regis Hotel.

Anchored in the center of the district is the Hainan provincial government, with HNA’s headquarters, a Buddha-shaped tower, sitting just down the road.

A COMPANY ISLAND

Hainan is in many ways an HNA company island. HNA Group operates 92 enterprises across the province, employing 30,000 workers, with total assets of nearly US$50 billion. It is Hainan’s biggest money maker, with total revenues outstripping the combined sales of the province’s next nine largest companies combined.

HNA is also critical to local government efforts to establish Hainan as a regional and global tourist destination.

The group operates the island’s three commercial airports and its flagship Hainan Airlines operates 17 international and regional routes from the province and transports about 45 percent of all visitors arriving by air here.

The company is currently investing 15.3 billion yuan for a second runway and terminal for Haikou’s international airport, part of an expansion to accommodate 35 million visits by 2025.

The branded tailfin of Hainan Airlines, which travels to 110 cities worldwide, has elevated the province’s name around the world, said Edward Tse, chief executive of Gao Feng Advisory Company, who previously advised Chinese companies at Booz & Company and Boston Consulting Group.

“HNA is a business card for Hainan province,” Tse said.

Hainan’s governor, Shen Xiaoming, who visited HNA’s Haikou headquarters in November just as the severity of the company’s financial struggles emerged, underscored the importance of the group to the province’s development.

“HNA took root in Hainan, understands Hainan, implemented a new development concept in Hainan, and built a modern economic system in Hainan,” Shen said. “If HNA is good, then Hainan is good; when Hainan is good, then HNA is better.”

GOVERNMENT CLEAN-UP

HNA and other non-state conglomerates in China have meanwhile been under intensifying pressure from Beijing to clean up operations and deleverage their businesses.

In recent weeks, Chinese regulators have taken control of Anbang Insurance Group. The government is also investigating the chairman of CEFC, which has agreed to take a US$10 billion stake in the Russian oil major Rosneft.

HNA executives have recently elevated their patriotic rhetoric and have tethered company goals closely to those of Beijing.

HNA Capital, for instance, announced on Feb 27 that it was helping to raise 20 billion yuan to help fund projects along China’s new Silk Road trade initiative.

HNA’s cause is the “cause of the party, the cause of the people and the cause of all mankind”, Chen Feng told HNA’s Communist Party members on Feb 7, according to a company report.

HNA’s co-chairman, Wang Jian, voiced a darker message, telling employees that the company’s difficulties were the result of a “major conspiracy” against the party and President Xi Jinping by foreign and domestic “reactionary forces”, according to an internally-distributed email.

China’s leading industrial conglomerates and technology companies all have Communist Party committees, and such rhetoric is not unusual now, said Tse of Gao Feng Advisory Company.

 

By Edward Tse
March 29, 2018

A Gap in Expectations – Why People Didn’t Understand China’s Innovation

Many people are now talking about China’s innovation like they have just discovered a New Continent. Some say China is now going “from imitation to innovation” while others even say, “It’s time to copy China.” This is unthinkable just several years ago.

Recently, I went back to my book China’s Disruptors, which came out in 2015, to recall what people said about China’s innovation at that time. The following is a relevant excerpt. In addition to the people quoted in the excerpt, I remember around that timeframe, Carly Fiorina, ex Hewlett-Packard CEO, was quoted saying, “…but what (the Chinese) can’t do is innovation, they are not terribly imaginative, they are not entrepreneurial…”

The following is the excerpt from my book.

Outsiders who get information about China from the Western media tend to view it as an innovation desert: a country of copycat firms, weak or nonexistent intellectual-property rights, and an education system based on rote learning.

Addressing a group of air force cadets in May 2014, U.S. vice president Joe Biden declared, “I challenge you, name me one innovative project, one innovative change, one innovative product that has come out of China.” Two months earlier, Harvard Business Review published an article with the headline “Why China Can’t Innovate.” The piece, written by business-school professors Regina M. Abrami, William C. Kirby, and F. Warren McFarlan, boldly declared: “Today, … many believe that the West is home to creative business thinkers and innovators, and that China is largely a land of rule-bound rote learners – a place where R&D is diligently pursued but breakthroughs are rare.”

The authors agreed with this outlook and dismissed the kind of advances seen at companies such as Alibaba and Baidu as “second-generation” innovation – adaptations of existing technologies for the Chinese market, and the kind of routine work companies around the world do day in and day out once someone else has done the blue-sky thinking.

Source: Google

This is bizarre. How can the authors of that article and many other similar pieces miss the impact that companies in a wide range of industries are creating in China, reworking daily life by inventing and applying new ideas in a variety of fields? Consider Haier in white goods. Huawei in telecommunications. Xiaomi in mobile phones. Alibaba in e-commerce and finance. Tencent in messaging and gaming. These are just a few examples; there are many more. Yet they are often overlooked. Why?

Rather than simply a snapshot of today, or even a view from the past, China’s development is inevitable, discontinuity is a way of life and often multi–dimensional. As such, linear and single-dimensional viewpoints will often miss the point.

The simplest explanation is a gap in expectations. Chinese companies have yet to produce basic technological research in power systems or chemicals, for example, or a product or service that has had the same impact on Western markets as the iPhone or Facebook, or a praised and adopted business process such as Japan’s “just-in-time” production system. But simply translating this into “China isn’t innovative” is short-sighted, simply focusing on what has not happened in China and not seeing what is actually taking place.

Source: Google

Since my book was published, China has taken huge strides in both innovation and entrepreneurship. Today, many people have come to recognize that China can be innovative, especially in tech-enabled innovations. However, as the above excerpt of my book indicates, this certainly wasn’t the case just a few years ago. It is always important for people to study China not from a long distance but be on the ground – all the time and across many dimensions. It is also important for people to adopt a prospective point of view on the likely changes in China instead of just taking a snapshot of today or constantly looking back at the past.

Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).

 

By Edward Tse | 24 Feb 2014

Four years ago, Dr. Edward Tse wrote an article, Don’t Belittle China’s Innovation Potential, which was published on Europe’s World. The date of the publication was February 24th, 2014.

Is China a breeding ground for innovation? Most people wouldn’t say so, as China is so often associated with copycats, restricted freedom of speech, poor protection of intellectual property rights (IPR), rote-learning education and an overbearing state sector. For some or all of these reasons, outsiders tend to see China as lacking the fundamentals for successful innovation.

But this view is simplistic and superficial. Let’s look at two of these so-called reasons in more detail. Lack of IPR protection is a real issue, but it hasn’t stopped innovation from taking place. Over the past decade, there have been many examples of innovation originating from China, both product and technology innovations as well as business model innovations. One can argue that change is still at a snail’s pace, but China’s IPR protection is improving and in recent years there have been cases where foreign companies successfully sued Chinese companies for IPR infringements.

The dominance of the state economy is another often-cited reason inhibiting innovation in China. Yet even the state sector can create innovations. Large scale examples include China’s space programme, its expanding high-speed rail network, the world’s highest-elevation railway (to Tibet), and the world’s fastest supercomputer. The list goes on and is lengthening. These were all developed under the auspices of the state sector. Regardless of what many people say about the Chinese copying or even stealing technology from others, for projects as complex as these, real innovations clearly do exist, and the dominance of the state economy was able to provide ample funding for these advances.

“Despite the state sector’s role so far, most of China’s innovation will not be coming from there. It will come from the companies or even individuals who compete in China’s increasingly open economy”

China’s market economy is still developing, and is now slightly over two decades old. This fundamental transformation away from the fully planned economy so deeply ingrained during the Chinese People’s Republic’s first 30 years is still just a small blip in China’s long history, and nothing that we have seen during the last 20 years is by any means perfect. But the forces shaping the future change need to be fully understood, and the direction and speed of their change recognised and appreciated.

Despite the state sector’s role so far, most of China’s innovation will not be coming from there. It will come from the companies or even individuals who compete in China’s increasingly open economy. And that includes both Chinese and foreign private companies as well as state companies. And as more mixed equity enterprises are formed in response to the needs of a competitive market, the lines separating these different kinds of companies will become more blurred than ever. China is undergoing a measured but definite process of deregulation, sector by sector. Not all sectors of the economy will ever be fully deregulated, but the trend is clear.

The size of China’s market and the potential for profits mean that when the government opens up a sector it becomes an arena for some of the world’s most intense competition. This forces companies to be innovative and to create the best products, services and business models to achieve success. There’s also a strong “why not me?” mentality among Chinese entrepreneurs, so when an opportunity arises they tend to give it a try. Some – maybe even most – may fail, but with a population of 1.4bn, even a small percentage of successes is noteworthy and these are going to encourage many others to try their luck. In short, waves of new entrepreneurs in China will be pushing for greater experimentation and more innovation.

Xiaomi, one of China’s leading smartphone players, is an excellent example of an innovative company in a highly competitive industry. Xiaomi’s leader, Lei Jun, understood the power of the Internet and built his company’s business model by “listening to customers” through social media – the concept known as “crowd-sourcing”. Its strategy is working so well that Xiaomi’s revenues grew from zero in 2010 to $5bn in 2013, with the company now reportedly valued at $10bn. The late Steve Jobs at Xiaomi’s U.S. counterpart, Apple, didn’t believe in focus groups because he felt he knew best, but Lei Jun takes the opposite approach, and is convinced that customers will be the best ones to tell him how his products should be designed and how its service model developed. With millions of fans, Lei Jun claims his business model is not to make money from the hardware, but from services.

At a more basic level of innovation, Haier, a leading Chinese white goods manufacturer, quickly gained market awareness and share by introducing a washer capable not only of cleaning clothes but also potatoes. This sprang from a customer claim and is an example of Haier’s “customer centric” management philosophy. Not every Chinese company will be like this, but the market is changing so rapidly that there are major incentives for Chinese companies to be agile, nimble and innovative.

“There’s also a strong “why not me?” mentality among Chinese entrepreneurs, so when an opportunity arises they tend to give it a try”

To successfully breed innovation, a country must be tolerant of mistakes and failures. These failures will include short-lived innovations, but they are part of the process and in fact often further examples of how innovation will be sustained in China. Tencent’s QQ, for example, was a precursor to WeChat, a fast-growing Twitter/WhatsApp type of platform very popular not only in China but internationally too. Although only two years old, WeChat already has over 600m registered subscribers and over 270m active users and the numbers are growing fast. It introduced voice capability before WhatsApp, along with a more recent payment capability that is undercutting China’s dominant incumbent, Alipay of Alibaba.

Telecom operators see WeChat and Sina’s Weibo as competitors because they eat into their own text messaging businesses and the prevalence of the Internet, in particular wireless internet, is fast cutting out traditional distribution methods. Only a few years ago, Gome and Sunning were the dominant retailers through their “bricks-and-mortar” retail stores and today, Sunning is having to quickly transform itself into an “O2O” (Offline to Online) retailer. The same goes for companies like Haier, while many retailers, especially state-owned ones, are looking at how they must revamp their business strategies to remain competitive.

As China’s economic transformation continues, more and more monopolies will be broken down. It’s unlikely that China will become completely deregulated in the near future, but it’s heading in the right direction, and the new government re-affirmed this trajectory at its recent Third Plenum when it was emphasised that market forces will play a “decisive role” in China’s economic development and non-state capital will gain access to more sectors. State-owned enterprises (SOEs) are set to remain important, but non-state companies were for the first time put on an equal footing with the SOEs. Experimental free trade zones like that of Shanghai are to be established in more cities across China, and an effort will be made to create economic conditions that are conductive to innovation by entrepreneurial companies, both foreign and state-owned.

China’s unique qualities are its complexity and size. Even a small percentage of successes can be significant in the context of global commerce. Europe and the rest of the world will need to keep a close eye on China’s innovations because as well as threats they will bring with them opportunities.

 

By Edward Tse | January 12th, 2018

It has become a tradition for people to come up with predictions around the new years and here’s my list for 2018. This is my first endeavor and given my professional focus, my predictions will center on strategy and businesses with focus on China and China’s increasingly involved role in the world.

No predictions of this sort will be totally MECE (mutually exclusive and collectively exhaustive), including mine. I will attempt to go through my thoughts from the top of my mind. My predictions for 2018 will be as follows.

1. China’s GDP growth for 2018 will be around 6.5 percent

I don’t really have a crystal ball and as you know, this sort of predictions is anyone’s guess. Nonetheless, my work through different parts of China has allowed me to talk to businesses and people from all over, As always, there is both optimism and pessimism. Overall, I sensed more optimism than pessimism and I felt that a somewhat positive momentum is being built. Like always, there will be areas in which China will struggle, for example, sectors with chronic overcapacity and structurally low performing SOEs in parts of China. There are also doubts on the prospects of China’s property sector in 2018 and China’s debt level remains high, causing concerns about its financial risks; however, there will be areas in which China will continue to do well. According to a study by the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences, China’s new economy – Internet-based businesses ranging from e-commerce to car-hailing services – grew twice as quickly as China’s overall GDP in the past 10 years to 2016. The contribution from the new economy to the overall GDP growth will continue in 2018, along with an increase in consumption and investment as well as trade, all serving to continue to prop up the GDP growth. In summary, barring major Black Swan events, I expect China’s GDP growth would hover around 6.5 percent plus and minus some, consistent with what the Chinese government and institutions such as the World Bank and IMF predicted. The perennial prediction of the “coming collapse of China” will unlikely to happen (again).

2. China’s consumers will continue to trade up

The fact that the Chinese middle class is growing and that their ability to afford more products and services continues to increase shouldn’t be viewed as a prediction anymore. This will happen almost for sure, but it’s still an important trend that’s worth mentioning. Depending on whose estimates you believe, the number of China’s middle class is currently around two-and-a-half to three hundred millions. All estimates are pointing to an overall increase over time. And these consumers are trading up. Instead of basic products and services, Chinese consumers are increasingly looking for those who can cater for better lifestyle and health. They are also increasingly digitally savvy and globally mobile, and are becoming more individualistic in their needs and consumption behavior.

3. Innovation and entrepreneurship in China will continue to thrive

China has begun to shed off its image as a copycat nation as more and more companies, both large and small, are becoming innovators in their own right, mostly in tech-enabled business models. Entrepreneurship is spreading across China – not only in top-tiered cosmopolitan areas but also in lower-tiered cities and across a wide range of sectors. Additionally, the entrepreneurs are getting younger. Many of them are in their 30’s or even 20’s. The Chinese central government has embraced innovation and entrepreneurship as a core part of the national development strategy. In 2018, we would expect more to come.

Source: Google

4. Technology will play an even larger role in driving China’s innovations

The wireless Internet and the smartphone have played a major enabler role for helping to drive China’s rapid growth in innovations for the past decade. As Chinese entrepreneurs continue to search for the next rounds of innovations, technology will continue to play a major enabler’s role. The Chinese have embraced various forms of new technologies in artificial intelligence (AI), internet of things (IoT), augmented reality (AR) and virtual reality (VR), and are experimenting many different ways for innovations. Surely, many of these experiments would fail but some of them would succeed. Given the size of the Chinese market, the ability of scaling up gives experimenters opportunities to try, learn and adapt, allowing a natural selection of the right application of technology to businesses.

5. Continued hyper growth of the Chinese ecosystems organizations

In 2017, China made history as Alibaba and Tencent became two of the world’s largest market cap companies and their rankings continued to move up. These two companies are prime examples of “mega-ecosystems” as they have built out from their original core business to form various ecosystems that together form a mega ecosystem. They jump from sector to sector as they see new market opportunities pop up as China continues its reform and opening up, and as technologies become available as an enabler for disruptive means of doing business. Each mega ecosystem attempts to offer what the consumer needs for his or her “lifestyle needs”, so each of them could be a bona-fide exponential business. When put together, the mega ecosystem becomes “super exponential” in their growth. While leading US tech companies such as Amazon and Alphabet are also major ecosystems players and are very successful, the Chinese seem to be more inclined to migrate across sector boundaries and to create larger ecosystems. Companies like Geely, Didi Chuxing, Ping’an, Meituan are building out their respective ecosystems in incredible speed and intensity. Clearly, access to abundant users’ data is the core for this kind of companies. Even shared bikes start-ups like Mobike and ofo claim that they are data companies and not just shared bikes companies, meaning that they would also build out their ecosystems with consumer lifestyle at their core.

Source: Google

6. Mixed ownership reform of Chinese SOEs will finally happen

China’s SOE reform has been talked about for at least for the last couple of decades. In recent years, the notion of mixed ownership reform was mentioned many times as the solution to the structural issues of the Chinese SOEs. However, not much has taken place. In 2017, China Unicom’s mixed ownership reform was given the green light by the Chinese government. It looks like the Chinese government is ready to step on the gas pedal for this sort of reform in 2018. Not only SOEs at the central government level, but also many of those at local levels will be targets for reform. And, reform will likely be focused on enterprises in the “competitive sectors.” Let’s see how it would go but from what I saw and heard, it looks like things can get much more serious this time.

7. More opening up will be allowed for foreign companies’ ownership of their operations in China

Since its reform around three decades ago, China has been gradually opening up its industry sectors for foreign participation. Today, while some of the sectors remain pretty closed, some of them are entirely open. And, some are somewhere in between. I would expect the gradual opening process would continue but it is unlikely every sector would become entirely open overnight. In November 2017, the Chinese government announced the ease in foreign equity participation in a range of financial services sectors. While this move didn’t allow full foreign ownership in the relevant sectors, the increase in scope and scale was quite significant. I would expect more opening up in 2018.

8. Foreign companies’ performance in China will continue to be mixed

Some pundits have claimed that the golden era for (foreign-headquartered) MNCs in China is over. I don’t agree with that. China’s continued growth offers plenty of opportunities for foreign MNCs. It’s a matter of how the MNCs view the opportunities. However, the performance of these companies in China to-date has been mixed. Some came to China and were disappointed with the market. Some of them even decided to withdraw from the China market. Some other MNCs are engaged in sectors where there is significant and structural overcapacity. These companies tend to be in a wait-and-see mode. Yet, some others have found China to have become one of their most important and most profitable markets, or even the most important and most profitable. This overall pattern will probably continue in 2018 but the dynamics would evolve. For the companies who are in the third category, I predict most, if not all, of them would continue to invest in China, and for some, significantly. For some who have left or have de-emphasized the China market, they may return to and re-invest in China. For these companies, China is just too big and too important a market opportunity, as well as a pivot for these companies’ global strategy, to ignore. Competition in China’s open sectors will become even more intensive in 2018 driving foreign MNCs to become more competitive and more innovative in their own right.

9. Cross-border M&As will continue

While Chinese companies’ outbound investment in 2017 has dropped from its peak in 2016 due mostly from the Chinese government’s capital control measures, the 2017 investment level was modestly higher than that in 2015. Chinese companies’ interest in investing overseas has not fully cooled down as many of the Chinese companies are still seeking for ways to do these investments. From the Chinese government’s standpoint, the reason for investing overseas has to be legitimate. But as long as they are regarded as legitimate, it looks like the Chinese government would give the green light. Two recent cases in point were Geely’s US$ 3.3 Billion purchase of 8.2% of AB Volvo, the truck manufacturer, in December and the US$ 9 Billion deal completed by private oil company CEFC China Energy to take a 14% stake in Russia’s biggest crude producer, announced in September. I expect this trend will continue in 2018. Perhaps the total volume or value of the transactions wouldn’t shoot up in a major way, but I would expect a modest increase. Of course, cross-border Chinese investments are sometimes blocked by the host government due to “national security” reasons. I expect this would continue to be a challenge for the Chinese investors as they look to investing overseas.

Source: Google

10. The China development model continues to foster

For a couple of decades, the so-called “China Development Model” with which a top-down guiding hand by the central government and the bottom–up grass-roots entrepreneurship has worked remarkably well for China. This model has created several decades of high economic growth and has lifted several hundreds of millions of people out of poverty. While some pundits continue to argue against the legitimacy and sustainability of this approach, surveys have shown the Chinese people are largely supportive of the results that this model has generated. In addition to the top-down government guiding hand and the bottom-up entrepreneurship, the “China Model” also includes a middle piece which gives the entire model extra effectiveness and resilience. That is the intensive coopetition among various provincial and municipal governments. Over the years, local governments have tried to build their respective advantageous positions over others. To this end, various governments would choose certain sectors or technologies as focus of their developments. This competition has generated much progress across China and in some cases, much waste. While this kind of competition will continue in 2018, regional clusters of cities are also being formed such as the Greater Bay Area linking key parts of Guangdong Province with Hong Kong and Macau, the Greater Shanghai Area, the Greater Beijing Area (Jing-Jin-Ji) as well as the development of the Xiong’An New Area in Hebei Province. While cities within each cluster would cooperate with each other, competition is somewhat significant across the clusters. This coopetition will manifest itself more profoundly in 2018 providing an underpinning for further progress for China.

So, here they are – my predictions for strategy and businesses in China in 2018. As I said, these are not MECE. For example, I haven’t covered major topics such as Belt & Road, capital market, financial reform. property market, shared economy, etc. Nonetheless, hopefully these predictions offer some insights as you plan for your business in 2018.

 

By Edward Tse | The WorldPost
October 19, 2017

SHANGHAI — If all goes as planned, China hopes to be the world leader in artificial intelligence by 2030. If successful, Beijing’s “moonshot” initiative – recently unveiled by the government – has the potential to be a game-changer not just for Chinese society but for global geopolitics as well.

My bet is that China will indeed reach its goal over the next decade, in part because of how far it has already come. While so much of the world today lacks clear direction, China has an edge in its ability to combine strong, top-down government directive with vibrant grassroots-level innovation.

Beyond this, China has an abundance of data to train AI-learning algorithms because of its huge population of Internet users – more than 700 million. China’s thriving mobile Internet ecosystem also provides a test bed for AI researchers to collect and analyze valuable demographics and transactional and behavioral big data and to conduct large-scale experiments at a much higher level than foreign counterparts.

This combination places Beijing in a unique position to dominate AI in just over a decade. It would be imprudent to expect otherwise. To understand why, look no further than the country’s current technological advancements.

China is investing in AI at the local level
Today, a number of local governments in China are offering financial incentives to encourage AI-related innovations. With the government’s assistance, Guizhou, one of the poorest provinces in the country, has become known as China’s “big data hub.” Major Internet companies such as Apple, Alibaba, Tencent and Qualcomm have set up new big data centers in the province, in large part due to this initiative. And in 2016, government data reported a 10.5 percent growth in Guizhou’s gross domestic product, one of the highest GDP increases among China’s provinces and municipalities.

Another example is the municipality of Chongqing. It was one of the first municipalities in China to establish a bureau to support local AI development. In May, Chongqing partnered with Baidu, a local search engine, to foster AI and big data. Elsewhere in China, Xiong’an New Area, a newly established district near Beijing, and Guangdong-Hong Kong-Macau Greater Bay Area, a city cluster, have also incorporated AI in their development plans as a key economic growth engine.

Workers test the functions of a giant robot as they set up a robot exhibition in Hefei, Anhui province. Sept. 26, 2013. (Reuters/)

China is inspiring tech to prioritize AI
The Chinese government’s favorable policies have inspired innovations across a wide range of tech players in the country. Leading Internet giants such as Baidu, Alibaba and Tencent, rising start-ups like iCarbonX and SenseTime, as well as “unicorns” – companies that have reached $1 billion valuation – like Didi Chuxing and Xiaomi are either adopting AI technology already in their operations or investing in it.

Baidu, for example, has shifted its company strategy from “mobile-first” to “AI-first.” Some of its initiatives include DuerOS, a conversational AI system that can be integrated into smart devices such as speakers, televisions and refrigerators; Project Apollo, an open source platform for the research and development of autonomous vehicles; and Baidu Brain, an AI platform with 60 different AI-enabled services. Its rival Tencent has also established its own AI lab, which developed the software that famously defeated high-ranking Japanese “Go” player Ryo Ichiriki earlier this year.

Additionally, Chinese health care start-up iCarbonX is building a digital “ecosystem” using AI technology to collect users’ biological and psychological data, provide personalized health analysis and predict users’ health status. And SenseTime, a Chinese AI start-up founded in 2014, focuses on innovative computer vision and deep learning technology. In July, SenseTime claimed it had raised the largest single round investment in AI globally at $410 million.

Alpha1 Pro, a humanoid robot for entertainment and education, at the Canton Fair in Guangzhou, China. Oct. 16, 2017. (Venus Wu/Reuters)

Still, there are some significant gaps to close before China becomes the world leader in AI. According to a recent AI report from Tencent Research Institute, the number of AI companies in China lags behind those in the United States, especially in the areas of core components and processes. China still falls short of the U.S. when it comes to new ideas and research related to AI but appears to have the upper hand in the application and implementation of these AI technologies.

Another potential challenge is geopolitics. According to an unreleased Pentagon report cited by Reuters, the U.S. government views Chinese investments in American AI start-ups as a potential threat to national security. As a result, the U.S. wants to scrutinize cross-border investment in sensitive AI technologies. On top of that, the Trump administration has proposed a 10 percent cut to the National Science Foundation’s spending on “intelligent systems.” This could present potential opportunity for China, through strong government support and financial incentives, to attract U.S. talent to set up AI labs and conduct pilots in China.

China has some work to do before it successfully harnesses the potential of AI. But it has the resources and talent to reach its goal – and now it has the political will to make it a national priority. That combination will be hard to beat.

This was produced by The WorldPost, a partnership of the Berggruen Institute and The Washington Post.

Edward Tse is the founding chief executive of the consulting firm Gao Feng Advisory Company. He has worked with the World Bank, the Asian Development Bank and the Chinese government on state-owned enterprise reform.

 

By Dr. Edward Tse

A few weeks ago, I had a meeting with the APAC head of a major Fortune 500 company at his office in Shanghai. It was the first time we met and the meeting was very enjoyable. He told me that he had arrived in China around six months ago and was sent from headquarters to run their Asia business with a particular focus on China.

He said he thought he would come to China to “teach.” While he knew China was a fast-growing country economically (and that things in general were changing fast), he believed that China was still somewhat “backwards” in terms of corporate management know-how and lacked innovation. In fact, many people still perceive China as a “nation of copycats”.

Since landing in China, he confirmed the pace and intensity of change in China, of course. That was easy. However, he was struck by the speed and magnitude of innovations taking place in China. He cited the dock-less bike sharing phenomenon, where literally over night the streets of Shanghai became overrun with thousands of bikes. Critically, this turned out to be a product/service that people really embraced rapidly. The way that Chinese innovations are taking place, he concluded, is often quite different from what he knew back in the United States.

He concluded his story by saying, “I thought I would come to China to teach, but instead I found out that I am here to learn. Or, at least to both teach and learn.”

This kind of reflections is becoming more and more prevalent among expat executives in foreign multinational companies (MNCs) in China. In the older days, i.e., a couple of decades ago, the “I come to teach” mindset was very common. Sure enough, back then China was at the early stage of its economic and political reform and opening-up. It was still at the initial stage of its transition from a planned economy to a so-called market economy. State-owned enterprises (SOEs) were dominant and privately-owned enterprises (POEs) were only at their infancy.

Corporate management practices in the modern definition were just being picked up by the Chinese. Copycats (“Shanzhai companies”) were all over. MNC executives who came to China during this time appropriately felt the knowledge and experiential advantage. For those who were compelled, they felt they could teach the Chinese.

As China grew, things evolved rather quickly. While SOEs continued to dominate some sectors, POEs were growing much faster, especially in sectors that were not as regulated. With the increasing prevalence of technology, driven by wireless internet, the leading POEs turned out to be not only entrepreneurial but also very innovative. They identified market opportunities and swiftly created new business models, often enabled by technology, to address major market pain points. Some of them have grown extremely fast creating what we call “exponential organizations” and in the process their executives also picked up a great deal of knowledge and experience on how to better manage businesses.

Source: Baidu.com

Today, innovation and entrepreneurship continue to pick up steam in China. Entrepreneurs are getting younger. Many of them are “post-80s” and “post-90s”. They can be found not only in major hubs like Beijing, Hangzhou and Shenzhen, but also in many lower-tier cities. They are dabbling in all sorts of start-ups across many industry sectors. Even more established companies have found they needed to change and to re-invent themselves in order to capture the new opportunities or at least not be marginalized. Many Chinese business executives are looking for inspirations from the cutting-edge development in technology, strategy, business models, organizations, and processes. More of them have concluded that while they were trying to learn from (“benchmark”) the western best practices in business and management a decade or two ago, they are now less able to identify appropriate western benchmarks for their growth going forward. Many of them need to figure out their own ways.

Across many sectors, Chinese companies are becoming strong competitors to western MNCs in China. They are not only fast, agile and adaptable (“they do everything”), but also increasingly sophisticated and innovative. At least the leading ones are. Most people by now know the likes of Alibaba, Tencent and Baidu, as well as Didi and DJI, but there are lesser known entrepreneurial companies such as Liby (household cleaning products), Jovo (Chinese alcoholic beverages), Three Squirrels (nuts and snacks), Lepur (yogurt) and Hema (grocery retail) that are disrupting their respective verticals including the major foreign incumbents. Examples of such are numerous and the number is increasing every day.

Source: Baidu.com

While there are still plenty of copycat companies around, the front end of the curve is driven more and more by innovative companies. They generate new ways of doing businesses and the leaders of these businesses also tend to be good students. To this end, MNCs found that their original superior positions are no longer guaranteed. They must adapt their strategy, organization and business models to China (and increasingly transfer their learnings from China to the rest of the world). There is no doubt that in some areas MNC expat executives still have things to teach the locals. And many of the locals are still open to learn. However, the reverse is also becoming true. MNC expat executives are quickly finding that they can learn a great deal from the local businesses. “The Chinese Way” is no longer a universally negative notion but increasingly being appreciated as ingenious and value-adding.

The transition from “I come to teach” to “I come to both teach and learn” took place over a relatively short period of time. The role of China in global business has evolved significantly during this period and one would expect more to come, perhaps with even higher speed and stronger intensity.

 

About the Interviewee:
Dr. Edward Tse
Founder and CEO, Gao Feng Advisory Company

About the Interviewer:
Jim Euchner
Chief editor at Research-Technology Management, a US business journal

For more than two decades, Edward Tse has lived and consulted in China and observed the country’s dramatic transformation, one driven by a new entrepreneurialism and encouraged by the Chinese Communist government.

He has seen countless multinationals misread these changes, and a few grasp them. In this interview, he discusses the opening of the Chinese economy, the role of Chinese entrepreneurs in the resulting growth, and what multinational companies can do to succeed in the large, growing, and dynamic Chinese economy.

JIM EUCHNER [JE]: Your book, China’s Disruptors, makes a pretty compelling case that innovation is thriving in China. It’s a surprise to many who see China in the narrower role of a contract manufacturer or an imitator. What has happened in the last 8 or 10 years that has changed how China is innovating?

EDWARD TSE [ET]: One of the biggest impetuses was to open up the private sector in China. For a long time, the Chinese economy was dominated by state-owned enterprises [SOEs]. And while the SOEs have contributed in their own ways to the development of China, business innovation has come largely from the private sector. The private sector has been growing very, very rapidly, which the mainstream media in the West have not fully reported.

The entrepreneurs in China, by definition, are looking for ways to grow their businesses, and many of them are looking at innovation as the way to differentiate themselves from their competitors. And, of course, technology has become a very important enabler—in particular, the development of the Internet. The wireless Internet has been especially important over this period. It may surprise people that China is really a very significant Internet nation. The enabling factors of technology and thriving entrepreneurship in the world’s most populous country have driven the change. There are other factors, as well, but I think these two are probably the most significant ones driving innovation in such a fast and significant manner.

JE: Can you talk about the dance between the opening up of the economy and the official control of both the communications infrastructure and the state-owned enterprises? How does that dance work for the entrepreneurs?

ET: It is certainly true that China is still a very governmentcontrolled country; in many cases, there’s not a full degree of freedom in what people and companies can do. The interpretation of that in the West is that, therefore, it’s very difficult for the Chinese to be innovative. And also, perhaps, the Chinese are not very happy. This is only partially true. In reality, although the control of the government is very, very significant, the entrepreneurs are still able to grow in their own ways. It’s a very interesting case, because it’s becoming a duality in the development of the Chinese economy.

While the state-owned enterprises remain strong in some of the sectors, the private sector also has been thriving in its own ways at the same time, despite not having 100 percent economic liberation (so-called freedom). In a way, the Chinese government has been very, very supportive, in terms of working with the private entrepreneurs and in innovation and entrepreneurship. They have not in general tried to block the development of the private sector. The government, in fact, is encouraging almost everybody in China to be entrepreneurs and to be innovative. It has developed into a very interesting case; despite the imperfections in the society, it is thriving in its own way, which I think defies the assumptions that many in the West have made about the development of China.

JE: Yes, I think so. I had a chance on a trip to China to visit with some entrepreneurial firms, and I was surprised by their willingness to take risks and to invest in the development of new technologies and new processes. The management was nonbureaucratic; it was decisive. Did I just see a good example?

ET: No, what you said sounds right. Entrepreneurial thinking is an extremely widespread and fast-growing phenomenon in China. It is spreading across China, not only in one or two geographic areas; it’s not only in big cities like Shanghai or Beijing.

As you go around China, from the eastern seaboard, where it’s more developed, all the way to the inland area, down south to Guangdong, you see the same thing. Shenzhen is one of the world’s most innovative technology hubs. You see that all around China. People are willing to take risks.

I have found the entrepreneurs I have met in China to be quite bold, and they’re very thirsty for knowledge about technology. They’re very thirsty to understand what the latest technology is and how to apply it to business, whatever makes sense. It’s happening across age profiles. The entrepreneur in China is actually getting younger. We’ve got a lot of young people, who we call the post-80s and post-90s, who have become entrepreneurs. Many of them don’t want to work for big companies anymore; they want to be successful, and they have an urge. They see predecessors, people like Jack Ma from Alibaba and Pony Ma from Tencent. They aspire to become the next Jack Ma or the next Pony Ma.

It’s very encouraging. Of course, entrepreneurship is a low-probability game. Many of these entrepreneurs won’t be successful, certainly at their first attempts. But this has not deterred these young people from all over the country from trying to make it happen. China today actually is culturally accepting of people who fail. If they try and they fail, that’s okay. People can come back again. It’s a very different culture compared to the China of 20 or 25 years ago. Entirely different.

JE: In your book, you profile Alibaba and Tencent. Both had early failures, and yet they ultimately achieved—I hate to sound ethnocentric, but they achieved the great American dream. They achieved the same things we think of the most successful entrepreneurs in the West as having achieved.

ET: Exactly. It’s the pursuit of the same values or ideals, but it’s happening in a very different political and social context. It’s very interesting. I think that there have been assumptions made that for these sorts of inspirations, innovations, or breakthroughs to happen, you have to have a certain context, in politics and the organization of society.
But I think that the Chinese phenomenon is proving that perhaps there’s another way.

JE: It will be interesting to see. In your book, you talk about four things that are driving growth in China, with the acronym SOOT: Scale, Open, Official support, and Technology, especially the wireless Internet. Can you start by talking about the scale effect? There is a large, emerging middle class in China. Is its growth akin to what happened in the US after World War II, where a large number of people moved into the middle class, and there was a bootstrapping going on as the middle class created demand, which drove a growth in good jobs?

ET: In terms of actual scale, it’s bigger than even the US after the Second World War, since China is the world’s most populous country. So the scale is significant. But of course, before the opening up of China, up until the Cultural Revolution, China was closed and the Chinese people were poor. Although there were a billion people, they were not really consumers. But during the rapid economic rise of China over the last 25 years, a real middle class has been developing. And this middle class, depending on your definition and depending on whose analogies you believe, ranges anywhere from 200 million to 300 million or more people.That’s not a small number. And that number will only continue to grow.

Source: Baidu

At the same time, it’s not only the middle class consumers who are driving demand. We’re also seeing demand from the lower-tier consumers, as the rural areas in China are also undergoing major changes. Chinese entrepreneurs have benefited from the fact that the scale of the market for them is significant and, mentally and culturally, many of them are quite willing to take their business model innovations to the market, even though that business model may not be 100 percent perfect. They go to the market with a somewhat imperfect model, use the market to scale up the business and to experiment with the business model; they use the feedback from customers to learn and adapt and refine the business model. The scale of the China market is very, very important because it allows that scaling up in a very fast manner, which allows people to adapt and to improve.

JE: That makes sense. The scale and the pace are two different things. The pace of change is also staggering. How does that play into the entrepreneurial activity there?

ET: The pace is happening in two ways. One is on the demand side; the other is on the supply side. The demand side is driven by the rapid increase in income levels, so everything that’s related to consumers has been changing very rapidly; as income levels go up, people gravitate more to lifestyle needs rather than just the basic consumer needs. That doesn’t mean that the basic needs are not necessary; they’re still very necessary. But at the same time, the upper end of the needs pyramid is also developing very quickly, and it’s happening within a very compressed time frame and with a huge volume. That is what is driving the pace of change on the demand side.

On the other hand, the pace of change on the supply side is also very significant. The underlying driver for all of this is the gradual transition of China from a planned economy, something like the former Soviet Union, to a so-called market economy. Unlike the Soviet Union, which accepted the IMF recommendation when the Soviet Union collapsed and took on the shock therapy, where everything had to be privatized overnight, the Chinese moved more slowly. Deng Xiaoping actually said, “We actually don’t know how this will go, but let’s do an experimental and gradual process.” He called that process “crossing the river by feeling the stones.”

That process is still happening today. Obviously, it has its drawbacks, but at the same time, it also has a significant benefit. Every time there has been a sector that has opened up during this gradual transition, it has exposed additional imperfections in our economy. When entrepreneurs see the imperfections, and combine that with the new technologies, they see opportunities, as well. Once a sector is open, a lot of companies jump into the market and try to get a piece of the action because they see the opportunities.

From the supply side, we often see the world’s most intense competition happening in China. There are SOEs, who want to hang on to some of the market. There are the multinationals, perhaps, who want to get a piece of the action. But there are also some Chinese competitors that you don’t see in the US or in Europe. They are thriving here in China. The birth and the rise of local competitors are significant. Competition drives efficiency, and it drives innovation. With these forces at work, the pace of change is intense. It’s incredible.

But at the same time, competition also drives companies to improve. Some get it, but some don’t get it. Later on, they find out there’s an alternative way to do business that can overtake the incumbents. All of this is happening. The pace is significant because people need to survive and because people want to get ahead. We’re talking about different levels of intensity; China is more competitively intense than in many other parts of the world.

Source: Baidu

JE: As the economy opened, did it do so sector by sector? Did the government open up the entire economy, or did they choose what sectors to open first?

ET: This is a very important topic. The West, in particular the mainstream Western media, have not really clarified this point. So when they make comments on China business, they’re often comparing apples to oranges. The transition from a planned economy to a market economy has been a gradual process in China, starting about 30 years ago. And it’s still going on. In my view, it will continue to go on for decades, if not forever; 40 years ago, everything was 100 percent in the planned economy—it was closed, certainly for foreign investors. And everything was run by state enterprises.

With the economic reform that was started by Deng Xiaoping, the Chinese government has been taking industries one by one from being closed to being open. In this process, some sectors have become 100 percent open; this means that everybody, no matter whether an SOE or a private company, whether a Chinese private company or a Western multinational, can compete in that sector. There’s not much regulation. In fact, in some sectors, there’s almost no regulation except for the common rules and laws that apply, like antitrust. So, some of the sectors are already open, but other sectors are still very closed: they’re restricted to SOEs. Not even private Chinese companies can participate in these sectors, and certainly not the multinationals. We still have some of those sectors in China. Telecom operations is an example. American telecom carriers are not able to offer their services in China.

There are also sectors that are somewhere in between; they’re partially open. An example is the automotive sector. From the standpoint of manufacturing, a foreign OEM needs to have a 50/50 joint venture partner in China to manufacture vehicles. The industry dynamics are totally different between an open sector versus a closed sector, and also between an open sector and a semi-open sector. That process of gradual opening up is still happening. Once a closed sector opens up for nonstate companies’ participation, you often see a drastic change in the industry dynamics. Such changes incentivize a lot of companies to enter the market, including many entrepreneurs who want to get a piece of the action.

So the business climate in China varies a lot by industry sector, depending on the degree to which it is open and how long it has been open.

JE: That makes sense. In your book, you note that official support for entrepreneurial firms and for the environment in which they operate is very important. Can you talk about the nature of official support?

ET: One might hypothesize that because China is a Communist state, it would stifle entrepreneurship, certainly entrepreneurship at the grassroots level. That is the assumption that many people make. But that is wrong. That’s not what’s happening in China.

While the government in China is still very supportive of state-owned enterprises, and while it is trying to achieve a lot of things through the SOEs, at the same time the private sector is developing. When the government sees the fruits that the private sector is bearing, it is very, very supportive of allowing entrepreneurs to do what they’re doing.
The innovation that the entrepreneurs are doing, and the employment and the social impact that they’re creating, and the wealth that they’re creating in the process, are important to the Chinese government. So the Chinese government is not only supporting entrepreneurs but also now regards innovation and entrepreneurship as a key pillar to the future development of the Chinese economy.

JE: And what does that mean? In practice, what does the government do to encourage that pillar?

ET: In general, they are very supportive of entrepreneurs when they are experimenting with new ways of doing business or new business models. As a new business model or new innovation comes about, there may not be a full set of regulations or policies to govern the new concepts, right? The Chinese government is quite willing to work with the entrepreneurs to develop new regulations and policies that are sensible.

The government also encourages the local governments all across China to work with entrepreneurs and to invest in them. There has been a huge amount of venture capital money in different localities in China, and in many cases, the major investor was actually the local government. Local governments are starting up funds that will fund the experiments that the entrepreneurs are suggesting. That’s another way that the government is supporting entrepreneurship.

JE: How fickle is it? Could the government shift its view and affect the fortunes of these entrepreneurial firms? For example, there are an awful lot of very small factories in China; I visited a few of them. I don’t know whether it’s accurate, but I have heard that there’s a state desire that they consolidate and get to the scale that they can become more professionalized. That’s obviously going to have consequences for some of the entrepreneurs who started those businesses. How does that kind of desire on the part of the government work?

ET: In some cases, there may be government action to try to consolidate some subscale operations. And as you also know, in many sectors in China, there is a lot of capacity in production, and a lot of this capacity is not that productive. From the standpoint of the government, it’s critical that there’s a way to rationalize the capacity. In fact, we now call it supply-side economics in China. On the other hand, there are sectors that have been growing significantly without much overcapacity, and in many cases, these are driven largely, if not entirely, by the private sector; in these cases, the government is not blocking private businesses unless there is major risk of fraud. And these firms can grow to a scale that is extremely dominant.

Alibaba is one case of a very significant firm. Tencent or WeChat is another. We’re seeing this phenomenon over and over. The government is not blocking these private entities because they’ve become so significant and so big. In fact, the government is encouraging them to continue to develop innovation. So two things arehappening at once. There is overcapacity in some sectors, which causes the government to respond, but there is also continued encouragement of companies that are thriving and developing dominant positions in their spaces.

JE: That’s helpful. You just mentioned what you call the BAT, or Baidu, Alibaba, and Tencent—the three big, very successful, Internet-based companies. Can you say a little bit about them?

ET: BAT—Baidu, Alibaba, and Tencent—are the leading Internet tech companies in China. They’re all private, entrepreneurial firms; they’re not state-owned. They were formed at about the same time, towards the end of the 1990s; none of them is more than 20 years old. They’re all growing significantly. Alibaba had its IPO in the US two years ago, and it was the largest in US history. Tencent is listed on the Hong Kong Stock Exchange, and it’s now the most valuable company in all of Asia. These companies have become very dominant in China.

Source: Baidu

But their positions are somewhat different. Baidu started with the search engine business, kind of like Google, but now is very much shifting into artificial intelligence [AI], because they view AI as the future. Alibaba has built itself into a diverse business ecosystem, but the core is still in e-commerce, kind of like Amazon and eBay. It has launched various e-commerce marketplaces, including B2B (Alibaba.com), C2C (Taobao), and B2C (Tmall) models. They also have created businesses in cross-border e-commerce, mobile payment, Internet finance, smart logistics, cloud computing, and many others. Tencent started off mostly as a game company—video games and online gaming, and online games have become a significant business for them. But probably their most influential and most commonly adopted business is WeChat. It started off as an instant messaging platform, like WhatsApp, but now is basically a lifestyle and business application. People can do virtually anything on WeChat. And it’s a very, very sticky platform.

All of them are very significant in size and dominance, but each finds its own areas of focus. BAT is at the core of what a lot of people look at as the tech sector in China.

JE: Something that I had not fully appreciated is that there are, in a real sense, two Internets. There’s the Internet in China and the Internet in the rest of the world. Some people talk about the Great Firewall. How important is this firewall to the success of these companies? In some sense, they’re protected against competition from companies like Google because Google won’t comply with the politicalrequests or demands of the government. It’s a differently open Internet. Can you comment on that?

ET: That’s a very good question, and in fact, a question that’s probably on the minds of everyone I’ve talked to about this topic. In general, the assumption, at least from people from the West, is that because of the Great Firewall, people can’t be as innovative as they can in the West, because they don’t have access to all information. Further, they assume that people must not be happy, because they don’t have access to everything from the rest of the world. And the Great Firewall gives unfair advantages to Chinese tech companies at the expense of the West. These are the assumptions.

They are not entirely wrong, but they are certainly not entirely right, either. Some US companies were really blocked: I think Facebook was blocked; Twitter was blocked. Google was not blocked, but they chose not to comply with the requirements of the Chinese in terms of censorship, and so they withdrew.

There are also Western companies in this space that were not blocked at all. They were actually quite welcome to come to China to play. This includes eBay, which tried to enter China 15 years ago, and of course, Amazon, which has been in China since the early 2000s. But despite the prominence of Amazon and Jeff Bezos, and despite the fact that there is not much in the way—the kind of regulations and policies that would prohibit Amazon from operating in China—Amazon has not been able succeed in China in the e-commerce business as it has in the West. And eBay, as I mentioned, was beaten by Alibaba hands down in two years. Alibaba is not an SOE. It had no government support, but succeeded because of its capability and its competitiveness.

So, it’s a factual mistake to claim that all Western tech companies were blocked by China because of Chinese policies and regulations and the Great Firewall. That’s only partially correct. For those who have tried, many have not been able to capture the potential of the China market. Some of the reasons relate to the China context, but most of the issues are internally driven. They are limited by their ability to really understand China and to develop the right China strategy and the right China approach. This applies not only to the Western tech companies but in general to Western multinationals.

Source: Baidu

JE: I would like to segue to what works. What have multinational companies, not just tech companies, but tire companies, auto companies, appliance companies, done to succeed as they’ve moved from manufacturing in China to development in China and finally into innovation in China?

ET: If I had to pick one area where the multinationals have really failed, it is that they have tended to assume that whatever they do in the rest of the world, in particular in their home market whatever product, business model, go-tomarket model they use—would apply equally in China. That is an assumption that many multinational CEOs have made. In the back of their minds, they say, “Well, we’re a successful American company, or we’re a successful German company. We’ve been in business for 50 years, 100 years, 150 years. And we are a leader or the leader in our space in the world. I understand that China is large and growing, but I can just apply my way to China.”

And when they do market analysis, what they can forget or not fully appreciate is that the China market is developing in a faster and more competitive manner, and frankly, in a much more sophisticated manner, than their experience in the rest of the world has prepared them for. The size of China, the pace of China, the degree and intensity of competition in China, the quick development of technology in China, and the willingness to learn via trial and error all contribute to the complexity. Add to this the emergence of consumers who are, from an economic standpoint, middle class, but from a demand standpoint, probably among the most sophisticated and complicated in the world.

Instead of trying to cut and paste your business model or product from wherever it originated to China, start with a really deep understanding of what the China context is. Try to fundamentally understand what China was, is, and will be in the future. And from that, try to extrapolate to what business you should be in and how you can capture the right position in China and the full potential the China market offers to you.

I have worked with a large number of clients over the years. I think that the willingness of global CEOs to do that is actually very limited, including many of the global Fortune 500 CEOs. That is actually the fundamental issue with multinationals in China, rather than China is mysterious, China steals IP, and so on. That’s 20 percent of the issue; 80 percent is the companies themselves.

JE: Can you give an example of a company that’s done it well?

ET: There are some. The auto industry is doing in general pretty well. China is now the largest automotive market in the world. The German manufacturers and also General Motors and Ford, they’re doing very well in China. For those companies, the rapid rise of the auto market, the sheer size of the market, and the willingness of the Chinese consumer to adopt Western brands, really carries the automotive multinationals. And the market continues to grow at double-digit levels.

Source: Baidu

There are also companies that are in very intensively competitive consumer markets that are open; there’s not much regulation, and they’re really thriving. I’m talking about the sporting goods companies like Nike and Adidas. They’re really the stalwarts; they’re the leading companies. Starbucks is also doing well. Why would the Chinese like to drink coffee? Chinese people used to drink tea. Starbucks is doing extremely well in cultivating a new coffee culture in China. A latte in China is more expensive than a latte in America.

Honeywell is a prime example of an industrial company that has gotten it right in China. Honeywell is a multibusiness-unit industrial company with a variety of B2B divisions and a few B2C business units as well. China is now the second largest market in the world for Honeywell, after the US. It contributes the largest growth for Honeywell. They are a good example of a multinational that gets it in China.

JE: And that is because they really took the time to understand the dynamics of the Chinese market?

ET: That’s correct, yes.

JE: One more question, in the limited time we have. When I was in China, I spoke to people about the rich startup movement in China, the equivalent of what’s going on in Silicon Valley, or Austin, Texas, in the US, or Toronto in Canada, or London. I know Shanghai has a thriving startup market, with an active VC community. How is the startup movement in China similar to and how is it different from that in the West? If a company wants to work with startups in Shanghai or one of the other centers in China, how would it operate differently there than in Silicon Valley?

ET: In many ways, the basic tenets of entrepreneurship are not that different between Silicon Valley and the Chinese centers. People are willing to take risks. People see the pain points, and they want to turn the pain points into opportunities. People are enthusiastic about the opportunity and are willing to take risks to act on it. So the basic tenets are more or less the same.

The pace and intensity of entrepreneurship in China is unique, however. You often find, in a very short period of time, a lot of companies are trying to do the same thing or similar things: everyone sees the opportunity, and they jump into it. Very often, the market becomes quite crowded, overly crowded. And when it’s overly crowded, some of the companies will not be able to make it, as in any market. That process is happening at a pace and intensity that’s faster than in any other place in the world—perhaps even including Silicon Valley. And this is happening in a period of significant regulatory uncertainty.

So from a multinational standpoint, when you work with a startup in China, you have to take a somewhat different mindset. Of course, multinationals know that these experiments are a low-probability game, and you have to go into it with that kind of mindset. But in China, the risk and also the opportunities are amplified. They’re magnified even beyond what you see in Silicon Valley. And so, when you’re working with a startup, you have to have a mindset that recognizes the higher opportunity but also higher risk. And at the same time, you have to develop internal processes for managing these sorts of situations.

JE: Is IP a specific concern? I hear it mentioned often.

ET: IP concerns are, in my view, somewhat of an excuse for many multinational companies. You do have to be careful with IP, but at the same time, you cannot let that stifle your willingness to grasp opportunities in China. It’s a careful balance, and every company needs to treat it somewhat differently. But in general, a blanket statement that because of imperfect IP protection in China we shouldn’t be bringing our products or our technology or our innovation and experimentation to China is a flawed assumption.

Over the last 10, 15, or 20 years, entrepreneurship and innovation in China have been happening, led by Chinese entrepreneurs, under a very imperfect regulatory context. The lack of protection for IP, of course, applies equally to the Chinese companies, not only to the multinationals. Yet at the same time, a lot of companies are able to innovate and experiment and create new businesses. And many of them fail, but some of them are extremely successful. One needs to be careful about IP, but one needs to be careful, as well, not to use it as an excuse to not do innovation in China. If you don’t innovate in China, you’re missing a huge opportunity.

JE: If you were advising a CTO or a leader of innovation at a Western firm, what key advice would you give for succeeding in China?

ET: My advice applies equally to the CEO, the CTO, the CIO, or the Chief Innovation Officer: you need to really understand what’s going on in China and in the Chinese market. My advice is to throw away your Western lens for a little while and truly look at China without any constraints; try to understand both the threats—the risks of doing business, but also the competitive threats—and also the huge opportunity China offers. Once you have a full appreciation of the China potential, then devise your innovation strategy and your China R&D strategy. You need to have a lot of good, on the-ground competence in China to drive these things. The capabilities at headquarters are still critical, but headquarters needs to support, not control. You need to empower appropriately. You need to have a good balance between empowerment of the local team and support from the global function. You must build a strong team on the ground, a team that understands the market and really turns the demand side from the market into innovation ideas. This kind of innovation has to be done on the ground in China because of the need to stay close to the market, and also because the competitive environment requires speed and responsiveness.

JE: What’s the best way for leaders to get it? How much time should they spend on the ground in order to really understand China? What do you recommend to someone who says, “Okay, I get your message. I want to understand China. How do I do it?”

ET: The first hurdle is mindset. I’ve seen quite a number of leaders, presidents of business units and so on, who say, “I moved to China. I’m based in Shanghai now,” and they think that gives them the perspective. But from the outside, I can see that the way that he or she behaves is actually still very non-Chinese. I think that where you’re based physically is of secondary importance; the first level of importance is having a new mindset. You can do that from Munich, Germany, or from Cleveland, Ohio, or from Houston, Texas.

Once you have that mindset, and you’re willing to use an approach that is very locally adaptive, the key is to find the right team on the ground that you can work with and that you can appropriately empower. Then, keep a very close connection between the headquarters and the China unit. You should also have good advisors to help you, to remind you, to help you steer the way. That is the basic mechanism that I have seen work.

If you set it up right, it can be very powerful. That is what drove Honeywell to its success in China. It sounds very simple. But in my career, which includes over 25 years in China, it is interesting for me to observe how little multinationals have actually been able to create this mindset.

 

By Edward Tse

China with its massive population and growing purchasing power has become a critical market for many foreign multinational corporations (MNCs). Over the years, different growth models have been adopted. Some have chosen to build their China presence organically while others have formed joint ventures with Chinese companies, or a hybrid approach. Some other MNCs decided to acquire local companies to accelerate their growth in China. Most of these acquisitions were with local privately-owned enterprises (POEs) because of simpler ownership structure compared to state-owned enterprises (SOEs).

Unfortunately, many of these acquisitions resulted in foreign MNCs and local companies getting a nasty shock. MNCs’ record of acquisitions of local companies is at best mixed, and in many cases, complete failure. Management of these MNCs have a go-to list of excuses for why these M&A deals failed (of course after the fact), with the target of the blame always being their acquired local companies. Often they claim these local companies are dishonest, cooking their books to make them look more profitable than they actually are, or that the eagerness to expand into the China market led to shoddy due diligence work that would have discovered these issues beforehand. Of course, in a number of cases this indeed was the truth and some of the falsifications were serious. However, these reasons do not fully explain all the cases that didn’t work out. (By the way, not all of the “local companies” accused of these improper behaviors were “Chinese”. Some of these companies were actually started and owned by foreign entrepreneurs. However, in the remainder of this article, let’s just call these companies “local Chinese companies” for sake of simplicity.)

Source: Baidu

In taking on acquisitions as a growth strategy for China, foreign MNCs normally assume integration of the local companies’ operations into the MNCs’ own operations to be an imperative. In fact, these MNCs’ management believe that integration is the best way for them to “add value” to the local operations because of their more superior management know-how and that synergies can be created via better economies of scope and scale – indeed a very common practice for MNCs in their M&As in many parts of the world. So why not doing the same in China? In order to ensure a smooth transition, the MNCs would typically offer financial incentives to senior managers of the local companies – often the founder himself or herself – to stay, at least for a certain period of time, until “integration is complete.”

From the local Chinese entrepreneurs’ standpoint, many of these acquisitions also didn’t realize their original expectations, but for different reasons. They were led to believe that under the wing of the MNCs who claim to be far more sophisticated and professional than the local enterprises, their own companies would have a better chance to continue to sustain, their brand would continue to grow, and that their companies would become a “long-lasting company”, or ji ye chang qing in Chinese. As the “integration” proceeds, many of these entrepreneurs begin to discover problems, the most common and biggest one being that foreign companies don’t really understand how to operate in China (lao wai bu liao jie) and how the original senior management are either forced out or leave of their volition after seeing that they are no longer welcomed or no longer “belong” there.

Like every situation in life, there are pearls of truth found in different perspectives of the same story. Both sides have their valid arguments, but the one-sided views often miss the overall picture. Based on what I saw through my consulting work in China, I would however suggest that the biggest contributor of these issues is the differences in behavioral approaches and norms between the parties involved. I believe there are four key reasons: 1. mismatch of expectations, 2. holistic philosophy vs. bits and pieces philosophy, 3. differences in rhythm and speed, and 4. decision making systems. (See Exhibit 1)
Exhibit 1:

MNCs vs. Local Chinese Companies

Mismatch of Expectations (top line vs. bottom line)
Foreign MNCs typically care for both top and bottom line growth. This is business 101. Most of these companies have been in operations for decades, if not for over a century. It’s only natural that they look for both top line and bottom line performance. In fact, that’s why many of them chose to enter the China market in the first place. After all, China is a high-growth market compared to more mature markets. The fact that many of the foreign companies, especially the larger ones, are publicly-listed makes the case of profitable growth even more compelling because the management of these companies need to be responsible to the capital markets. This can be very different for Chinese companies, at least for some of them, especially when China’s economy was growing at high speeds and opportunities seemed to have presented themselves left and right. For many Chinese entrepreneurs, their first priority was to grow, or to “land grab”; so top line growth was often more important than bottom line growth. Of course, this strategy wouldn’t work forever. But for a certain period of time, it was the go-to strategy for many Chinese entrepreneurs. Clearly, this divergence in points of view often led to difference in strategy, level, pace of investment, and if not properly handled, mistrust. Of course, the laws of gravity also apply in China. And companies, regardless of their ownership, need to be profitable. However, for some of the companies during certain periods of time, their priorities could be different.

Holistic Philosophy vs. Bits and Pieces Philosophy
Many foreign MNCs have built excellence by function across geographies over long periods of time. These global functional capabilities became the backbone of these companies’ well-being. And, they naturally desire to apply these capabilities across all geographies in the world. China wouldn’t be an exception. To this end, many MNC executives become specialists in their own right. They are very good at what they specialize in, but as a result, they are often less aware of areas beyond (or the “broader context”) and the often need for making necessary trade-offs. On the other hand, given that the Chinese owner/CEO often builds their company in a rather short period of time in an environment that is often ambiguous, imperfect and fast-changing, and filled with a large range of stakeholders, they frequently need to make tradeoffs across many dimensions and their solutions are commonly an optimization of numerous factors facing various constraints. So, when someone with a single-dimensional view looking for consistent, global standards and someone who has always been juggling different considerations across multiple dimensions in an evolving, imperfect environment have to work together, they would inevitably run into conflicts. These conflicts, if not properly managed, could lead to frustrations and mis-trust.

In their eagerness to “help”, many MNCs would assign some of their own people to fill in key management positions to “assist” the Chinese entrepreneurs. These people would typically be Mandarin speakers, either ethnic Chinese or non-Chinese who’ve been in China for some time. The MNCs often assume that “since these people were trained in my system and they know China, they must be able to help.” Unfortunately, that turned out to be not always the case. From the Chinese entrepreneurs’ standpoint, these people while technically sound, often lack the ability to see beyond their narrow specialty and to understand broader implications of a holistic perspective of the business. So, these attempts often ended up with mixed records at best.

Differences in Rhythm and Speed
Compared to foreign MNCs, Chinese POEs typically are far speedier, more agile and more adaptive. Foreign MNCs are much more focused on checks and balances, and deliberations which makes them slower. Many Chinese POEs are quite willing to quickly build a good enough product or business model, throw that into the market, and let the market tell them what they need to improve and adapt. This is of course risky, and unacceptable, if the product hinges on quality, safety and security. However, in cases of new business models, the willingness of the market to accept imperfect business models can actually be pretty high, especially in the first trials. But consumers do appreciate companies whose business models or products cater to their needs and utilize fast feedback cycles to improve their offerings to the consumers’ taste. In these situations, Chinese POEs tend to have an upper hand over more established foreign MNCs. So when these two different speeds and rhythms come in contact with each other, incompatibility naturally occurs.

Decision Making Process
Many Chinese POEs came into existence in less than couple of decades and many of them were able to achieve lots of growth piggybacking off China’s fast pace of economic growth. Many are still run by the owner who typically grew the company from nothing to its current size. These organizations are typically concentrated to the one person or a small group of senior executives with the founder/owner still calling the shots. In this structure, the organization is very top down and often hierarchical. While there are people who by title are leading various functions such as marketing, logistics, sales, or R&D, more often than not, they are merely carrying out orders from the most senior person(s). In a way, the founder/chairman/CEO in reality is the synthesizer of information and the decision-maker for all decisions affecting the company, no matter how large or small. Decisions often come from the top of the pyramid with the rest of the management simply there to execute. On the other hand, foreign MNCs, especially large ones, are organized with clearly defined roles and responsibilities throughout the chain of command. In a local POE, a senior VP of Marketing’s role is likely to execute the vision and strategy developed by the most senior person in the company. In an MNC, an individual with the same title will be actually responsible for the marketing strategy.

Source: Baidu

So, what should foreign companies do as they consider M&As in China? Clearly, one needs to do the basic homework well. Rigorous due diligence is a must. But for all those cases where the conducted due diligence did not identify the problems that were later discovered, that by itself is its own problem. For sure, these companies would have hired management consulting firms or auditing companies (and I am sure these are world-renowned brands) to do the due diligence and yet they couldn’t uncover some of the most basic yet critical problems. The reason behind this issue is that it really requires someone who understands the nitty gritty of businesses in China to do a proper and thorough job. This sort of capabilities is still rare in the professional firms in China especially those who are not headquartered in China.

Foreign MNCs shouldn’t assume that “integration” is the only way to capture the value of their acquisitions in China. At least, not “integration as fast as possible.” While in some cases integration may make sense, in many other cases, it may not. It depends on the contextual factors I mentioned above and the severity of the gaps in behavior and perspectives between the two sides. Due diligence should not only cover the “data” per se but also the culture, behavior and beliefs. This won’t be easy especially for many foreign MNCs. They tend to assign their M&A team from global HQ to carry out these tasks. While these people are usually technically sound and experienced with many deals under their belt, they often lack the experience and sensitivity needed to understand the softer, often unspoken, elements especially in a culture and context that are very different and can be overwhelming. Almost certainly, they don’t fully understand nor appreciate the China context. Over-eagerness in creating value often backfires as well as simple notions such as shared services, while a proven approach for realizing value in M&A deals in many parts of the world, may or may not achieve the same level of impact in China due to China’s complicity and diversity in labor rates, local regulations and requirements, as well as availability of competent human capital in key functions.

Fundamentally, MNCs need to fully evaluate the tradeoff between immediate integration or keeping companies separated or a gradual migration from separation to integration, and the speed and intensity associated with the process. Immediate and full-scale integration, which is often MNCs’ incoming assumption, may or may not actually yield the best result. Sometimes overzealous attempts at integration could result in loss opportunities for the MNCs to learn from the Chinese companies on how better to run businesses in China. For example, some Chinese companies are good at keeping their costs at manageable levels, while foreign MNCs tend to somewhat “gold-plate” things. For some local companies, their relationship with their distributors is often more win-win and intimate, while their foreign MNC counterparts can be more transactional.

Making the decision on integration or not correctly, and the manner of how, requires senior executives who can see the forest beyond the trees within the China context and increasingly, the role of China in the rest of the world, as well as being able to align the China realities with the expectation of the global headquarter. This capability does not always exist in MNCs but when it does, it’s a rare asset to have and to cherish.

About the authors
Dr. Edward Tse is founder and CEO of Gao Feng Advisory Company. A pioneer in China’s management consulting industry, Dr. Tse built and ran the Greater China operations of two leading international management consulting firms for a period of 20 years. He has consulted to hundreds of companies – both headquartered in and outside of China – on all critical aspects of business in China and China for the world. He also consulted to the Chinese government on strategies, state-owned enterprise reform and Chinese companies going overseas. He is the author of over 200 articles and four books including both award-winning The China Strategy (2010) and China’s Disruptors (2015) (Chinese version «创业家精神»).
Email: edward.tse@gaofengadv.com

Apr 12, 2017 BUSINESS & TECH
By Yang Ge

(Beijing) – The elderly in China are getting a pick-me-up from the world’s biggest coffee chain, with the announcement that Starbucks will extend health insurance to parents of its employees for critical illness.

Analysts said the move should bring positive publicity to Starbucks Coffee Co., in a country where the elderly traditionally command a high degree of respect. The move also comes as Beijing and local officials plead with younger Chinese to take better care of their parents, many of whom survive on modest pensions and live in distant villages from the big cities where their children work.

Starbucks said its new program will provide insurance for up to 10,000 of its employees’ parents if they become critically ill.

It said the new coverage is designed to supplement China’s national health plan, and is an outgrowth of a broader program the company launched in 2010 to provide financial assistance to its workers. An analysis of data from that program showed that 70% of employees were concerned about the health of their parents as they aged.

China is in the midst of overhauling its health system to provide basic care to all of the nation’s more than 1.3 billion people. Many of those have fallen through the cracks in the country’s transformation from a planned economy, where health care was provided by state-run employers, to a market-based system where such coverage isn’t always guaranteed.

“The active participation by the private sector is critical to China’s efforts to further enhance the social security system to support our aging population,” said Jiang Chongguang, deputy secretary-general of the Insurance Society of China. “Starbucks has responded positively to the government’s call to elevate the commercial health insurance industry, our social security network and to promote a ‘healthy China.’”

Starbucks has been one of the stronger advocates of such corporate social responsibility (CSR) in China, alongside other big multinationals like The Coca-Cola Co. and Apple Inc., said Edward Tse a corporate strategist and CEO of Gao Feng Advisory Co. Programs like the latest one from Starbucks are particularly important in China, where big multinationals can sometimes get criticized for generating big sales in the country without giving back through investment and other social contributions.

“This is a great move by Starbucks in China as it sends a strong signal to its China employees that ‘We care,’” said Tse. “Taking care of the elderly is a core value of the Chinese culture. With the employer taking a proactive initiative to help, it sends the right goodwill message to its staff. This will bode well for Starbucks in China and sets a benchmark for other western companies operating in China.”

Tse added that Starbucks is probably also being motivated by recent calls by Beijing and local governments for young people to do more to support their parents, leading some observers to say that filial piety can’t be legislated.

A law passed in 2013 required children to pay frequent visits and ensure the spiritual and financial needs of parents older than 60. The law also allowed parents to sue their children if they are negligent, but did not specify penalties in cases of guilty children. In cases where parents sue, some judges have ordered children to make specified numbers of visits each month and provide support. But experts have pointed out the law and verdicts from ensuing lawsuits could be difficult to enforce.

Shanghai also made related headlines last year when it said children who violated the law could have their credit ratings reduced.

 

By Dr. Edward Tse
1:39 PM at Oct 25, 2016

Xiaomi, a Chinese electronics company founded in 2010, is often regarded as the Apple of China. It became the world’s most valuable “unicorn” in 2014, with a private valuation of more than US$46 billion.

Though it is best known for low-cost, value-for-money smartphones, Xiaomi is not merely a smartphone manufacturer. It has been aggressively building an ecosystem of smart connected devices, including: smart TVs, air purifiers, sports cameras, VR devices, drones, and even smart rice cookers.

Xiaomi became China’s largest smartphone brand in 2014. It attracted a lot of first-time, young, tech-savvy consumers due to its inexpensive pricing, highly customizable smartphone, and fan-based marketing. It rejected brick and mortar retail stores, traditional distribution channels, and conventional advertising.

Instead, Xiaomi utilized a unique and innovative way to engage its consumers with its “geeky” brand positioning. It leveraged online user communities, social media, flash sales, and online-to-offline (O2O) events which hyped consumer expectations.

The company ensured customer satisfaction by incorporating user feedback to make frequent software and features updates. As a result, Xiaomi created a sticky fan base, known as “Mi-fans.”

However, it didn’t take long before Xiaomi’s sales began to slow down. Its sales dropped by 5 percent in Q1 of 2016 and 38 percent in Q2 of the same year.

It also fell out of the global top 5 brands in terms of smartphone sales. So what exactly happened?

Reasons behind recent struggles
Xiaomi’s mission statement is to offer affordable smart devices so people can enjoy the benefits of technology and connectivity at a lower price.

However, Xiaomi’s core initial customers now have a desire for more premium products. Despite clear evidence that Chinese customers are willing to trade up, the company continues to focus on the budget end of the market.

Photo credit: Maurizio Pesce.

Xiaomi has also been focused on its young, tech-savvy consumers, marketing heavily through social media and online word-of-mouth. Consequently, its marketing efforts do not reach beyond its core fan base.

In addition, the majority of its customers are not devout Mi-fans. They buy its products based on their value without really embracing Xiaomi’s ecosystem. The company’s limited content has also failed to make return customers.

Chinese consumers have a broad range of brands to choose from and flock to whomever can offer them better value for money. Xiaomi has only had a few smartphone models on shelves for a very long time, which gives direct Chinese competitors like Oppo, Vivo, and Huawei room to steal the show.

To add to this, customers are increasingly frustrated by the company’s flash sales, hunger marketing tactics, and its inability to innovate independently. Its consistent mimicking of Apple’s image has become proof of its lack of innovation.

While Xiaomi has stuck to its non-traditional techniques, other Chinese competitors have leveraged traditional strategies to full effect. These competitors have offered better product features, stronger offline marketing, and a wider distribution channel. This allows them to grab a larger share of the Chinese consumer’s wallet.

Essentially, Xiaomi has been too slow to match its products with the fast-changing value propositions of young Chinese consumers, who aspire for a more individualistic and personalized lifestyle.

While Xiaomi has continued to expand its product portfolio, the brand has failed to maintain its hype and has become overly diversified. General consumers have begun to lose track of what the company stands for and the benefits of joining their ecosystem.

With the company’s recent expansion to emerging markets comes a new set of problems. Factors such as supply constraints, limited local market understanding, and legal issues have hampered their efforts overseas.

What did other Chinese players do?
Local competitors like Huawei, Vivo, and Oppo are focused on establishing premium brands. For example, Vivo focuses on high-end devices with leading technologies such as high resolution phones, fingerprint readers, and extra software features. The same can be said of Huawei, but more in the mid-end products range.

As Chinese consumers begin to trade up, these competitors are much better equipped to capture the market.

Xiaomi has traditionally sold its devices online to bypass costs of offline marketing, retail stores, and dealerships. In comparison, rivals such as Vivo and Oppo have heavily invested in traditional retail and distribution channels and expanded their dealership network.

These competitors have also managed to offer more effective and differentiated marketing. This includes product placement, out-of-home advertisement, brand ambassadors, and sponsorships for popular TV shows. For example, Oppo is the official phone partner of America’s Next Top Model.

Xiaomi is left in the unenviable position of trying to reestablish relevance amidst a highly competitive market.

Implications to Xiaomi and beyond
Xiaomi’s customer-centric, crowd-sourcing, community-driven approach and its founder’s mindset was once very well received among Chinese startups and even multinational companies. However, the initial hype seems to have faded, replaced by questions of the company’s value and long-term sustainability.

In a way, Xiaomi’s story demonstrates the speed, complexity, and dynamism of the Chinese context. The changing consumer landscape, hyper-intensive competition, and rapid technology development require companies to be alert at all times and to create sustainable competitive advantages.

Xiaomi needs to re-examine its strategy with a flexible mindset in order to avoid further market decline or even death.

With this story, many questions arise. Does this ecosystem approach work for every company? Could every industry take a lifestyle-driven, customer-centric business approach? How do you build a sustainable business in the new economy?

It is time for brands with Xiaomi-esque tactics to re-evaluate the sustainability of their consumer engagement approaches. ( Editing by Jaclyn Teng)

Dr. Edward Tse is founder and CEO of Gao Feng Advisory Co., a global strategy and management consulting company, and the author of “China’s Disruptors” (Portfolio, 2015).

 

Posted Aug 28, 2016
By Dr. Edward Tse

People have often referred to Google, Facebook and Twitter as cases where foreign tech companies are blocked in China. In reality, while Facebook and Twitter were indeed blocked, Google chose to withdraw because they didn’t want to comply with Chinese censorship regulations.

It’s important to note that most foreign tech companies were not blocked, and companies like eBay, Amazon, Viadeo and, of course, Apple and Samsung all entered and competed in China.

EBay was beaten by Alibaba more than a decade ago. Amazon entered China throughthe acquisition of a local company, Joyo, in 2004, but was never able to build a commanding position in China the way they did in the U.S. Viadeo withdrew in 2015 due to a lack of market traction mostly because of the entry of LinkedIn.

On the other hand, Apple and Samsung have done well in China, despite increasing competition from the Chinese who are chipping off pieces of their pies. More recently, UberChina and Didi Chuxing reached a mutually beneficial deal, though some see it as Uber essentially surrendering the China market to Didi Chuxing.

This all seems to beg the question: Can foreign tech companies win in China?

Clearly, China’s regulatory regime regarding the internet, in particular social media, isfar more restrictive than that of the U.S. and many other western countries in general. The “Great Firewall” has proven itself repeatedly to be a thorn in the side of foreign companies, and not all have been able to overcome this hurdle. Most have tried, but with varying degrees of success.

It all comes down to the company’s mindset and willingness to adapt. Some firms decidedthey didn’t want to play in such a context, like Google, and withdrew their operations. Some want to play but got blocked, like Facebook, yet continue to lobby the government for access. Some were allowed to play but couldn’t quite get their act together (for whatever reason), like Amazon, Viadeo and perhaps even Airbnb. There was also Yihaodian, which was Walmart’s online business, but eventually Walmart sold it to JD.com in exchange for some of JD’s shares.

China is not easy. It’s tough for everyone, no matter if one is foreign or not.

But there are some who seem to “get it,” like LinkedIn (at least for now). They entered the China market in 2014 with a dedicated Chinese site, Lingying, andwithin two years grew their user base to 20 million subscribers and counting. How did they manage such a feat where several others failed? They adapted to the Chinacontext. Not only did they localize by conforming to restrictions on content, they partnered with local firms Sequoia China and China Broadband Capital to further understand the China market.

LinkedIn also created local leadership by hiring a president for LinkedIn China, giving the team more autonomy to integrate and cater to local needs. Examples include collaborating with Tencent’s WeChat so users could link profiles, launching a Chinese business social networking app “Chitu” and planning to release a Chinese version of its Pulse news reader app.

Another such example is Evernote. They, too, found success through a focus on meaningful localization. Not only did they hire locally, they employed localized marketing strategies by leveraging local social media like Weibo and WeChat, and had localized customer service, which supports real-time customer support on the mentioned platforms. They did thorough market research before entering in 2012, and looked to solve the “pain points” of the Chinese consumer, mainly security and privacy. Lastly, they had an easy-to-recall Chinese name (Yinxiang Biji) with a memorable pun. This strategy paid off; within the first year after launch they had 4 million users in China, and by 2015 their user base reached 17 million.

The notion that lower-quality clones sprung up because of foreign tech companies being blocked is only partially right. One could argue that the major Chinese social websites of Baidu, Ren Ren, Sina Weibo and Youku Toudu are clones of Google, Facebook, Twitter and YouTube, respectively. While the likes of Ren Ren weren’t able to replicate Facebook-like success in China, others have evolved beyond being clones to having their own unique, innovative ecosystems.

One such example is WeChat. Though it was originally inspired by Kik, and had similar features to WhatsApp, it evolved from mere messaging to becoming an integral part of the Chinese connected lifestyle. WeChat users can now link their bank cards to WeChat Pay, make in-store payments, transfer money to peers, buy movie tickets, hail taxis, pay for utility bills and so on. In fact, the list is practically endless, and shows how WeChat’s business model has become so powerful, and has grown from being a simple messaging app like WhatsApp (which, incidentally is also not blocked in China, but cannot hope to compete on WeChat’s scale).

Foreign tech players tend not to be as extensive in ecosystem building.

Importantly, Chinese innovators are developing new intellectual capital. They are crafting innovative business models and reaching new frontiers of business strategy and organization. Prime examples include Alibaba and LeEco. Jack Ma has built Alibaba into a sprawling internet business through “multiple jumping” from one business area to another, while building its capabilities along the way through a combination of self-built and collaborative partnerships. This disrupted the conventional “core competence” approach that has ruled modern business for the past 30-odd years.

LeEco is, broadly speaking, a “lifestyle” company, with a diverse ecosystem of infotainment content, smart devices and internet-connected mobility. Many commentators by now have pointed out that Chinese innovators are fast, agile and adaptive. However, these are merely phenomenological observations. At heart, the best and brightest of these innovators are deeply reflective on what the new frontiers of business are, focusing on “how can we get it right and do it well?”

Of course, China’s market for tech companies has evolved significantly for over a decade and a half. When Alibaba was competing with eBay more than a decade ago, China’stech market was pretty primitive. Alibaba merely used guerrilla warfare tactics based on its grit to defeat a major foreign player. Today, both the market and the players are much more sophisticated and their business approaches are much more refined. The leading Chinese innovators are digital ecosystem players building scale and creating customer stickiness through their entire ecosystem. Foreign tech players tend not to be as extensive in ecosystem building.

To “win,” foreign tech companies need to adapt to the China context and deeply understand the key factors of success. Local leadership is critical and appropriate empowerment by the global headquarters to the local leadership to do the right things is essential. While for some, the market is not open or they are not welcome, for many, the opportunities are right there. China is not easy, but why should it be? It’s tough for everyone, no matter if one isforeign or not. And no one can be sustainably successful if they don’t observe, learn and adapt.

LinkedIn China’s Chitu, for instance, is struggling to get market traction. Evernote, while achieving early success in China, seems to be facing some challenges forsustainable growth, mainly due to lack of premium paid users and growing competition from Chinese startups. In fact, drawing a line on “who’s Chinese and who’s not” is also somewhat artificial, given that Alibaba’s and Tencent’s largest respective shareholdersare not Chinese, and some of LinkedIn China’s and Uber China’s key shareholders are Chinese.(Sequoia China, whose parent is a Silicon Valley-headquartered VC fund, has its operations led by Chinese venture capitalist Neil Shen, who has a deep understanding of the China context.)

As China’s digital business grows, it’s going to provide more opportunities for many players. Who “gets it” and who doesn’t will certainly not only be a function of “being blocked or not,” but equally (or even more importantly) those who have the right mindset and approach to the China context (and for that matter, China for the world). To this end, it’s a real test of the leadership and capabilities of the companies, as well as the capital behind them.

Dr. Edward Tse is the founder and CEO of Gao Feng Advisory Company, a consulting firm that advises corporations, startups and VC funds on business strategies in China.

 

Aug 5, 2016 @ 06:13 AM
By Dr. Edward Tse and Bill Russo

Disrupting The Disruptors: The Merger Of Uber China And Didi Chuxing

On August 1st, Didi Chuxing and Uber China announced a plan to merge their businesses in China, effectively putting Didi in control of their combined ride-hailing business for the China market. The deal has attracted a great deal of attention since the announcement and a number of critical questions have been raised. We would like to share our perspective on some of these questions.

What does the merger mean to anti-trust?
While the China government is typically very actively involved in industrial policy and development, they have actually resisted getting in front of developments related to mobility services. This is mainly resulting from the very favorable public response and popularity of these services. Ride-hailing, or On-Demand Mobility (ODM), services address “pain points” associated with the expanding demand for mobility in an increasingly urbanized China, and are empowering both users and drivers. Services such as Didi Chuxing, Yidao, UCar, and Uber China have until now gone unregulated. New draft regulations have recently been circulated, but this is notably after the emergence of the services and there’s been no attempt to curtail them in any way.
Can foreign tech companies compete in China?
Of course they can, but it won’t be easy. Tech companies such as Apple AAPL +1.49% have had success in China, but foreign companies must be prepared to adapt their approach to the China context. The usual cause for failure is when the companies are either unaware of the local context or unwilling to seriously consider it. Unlike traditional manufactured products, Chinese tech players – especially the tech giants like Baidu BIDU +3.05%, Alibaba and Tencent (BAT) and their ecosystem partners – are very well embraced by Chinese consumers. This success comes not as a result of favored treatment by the government, but rather from their ability to tailor solutions that are relevant to the “pain points” experienced in the market. This is certainly the case for the mobility solutions players. Didi has over 85% share because they simply were faster and smarter at delivering a solution to the market than other local and foreign competitors – not because they were given any favorable treatment by the government or by policies (which, as noted earlier, did not exist in the early stage of development).

If foreign companies want to join the game, they need to think and act like the entrepreneurial Chinese companies like Didi who are rapidly emerging and growing exponentially. They must learn to compete in or cooperate with the BAT ecosystem players or other tech companies who are often open to local or global collaborations with foreign tech firms.

Did Uber China win or lose? Could Uber China ever become the dominant player in the country if it decided to press ahead?
Win or Lose is a judgment call. We think they both get something which they can call a win. Didi has more than 85% share of China’s ride-hailing market and over 7,000 employees. Uber could not possibly match that without enormous investment and heavy discounting. The merger was a way forward that at least makes Uber Technologies a large shareholder of Didi. They have a seat at the table and can collaborate with Didi locally and globally.

Internet companies can make as much or more money from licensing IP as they can from being the brand that commercializes the technology. Uber gets a big share of a huge Chinese start-up that will go up in value and now has the option of licensing them advanced technology for transportation systems. In return, Didi gets a global mobility solutions partner that can help them expand internationally. Didi is also well positioned as the mobility company that can commercialize offline services related to mobility (because they have access to a digital ecosystem from their BAT partners, which Uber lacks in China).

What does the merger mean to anti-trust?
It depends on the how the boundary of the relevant market is defined. In terms of the ride-hailing service market, Didi is the dominant player. But if we are talking about the broader transportation market (which also includes bus, metro, train, etc.), Didi is not dominant. Looking back to 2009, China’s Ministry of Commerce rejected Coca-Cola ’s acquisition of Huiyuan, a Chinese juice-maker, stating that the deal would give Coca-Cola a dominant position in the market. Coca-Cola argued, unsuccessfully, that the position would not be as dominant when contrasted with the larger FMCG beverages market. Clearly, every case is different and up till now, it is unclear how the Ministry will view the Didi-Uber case.

What will this deal mean to Uber and Didi’s global strategies?
So far, the focus of this transaction is on China, but it is interesting to consider how Didi and Uber’s strategies will be impacted elsewhere. Didi and Uber could expand their collaboration and become a global ODM services partnership, where each offers branded services for specific regional markets, with Didi dominating China and Asia and Uber leading in the US and Europe.

They may also choose to leverage complementary capabilities from each party where Uber focuses on advanced transportation technologies and development of algorithms for movement of people and things, while Didi delivers the actual mobility service to the consumer. Apple’s recent US$1Bn investment in Didi also raises an interesting question of what role they may eventually play in this alliance.

In any case, both companies can now better focus their resources in building a profitable business in their respective markets. Didi can work to cement its dominant position domestically in a bid to further distance itself from other local rivals in China. Uber can now invest in expanding its own services, while pivoting from low-end ride-hailing to more sophisticated transportation and perhaps building out its autonomous transportation capabilities. It is clear that other companies will start feeling the heat, especially Lyft in the US, should Uber decide to redouble its efforts on its home turf.

The global implications of the relationship remain to be seen, especially among the stakeholders of the respective companies. This raises the core question: how will this rapidly evolving landscape of partnerships reshape the future of mobility? And for sure, we can look forward to even more exciting developments in the future.

About the Authors:
Dr. Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).
Bill Russo, Managing Director and Auto Practice Leader at Gao Feng Advisory Company.

MAY 23, 2016 @ 09:35 PM | FORBES.COM
Co-authored by Edward Tse, Bill Russo and Alan Chan

On May 13, Apple announced a USD 1 billion investment in China’s leading on-demand mobility (ODM) service, Didi Chuxing (Didi). Didi’s legal name in Chinese means “little orange”, and an internal announcement made to Didi’s employees literally welcomed the apple to the orange family.

To understand the logic of this investment, it is important to first understand the popularity and explosive growth of such services in China – along with the role that Didi plays inside the expanding ecosystems of its largest investors, Tencent and Alibaba.

Originating from separate taxi-hailing services in 2012, Didi is now a one-stop mobility solutions provider that provides a variety of services including taxi-hailing, private-car hailing, on-demand bus, peer-to-peer ride-sharing, designated driver and test driving. Didi currently has 14 million registered drivers, completing over 11 million rides per day in over 400 cities across China. With over 87 percent share of the Chinese private car-hailing market, Didi is far larger than all the other ODM service providers in China, including Uber.

As a global leader in smart connected device technology, Apple has been exploring opportunities to expand the reach of its iOS ecosystem. It is an “open secret” that Apple is working on its own vehicle program, code-named Project Titan, investing billions in R&D and poaching talent from leading automakers including Tesla, General Motors and Ford. As a manufacturer of intelligent devices, Apple is a “serial disruptor” of industries ranging from media to telecommunications, and views smart transportation as a key target.

The logic of this collaboration is quite evident: the premier global smart device maker (Apple) has set its sights on disrupting transportation in partnership with the dominant mobility services platform (Didi) in the world’s largest car market with the largest number of mobile internet users. Through this partnership, Apple and Didi will have the opportunity to shape the connected mobility ecosystem for China as well as the rest of the world.

A Collaboration Model for Connected Mobility Innovation
The traditional owner-centric business model of the car industry is being disrupted by shared ODM services. As a result, we have witnessed the rapid emergence of a user-centric business model served by mobility services platforms dominated by Uber and Didi. Apple’s investment in Didi will ensure that they will be able to access China’s dynamic internet and mobility ecosystem.

Apple gains a Chinese partner not only with a strong mobility services brand, but also with a proven market sensing capability and keen understanding of how to address mobility pain points. Apple can leverage this to launch a car that delivers the perfect connected mobility user experience, and this can be leveraged both inside and outside of China. Didi will benefit from being affiliated with the world’s premier smart device company, and also gains a major global strategic partner to help penetrate into overseas markets and compete globally with Uber.

While not the primary motivation, Apple’s investment in Didi can also help foster goodwill in China, signaling a willingness on the part of Apple to collaborate with leading Chinese companies. The importance of maintaining such goodwill was underscored recently when Chinese regulators shut down access to some of Apple’s online media stores, triggering concerns among investors. In addition, Didi expects to turn a profit next year and eventually list their shares, which could provide Apple with a fast return on their capital investment.

The recent loss of momentum in Apple’s profit growth and share price performance has raised concerns among investors that the Apple may not be able to recover its shine. The deal with Didi brings hope that Apple can disrupt the auto industry in the world’s largest auto market.

From Connected Mobility to Connected Lifestyle
However, connected mobility is just one segment of the larger “connected lifestyle” opportunity. The convergence of disruptive technologies such as autonomous driving, artificial intelligence and virtual reality will have the power to transform our everyday lives. The implications of this go far beyond mobility, which is just one of the spaces where we will be connected through a smart device or platform.

Cars will increasingly become smart, connected, electronic and autonomous – and increasingly accessed through a mobility service. A logical interpretation of Apple’s strategy is that it views the car as a “third place” after home and office where people are connected to the internet. Its investment in Didi should be viewed as a strategic opportunity for Apple to capture a larger share of a mobility user’s time online, thereby generating recurring revenue. By creating a more personalized mobility solution, Apple also hopes that the users of such a mobility service would eventually prefer an Apple hardware platform when they are on wheels.

More than just a taxi-hailing service, Didi is a technology-enabled platform. With advanced algorithms to match supply and demand, surge pricing and real-time route optimization, Didi is efficiently moving people and things by maximizing the utilization rate of vehicles. More importantly, with big data and machine learning capabilities, Didi’s competitive advantages are constantly evolving and being reinforced.

Like WeChat and Alipay, Didi has emerged as one of the few “Super Apps” holding a vital part of Chinese consumers’ daily connected lifestyle. These Super Apps typically start by addressing a major pain point and eventually evolve into ecosystems of connected lifestyle services for potentially billions of users. They possess valuable “big data” on a user’s mobility patterns that are of high commercial value.

“Apple + Didi” vs. “LeEco + Yidao”
In fact, the “Apple + Didi” model is already being experimented by LeEco, a leading Chinese internet media company founded (as LeTV) in 2004. Last year, LeEco purchased a 70 percent stake in another Chinese car-hailing app Yidao Yongche. LeEco is also the principal investor in Faraday Future, a U.S.-based electric vehicle startup that is featuring a “subscription model” where users can enjoy the flexibility and convenience of mobility on-demand without having to own the vehicle. Apple’s recent monthly paid iPhone subscription program indicates that they may already be considering such a business model for other smart devices.

The usage-based model effectively eliminates the problem of up-selling features to individual owners by allowing the businesses that generate revenue from the device to cover the cost for adding the technology.

LeEco’s vision is to cover all aspects of consumer’s connected lifestyle by establishing an extensive business portfolio with mobile internet, e-commerce, sports, internet finance, entertainment and others. It is rapidly building a vertically-integrated ecosystem comprised of “Content, Devices, Platforms and Applications” offering premium user experience across multiple screens (i.e. mobile, tablet, computer, cinema, TV and cars).

Disrupt or Be Disrupted
Going forward, we expect to see increasing levels of coopetition, and more cross-border, cross-industry collaborations:

Coopetition: Google is an early investor in Uber while Baidu is a strategic investor in Uber China. Alibaba is a major investor in Didi. Meanwhile, Ant Financial Services Group, Alibaba’s affiliate that runs Alipay and other financial services, has partnered with Uber to enable Alipay globally. Apple’s deal with Didi could potentially challenge both Uber and Google. In addition, Didi is a member of an “anti-Uber alliance” including Lyft in the U.S., Grab (formerly GrabTaxi) in Southeast Asia, and Ola in India. With Didi’s aspiration to become a global company, Apple could eventually extend strategic partnerships to other companies in the alliance as well.

Cross-border: China (Beijing) and U.S. (Silicon Valley) will be the leading innovation hubs for connected mobility and beyond. The Chinese government is keen to promote electric vehicles adoption and digital transformation to improve urban mobility and address environmental issues. China could leapfrog and become the epicenter for connected mobility innovation on a global scale, with its massive population serving as a fertile ground for technology commercialization, as well as connected lifestyle. Permutations and combinations of cross-border alliances for connected lifestyle will create tremendous value for Chinese internet users as they trade-up for better products and services.

Cross-industry: The boundary between automotive and internet technology industries will become increasingly blurred. General Motors, as one of the most forward-looking incumbents, has formed a strategic partnership with Lyft, acquired self-driving start-up Cruise Automation and established a new business division named Maven to experiment with new mobility services. Other automakers are also catching up by piloting ODM services, including Daimler’s Car2Go, Ford’s Go!Drive and Ford Pass, BMW’s DriveNow, and Audi On-Demand. We have already seen emerging “disruption clusters” in China, including (1) LeEco, Faraday Future, Aston Martin and Yidao Yongche, (2) Future Mobility, Tencent and Foxconn, (3) NextEV, Tencent and JD.com, and (4) Alibaba and SAIC.

A Partnership to Reimagine Mobility
China is at the epicenter of a disruptive wave of automotive innovation and beyond. The mobility experience is being redefined with innovative usage-based business models. Incumbents and new players must re-evaluate their connected mobility strategies with a new lens for delivering the perfect connected mobility experience. Past success in the old automotive game is not a guarantee for future success. In fact, one would surmise that past legacy could often become a barrier for swift and innovative moves going forward. It is time for the leading companies from China and Silicon Valley to join forces to re-imagine mobility and the marriage between Apple and Didi could offer the promise of doing just that.

About the Authors:
Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).
Bill Russo, Managing Director at Gao Feng Advisory Company and Alan Chan, Senior Consultant.

 

May 16, 2016 @ 01:55 AM | Forbes
By Edward Tse

Multinational corporations (MNCs) started making significant investments in China back in the early 1990s in particular after Deng Xiaoping made his now famous “visit to the south” in 1992. Over a couple of decades of investing in China, MNCs’ attitude on China has evolved. Broadly speaking, there are now three distinct groups of companies we can classify according to their market views. The first group includes MNCs who have come to China, made investments and being unsuccessful, decided that China is not their cup of tea. They generally found it difficult to be profitable and some have withdrawn from China. Examples of these include Home Depot HD +0.31%, Best Buy BBY +0.32%, Media Markt, and Mattel MAT +1.36%. The second group of companies are those belonging to sectors with overcapacity – often quite significant ones – in China. These companies include the cement sector, steel, aluminum and the like. These companies are typically in a wait-and-see mode, waiting to see if and when the overcapacity may be managed away. The final group of companies are those who have found China to be a major, and often highly profitable market. For them, China is one of their largest, if not the largest market in the world. Prime examples are the car makers such as VW/Audi , BMW, Daimler, General Motors and Ford. But this group also include others like Starbucks, Nike and Honeywell. Recently, Apple reported a drop of its quarterly earnings by 13% and China contributed to 26% of that drop.

The Chinese government continues to open more sectors for non-state capital to participate in and it is also visibly applying more stringent laws and policies such as those in anti-trust and anti-corruption. In the open sectors in China, competition is extremely intensive, often the most intensive in the world. In addition to their usual MNC competitors, MNCs will also have to deal with local Chinese competitors, some state-owned and some privately-owned. While MNCs are somewhat used to how other MNCs compete, the ways that the Chinese companies compete are often quite different and hence surprising. The leading Chinese private companies have become increasingly more competitive and in many cases innovative across a wide range of industries. The leading private companies are disrupting traditional businesses with incredible speed and intensity. The rapidly changing, complicated and ambiguous operating environment in China is catching MNCs off guard. Increasingly, MNCs now realize they cannot just apply their cookie cutter ways from the rest of the world to China and that they need to adapt. The question is how and when and all this will need to be aligned and accepted at headquarters.

Though economic growth in China has slowed (off a larger base), the growth of some sectors continues to be very strong. Demand for innovations in the healthcare and environmental sectors is very strong. China became the world’s largest robotics market with purchases making up 25% of the global total. The on-demand mobility app Didi Chuxing totaled 1.43 billion rides in 2015 alone, in contrast to Uber, which took six years to hit 1 billion rides worldwide. Chinese travelers spent US$184B abroad, making them one of the largest tourist segments globally by spending. While there are some structural problems in China’s economy, the growth that is cast within the context of a complicated and fast changing environment will bring a variety of leapfrogging phenomena and is filled with both tremendous opportunities as well as challenges for everyone, MNCs included. The key for MNCs is to know how to strategically anticipate and capture these opportunities and handle the challenges properly. Those MNCs who see the opportunities coming from China, will stay and continue to invest, and if they manage to build the right capabilities on the ground – both tangible and intangible – they will be able to compete effectively.

Years ago, when MNCs started pouring into China, they were the dream employers for China’s youths. Compared to other options at the time, MNCs’ salaries were higher and they provided better training, often accompanied by opportunities to go abroad. Using English daily gave the young Chinese people a sense of glamor and cosmopolitism. If the company they worked for was an elite brand like Coca-Cola, Procter & Gamble or Microsoft, just mentioning this to others would bring them a sense of pride and accomplishment. At that point of time, employment at MNCs was without a doubt the goal of China’s best and brightest.

In the wake of their operations in China, foreign MNCs find their standing with China’s youth in a constant state of flux. For the past couple of decades, many MNCs would often claim that China is their (most) important and strategic market, and that in China they need to “localize.” However, for many, “localization” simply means hiring some token Chinese managers or in some cases, expatriates who have lived in China for a long time. These roles would have nice sounding titles like “China Chairman” or “China CEO” but they often lack full business authority or decision making capabilities. In almost all cases, these local executives are not placed at the core of thought leadership generation at the largest levels of the company for driving China’s strategy, organizations or business models, and for that matter, those for defining China’s role in the company’s global strategy. These considerations and decisions are, typically, in the realm of the global or regional headquarters. In most cases, the so-called “local management” is only for execution and has little real authority.

Many local talents who work for MNCs after a while would find their jobs unfulfilling. Some of them query the MNC employers’ lack of “higher-order purpose” while others find the relatively slow speed of decision making coupled with a general feeling that “the HQ people just don’t get China” a real source of frustration. To be fair, there are many MNCs that are genuine in their desire to hire and groom local talents. Some even make it a strategic imperative. And, at least some MNCs really want their best Chinese managers to eventually make it to the top echelon of their global organizations. However, some MNCs are also frustrated by the locals’ inability to transform themselves into real business thought leaders and by their seeming lack of loyalty. For a handful of MNCs who have had the good fortune of recruiting some real outstanding Chinese talent, their CEOs or HQ senior executives often become defensive after the Chinese executives repeatedly tell them that “China is different.” For the very best Chinese, the opportunities in China today are just overwhelming. As innovation and entrepreneurship are becoming the mainstream in China, career opportunities with significant upside potential are being made available to many young people. MNCs are no longer the best employment option. Creating new ways to win the human capital battle in China will be key for MNCs.

As China continues to evolve, opportunities and risks will inevitably surface and so the context for developing China’s strategy will also evolve. MNCs must understand the context better and leverage that into their strategies, organizations and capabilities.

About the Author
Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).

 

By Edward Tse

APR 5, 2016 @ 05:32 AM

Over the past two decades, entrepreneurship in China has grown at an exponential rate. It is bringing forth disruptive changes not only to China but increasingly also to the rest of the world.

In 2000, total revenues earned by Chinese state-owned industrial enterprises and those in the non-state-owned sector Chinese private enterprises were roughly the same at about 4 trillion yuan each. By 2013, while total revenues at state-owned companies had risen just over six fold, revenues in the non-state sector had risen by more than 18 times. Profits in the same period showed an even more remarkable difference, with state-owned companies showing a sevenfold increase but profits at non-state-owned ones increasing nearly 23 times.

China’s entrepreneurial spirit runs deeper than just in business. It manifests itself in the government and in the desires of ordinary people. Premier Li Keqiang called for “mass entrepreneurship and innovation” and made it the leading agenda of China’s national economic strategy. In his work report speech at this year’s National People’s Congress, Premier Li mentioned the word “innovation” 59 times and “entrepreneurship” 22 times. Other popular phrases such as “Internet Plus”, “sharing economy”, “big data” and “Internet of Things” also appeared in the report multiple times.

In July 2015, my book China’s Disruptors was published and in last December, a Chinese version was also released. The conception of this book started over a couple of decades ago, when China’s private-owned enterprises and the culture of entrepreneurship were still in its infancy; though many people were already operating their own businesses. At that time, many business people in China were opportunistic, trying their luck to bank on the opportunities that China’s rapid economic development brought about. Many of them did not have much knowledge or experience in running companies, certainly not on a sustainable basis. Over the years, I have come across many different entrepreneurs. Despite coming from a diverse range of backgrounds, industries and demographics, they seemed to share some underlying common characteristics: tremendous ambitions and forward-looking optimism coupled with an almost insatiable curiosity. Many sought my expertise to gain a deeper understanding of business strategy and management, and to broaden their knowledge of “international best management practices.” This was also around the time of the rapid growth of China’s Internet industry, and many entrepreneurial minds saw the opportunity to incorporate internet technology into their businesses.

Yet during this same period, the rest of the world (especially the mainstream western media), perceived China in a different light. China was portrayed as a predominantly state-owned economy driven by large-scale enterprises, some of which held (near-) monopoly advantages in industries that were (largely) closed to non-state companies. In their view, at the core of China’s economy was the controlling one-party leadership fueling unfair (or sometimes even non-existent) competition. Some called this phenomenon “State Capitalism” which carried somewhat negative connotations. For sure, the state economy played, and continues to play, a critical role in the Chinese economy. But the western media had for a long time almost completely ignored the other side of the Chinese economy, the growing private sector and rising group of entrepreneurs.

The first wave of reforms and opening up of China’s economy under Deng Xiaoping spurred the vanguard generation of entrepreneurs in the 1980s. These entrepreneurs typically had little to no access to knowledge of modern business management. Some even lacked post-secondary education. At the time, they were pioneers who were remarkably bold to start their own businesses. In the early 90s, a number of government officials inspired by Deng’s “Southern SO +0.10% Visit” left their government roles and ventured into businesses. This was a rather speculative move that required great courage. If they failed, the “iron rice bowl” they had abandoned would not welcome them back with open arms. At this time, these people were considered foolish by many for leaving these highly desired positions of stability and prosperity. The majority of this “Gang of 1992” were quite successful in their entrepreneurial pursuits and some of them eventually became industry leaders.

Internet entrepreneurs started to emerge in the mid to late 1990. Contemporary giants Alibaba , Tencent and Baidu were formed shortly thereafter. The bursting of the first internet bubble took out a fair number of Chinese internet companies, but soon thereafter, the growth of internet industry resumed and gained momentum. The number of entrepreneurs grew again throughout the 2000s. Leaders from Xiaomi, JD.com and Qihoo 360 are all prime examples of China’s internet entrepreneurs that arose during this period. Apart from the internet and mobile technology sectors, many entrepreneurs started appearing in other industries: energy, healthcare, financial services, consumer, retail among others, where businesses were increasingly intertwined with the rapid growth of science and technology.

Today in China, we see numerous young people who were born in the 1980’s and 1990’s with entrepreneurial aspirations. They come from not only the metropolis like Beijing, Shenzhen or Shanghai, but also from second-tier or even smaller cities.

Undoubtedly, a fair number, or perhaps the majority of them will not succeed or at least not on their first attempt, but a few may. China is large and even a small percentage of a large base is still a significant number. Unlike their predecessors, these youngsters are not afraid of failure. For them, “trial and error” is an inevitable part of the process. The outcome, whether positive or not, adds to their experience and opens up even more opportunities in the future.

To be sure, many business people in China are still trying to take short cuts and may not abide by rules and ethics. However, we do see an increasingly growing number of entrepreneurs who are genuinely trying to grow their business and be successful in legitimate ways. We are living in an era where entrepreneurship is spreading fast, entrepreneurs are getting younger, and growth is often exponential. This new generation of China’s entrepreneurs illustrates the vitality, creativity and increased productivity that are the core driving forces propelling China’s next stage of development.

China is now the world’s second largest producer of “unicorns,” i.e., non-listed companies valued at over US$1Bn. The most representative ones are Xiaomi, Didi Chuxing, China Internet Plus (recent merger of Meituan and Dianping) and DJI. In addition, Baidu, Alibaba, Tencent and Xiaomi are on the world’s 50 smartest companies list presented by MIT Technology Review in 2015. Furthermore, by the count of China’s Ministry of Science and Technology, there are 115 university science parks and over 1,600 technology business incubators in the country providing mentorship, legal advice and office space to dreamers and aspiring entrepreneurs.

A majority of these Chinese innovators excel in business model innovation. As they move on to acquire new capabilities by building ecosystems through strategic partnerships and mergers and acquisitions, we expect to see more China-rooted technology innovators on the global stage. At the heart of China’s disruptors are the entrepreneurs with a shared dream for success, a pursuit of objectives brimming with creativity and a relentless drive to realize their goals. These goals will ultimately rewrite the rules of business for China and increasingly for the rest of the world.

A unique phenomenon is taking place in China today. While its political system is inherited from a top-down planned economy hierarchy, its leading entrepreneurial companies, especially the younger, more dynamic ones found in the Internet industry, adopt much of their mindset, culture and organizational principles from Silicon Valley. In fact, many are closer to Silicon Valley than they are to Beijing. For these companies, China’s political and economic structure is mixed with Silicon Valley culture, each influencing the other and creating something new. This osmosis is changing China in a way that we have not seen before and would lead China into a new era.

Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).

 

Author: Edward Tse
Mar 8, 2016 @ 08:25 PM

Is China capable of innovating? This is a controversial question. Plenty of people, especially those in the West are doubtful of China’s innovative capabilities. But it’s not just outside of China where you find non-believers, many Chinese also mock the concept of “Chinese innovation”. To be fair, China is famous (or should I say infamous) as the “Empire of Shanzhai” (counterfeits).

In May, 2015, the U.S. Vice President Joe Biden gave aspeech to a group of cadets at the US Air Force Academy where he said, “… I challenge you, name me one innovative project, one innovative change, oneinnovative product that has come out of China.” Two months earlier, the Harvard Business Review published an article entitled “Why China Can’t Innovate”. The authors, Regina M. Abrami, a Wharton Business School professor, F. Warren McFarlan and William C. Kirby, two professors from Harvard Business School stated, “Today, though, many believe that the West is home to creative business thinkers and innovators, and that China is largely a land of rule-bound rotelearners—a place where R&D is diligently pursued but breakthroughs are rare.” Former Hewlett Packard’s CEO, Carly Fiorina, echoed this view in a bookshe published last year, “Although the Chinese are a gifted people, innovation and entrepreneurship are not their strong suits. Their society, as well astheir educational system, is too homogenized and controlled to encourage imagination and risk taking.”

In the spring of 2014, I published in Europe’s World an article entitled “Don’t Belittle the Potential of China’s Innovation”. In this article, I described my perspective on China’s innovation potential. In October, 2015, in the Schumpeter column of The Economist, China was acknowledged as capable of innovation in certain areas. These “certain areas”were referring to China’s capability to create highly adaptive and responsive business model innovations in a fast changing environment. The column’s writer quoted the thesis of my book China’s Disruptors. That was ground breaking because it was the first time ever that mainstream, western media openly recognized China’s innovation capabilities. Recently, more western media are talking about China’s innovation capabilities. Last year, the December edition of Wired published an article entitled “How a Nation of Tech Copycats Transformed into a Hub for Innovation”. The article discussed the large surge in number of young tech entrepreneurs, especially internet entrepreneurs, in China. The cover of Wired’s March issue showed a complete reversal on how the west is now viewing China’s innovation capabilities. Placed beneath the face of Xiaomi founder LeiJun are the headlines, “It’s Time to Copy China. What You Can Learn From Its Most Inventive Startups.” In January, Uber CEO Travis Kalanick gave a talk inB eijing where he forecasted that in the next five years, China’s innovationwill surpass that of Silicon Valley. He also warned his colleagues in Silicon Valley that they need to be aware of this paradigm shift and cannot become complacent. Wired, Travis Kalanick, and The Economist are not marginal players. They all have their fingers on the pulse of global business and technology.Their views on China’s innovation are worth taking note of. So why is China’s innovation apparently taking a giant leap forward forcing industry and opinion leaders to finally taking note. I think it’s because of the following reasons:

“Why not me?”: At the end of the 1970s during the onset of China’s era of reform and opening to the world, the Chinese discovered that not only was their economy backwards and undeveloped compared to the economies of the developed nations,but the gap between the Chinese economy and those economies was vast. For a nation that had believed they were living in an utopian state stemming from acivilization with a rich history going back thousands of years, this dose of reality created a sense of inferiority and complete shock. Against this background spurred a new sense of purpose among Chinese entrepreneurs. The desire to strive for success and show the world that they too can succeed. They thought to themselves, if Li Ka-shing and Bill Gates can become men of great wealth, why not me? Although it’s been 40 years since the opening of China, this question of “Why not me?” is still the key engine that drives the Chinese entrepreneurial spirit.

Market opportunity provided by the state economy: For a very long time, China’seconomy was dominated by the state-owned enterprises (SOEs). SOEs have theirrole to play in the Chinese economy, but they also have shortcomings. In a market defined by fast changes, intense competition, and need for innovation,SOEs are slow to react. Many innovative companies have taken advantage of this market gap and have seen extra ordinary growth.

Transformative and intense competition: China’s process of shifting from a planned economy toa market economy is gradual. It’s taken several decades already and wouldlikely take another couple of decades more, if ever to completely transition.During this shift over time, a range of sectors were opened up. The allure ofthe China market’s massive scale continues to attract numerous players and ignites intense competition. The hyper competition spurs companies to enhance their competitiveness and innovation is the best way for companies to stay ahead.

Chinese society’s pain points: In Chinese society’s process of transformation, painpoints that had been hidden from sight are increasingly being exposed out in the open. While these pain points are part of the imperfect environment, they provide entrepreneurs opportunities for innovation. Many innovations came about for the sake of solving societal ills or easing the pressure created by societal pain points.

The rise of mobile internet: This of course is a key driving factor. With the internet, smart devices, and social media becoming a core part of the everyday life of Chinese consumers, this provides tremendous disruption opportunities forinnovators and entrepreneurs alike.

The massive scale of the Chinese market: The size and fast changing nature of China’s market allow companies to rapidly scale up. At the same time, it provides plenty of room for innovators and entrepreneurs to learn via trial anderror. Leading Chinese companies are also benefitting from high valuations that are based on favorable forward looking expectations of China’s market potential. This gives them the needed capital ammunition to support their growth.

Capital resources: Over the past 20 years of China’s development, many venture capital firms and angel investors have benefitted from exceptional returns from theirinvestments in China. Regardless of whether these investors came from abroad or were homegrown, Chinese companies have also greatly benefited from the vastsums of capital these investors have provided over time.

China has entered new era. A new generation of entrepreneurs defined by their youth and exponential growth nature has generated new energy and vigor into the country. Of course, in the process of innovation and entrepreneurial pursuits, only a few would succeed or succeed at the first try. Perhaps incertain situations the government would interfere. But as long as these entrepreneurs do not break laws or defraud consumers, China’s society now allows and welcomes trials and errors. This era — the era of China’s entrepreneurs — is bringing forth real ground breaking times in China’s long history.

About the Author:

Edward Tse is founder & CEO, Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. A pioneer in China’s management consulting profession, he led the Greater China operations for two major international management consulting firms for 20 years and is widely known as China’s leading global business strategist. He is author of The China Strategy (2010) and China’s Disruptors (2015).

 

China’s disruptors: 7 startup tips from the rise of Alibaba, Xiaomi, Tencent, and other innovations

MADANMOHAN RAO
SEPTEMBER 9, 2015

Emerging digital companies from China such as Alibaba, Xiaomi, and Tencent are not just shaking up business in China but are reaching out across the world as well through their self-assurance, speed, agility, and energy.

Insights, tips and lessons from these innovators are offered in the new book, ‘China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies are Changing the Rules of Business,’ by Edward Tse, Founder and CEO of Gao Feng Advisory Company, and author of ‘The China Strategy.’ See also my reviews of the related books ‘startup Asia'(by Rebecca Fanin) and‘ China Fast Forward ‘ (by Bill Dodson), and YouStory’s curation of quotes by Alibaba founder Jack Ma.

The 256-page book is a good mix of storytelling, case studies, economic history and business tips. Despite the current economic downturn in China, entrepreneurship will remain a strong force and the leading digital players will continue to have a powerful influence overseas as well.

Four decades of entrepreneurship in China

Tse divides the history of entrepreneurship in China into four decades. The economic liberalisation of the 1980s led to the birth of Huawei, Haier, Legend (now Lenovo), Geely, Broad Group and Wanda; many of the founders had no prior experience or even a high school education, but built global brands.

In the 1990s, further economic liberalisation led to more entrepreneurship by the so-called Gang of 1992 or well-educated founders from government and academia (eg. Vantone Holdings in real estate). In the early 2000s, WTO membership along with the rise of the Internet spurred the growth of digital giants with internationally-minded founders: Alibaba, Tencent, Baidu, Sina, Youku, Qihoo, DHgate and JD.com.

Over the last decade, founders who grew up in the reform era have created startups riding the mobile Internet wave, such as Xiaomi, VIPshop, Meituan, and Yihaodian. The GDP contribution of the private sector accounts for around three quarters of China’s economic output, far outstripping the incumbent government and public sector. Entrepreneurship is booming in Beijing’s Zhongguancun, Wenzhou, Dalian, and beyond.

Players to watch

Jack Ma’s Alibaba dominates e-commerce and electronic payments in China, and its $25 billion IPO in 2014 was the largest to date. Its various sites account for around 80 per cent of e-commerce in China, and are worth more than those of eBay and Amazon combined. On November 11, 2014 (‘Singles’ Day), its transactions were three times bigger than CyberMonday in the US (the first Monday after Thanksgiving). Alibaba has also launched TMall, an online shopping mall.

Pony Ma’s Tencent dominates messaging (WeChat) and online games. Robin Li’s Baidu accounts for over 60 per cent of Chinese search engine activity. Together, these three companies are sometimes referred to as the ‘BAT’ companies.

Ren Zhengfei’s Huawai is the world’s leading manufacturer of mobile and fixed-line telecom network equipment, competing against Ericsson and Cisco. Lei Jun’s smartphone company Xiaomi is taking on Samsung.

Yu Gang, formerly with Dell, founded online supermarket Yihaodian. Geely Auto, founded by Li Shufu, acquired Volvo in 2011. Xu Lianjie’s Hengan International competes with P&G and Kimberly-Clark in diapers, tissues and sanitary napkins. Diane Wang launched and sold online bookstore Joyo.com to Amazon, and then launched B2B website DHgate.

Chen Haibin has launched a chain of private medical labs, and Wang Jingbo launched private firm Noah Wealth Management. Zhang Yue branched out from air-conditioners to pre-fab homes and wants to construct the world’s highest building in Changsha, Hunan province.

These players offer useful tips to other startups and growing companies with respect to quality, focus, growth and innovation. Here are my seven takeways from the book, on what other startups and entrepreneurs can gather from their Chinese counterparts.
Focus on quality
Zhang Ruimin is the founder of Haier, the world’s largest maker of washing machines, air conditioners and other appliances. He has set a high bar for quality by once famously smashing a faulty refrigerator with a sledgehammer, and then asking his employees to do the same. ‘Good enough’ products also have to be ‘good’ products, and many Chinese companies are moving up the quality and value chain.
Continuous reinvention
Successful entrepreneurs don’t bank on just one good idea, but a steady pipeline of transformative ideas. Haier has an eye for innovation, via small refrigerators for cramped homes, extra-tough cabling to be rat resistant, and freezers that could stay cool even when electricity was cut off for 100 hours. Haier is now reinventing itself for the Internet age via e-commerce, and fires employees who do not contribute to performance or innovation.

At age 26, Wang Xing sold his first startup, social media site Xiaonei (later renamed as Renren) and then launched message service Fanfou, followed by group discount site Meituan.com. Lei Jun joined Chinese word processor giant KingSoft, then launched a series of startups, including Joyo.com and video sharing platform YY – and eventually created Xiaomi with former Google engineer Lin Bin.
Treat challenges as opportunities to innovate
A challenge should not be seen as a reason to lose market share. For example, when eBay entered China, Alibaba’s B2B network was only five years old. To combat eBay, Alibaba launched Taobao, a C2C site (but without transaction fees) and the Alipay online payment network. Today Alipay processes half of all online transactions in China. By converting a challenge into opportunity, Alibaba innovated in new ways to its long-term advantage.

Go global
It’s not just Chinese government firms which are going global, but entrepreneurs as well – via geographical presence and investments. For example, Mindray Medical has bought US firm Datascope Corporation; Geely bought Volvo from Ford; Hanergy acquired Alta Devices and Global Solar Energy in the US; and Fosun bought Portuguese insurance group Caixa Seguros.

Lenovo has set up dual headquarters in Beijing and North Carolina. Tencent has bought US video game publisher Riot Games. Alibaba has taken stakes in US messaging firm Shoprunner, luxury e-commerce site 1stDibs and travel sharing service Lyft. Many Chinese firms are also targeting other emerging economies in Asia and Africa and then moving into Western markets, using their deep experience in dealing with complexity and hyper-competitive changing environments.
Aim for Number One
“We don’t want to be Number One in China. We want to be Number One in the world,” Jack Ma told the South China Morning Post during the early years. His vision and marketing skills have attracted a number of investors, including Goldman Sachs and Softbank. In addition to e-commerce and payments, the company offers consumer finance products like Yu’e Bao (‘extra treasure’).
The ‘Jump’ strategy
Mobile and the Internet connect a number of diverse firms, industries and ecosystems together, thus allowing companies to ‘jump’ into other sectors. Chinese companies use the ‘jump’ strategy to enter markets beyond their industry and even geography.

For example, Lenovo used to sell only one product, the PC, in China. It saw an opportunity in buying IBM’s money-losing PC division, and vaulted into the global league. It also moved into the server business. Its first mobile foray did not work so well, but it bounced back with new products like the Yoga IdeaPad.
Challenge incumbents
Even in sectors which are dominated by heavyweights, nimble players with creative business models can disrupt the status quo. Xiaomi, founded by Lei Jun (the ‘Chinese Steve Jobs’), competes with the mobile handset giants; it makes most of its sales online in batches, and crowdsources product ideas.

The Road Ahead

“At the heart of China’s entrepreneurial spirit lie three core elements: pride, ambition and a shared cultural heritage,” Tse explains. Chinese are proud of their ancient history of innovation, which includes papermaking, printing, the compass and gunpowder. Many Chinese companies are now moving away from just ‘copycat’ mode, and innovating beyond ‘derivative’ offerings across the chain: product, service, practice and process.

The government is also increasing R&D spending (overall and as a percentage of GDP), and China is now the world’s second largest investor in R&D (over $200 billion annually). China’sscale,speed,digital infrastructure and talent make it ripe for international players as a local market as well as base to launch new global products, though many analysts have concerns over media control, loose IP laws, corruption, and political controls.

For international players to succeed in China, they will need to find the right local talent as well as groom managers from overseas in the local ecosystem. Local acquisitions and equity stakes are another option, as shown by WalMart (invested in Yihaodian), Hershey (buying Golden Monkey) and Nestle (buying Yinhu). They can also sell products on Chinese e-commerce sites, eg. Nike and Adidas on TMall.

Many entrepreneurs are now addressing issues of environmental sustainability as well, and while they do have suggestions to politicians for better governance, they do not want to get involved in politics. Some sectors like telecom service and healthcare, however, are still dominated by government.

Trends to watch include the new wave of disruption via mobile apps (which are now blurring the earlier demarcation between the BAT players), manufacturing innovations like 3D printing (eg. airline parts by CACC) and the rise of innovation incubators and funds (eg. Innovation Works incubator; China Smart Device Innovation Fund).

“China has embarked on a renaissance that could rival its greatest era in history – the Tang dynasty of 618 to 907,” concludes Tse.

About the author: Edward Tse is Founder and CEO of Gao Feng Advisory Company, a global strategy consulting firm. His previous book was ‘The China Strategy: Harnessing the Power of the World’s Fastest-Growing Economy,’ and Tse has also written for Harvard Business Review and South China Morning Post. He lives in Hong Kong and Shanghai, can be followed on Twitter at @Edward_Tse.

 

Ed Tse 2014-09-25

Is China a breeding ground for innovation? Most people wouldn’t say so, as China is so often associated with copycats, restricted freedom of speech, poor protection of intellectual property rights (IPR), rote-learning education and an overbearing state sector. For some or all of these reasons, outsiders tend to see China as lacking the fundamentals for successful innovation.

But this view is simplistic and superficial. Let’s look at two of these so-called reasons in more detail. Lack of IPR protection is a real issue, but it hasn’t stopped innovation from taking place. Over the past decade, there have been many examples of innovation originating from China, both product and technology innovations as well as business model innovations. One can argue that change is still at a snail’s pace, but China’s IPR protection is improving and in recent years there have been cases where foreign companies successfully sued Chinese companies for IPR infringements.

The dominance of the state economy is another often-cited reason inhibiting innovation in China. Yet even the state sector can create innovations. Large scale examples include China’s space programme, its expanding high-speed rail network, the world’s highest-elevation railway (to Tibet), and the world’s fastest supercomputer. The list goes on and is lengthening. These were all developed under the auspices of the state sector. Regardless of what many people say about the Chinese copying or even stealing technology from others, for projects as complex as these, real innovations clearly do exist, and the dominance of the state economy was able to provide ample funding for these advances.

“Despite the state sector’s role so far, most of China’sinnovation will not be coming from there. It will come from the companies oreven individuals who compete in China’s increasingly open economy”

China’s market economy is still developing, and is now slightly over two decades old. This fundamental transformation away from the fully planned economy so deeply ingrained during the Chinese People’s Republic’s first 30 years is still just a small blip in China’s long history, and nothing that we have seen during the last 20 years is by any means perfect. But the forces shaping the future change need to be fully understood, and the direction and speed of their change recognised and appreciated.

Despite the state sector’s role so far, most of China’s innovation will not be coming from there. It will come from the companies or even individuals who compete in China’s increasingly open economy. And that includes both Chinese and foreign private companies as well as state companies. And as more mixed equity enterprises are formed in response to the needs of a competitive market, the lines separating these different kinds of companies will become more blurred than ever. China is undergoing a measured but definite process of deregulation, sector by sector. Not all sectors of the economy will ever be fully deregulated, but the trend is clear.

The size of China’s market and the potential for profits mean that when the government opens up a sector it becomes an arena for some of the world’s most intense competition. This forces companies to be innovative and to create the best products, services and business models to achieve success. There’s also a strong “why not me?” mentality among Chinese entrepreneurs, so when an opportunity arises they tend to give it a try. Some – maybe even most – may fail, but with a population of 1.4bn, even a small percentage of successes is noteworthy and these are going to encourage many others to try their luck. In short, waves of new entrepreneurs in China will be pushing for greater experimentation and more innovation.

Xiaomi, one of China’s leading smartphone players, is an excellent example of an innovative company in a highly competitive industry. Xiaomi’s leader, Lei Jun, understood the power of the Internet and built his company’s business model by “listening to customers” through social media – the concept known as “crowd-sourcing”. Its strategy is working so well that Xiaomi’s revenues grew from zero in 2010 to $5bn in 2013, with the company now reportedly valued at $10bn. The late Steve Jobs at Xiaomi’s U.S. counterpart, Apple, didn’t believe in focus groups because he felt he knew best, but Lei Jun takes the opposite approach, and is convinced that customers will be the best ones to tell him how his products should be designed and how its service model developed. With millions of fans, Lei Jun claims his business model is not to make money from the hardware, but from services.

At a more basic level of innovation, Haier, a leading Chinese white goods manufacturer, quickly gained market awareness and share by introducing a washer capable not only of cleaning clothes but also potatoes. This sprang from a customer claim and is an example of Haier’s “customer centric” management philosophy. Not every Chinese company will be like this, but the market is changing so rapidly that there are major incentives for Chinese companies to be agile, nimble and innovative.

“There’s also a strong “why not me?” mentality among Chineseentrepreneurs, so when an opportunity arises they tend to give it a try”

To successfully breed innovation, a country must be tolerant of mistakes and failures. These failures will include short-lived innovations, but they are part of the process and in fact often further examples of how innovation will be sustained in China. Tencent’s QQ, for example, was a precursor to WeChat, a fast-growing Twitter/WhatsApp type of platform very popular not only in China but internationally too. Although only two years old, WeChat already has over 600m registered subscribers and over 270m active users and the numbers are growing fast. It introduced voice capability before WhatsApp, along with a more recent payment capability that is undercutting China’s dominant incumbent, Alipay of Alibaba.

Telecom operators see WeChat and Sina’s Weibo as competitors because they eat into their own text messaging businesses and the prevalence of the Internet, in particular wireless internet, is fast cutting out traditional distribution methods. Only a few years ago, Gome and Sunning were the dominant retailers through their “bricks-and-mortar” retail stores and today, Sunning is having to quickly transform itself into an “O2O” (Offline to Online) retailer. The same goes for companies like Haier, while many retailers, especially state-owned ones, are looking at how they must revamp their business strategies to remain competitive.

As China’s economic transformation continues, more and more monopolies will be broken down. It’s unlikely that China will become completely deregulated in the near future, but it’s heading in the right direction, and the new government re-affirmed this trajectory at its recent Third Plenum when it was emphasised that market forces will play a “decisive role” in China’s economic development and non-state capital will gain access to more sectors. State-owned enterprises (SOEs) are set to remain important, but non-state companies were for the first time put on an equal footing with the SOEs. Experimental free trade zones like that of Shanghai are to be established in more cities across China, and an effort will be made to create economic conditions that are conductive to innovation by entrepreneurial companies, both foreign and state-owned.

China’s unique qualities are its complexity and size. Even a small percentage of successes can be significant in the context of global commerce. Europe and the rest of the world will need to keep a close eye on China’s innovations because as well as threats they will bring with them opportunities.