By: Yinglan Tan
Innovation in China—mystery or mastery? It is widely believed that China’s entrepreneur class has grown, and that their businesses are succeeding, primarily due to their knowledge of the domestic market, their quick adaptation to market changes, and their resourcefulness. What are the real secrets? Yinglan Tan, author of Chinovation, in an exclusive look at his upcoming book discusses….
Since 1999, Chinese founders have led more than 46 Chinese firms to IPOs on NASDAQ. From this unprecedented number of start-ups to a rising class of billion-dollar giants going global, high-tech companies in China have a dramatically intensifying need for leadership.
In fact a new era is under way for global high-technology innovation and entrepreneurship, marked by the rise of China, that impacts on all leaders.
During the past several decades, Beijing, Shanghai, Shenzhen, and other cities have developed as centers of key information communications technology industries. More recently, from Beijing to the Pearl River Delta, markets for new products are expanding, competencies in new technologies are growing, and a new generation of high-technology regions is emerging. All these signs point toward China as a rising powerhouse, accelerating the shift of locus for the global high-technology arena across the Pacific.
From high-profile young executives taking companies public to mainland entrepreneurs who are redefining the norms of daily activity, Chinnovation traces the humble beginnings of entrepreneurial innovation and the backstories of some now well-established consumer goods firms from Mao’s Cultural Revolution through the self-made Internet era to the Middle Kingdom’s rapid growth.
The ascent of Asia has introduced new avenues for entrepreneurship, especially in China. Innovation has been a hot topic for many Asian governments; however, little has been written about innovation in China. Suppose you were at a cocktail party and wanted to explain in 30 seconds: Is there innovation in China? What are examples of innovation in Chinese companies? What is the path that an innovative Chinese private-owned enterprise is likely to take? What are the experiences and capabilities that these innovative companies acquire? How do these companies experiment with innovative approaches and also manage the risk of innovation? What are the lessons learned and how would these entrepreneurial innovators advise others who are embarking on the same journey?
What is Chinnovation?
(Ch)innovation is applying changes in technology and business strategy to have new better ways to create value for both the customer and the corporation. In China, this is often characterised by 8 unique characteristics distinct to China (termed the 8Rs of Chinnovation)
- Revenue. Compared to their western counterparts, Chinese innovators are laser-focused on revenues. If one compares Facebook to QQ (China’s largest social networking service), Facebook has 300 million active users compared to QQ’s 450 users. Facebook was only recently profitable while QQ has a $2B revenue and $1B profit.¹ Eric Tao, vice president of Keytone Ventures (formerly an associate at Kleiner Perkins Caufield and Byers China) concurs. ‘‘The investment strategy for China is very different. Companies like Google with 100X returns don’t come to China. VCs tend to do later-stage deals and invest in the later rounds. For example, U.S. Kleiner Perkins offices invest in over 30 pre-revenue companies. The KP office in China is completely the opposite; our China team never invests in companies without revenue, unless the company has an extremely convincing model and revenue and clear customer absorption rate.’’
- Rapid. Chinese innovators move fast. Nick Yang co-founded the Kongzhong in March 2002 and listed it on the NASDAQ hardly 2 years later in July 2005. One of our innovators acted on an inspiration days after Michael Jackson’s demise, securing the rights to build Neverland in China. In manufacturing industries, certain companies which started off with OEM for foreign companies have moved from OEM, ODM, Research and Development to taking over the entire value-chain within a couple of years. One of our innovators only took 18 months between starting a company and listing the company on NASDAQ. Rapid also refers to the rapid prototyping process, where Chinese innovators are lauded for engaging with customers closely to iteratively develop products and sales process rapidly.
- Requirements. Requirements are whatever the customers say it is. Chinese innovators are highly localized and sensitive to the needs of their customers as they pay close attention to people who are struggling with existing solutions in China. Widely perceived as the world’s largest manufacturing base, China innovators understand that the higher value in the chain is in consumer-facing innovative products. By tapping on China’s cost advantage in niche markets to increase their process flexibility, China innovators are fulfilling the requirements of their customers at rock button prices.
- Reproduce. One Facebook in the U.S. will spawn 20 copycats in China overnight. There is a fine line between innovation and low-value reproduction. The author heard from several Chinese entrepreneurs that VCs refused to fund them because their business model was not based on proven US business model. Zany Zeng expresses “There are more me-too innovation in China. When I operated Xiaonei, we would change our homepage when Facebook changes theirs, without understanding why. Our rationale is that if Facebook has a reason to do this – and we had better emulate this.” Despite this, Farmville has its roots in China. QQ (a Chinese social networking service) is more profitable than Facebook.
- Rivals. China is good or bad because everyone is an entrepreneur. Spurred by rivals, Chinese companies have key stimulus to innovate. Innovators who do not innovate after copying usually do not survive. China has a handful of local copycats appearing within weeks of a company being featured on prominent western technology magazines.
- Restrictions. Restrictions have spurred entrepreneurship and innovation. The banning of Facebook in China has resulted in at least half-a-dozen Facebook clones mushrooming in China. Frank Levinson, a former successful entrepreneur who listed a company on Finisar, explained that resource limitation stimulate creative thinking. Often the best movies were shot due to budget constraints and the director had to innovate – the same principles applies for startups. In response to rural workers expressing the need to wash potatos and clothes but could only afford one washing device, Haier released a washing machine capable of washing both clothes and potatoes.
- Remix. Breakthrough ideas are often less about the purposeful act of inventing new things, then combining the best ideas from similar sectors and geographies. What do themes parks and shopping have in common. A supermarket in China uses roller coaster-style cars to take shoppers through the aisles. In response to rodent-infested rural China, Haier came up with an innovation, remixing different features to come up with the rodent-proof fridge. The specially designed refrigerator features metal plates to cover holes in the fridge and uses thicker “bite-proof” wiring. QQ’s ostensibly simple user interface combines Cyworld2-like avatars, ICQ messaging and Hangame3-like casual games and virtual goods.
- Raw Materials. China does not merely have plenty of tangible raw materials, but also intangible raw materials.
- Human Capital i.e. Density of entrepreneurs. China possess a large number of returnees who come back to China to embark in entrepreneurial endeavors, frequently monetizing US business models. According to the 2009 GEM Report, from 2004 through 2009, China had the highest rate of high-expectation entrepreneurship (intending to create more than 19 jobs) of any country covered by the study. More than 4% of the Chinese working-age population is engaging in high-growth-expectation entrepreneurship. In the U.S. that share is less than 1.5%. However, fresh graduates from China are often theoretical and lack practical experience.
- Intellectual Capital i.e. High density of science and technology Ph.Ds. Fact: The Chinese Academy of Sciences alone produces close to 100,000 Ph.Ds per year. These have translated to innovative companies grounded on strong intellectual property. For example, Wuxi Pharma Tech is a leading low cost, high quality contract chemistry services company. With a high density of returnee Ph.Ds, Wuxi Pharma Tech offer a full time equivalent (FTE) programs which assign scientist to work on a client’s project for a defined period which includes drug discovery and development. FTE is so popular that it makes up the majority of Wuxi’s revenue. The high quality of services that the company provides enable Wuxi Pharma to reach $21million revenue within four years.
- Financial Capital. i.e. Venture capital and purchasing power. In 2009, there were more than 420 venture investments in China which involved a combined investment amount of US$2.70B.4 Consumer power is escalating. The total retails sales of consumer goods reached RMB12 trillion in 2009 and is expected to hit RMB15 trillion in 2010.
The 8Rs summarizes the most common traits we see in Chinese innovators. Most companies have a combination of the Rs – it is rare to see all 8Rs in one company.
By Yinglan Tan
About the author
Yinglan Tan is the author of Chinnovation – How Chinese Innovators are Changing the World (Wiley, 2011) and The Way Of the VC: Having Top Venture Capitalists On Your Board (Wiley, 2010). He is a Kauffman Fellow and an Adjunct Assistant Professor at Nanyang Technological University.
- With most of Facebook’s revenue from advertising, 90% of QQ’s revenue mostly came from virtual goods. While Facebook relies on transactions on Credit Cards, QQ relies mostly on microtransactions and payments.
- Cyworld is Korea’s largest social network
- Hangame is Korea’s largest casual gaming portal. Tencent, the developer of QQ, made a billion USD in 2008 and over 400 million USD net profits, gathering cents from 300 million Internet users and 700 million mobile users.
- Zero2IPO Annual Venture Capital Report 2009.