Chinnovation: Unraveling the Dynamics of Chinese Innovation
Tan Yinglan, Class 14
The growth of China's entrepreneur class and their businesses success is widely attributed to Chinese entrepreneurs' knowledge of the domestic market, quick adaptation to market changes, and resourcefulness, but what are the real secrets? Building on my previous book, The Way of the VC: Having Top Venture Capitalists on Your Board (Wiley, 2010), in this article I offer a preview of my second book, Chinnovation—How Chinese Innovators Are Changing the World. From high-profile young executives taking companies public to mainland entrepreneurs redefining the norms of daily activity, Chinnovation traces the humble beginnings of entrepreneurial innovation and the back-stories 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.
In late 2006, I was "airdropped" into China as Director for China at 3i Venturelab, a joint venture between a private equity firm (3i) and an international graduate research institution (INSEAD). I shuttled between the hi-tech parks in Zhongguanzun in Beijing and Zhangjiang Science Park in Shanghai with ambitious, hungry entrepreneurs, mulling over industry trends in tech conferences and swapping stories with other Chinese and Western industry veterans and venture capitalists. Chinese consumer demand was just picking up, but the energy and drive of Chinese entrepreneurs to capitalize on this latent demand was palpable. My daily routine revolved around meeting these high-powered entrepreneurs.In one of these visits, I met Jack Ma, founder and CEO of Alibaba, which IPOed in 2007 on the Hong Kong Stock Exchange and raised $1.5 billion in the biggest initial stock sale by a Chinese internet company (investors sought more than 180 times the number of shares on offer). I asked Ma what he felt was Alibaba's comparative advantage, and he replied, "There were three reasons why we survived. We had no money, we had no technology, and we had no plan. Every dollar, we used very carefully."1The year 2006 was also the year when China's total venture capital investment reached $1.78 billion and China became number two globally, next to the United States; U.S. venture capital (VC) investment was $25.6 billion that year, accounting for 67.9 percent of the world total ($37.7 billion). Fast forwarding to 2011, VC investment in China has jumped almost 2.5 times to $4.4 billion in 20102 while VC investments in the United States have dropped to $21.8 billion in 2010.3 According to a running joke among Silicon Valley venture capitalists, it is far more likely to run into a colleague at a hotel bar in Beijing or Shanghai than at a local haunt in Northern California.Since 1999, Chinese founders have led more than 46 Chinese firms to IPOs on NASDAQ.4 From this unprecedented number of startups to a rising class of billion-dollar giants going global, high-tech companies in China have a dramatically intensifying need for leadership.A new era is underway for global high-technology innovation and entrepreneurship, marked by the rise of China. During the past several decades, Beijing, Shanghai, Shenzhen, and other cities have developed as centers in 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.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 and ready answers have not been available for the questions that arise. 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? In this article, I offer some insights into these questions, which are more fully explored in my upcoming book.
Defining Chinnovation
Chinnovation (coined from China + innovation) means applying changes in technology and business strategy to develop new and better ways to create value for both the customer and the corporation. Although this term can be applied in any market, there are eight characteristics unqiue to China—the 8Rs of Chinnovation—that summarize the most common traits of Chinese innovators. Successful innovators usually demonstrate a combination of several Rs.
Revenue Focus
Compared to their Western counterparts, Chinese innovators are laser-focused on revenues. If one compares the largest U.S. social networking service (Facebook) to China's QQ, Facebook has 500 million active users compared to QQ's 630 million users. Facebook was only recently profitable, while QQ has a $2 billion revenue and $1 billion profit.5 Eric Tao of Keytone Ventures (formerly at Kleiner Perkins Caufield and Byers China) highlights that
the investment strategy for China is very different. In China, VCs tend to do later-stage deals and invest in the later rounds. For example, the Kleiner Perkins U.S. offices invest in over 30 pre-revenue companies. The Kleiner Perkins 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 Movement
Chinese innovators move quickly. Nick Yang cofounded KongZhong Corporation in March 2002 and listed it on NASDAQ (KONG) only three years later, in July 2005. One entrepreneur acted on an inspiration days after Michael Jackson's demise, securing the rights to build Neverland in China.In manufacturing industries, certain companies that started off as OEM (original equipment manufacturer) for foreign companies have moved from OEM to ODM (original design manufacturer) to Research and Development, taking over the entire value-chain within a few years. "Rapid" also refers to the rapid prototyping process: Chinese innovators are lauded for engaging with customers closely, to iteratively and rapidly develop products and sales processes.
Requirements Driven by Customers
Requirements are whatever the customers say they are—Chinese innovators are highly localized and sensitive to the needs of their customers, paying close attention to people who are struggling with existing solutions in China. Although China is widely perceived as the world's largest manufacturing base, Chinese innovators understand the higher value in consumer-facing innovative products. By tapping into China's cost advantage in niche markets to increase their process flexibility, Chinese innovators are fulfilling the requirements of their customers at rock-bottom prices.
Reproduction of Existing Models and Products
One Facebook in the United States will spawn 20 copycats in China overnight, yet there is a fine line between innovation and low-value reproduction. One common gripe of Chinese entrepreneurs is the lack of Chinese VC funding because their business model is not based on a proven U.S. business model. Zany Zeng, co-founder of Xiaonei (widely known as the Facebook of China) expressed,
There are more me-too innovations 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.6Despite the tendency of Chinese entrepreneurs to emulate business models from the West, the trend does occasionally reverse; for example, the popular application Farmville has its roots in China.
Rivals Require Innovation
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 Inspire Innovation
Restrictions have spurred entrepreneurship and innovation. The banning of Facebook in China resulted in at least half-a-dozen Facebook clones mushrooming in China. Frank Levinson, a former successful entrepreneur who co-founded Finisar (a NASDAQ-listed company), explained that resource limitation stimulates creative thinking. The best movies often result from budget constraints that inspired the director to innovate—the same principle applies for startups.7 In response to rural workers expressing the need to wash both potatoes and clothes but the money for only one washing device, Haier developed and released a washing machine capable of washing both clothes and potatoes. Haier has since seen its business in second- and third-tier cities in China surge ahead of its competitors.8
Remix, Remix, Remix
Breakthrough ideas are often less about the purposeful act of inventing new things, than combining the best ideas from similar sectors and geographies. What do theme parks and shopping have in common? A supermarket in China uses roller coaster-style cars to take shoppers through the aisles. QQ's ostensibly simple user interface combines Cyworld9-like avatars, ICQ instant messaging, and Hangame10-like casual games and virtual goods. In response to rodent-infested rural China, Haier innovated by remixing different existing features to develop the rodent-proof refrigerator: metal plates cover holes in the fridge and it uses thicker "bite-proof" wiring.11
Raw Materials, Tangible and Intangible
China's wealth in tangible raw materials is well known, but the country also has an abundance of intangible raw materials: human, intellectual, and financial capital. By human capital, I mean density of entrepreneurs: China possesses a large number of returnees seeking entrepreneurial endeavors and frequently monetizing U.S. business models. 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 2009 Global Entrepreneurship Model Report.12 More than 4 percent of the Chinese working-age population is engaging in high-growth-expectation entrepreneurship—in the U.S. that share is less than 1.5 percent13—however, fresh graduates from China are often well versed in theory but lacking practical experience.
Intellectual capital refers to China's high density of science and technology PhDs: The Chinese Academy of Sciences alone produces close to 100,000 PhDs per year.14 This strong academic foundation has 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 PhDs, Wuxi Pharma Tech offers full time equivalent (FTE) programs that assign scientists to work on a client's project for a defined period including drug discovery and development. FTE is so popular that it makes up the majority of Wuxi's revenue—the high quality of services the company provides enabled Wuxi Pharma to reach $21 million in revenue within four years.15With financial capital, I refer to China's venture capital and purchasing power. In 2009, there were more than 420 venture investments in China that involved a combined investment amount of $2.70 billion.16 Consumerpower is escalating: Total retail sales of consumer goods reached $1.8 trillion in 2009 and are expected to hit $2.2 trillion in 2010.17
Assessing the Future for Chinese Innovation
Chinese innovation is underpinned by its massive and growing internal market, giving it an advantage in economies of scale. Using the lens of the Rs described above, this section explores why the trend of China innovation is likely to translate into an increasing number of game-changing companies.
Resources—Domestic Demand in China Will Only Increase
As discussed above, China has the latent resources for domestically driven economic growth. Exports in China have been a major driver, but there are clear signs that a shift toward domestically driven economic growth is well underway. China and India already boast some 500 million internet users, and the McKinsey Quarterly forecasts that nearly 700 million more will be added by 2015; internet opportunities in emerging Asia could reach approximately $80 billion by 2015.18
In addition, latent demand in second-tier cities has yet to be unleashed. For example, when outside observers hear that China is the world's largest beer market, they often assume the top selling beer is Tsingtao. Most find it surprising that the top beer in China is in fact Snow beer—CR Snow is a joint venture between China Resources Enterprise Ltd. and South Africa's SABMiller. The key to CR Snow's success has been its focus on second-tier (or lower) cities in China's regionalized beer market. CR Snow implemented a green field expansion program in 2006 through successive acquisitions of breweries in Dongguan, Lanzhou, Harbin, Yanjiao, Nanjing, Anhui, Liaoning, and other locations.19
Remix—Grassroots Innovation in China Will Be Increasingly Dominant Globally
There is increasing evidence that advantages in China will be essential to future business. Shenzhen-based Yosion has unveiled a product called the Apple Peel 520, a hack that can turn any iPod Touch into a cell phone. The Apple Peel attaches to an iPod Touch like any protective case but functions as a dock, an extended battery, and most intriguingly, a SIM card slot.20 With Chinese comparative advantage in battery technology (most notably by BYD, "Build Your Dreams"), Chinese-made batteries (in a CODA automotive battery in Tianjin, China) have been merged with complex U.S.-system electronics and final-assembled in Oakland, California. The future will bring more partnerships like these.
Chinese consumers perceive foreign elements to be synomous with quality, which presents an opportunity for exporters; in addition, Chinese consumers believe that Western products elevate their social status, which is extremely important in China. Many Chinese companies therefore try to position their products to have Western appeal. For example, the Chinese casual-wear fashion company Metersbonwe uses Western models to showcase their apparel. This tactic works: According to a survey by McKinsey, 90 percent of Chinese respondents surveyed believe that Metersbonwe is a foreign company.21For multinationals that want to capture Chinese consumers' hearts, minds, and wallets, it is wise to promote the flagship brand(s) but remix them to Chinese consumers' tastes. Combining features from Amazon, eBay, and Rakuten, Alibaba's success defied many Western misperceptions about China and innovation.
Restrictions—A Top-Down Mandate from the Chinese Government to Innovate Will Ease Some Areas
Some restrictions will be eased through China's innovation strategy of taking a top-down,bottom-up approach.Chinese Commerce Minister Chen Deming22 said that China will improve some of its innovation and government procure-ment policies to allow for innovation. China has also put in place the right measures in terms of (1) thinking long-term and with ambition, (2) investing in infrastructure, and (3) emphasizing science and technology.
First, for long-term ambition, China has four national innovation challenges that are multi-billion-dollar, 25-year horizon, game-changing investments: two in the transport sector, one in life sciences, and one in automotive manufacturing. The financial commitment and long-term planning involved is a test for the public–private capability of the Chinese.Second, for investment in infrastructure, one of those four moonshots includes building a network of ultramodern airports and a web of high-speed trains connecting major cities. These improvements will unlock the latent demand of Chinese consumers and—most importantly—create jobs.Third, in the area of life sciences and clean energy, the focus is very much on biosciences: the Beijing Genomics Institute ordered 128 DNA sequencers to launch China's stem cell and genetic engineering industry. China also hired a "dream team" of 16 state-owned enterprises to work on electric cars.23 With these conditions, I foresee the emergence of a Chinese Tesla.The remaining restrictions in China, however, also present new opportunities. With Twitter blocked in China since 2009 (along with other popular U.S. websites like Facebook and YouTube), entrepreneurs have capitalized on this pain-point. AnchorFree, a startup based in Sunnyvale, California, has built a profitable business by providing free, advertising-supported software called Hotspot Shield that tunnels about 7.5 million people around the world into the internet by encrypting users' data and cloaking their identities.24 Home-grown versions of Twitter are also hugely popular in China.The typical perception of small companies is that they are cash-strapped, lacking in resources, and slow to respond, but Jack Ma of Alibaba believes that innovation will come from small companies and trickle up to large (mostly Western) multinationals. In fact, according to Ma, 70 percent of the world's innovation is being created by small businesses, despite the lack of aid from government or policymakers. Ma's philosophy is simple: "By helping [small business] people make money, we [Alibaba] are making money."25
Raw Materials—Immeasurable Depth of Talent Is Available in China
Innovation Works is a Beijing business incubator founded a year ago by former China Google Chief Lee Kai Fu. Lee is betting that young Chinese entrepreneurs will flourish:
There are so many good people, good engineers tackling interesting problems. We are providing what is much needed to create value and interest and excitement and help out people.26
In addition to the benefits of China's top-down policies to support innovation, bottom-up innovation is and will continue to be pervasive. China abounds with stories of innovative, creative, savvy entrepreneurs who are the driving force of innovation. The household brand Grandma Chilli Sauce, now a multimillion-dollar business, was started by an illiterate grandma who had only a primary school education. She only figured out her business model and comparative advantage when other noodle owners came to ask for her sauce and then sold their noodles for a higher premium. In another example, a Chinese entrepreneur who saw the market opportunity for a customized mousepad mitigated his risk by designing the mousepad, went to Alibaba to find a larger buyer, then found a manufacturer afterward. Another entrepreneur who lost his fortune gambling in mah-jong started a hotpot chain that allowed its diners to play mahjong, with the waiters sporting mahjong-styled hair and holding regular mahjong contests at the restaurant.27
Requirements—Large, Untapped Potential Remains for Customized User Requirements
Lenovo, a leading producer of personal computers in China, is increasingly focusing on user requirements in China's "emerging markets." Since early 2009, desktop sales in the emerging markets cluster have increased from 45-70 percent of Lenovo's total desktop sales. Li Ning, China's leading sports apparel manufacturer, realised that the company's strength in customising products to requirements in China's smaller cities is propelling the company forward much faster than its competitors in tier-one cities who are not seeing the same rate of growth.28
Rivals—To Penetrate the Chinese Market, Understand Your Rivals
To discuss the benefit and potential danger of business rivals, I return to Jack Ma's Alibaba. As founder and CEO, Ma believes that rivals keep an enterprise sharp: "Why are goats in the western U.S. more tough and why do they run faster? Because the west has wolves!" Looking far ahead, he said,
Successful enterprises do not measure themselves in the first 100-meter dash, because we are running a 3,000-meter marathon. In a long race, one only sees the gap after 300 or 400 meters.29
When eBay entered China, Jack Ma launched a new website named Taobao or "digging for treasure"—free of charge for individuals buying and selling virtually any consumer goods. Knowing that most small-business owners would rather watch TV than log on to the internet, Ma secured advertisements for Taobao on major TV channels; the company attracted a lot of attention through the smart play on words in its name. Taobao's model appeared to be more customer-centric while eBay EachNet's was more product-centric. Taobao got a quick start with its free listings and continued to gain momentum as more and more users switched from eBay EachNet to Taobao. In 2007, EBay shut down its China site.30
Redefining Opportunity in China
Looking to the future, cost innovation will remain a comparative advantage of China, particularly where it is combined with innovation. An early indicator of the China momentum is that a TCL 40-inch television can be bought from Amazon for $499 with a two-year warranty, but a few years ago this size cost $2,000—Japanese, South Korean and Taiwanese television vendors cannot be profitable at the current price. The new product challenges from China will not be limited to televisions but will include automobiles, pharmaceuticals, and so on; China is also developing its own 737-type aircraft and considering a 747-type.31 Chinese manufacturers are capitalizing on cost innovation in the manufacturing process to allow them to produce for less and eventually move up the value chain.
However, Alibaba's vision of being a world innovator goes counter to China's overall reputation as a country whose businesses compete on price, reflecting the trends discussed above. Jack Ma advises Chinese innovators,
Innovators learn by discussing in forums, through engaging in conversations, and seeing new things. As a leader, having foresight and staying broad-minded is critical. Travel and see New York and Tokyo. If you are perpetually in one city (like Hangzhou), how do you converse with your large clients?32
Despite the large potential and opportunity of the Chinese market, there are red flags for getting involved in Chinnovation—being famous can cause a product to be be Shanzai, or "copied," destroying a business through no fault of the owner. For example, one can buy fake Tsingtao beer: The culprit, called Quanmai Beer, was for sale in 2010 in the Hangzhou South Railway Station for about 75 percent the price of a Tsingtao. It was being sold alongside a Shanzhai for Budweiser, called "Blue Diamond" beer. This scenario has been repeated all over China for all consumer goods and services.Alibaba is one example of Chinese entrepreneurial success highlighting the unique features of the Chinese market. "In the last century, big was better," Jack Ma says.
But in the twenty-first century, I believe small is beautiful because it is not about how much equipment you have, it is about how quickly you can change yourself to meet the market.33
China enterprises are reaching their potential and becoming serious players in global—and domestic—innovation through China's continued rise and stability as a well-balanced global economic power.
Tan Yinglan
A member of Kauffman Fellows Class 15, Yinglan is serving on the boards of innovative growth ventures and venture capital funds in Asia. He is currently the Head (Projects), National Research Foundation at the Prime Minister's Office (Singapore) where he oversees the National Framework of Innovation and Enterprise. He was the first director of 3i Venturelab China, a joint venture between private equity firm 3i (LSE:III) and INSEAD, one of the world's leading business schools. Educated at Harvard, Stanford, and Carnegie Mellon, Yinglan is an Adjunct Assistant Professor at Nanyang Business School and teaches the Master's program in Technopreneurship and Innovation (Chinese). He is the author of The Way of The VC: Having Top Venture Capitalists On Your Board and Chinnovation: How Chinese Innovators are Changing the World, and also writes as a columnist for China Daily.
1 Tan Yinglan, Chinnovation—How Chinese Innovators are Changing the World (Hoboken, NJ: Wiley & Sons, 2011), 71.2 Tan Yinglan, "8 Rs of Chinese Innovation," Business Times, (5 May 2011): para. 33 Zero2IPO Research Center, China Private Equity Annual Report 2010 (15 March 2011), 14.4 Ibid, 12.5 Most of Facebook's revenue comes from advertising, while 90% of QQ's revenue is from virtual goods. While Facebook relies on credit card transactions, QQ relies mostly on microtransactions and payments (Bemjamin Joffe, "Inside Tencent Reports," 10 April 2011).6 Zany Zeng, interview by author, July 2010 in Singapore.7 Frank Levinson, interview by author, August 2010 in Singapore.8 Haier employees, interviews by author, September 2010.9 Cyworld is Korea's largest social network.10 Hangame is Korea's largest casual gaming portal. Tencent, the developer of QQ, made $1 billion in 2008 and over $400 million net profits, gathering cents from 300 million internet users and 700 million mobile users (Benjamin Joffe, "Inside Tencent Reports").11 Haier employees, interviews by author, September 2010.12 Niels Bosma and Jonathan Levie, Global Entrepreneurship Monitor 2009 Global Report (with William D. Bygrave and others), 2009, 27.13 Ibid., 31.14 Chinese Academy of Sciences staff, interviews by author, September 2010.15 Richard G. Hammermesh and Simin Zhou, "Wuxi Pharmatech," Harvard Business School Case 9-806-003, (2006):6.16 Zero2IPO Research Center, China Venture Capital Annual Report 2009 (2010), 2.17 Hao Yan, "China's Foreign Trade to Recover in 2010," China Daily, 8 December 2009, para. 8.18 Vikash Daga, Nimal Manuel, and Laxman Narasimhan, "Riding Asia's Digital Tiger," McKinsey Quarterly, Sep 2010, 3.19 China Resources Enterprise, "CR Snow Announces Three Acquisitions in Anhui, Liaoning and Zhejiang," (2009):4.20 GrandMax, "Apple Peel 520 Protective Case Turns iPod Touch into an iPhone—Yosion Technology."21 Max Magni and Yuval Atsmon, "From Made in China to Made for China," Harvard Business Review, (September 2010):5.22 China Daily, "China Needs Foreign Firms in Economic Transformation: Commerce Minister," (8 November 2010).23 Tan, Chinnovation, 60.24 Ibid., 75.25 Ibid., 71.26 Ibid., 70.27 Ibid., 120.28 Ibid., 60.29 Ibid., 71.30 Ibid., 115.31 Tan Yinglan, "8 Reasons Why Chinnovation Will Persist," Innovation Management, (23 February 2011).32 Tan, Chinnovation, 71.33 Ibid., 71.
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