The Coming Out of China’s Tech Companies (Part 1)
I lived in Beijing for the past 7 years, immersed in China’s tech sector from a truly early stage investor’s angle. Earlier this year, I relocated with my family in the Bay Area, to be exposed to the tech ecosystem that most people in our industry still consider to be the center of the world. It is indeed, but it is also entrenched in its own borders, and it is largely underestimating the ever-increasing might of China’s tech industry.
There is little excuse for the current level of misinformation, negative predisposition, or outright ignorance on the rapidly maturing Chinese tech ecosystem, especially from industry professionals who are community members of the largest congregation of smart people from all over the world, the Silicon Valley. Cliché criticisms around government intervention and media censorship, favoritism of the local companies, copycat start-ups, Facebook and Twitter’s blocking, Google’s very unfortunate exit, as well as eBay’s, Paypal’s, Amazon’s (and so on, the list is long) notorious failures to breakthrough in the China market in the past decade have all got considerable elements of truth in them but, left at that, they are no more than Aesopian “sour grape” type of aphorisms. They are only one side of the coin and thus dangerously misleading.
The reality is that primarily in Beijing, but also in Shanghai, in Shenzhen, in Chengdu and several other first and second-tier Chinese cities, the tech ecosystem is buzzing with unprecedented activity, a wealth of talent, as well as considerable innovation. Chinese developers are already beginning to leapfrog their foreign counterparts in consumer mobile internet products, and they are catching-up fast in pretty much every other tech sector. Chinese entrepreneurs have already been innovating in terms of new business models and processes for several years. Silicon Valley needs to start taking notice of a whole array of companies coming out of China, beyond the usual suspects (Baidu, Alibaba and Tencent) because we are coming to a stage where more and more of these Chinese tech companies are ready, cash-rich enough, and — more importantly — confident enough to bring their products to the world and compete effectively.
Here are my observations from the past 7 years in China’s tech ecosystem, and some thoughts on what we should expect in the near-term future. I will write this in 3 sequential parts.
Understanding the China Macro Side
Chinese entrepreneurs are simultaneously blessed as well as damned to have to serve the largest consumer market in the world, and also the toughest user base that I have personally interacted with. Beyond the usual GDP growth numbers that everyone refers to, the real influence on all the tech products designed by Chinese developers comes from two irreversible trends: (a) the incredible rise of a new, affluent, urban, upper middle class (estimated to go from around 35M in 2012 to almost 200M in the space of 10 years), and (b) the booming of private consumption, with the blessing of the Chinese government, which sees increasing domestic household spending as the counter-balance to the plateauing growth coming from the manufacturing sector and the stimulus-sponsored infrastructure projects. It is worth noting that last year China’s private consumption was still at an incredibly low 35% of GDP, as opposed to more than 70% in the U.S., or 60% in India, whose economy is very often — rather undeservedly in my opinion — compared to that of China. Can you imagine the growth opportunities that are still out there for the Chinese tech companies if that 35% goes anywhere near the U.S. figure? It’s only recently that the average Chinese middle-class citizen could afford and finally bought his first smartphone device, his first flat-screen TV, his first car, and — the culmination of all achievements in modern Chinese society — his first flat.
In theory this is a very rosy picture. In practice there are tremendous challenges for the Chinese entrepreneur to navigate.
For once, beyond the generation of Chinese kids born in the 90s (the “90后”), which have more in common with their Western counterparts than with their own parents, the average Chinese consumer is culturally still relatively frugal, averse to borrowing, and an avid bargain hunter. Founders have to deal with users that expect everything to be “免费的” (free), that have very little loyalty even for established products and services, that demonstrate limited brand recognition (especially true for the mass population in rural areas), even more limited appreciation of good service, and with users that are naturally suspicious of new products, services and platforms. After all, a large percentage of the consumer base has at some point or another already fallen victim of some form of cheating, or of fake goods, or of incredibly bad service. On top of that, in the past 2–3 years, with the pervasiveness of Sina’s Weibo micro-blogging platform (which went from 0 to 300M users in 3 years) and Tencent’s 微信 (WeChat) chat platform (which went from 0 to 300M users in 2 years), founders must also contend with the very public, viral and very often intentional barrage of comments, criticisms, abuse, and so on, thrown at them (and their products) in the Chinese social media.
Modern Chinese urban society is to a large extent a “nouveau riche” society, but one that is in constant conflict with the traditional Chinese cultural soul. This creates daily paradoxes and near-comical situations. Grand-parents will not spend a single RMB on their own well-being but will pamper their kid, and especially their grand-kid, to oblivion. You can see a gold-plated (!) BMW X6 in the little “胡同” (alleys) in Beijing, a $150,000 car where it can barely squeeze through, then hear the driver coming down to argue, bargain, curse for more than 30’ with the parking assistant in the street, about whether or not he should pay the 10 or 15 RMB ($1-$2) parking fee. Of course, these are not just Chinese phenomena, pretty much every country in the world has gone through its “nouveau riche” phase at times of rapid economic growth, it’s just that in China everything happens at a China scale and at a China pace.
And all this in a fiercely competitive environment, with laws that exist but that are selectively enforced on numerous occasions.
The urban 90后 generation is an entirely different “animal”. They have never felt deprivation the way their parents have or scarcity the way their immediately previous generation (the “80后”) has. They were born in a China of relative abundance, a more open China, a China already connected to the world, a China online, where any NBA or Hollywood star is as approachable to a Chinese kid as it is to one from e.g. South Dakota. In fact, there are certainly a lot more NBA and Hollywood stars visiting Beijing and Shanghai than e.g. South Dakota. The degree to which this young generation of Chinese is “hungry” for foreign content, like for instance the American TV series, has the Chinese government so concerned that it recently had to put restrictions to several online video sites, on one hand because of the rampant piracy and the need to comply with WTO regulations but on the other, because of the fear of the degree of cultural influence this imported content has on the young generation. The 90后 will be the first generation that will have credit cards, that will overspend and that will have an insatiable appetite for goods and content consumption. Besides increasing affluence, a lot of these phenomena are also the direct result of the pampering that takes place in the average “one child” Chinese family. Fun times ahead.
Understanding the Chinese Internet
The Chinese internet is enormous. Close to 700M users, more than 500M on mobile internet and growing. But it is different in terms of demographics and usage patterns from the U.S. or the average Western country, as much as it is similar to other developing countries like e.g. Indonesia or Brazil, a fact that has not gone unnoticed by the very clever, larger Chinese tech companies.
The average age of the Chinese user is at least 15 years younger than that of the U.S. user. Entire generations have probably missed the technology boat in China. The internet is instead a youth phenomenon. For a very large part of the Chinese youth, it is still the only affordable source of entertainment. The average Chinese user is more curious to discover and spends more time on the internet than his Western counterpart. For the younger generation, in a society where older people are still tight in expressing their emotions and their feelings openly, the internet is the only available platform for self-expression and for communication with one’s peers. It is also a platform where even the one billionth Chinese can at some point achieve fame and pride through a virtual identity, something that Chinese game developers have manipulated, turned it into a science and taken it to an entirely new level. Overall, the Chinese internet is a lot more about entertainment than it is about productivity. Email is dead in China. People talk to each other on WeChat, on their smartphone device.
The Chinese internet is the most mobile of them all. The notion of “mobile first” has come out of China. While the majority of young people are fairly savvy PC users thanks to the neighborhood internet café, or their time at university, or the computer provided at work, relatively few of them actually own a PC at home. But pretty soon everyone in China below 50 will own a smartphone device. And in smartphone devices in China, Android rules. We have gone from a negligible amount of Android devices in early 2009, to more than 400M today. Food for thought for our Amphitheatre Parkway neighbors who decided to withdraw from the Chinese market. Chinese OEMs are building the widest range of low cost Android devices imaginable. Prices have gone down to 1,000 RMB (around $150) for a more than decent Android device, making it possible for the majority of Chinese to finally own their first smartphone. Xiaomi has gone from 0 to a $10B valuation in 3 years, for being one of the first Chinese companies that is building affordable Android devices, designed by Chinese, for Chinese. This is a company that very few people still know of today in Silicon Valley, and it would have been even fewer if it wasn’t for (a) Xiaomi’s recent poaching of Hugo Barra, a senior executive, directly from Google’s Android team, and (b) the fixation of its founder and notorious Chinese super-angel, Lei Jun, with dressing and behaving on stage like the late Steve Jobs.
The Chinese Android ecosystem, in general, is quite amazing. Our own portfolio company, Wandoujia, is the one-stop-shop content (apps, videos, music, ebooks, etc.) discovery platform for Android in China. It was founded in early 2010 and has more than 300M registered users today. But more importantly, with all the bias that I have as an investor and a friend of the founders, it has a truly innovative, local Chinese product. I would encourage any user outside of China to objectively compare the versatility, the completeness, and the overall user experience in Wandoujia’s Android products with that of e.g. Google Play.
Apple, for which the China market is extremely important, will need to re-think its strategy if it doesn’t want to be marginalized in the minority segment of the Chinese population which can afford its products. While the Apple products remain today objects of desire and status symbols for a large proportion of the white collar population, the brand value is slowly but steadily eroding in the face of increasing competition by fearless domestic players, such as Xiaomi, as well as the high-end Android devices offered by e.g. Samsung, which has done a solid marketing job in China in the past few years.
And then there is online shopping. In 2012, the total sales volume of Black Friday and Cyber Monday just about equaled the — then newly established — Chinese “Singles Day” on November 11 (11/11, got it?). It was also the first time that I know in Chinese history, when a lobby of e-commerce companies, led by Alibaba, essentially instituted a new “shopping holiday” in the lives of Chinese citizens. Just because they wanted, and they could. Last year, the Singles Day volume was four times (!) that of Black Friday and Cyber Monday together, Alibaba’s Taobao (C2C) and Tmall (B2B2C) accounting for more than half of that. No wonder Alibaba is going to be one of the largest tech IPOs ever in the coming days. Let’s see what this year’s festive season will bring.
All this in a country where logistics’ infrastructure is improving by the day, where free (!) same day delivery in first and second-tier cities is the norm, where you can track your shipment’s itinerary “live” on your smartphone (like you do with your e.g. Uber ride), where more than half of the transactions are still cash-on-delivery and where, if you are not happy with the product that you ordered and has just arrived at your doorstep, you can just send it back with the same guy that brought it to you. Welcome to Chinese e-commerce! Did you say “Amazon Prime”?
The Chinese internet is also teaching the world what real freemium means. For many years, in the American user’s dictionary freemium meant e.g. the Angry Birds few-levels free teaser app, as a prelude to the paid version. Chinese users’ aversion to paying upfront for any internet product has forced Chinese developers to come up with freemium models with the most sophisticated monetization techniques, using in-app purchasing, before anyone else did in the world. Game developers in China have a deep understanding of human psychology, the user’s desires and weaknesses. As a rule of thumb, Chinese games’ ARPPU is on average much higher than their counterparts’ abroad, while the Chinese GDP per capita is still only a fraction of most other countries.
The market is still largely dominated by the “BAT” (Baidu, Alibaba, and Tencent), 3 companies that are worth collectively more than $400B in capitalization and that by now deserve to be included in the global tech elite. It is worth every Silicon Valley tech professional’s time to carefully study these 3 companies, their history, their products, and the breakdown of their revenue streams. If you have to pick only one, that would be Tencent, a formidable company. But the overall landscape of the Chinese internet is changing every month, with new companies and products entering the fight. China is the most fiercely competed internet market in the world. Equity research analysts are having nightmares covering this sector.
There are several other Chinese tech companies that cannot be overlooked by anyone in the world anymore, beyond the 3 giants and the earlier generation incumbents, like Sina, Sohu and Netease. Most of them are also publicly listed in the U.S. or in Hong Kong. Such companies include category leaders like Qihoo, Youku, Jingdong, YY, Xiaomi, UCWeb, and the list goes on. They are all starting by building their own strongholds, often with practices that in the U.S. would have quickly triggered regulatory intervention, and then move on to competing across each other’s territories. It is a monumental battle to the death.
Most of these companies are usually led by a strong, single founder and his senior management entourage, the king and his court. The majority of these founders are still at most in their mid-40s, very much at the helm of their companies and deeply engaged. There are quite a few — undoubtedly — charismatic leaders in that generation of Chinese entrepreneurs.
[End of Part 1]