The Missing Element in China’s Start-up Scene

Welcome to the new age of start-ups in China.

Ever since December in 2016 when Chinese government released its National Strategic Emerging Industry Plan as a part of its “13th Five-Year-Plan”, billions of dollars have funded hundreds of start-ups and projects alike. China Construction Bank, a top bank in China, has already set up $47bn to back up this plan. China Daily reports that the strategic emerging industry will account for 15% of China’s GDP by 2020.

Now, just exactly what are these Strategic Emerging Industries?

Pretty much all the buzzwords you now hear in tech everyday, such as Blockchain, New Energy, Electric Vehicles, Artificial Intelligence, Internet of Things, etc.

As a result, we see hundreds of tech start-ups emerging in the past few years . The start-up scene has also drawn some serious international attention. Zhonguancun, a start-up hub in Beijing, and Shenzhen, a populous city in Guangzhou Province, have both earned the moniker as the “Silicon Valley of China”. Among the cluster of start-ups headquartered in Zhongguancun, Xiaomi now has a market cap around $70bn. The company has experienced tremendous growth since its birth not too long ago in 2010. Zhonguancun also has Baidu, a search engine that has dominated mainland China. In Shenzhen, we see tech giants like Huawei and Tencent, each now with remarkable sales and reach that would dwarf many of their western counter parts. And thanks to Alibaba, Hangzhou now starts to bud as another start-up hub. Meanwhile, Shanghai is also trying to catch up. Given its financial strength and unique culture, many life-style technology companies have succeeded in the city of Shanghai.

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YC makes its launch in China

In some sense, China now resembles post WWII America. When the country is on its rise, many people made a lot of money. Now they might want to diversify their investments, or perhaps they just like the idea of getting richer faster. But there simply aren’t enough projects around for them to invest in. Given this scarcity, entrepreneurs can now easily get funded for any ideas as long as they can make pitch decks and sell.

It is crazy how years after ofo and mobike dominated Chinese bike-sharing market, you can still find new bike sharing companies with the same business model entering the space. This means people are still walking to investors, pointing out the window at ofo bikes and saying, “I want to build something just like that.” Then they find themselves walking out the room with some seed money.

How is this possible?

‘Cuz diversification, or shall we say, spray and pray.

Here is where the problem comes in behind all this frenzy. Capital, resources, media attention, government support… The Chinese start-ups seem to have them all. But there is one key element missing in the market.

Patience.

In The Great Gatsby, two cities are divided by the Valley of Ashes, East Egg and West Egg. Residents from both cities are wealthy but their wealths have different make-ups. East Egg is what we now know as the old money while West Egg is the new money up and coming. For a while and even till today, Silicon Valley techies have been considered as the “new money” compared to East Coast bankers. Now, as Silicon Valley grows a little bit older, the Chinese are the “newer money”.

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While entrepreneurs can be the brave and bold who want to build unicorns and change the world, Chinese investors typically are not. Most investors that start-ups meet in their seed round have the money but not on a scale that is accumulated over generations. When it comes to investing their hard-earned money, their valuation model is very simple: ROI. So, the very first question investors usually ask is,

When are we gonna start make a profit?

Given that Twitter only made a profit in Q4 2017 for the first time since its IPO, the reality is many great ideas take a long time to grow and mature. Yet, this is so unintuitive to most wealthy Chinese who made their fortune in manufacturing or real estate.

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Of course, experienced VCs and institutional investors understand the process from a seed to a unicorn. They know exactly what the books should look like at each stage. However, the hastiness is more of an attitude across the board. The success stories reported in China are rarely the kind about a start-up survives a decade of winters and finally harvests. Instead, it is more likely to hear about people who cashed out $1 million in a month through an ICO, or someone who quickly became famous on a streaming platform, built a media company, and then sold it for millions.

Overnight successes have hijacked the narrative of start-up grinds.

There are two other reasons behind this rush.

First, the same cause of half China’s problems is its population. In this case, China has a lot of people which makes up a huge market. When the market is THAT big, most start-ups’ priority shifts from the quality of a product to the speed of its shipping. Lower costs and bigger scales become the solution to everything. You don’t have to develop an edge over your competitors, you just have to get more customers faster than your competitors. While this approach exists in every market, it is especially prevalent in China.

Second, major start-up hubs now share the same problem as Silicon Valley. The steep housing price simply jacks up the opportunity costs for start-ups. It hurts both start-ups’ growth and recruiting. As an entrepreneur, you have to make money fast, or else you can’t afford the rent. You have to pay your employees fast, or else they can’t afford the rent. As a matter of fact, this problem is more severe in China than the US. For example, Shanghai’s average apartment price per square feet is actually higher than San Francisco, but people in Shanghai only possess about half the purchasing power on average than those in San Francisco.

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City Apartments in Shanghai

Seems like everybody in tech is in a hurry. Under this culture, the Chinese start-up environment has created a lot of economic growth, but it hasn’t nurtured much innovation. The lack of patience reflects how the environment cares more about profits than ideas. Unfortunately, great ideas usually take a longer journey before they are profitable.

A culture fix, not just more government spending, is the ingredient that Chinese Start-ups need.

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/ˈlimənl/ relating to a transitional or initial stage of a process.

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