China Market Entry Considerations For Foreign Tech Startups (Part I)
In a series of posts, we’ll examine the Chinese consumer tech market and determine a thoughtful framework by which to assess market entry
China at an Inflection Point
Made in China, the Great Wall, Bruce Lee… China, a global leader in technological innovation? China is back on the radar, but not for the reasons you might expect. After decades of experiencing double digit economic growth on the back of manufacturing and industrial development, there has been a successful rebalancing over to consumption and services, which is greatly facilitated by consumer technology, and increasingly by domestic innovation.
Without a doubt, over the years China has benefitted from leveraging core technologies developed overseas, rightfully winning its reputation as a fast follower, if not an outright copy-cat. Yet I argue this is not due to an inherent lack of creativity by the Chinese people. Any person (or in this case country) incentivized to maximize growth should begin by learning from others. After all, what is originality other than building on the back of giants and reshaping those foundational pieces into your own creations.
Believe it or not, innovation in China is very real, much of it driven by unique market conditions, genuine consumer needs, and some of the fiercest competition in the world. In a consumer tech obsessed world, China is taking it to Silicon Valley, with companies such as Alibaba, Xiaomi, Tencent (Wechat) already world beaters and increasingly serving as inspiration for their Western counterparts. Beijing is not the next Silicon Valley; it is already there.
Market Observations
To better understand the context in which tech development is happening in China, let’s first take a step back and examine underlying fundamentals. The sheer size of the market immediately stands out. With 1.5 billion people and 700 million activated smartphones, China already has the largest base of mobile internet users in the world. With significant government support, network infrastructure is being rapidly developed, and 4G networks are expected to cover over 500 million users by the end of 2016. In conjunction, smartphone and data package costs have seen sharp decline over the past few years (driven by Xiaomi and co), encouraging more users to go online and stay online for longer. These mobile native consumers are used to a bevy of apps designed to maximize entertainment and facilitate consumption, and they are clamoring for more.
Given a receptive consumer base that expects rapid and constant innovation, this makes China not only the largest internet market in the world, but also the biggest lab opportunity by which to experiment with new features and applications at scale. Against this backdrop, it becomes clear that for Chinese tech companies, innovation and R&D are no longer cost centers, but rather have become a fundamental part of growth strategy, and at its extreme a matter of survival.
Big Bad Wechat
Let’s examine Wechat as an example. In its simplest form, Wechat is a messaging app comparable to Whatsapp or FB messenger, but that has become something much much more. When I first tried Wechat in 2012, I was instantly hooked by its ‘voice text’ feature, which allows users to leave a short voice message and text it to others. Simple but useful, voice texts enable a user to express his/her thoughts in a manner more intimate than the traditional text message, but avoiding the hassle of calling someone or leaving a long voice mail on a trite topic. That is the first instance of Chinese mobile innovation that I can recall, and boy has Wechat (and China) come a long way.
Today, Wechat is used by over 700 million active users, and offers a wide array of services that include messaging, payments, food delivery, taxi hailing, social media, AI personal assistant, and more, all rolled into one super app. Given its popularity, Wechat has effectively created its own ecosystem and pioneered an emerging model of messaging as a platform. Connie Chan from a16z is one of my favorite experts on all things China and tech, and she has written extensively on this topic here. As she describes, these developments are not only impressive, but it’s even more astounding that Chinese consumers have been able to enjoy these services for years, whereas in the US only now are we starting to catch up (i.e. notice FB messenger rolling out taxi hailing, bots, and a host of other services within its messaging platform). In fact, take a closer look at Facebook’s product roadmap and it’ll start looking unabashedly like Wechat (but the Wechat of a few years ago). We can explore other examples of Chinese innovation in upcoming posts, but for now it should at least be clear that Chinese innovation is very real, and it is only going to accelerate.
Market Entry Considerations
So what does that mean for US companies? Well baseline strategy involves turning a dedicated eye towards China to learn from its unique set of innovations. A more committed approach requires direct investment and potentially market entry, which we’ll examine in more detail in this post. As a caveat, I write from a growth stage tech company’s viewpoint, given my direct work experience. It’s also worth mentioning that most tech start-ups should not even consider China entry in the early days, as building up tech and achieving a focused product-market fit should be the only priority, and a premature obsession over China could very well be a huge distraction. But for companies that are post Series B or C fundraise, or that have built up a relatively sustainable business and are looking to scale, a thoughtful, well executed China strategy could create significant value.
I’ll begin by reiterating just how difficult it is to crack the China market. Yes, 700 million active internet users constitute an enormous market opportunity and could very well boost company fundamentals, but there is no free lunch. There are immediate barriers to entry — China deploys a firewall that either fully blocks certain sites (i.e. FB, Google, etc.) or at least impairs the app experience of companies that have not set up domestic servers or been fully vetted by local regulators. Furthermore, unlike the Apple/Google app store duopoly in the US, China supports 200+ app stores each with its own set of rules, which puts far greater strain on dev, QA, and commercial resources required to support.
And on top of that, China has arguably the most competitive market in the world, with 5m new graduates per year and many of these being funneled into tech roles. This movement has only accelerated since China rolled out its ‘Internet+ Initiative’, which includes $338 billion in government backed VC funding, with a tacit obligation to support local businesses. No longer the ‘sick man of Asia’, a nation historically and categorically taken advantage of by foreign powers, China has become a major power in its own right, and is increasingly inclined to do thing on its own terms.
Case Studies
Unsurprisingly, there are few examples of foreign tech companies successfully entering, creating a new market, and dominating. Instead the battleground is littered with examples of failure, from Google and Facebook that were outright blocked, to eBay and Groupon, companies that experienced significant growth in other markets but ultimately could not match the speed and ingenuity of domestic counterparts. For example, eBay raised a $100 million war chest dedicated to winning China in the early 2000s, only to meet spectacular defeat at the hands of newcomer Alibaba. While it could not initially match eBay’s funding or scale, Alibaba understood the local market well, that deal making in China requires excessive negotiation, and so it smartly introduced an instant message service that allowed buyers and sellers to haggle over deals and get comfortable with each other first before transacting. Alibaba is now worth $250 billion, with the largest IPO in history at $25 billon, and by some measures bigger than Amazon and eBay combined
As another, more recent example, Uber entered China aggressively in 2013, raising over $2 billion to support CEO Travis Kalanick’s personal mandate of conquering the China market at all costs. 3 years in, after having spent $ billions on unsustainable subsidies designed to gain market share, Uber was still unable to thwart local competition — embarking on a race to the bottom against Didi, and even finding itself blocked on WeChat, one of the most important avenues for customers to book an Uber car in China. Uber’s eventual capitulation to domestic competitor Didi, which acquired Uber China for a 20% stake in Didi worth $7 billion, is in many ways a great outcome. Bruised egos aside, $7 billion of value creation and exposure to a market that could never have been theirs is nothing to be ashamed of, and in fact is far superior to other deals brokered in China.
Conclusion
Despite attractive market fundamentals, there are serious barriers to entry — without setting realistic expectations and being smart about entry approach, most early stage tech companies would find the China strategy a huge distraction. That being said, as evidenced by Uber, Apple, and a handful of others, carefully designed, controlled exposure to China can create tremendous value. In my next post, I’ll offer a few more case studies on successes and failures, while also providing a more practical framework by which to think through market entry before committing serious resources towards what could be a Quixotic quest.
