A Novice’s View of China’s Innovation Economy
I have just returned from a week in China I will never forget. My last China trip was a family tour seven years ago. But, this time my primary goal was to learn about technology-driven innovation. I wanted to see this ecosystem from a variety of perspectives, including the customer, the start-up, the investor, the advisor and the platform companies (Alibaba, Tencent, Huawei). Friends from different backgrounds graciously assisted on my journey. I was promised that China, both as a country and as an innovation economy, could take a lifetime to understand. So, these observations from a one-week visit are admittedly a novice’s view based on limited experiences. However, my hope is they provide some insights to others and spark important conversations in the United States and abroad.
My trip began in Shenzhen — a city that didn’t really exist forty years ago. Today, it boasts over 12 million residents and is considered a Tier 1 city in China. Hangzhou was next — primarily to spend time with Alibaba learning about their work in applied ML/AI and visiting my first Hema store.
Next up was the “always on” city of Shanghai with its amazing mix of history, culture and innovation. There I experienced the depth and strength of the Microsoft diaspora in China. I also met a mix of start-ups, larger company executives and commentators on China. Both evenings concluded with a drink at a rooftop bar on the Bund overlooking the spectacular buildings and lights of Pudong.
Finally, I arrived in the nation’s capital, Beijing. There my visits focused more on rapidly growing start-ups, investors of many types and an especially high impact day at GGV’s Evolving 2018 Conference.
My experiences were mind blowing on many levels. There are so many positives in the vibrant Chinese economy and some very notable differences around personal freedoms, economic disparity and state control. My higher-level observations, primarily focused on innovation, are:
1. China is becoming a “total mobile” society where the smartphone is truly the remote control of your life. Mobile communication, discovery, ordering, payment (for everything), delivery, transportation and tracking are ever present. The dominant enabling app for total mobile is WeChat (owned by Tencent). WeChat has over 1 billion users, which is greater than the 800 million smartphones in China and approaching one-third of the 3.5 billion smartphone users in the world. WeChat is used for chat, voice/video communication, social media, payments, mini-apps, ride/bike hailing and much more. Early in my trip, I couldn’t even buy a Big Mac at a McDonalds because I didn’t have money in my WePay account and they didn’t accept US credit cards!
2. Tier 1 Chinese cities like the ones I visited are “always on”. Whether arriving at an airport at 1:30am, meeting with a start-up any time on the weekend or watching shopping mall patrons always using their smartphones, people are busy, connected and engaged. There appears to be a relentless pursuit of “more” in China. This hunger for personal and economic success and a willingness to sacrifice to achieve it is greater than any other place I have seen in the world with the possible exception of the United States.
3. Many aspects of life in China are being reinvented by combining digital and physical world innovations. We call this global trend Di-Phy at Madrona, but the pace and scope of innovation in China is unparalleled in the world. At the GGV conference, Alibaba founder Joe Tsai described it as “the physical and digital environments interacting with each other to serve customers better.” My favorite example is the Hema stores launched by Alibaba a few years ago that have completely reimagined the grocery store inside and out (see below). And, with both Alibaba’s AliCloud and Huawei’s efforts to move in to cloud computing, the digital capabilities of Chinese companies are becoming increasingly global. To the extent Chinese companies can adapt their solutions to other contexts and cultures, they could emerge as global leaders in Di-Phy innovation over the next decade.
4. The size, scope, speed and scale of new companies in China is awe-inspiring and outpacing the United States on many fronts. Companies like Luckin Coffee, BingoBox, LAIX, Keep, SenseTime, and many more are scaling to become market leaders in months versus years. And, Chinese consumers appear willing and ready to try new technologies and solutions — which is often referred to as “China speed”. Sometimes these companies try to do too many things at once potentially defocusing them. But, with China’s many concentrated urban population centers, comparatively low-cost labor, reach to 1.4 billion citizens and increasingly global aspirations, rapid scale and diversification may be a winning strategy for start-ups.
5. AI is ascending and abundant. AI research and applications are a core focus of the government, established companies, university researchers and of course start-ups. China’s advantages here are in generating more data, increasing digitization of data and having more flexibility (including less privacy protection) than other countries in how data is used to train models and build intelligent applications. In health care specifically, I met with the very impressive BGI genomics research team and also AI teams focused on health care at TenCent and Alibaba. They are applying AI/ML technologies to health data to find solutions and cures at the intersections of innovation in computer/data sciences and bio/chemical sciences. While data privacy and central control are valid concerns around data use in China, there are many examples of data model building for good or at least for a fair “value trade”.
6. Finally, as a friend predicted before I went, China is truly a place where you must be comfortable with ambiguity relative to America where personal freedoms, democratic elections and rule of law broadly apply. The Chinese system appears by many measures to be working well. But, just like any country, they have their economic (deleveraging, trade wars), demographic and political challenges to face in the future.
To illustrate my observations, here are four company vignettes:
Hema: I will describe Hema in more detail in a future post, but in short it is a reimagined grocery store that is a coherent blend of Whole Foods, Uber Eats, and Amazon Go. Launched by Alibaba in 2016, Hema is already approaching 90 opened stores in Tier 1 and Tier 2 Chinese cities. They offer a compelling combination of fresh, quality food, mobile-dominated interaction, 30-minute or less delivery and real-time food preparation and dining. Here is an already dated Alibaba video highlighting these stores (https://bit.ly/2P8Caku). More than 50% of all purchases are via mobile orders which are picked and delivered by technology-enabled workers creating a seamless customer experience. From what I was told, Hema stores have significantly higher sales per square meter than the typical grocery store and manage approximately 8,000 SKU’s customized for the local market.
Luckin: Luckin Coffee is a mobile-only coffee shop attempting to compete with Starbucks in China. Launched a year ago in October 2017, today there are over 800 stores in operation (some are fulfillment only) and a recent Quartz story (https://bit.ly/2L2VtNO) describes the company this way: “First, Luckin Coffee revolves around the smartphone. When customers walk into one of its blue-and-white shops, they’re immediately asked to download the Luckin app to order coffee (assuming they haven’t done so already). They can pay using WeChat payments or Luckin’s own “coffee wallet” — but not cash. This fits into China’s so-called “new retail” trend, in which tech giants like Alibaba and Tencent partner with supermarkets and convenience stores on mobile payments, analytics, and inventory management.”
Mobile only means the consumer uses the Luckin app to search, order, pay and then pick up/receive their coffee and food. The consumer experience is compelling and efficient, and the price point is modestly less expensive than Starbucks which is viewed as the premium coffee store brand in China. In fact, Starbucks has recently launched delivery services and unveiled a delivery partnership with Alibaba/Hema. The Chinese refer to physical markets digital retail concepts like Hema, Luckin and Bingo Box as “new retail”. And, these core concepts are expanding to health, fitness, apparel, transportation and more.
SenseTime: Vision is rapidly following voice as another human sense that is transforming the way machines and mankind are interacting with content and services. SenseTime focuses on leveraging photographic and video camera “vision” data to transform consumer experiences and government oversight. They are also innovating on an AI platform for facial recognition powered by 170 PhD’s mostly trained in artificial intelligence. SenseTime works with large handset manufacturers to deploy deep learning models designed to improve picture taking and augmented reality (think Snapchat). They also work with different government entities to manage traffic flows in “smart cities”, identify and track people and objects (cars, scooters) who may have violated the law, and address other congestion issues in major urban areas. SenseTime’s technology is focused more on applied deep learning and they partner with hardware companies like Nvidia and Huawei for infrastructure. They are also expanding into other vision areas like autonomous vehicles (notably a very large contract with Honda). And, their founder, an MIT graduate with strong ties to Tsinghua University, published an AI text book to train the next generation of data scientists in China and beyond. SenseTime has raised over $1 billion from a marquee group of investors including Silverlake, Tiger Global and Softbank. Their latest valuation topped $6 billion.
Keep: Keep is a “Di-Phy” health and fitness brand. Keep highlights how rapid traction in one core area often expands into adjacent areas in China. They started in 2015 with a social media and fitness tracking app that encouraged individuals to “Keep” achieving their fitness commitments and goals. Today Keep has over 160 million registered users with over 20% (35 million) monthly active users. Their latest “Keep 3.0” platform is now available in 17 languages and also has over 10 million registered users outside China in less than 1 year. Keep has expanded into physical workout facilities (watch out Soul Cycle), a line of millennial-targeted athletic ware (think Lululemon) and even a low-cost, smart treadmill (Peloton-light). Their advertisements are aspirational (https://bit.ly/2RsjEUH) and their community of active, young members are exactly the demographic that most brands aspire to reach.
IMPLICATIONS FOR GLOBAL INNOVATION ECONOMY
There are so many more examples and stories to share from just one week in China. But, I came away asking what the implications are for technology-driven innovators and venture-backed companies around the world and especially in the United States:
· Opportunities are expanding for “total mobile” business models that combine digital and physical world experiences to make customers lives better. Other markets have different limitations (notably payment friction, higher labor cost and lower density), but the opportunities to reimagine abound. How can travel (consumer and business) be reimagined? Would a concept like Luckin Coffee work in the USA? Is it time for cross-platform transportation meta-search in America (see AMap from Alibaba)? In America, the biggest obstacles to embracing these opportunities appear to be regulatory constraints, reducing the cost and friction to adopting mobile payments and getting the mix right between higher cost labor and increasingly intelligent automation that can most effectively deliver a better service to customers.
· The global competition is on for AI-driven intelligent applications and US-based companies need to move even faster to access data, establish data consortiums and build/apply trained data models to real world problems. Younger Chinese companies like SenseTime, LAIX, Momenta are building AI/ML powered solutions for specific commercial markets. And, the Chinese government has made success in AI/ML a top priority. There is a virtuous cycle in machine/deep learning where those who access large amounts of data early, build relevant models and deploy them at scale can continuously learn and improve. Our expectation is that early leaders will have a significant competitive advantage in applied AL/ML. So, companies building these intelligent applications should pursue strategies to maximize data access and rapidly bring products to market.
· In many respects, US venture-backed companies are operating too conservatively relative to Chinese start-ups. They should expand to have a more international, fast-paced and hungry approach to competing and winning on a global stage. I remain a big believer in finding and operating businesses with positive unit economics. But, the opportunity to deploy large scale, cost effective solutions that leverage modern cloud, mobile and ML/AI technologies is allowing Chinese companies to grow rapidly. A related point here is the urgent need for US immigration reform that would attract and retain the most talented and motivated people from around the world to live in America and increase the likelihood that great businesses and job opportunities will be based here!
· Having exhorted American companies to think bigger and to move faster, that imperative must be balanced with the temptation to spend capital rapidly without a business model. There were examples like the electric bike and scooter industry in China that appeared to have capital inefficient and “race to the bottom” competitive dynamics. And, other companies with initial product-market fit seemed to try to many things at once to leverage their initial advantage. Our enduring belief that every invested dollar (or Yuan) demands a return applies globally. And, both a coherent strategy and capital efficient execution will continue to matter even in rapid growth environments.
· Finally, it is challenging for non-Chinese companies, especially in technology, to be successful expanding in to China. Success may require a different mindset and often an “outbound strategy” is optimal for a successful start in China. Airbnb waited to enter China until they had success in other geographic markets. And, they entered by helping Chinese traveling abroad to use Airbnb to book places overseas. They needed to make “localization” investments in language, payments and mobile formats to adapt their app to the Chinese market. But, their outbound-first strategy succeeded and now they lead the domestic Chinese market for house sharing. Similarly, Amazon has had substantial success working with Chinese manufacturers to onboard and successfully sell in the Amazon marketplace worldwide.
CONCLUDING THOUGHTS AND QUESTIONS
The Chinese innovation economy is vibrant as the Alibaba slogan below highlights. And, despite the current challenges in the China capital markets and US-China trade uncertainties, the total amount of venture capital invested in China this year will exceed $100 billion and be greater than American venture capital. The combination of mobile-only lifestyles, AI abundance and an always-on culture powered by talented and hungry entrepreneurs cannot be underestimated.
I was also heartened in China by strong gender diversity in the researchers, entrepreneurs and investors I met with. While there are plenty of reasons to have concerns about the Chinese system and relative lack of freedoms for individuals, the rest of the world and US companies in particular, should consider a mindset change. That is especially true in Seattle which is the major US city geographically closest to Beijing and home to research and development centers for every major Chinese technology company (with many ties to Microsoft alumni on both sides of the Pacific). Here are three questions that every US start-up should think through:
1. What companies and market segments are experiencing rapid success in China and how are those markets, contexts and customer types different in America? What can our company learn from successful models in China?
2. How would I think about entering the Chinese market (2nd largest economy in the world) with my business and how should I prioritize that opportunity relative to other corporate priorities?
3. How can US-based companies grow at the pace and scale that Chinese-based ones are growing? What is limiting our company from expanding faster in our existing priority markets?
As I mentioned at the outset, my views are primarily informed from a whirlwind week in China. There is still so much to learn and to discuss. My hope is to engage with many others on the implications of the Chinese innovation economy for newer and older companies in the US and the world.
