Where are the Most Promising VC Investment Opportunities in China?

Rapid-fire Q&A with Tina He and Adam Bao. Covers China VC trends and opportunities across consumer internet, education, enterprise, AI, China <> US, and more. Tina is a senior at Cornell University and member of The Harbinger China. Adam is the founder of The Harbinger China.

TL; DR 👇🏻

• Wechat’s ecosystem offers a new playground where customer acquisition cost is extremely low, so there’s a lot of new opportunities here to leverage this distribution channel.
• Ed tech in China is booming with people’s eagerness to learn as well as the companies’ capability to monetize through paid content. Accessibility of knowledge and information becomes huge because more and more people feel anxious that they’d be left behind.
• Mobile first payment has made transactions within products extremely seamless and easy.
• Enterprise software is still in its early stage because companies are unwilling to pay, but tons of opportunities in the future as small companies are undergoing rapid growth.
• Competition is super fierce in China with major big players (counterparts of FANG in the US)… incumbents have a lot of power! There are so many peeps in China that a specific TAM (total addressable market) can be a lot larger than people expect — serving a targeted niche market or coming up with a creative business model are great ways to stand out.
• The startup ecosystem is truly becoming global — more VCs are coming to China and Chinese VCs are also encouraging talents in the US to found companies in China.

Edited by Tina He, Juzhi Zheng

[Editor’s note: this interview has been edited and condensed for clarity. The opinions expressed in this article are Adam’s own and do not reflect the views of any of the companies that he is advising]

Chinese Consumer Internet

Tina: So let’s start with the sexy industry first, consumer Internet. When people in the U.S. talk about Chinese tech, the first thing that comes up is always Wechat. They’ve heard stories about how you can do everything with it from paying to your parking to looking for a gym class. So it basically breeds an entire ecosystem, a lot bigger than the chat app that it first started off with. Can you tell us a bit more about Wechat and what’s new?

Adam: Sure. Well Wechat reflects a lot of what’s happening in China’s consumer Internet. Some of the major developments have happened in mobile. Six to seven years ago, were are a lot of new applications that came out, messaging being one of the biggest ones. Social media, payments, these are all things that Wechat provides. And at least from an investor’s perspective these days, a lot of the low-hanging fruit in consumer Internet have been taken. For example, for short videos and live video you have Kuaishou, Yizhibo, some of these companies; social media again, that’s mostly QQ, WeChat. For messaging obviously Wechat takes the cake there. When it comes to e-commerce, think Taobao, JD, and increasingly Pinduoduo. So a lot of these big opportunities have been taken. When you look into the future of consumer Internet, a lot of investors are scrambling for start-ups that can acquire large traffic, or “流量”.

Wechat plays a critical role here. Wechat has been investing in a new initiative called 小程序, which in English is “mini-programs.” For those who don’t know what a mini-program is, think about it as any app which is built within the WeChat ecosystem. So instead of needing to go to an app store, using a separate operating system to access an app on your phone, people can literally build apps within Wechat, such that it’s platform-agnostic. And if I open up Wechat in an Android phone versus Apple, versus Xiaomi variants, it’s all going to be the same app within it.

These are typically simple, light applications, but getting more sophisticated. So, as an example, mini-programs include JD’s shopping app or Ctrip, which I use often to book plane or high speed rail tickets. There are also other apps that integrate well with Wechat mini-programs. For example, Pinduoduo… obviously a lot of people have heard about this company, which is like a turbo-charged Groupon, and it heavily leverages WeChat traffic, not just through mini-programs but also via the concept of group-chat and sharing. Everything is so easy when you have hundreds or thousands of friends using Wechat and you can share potential deals within your social network. This is part of the reason why Pinduoduo grew so quickly and hit 20 billion GMV within three years’ time (valuation in the tens of billions USD).

In one and a half years’ time, there have been 580,000 mini-programs developed, with about half of Wechat’s MAUs on it. So basically if you are a new startup trying to building something and you want to find ways to access traffic, then why not look to Wechat mini-programs. This traffic is also very cheap, because at least currently Wechat doesn’t charge for the traffic. For example, as an app developer you may need to cough up 20–30% via the various smartphone app stores. But for mini-programs, currently it’s free. This may not always be the case, and Wechat/Tencent could possibly hike rates. There are also other risks, including the fact that mini-programs are built on Wechat, which is a Tencent platform. In the meantime, founders and investors alike are looking at Wechat mini-programs and future opportunities that could be built on top of this high quality traffic.

Tina: You mentioned that the current customer acquisition cost for these mini-programs within the ecosystem is extremely low. Do you think Wechat will eventually monetize by charging for the traffic?

Adam: That’s a possibility, but in general I’d imagine Tencent cares more about building up the Tencent platform to maximize traffic. Tencent is a very good example of the classic consumer Internet in China. Its business spreads out across a lot of different areas: gaming, social media, messaging, etc. All they really care about is traffic, either by building or investments. So I think their key intention is really to get as many people to use Wechat and use many mini-programs as possible. Given their positioning, I don’t think they are worried about monetizing any time soon on that.

Tina: Yeah that’s really cool, because looking at the trajectory of social media in the U.S. like Facebook right now, they are primarily ads-based business models, I’m just curious about how Chinese counterparts are strategizing in the future.

Adam: In China, it’s not just Wechat and Tencent. The major difference is that consumer Internet companies don’t need to monetize purely via advertisements. Actually it seems like a relatively inefficient model when you think about it… let’s say you have an app and you want users to use it, and then by getting traffic you get eyeballs. So one way to monetize that is via advertisement. But what are ads used for? The value of an advertisement is to lead viewers down the purchase funnel, to encourage transactions. So in China where a lot of people have mobile payment built directly into the phone, you can bypass certain steps in that funnel. Instead, draw in users in to look at the products, reviews, and user-generated content, and then just buy a product directly. There is a pretty interesting model that is built out of that.

A lot of folks have talked about this in the past so I won’t get into too much detail. Look at live video: Yizhibo, Inke, etc. Those companies basically involve a live-streaming app with a set of broadcasters singing, dancing, and doing whatever they do. And then all the viewers, they love this content. It’s extremely entertaining for them. Not only do they watch it, but they also purchase virtual currency which they send as gifts to the broadcasters (e.g. encourage the broadcaster to give them a shout-out). So this is a pretty innovative and interesting model in China you don’t really see in the U.S. as much, in certain cases.

China’s Massive Opportunity in Education

Tina: Yes, it’s super interesting. Speaking of consumer Internet, another sector that has been really popular in China these days is actually education. Having grew up in China, I know that education is really an integral part of basically every household. After the one-child policy was abolished two years ago, really there is the new baby-boom with this new population of young children. How has this impacted the education sector in China and what are the opportunities and challenges?

Adam: Education is definitely a really big sector in China, and it is a large opportunity from the VC perspective as well. Because of the one-child policy, a lot of the folks growing up over the past decades essentially have three sets of parents — your parents, both your mom’s side and dad’s side of your grandparents. Everyone is catering around the one child, so a lot of money is spent in this sector in general. These days, because of the digitization of education, essentially you have people not just from first-tier cities, but second-tier cities and third-tier cities with increasing access to the Internet and internet-based education models. One really good example of this is VIPKID. I’m sure that a lot of our listeners have heard about that company. Their valuation is what… four or five billion dollars? They’ve generated about a billion dollars of revenue last year, and they are close to two billion dollars this year. This is incredible, because it’s only taken them four to five years of time. There are not many education companies that are making that much money a year. It typically will take some of the offline counterparts over a decade to achieve this.

Some other models I’m particularly interested in involve knowledge-sharing apps. For example, in the U.S. podcasting is very popular — and why we are doing this podcast. Usually with these podcasts, people just want to get shared knowledge. In the U.S., monetizing podcast by ads: you’ve heard advertisements like Casper Mattresses or other comparable products.

In China, podcasting is really big. It’s not just podcasting, but also — let me give an example to describe this — these few apps like Dedao (iGetGet) or Ximalaya.fm. These are similar to podcasting or Soundcloud in the U.S., but they monetize a heck lot better. They charge subscription or content specific fees. Not all contents have a fee attached to it (a lot of them are free), but the fact is that a lot of people in China want to learn. There is a focus on education. There is also a feeling of FOMO with it. If I’m not listening to educational content on my way to work, maybe I’ll fall behind some of my peers. Or it’s just that a lot of people like the concept of learning. For example, in Ximalaya there are a lot of short audio sessions. It could be five minutes, or a little bit longer, that are done every single day or week, with a subscription price of about 99 RMB or 199 RMB. People are willing to pay for that because they just want to consistently access quality content. There is also the longer form content where individuals are basically creating classes or coursework that are all audio-based. They might charge a little bit more for that type of content.

We see a wide variety of such educational content on platforms like Dedao (iGetGet) or Ximalaya. For Ximalaya, I’m not sure that folks around the world or in the U.S. are familiar with it, but they are already a unicorn company (about $3–4 bn USD). I think they’ve had their pre-IPO round earlier this year and should go public pretty soon. Clearly they’re doing much better than Soundcloud!

Tina: Right. Beside the point that you mentioned about, like Chinese people’s willingness to learn, do you think there are any other factors that might contribute to this unique success in particular Chinese market versus the U.S. market that isn’t doing so well in terms of monetizing content?

Adam: Yeah. One big part of this is literally mobile payments that I mentioned earlier. Because when you have payments attached to the phone, it really makes it a lot easier to monetize. There is less friction that prevents the users from paying. So if everyone has a phone and everyone is using WeChat Pay or Alipay, and a lot of the educational content on Ximalaya or Dedao is so cheap, people don’t really think too much about it. They have the habit of just pressing the pay button. I think this is really big part of it. Also I would say that from the content generation side, the quality is very good. People are putting a lot of effort and time to building such content. Celebrities get involved as well… for example, Bob Xu from ZhenFund is one of the so-called educators on these platforms. You have former TV anchorpeople or current anchorpeople; you have folks who are experts in their areas; you have some folks from movies and film backgrounds. So the quality is very good. And when the quality is good and it’s actually relatively instructive, then there should be willingness to pay for the content. You can reference the U.S. company MasterClass (number of celebrities who are sharing best practices with their audience via video content). People pay a subscription fee in order to access top content. People are willing to pay and learn from the very best.

Tina: Right. That’s super interesting. It seems that in the consumer sector, education is an emerging force that people should really look into.

Adam: Yes, and one more point here. In China, a lot of these educational contents we are talking about are online-based. There is also offline-based education, more like an O2O, online/offline complementary services. What I mean by that is that, keeping in mind the example I mentioned earlier, some of these instructors are not just having online content (e.g. monetize via monthly subscription fees), but also teach classes offline. So 混沌大学 (Hundun University), does a really good job by organizing a short series of offline classes taught by celebrities and well known subject matter experts. You’ve got instructors like Yao Jinbo from 58.com, Liu De who is essentially the head of Xiaomi’s ecosystem. You have people of that caliber teaching. Segway-Ninebot CEO Lufeng Gao, Segway Robotics’s president Li Pu, and others attended these programs. It’s an opportunity for them not just to learn, but also to network with other leaders, business managers and technologists in the field. These sessions monetize extremely well, and are very popular.

Tina: Right. Would you say it’s because maybe China hasn’t really had an established business school as the U.S., whereas the U.S. has a very established business school ecosystem within the universities?

Adam: I don’t have too many specific examples to speak to that. I imagine that’s partially the case. But perhaps it’s just the opportunity for a lot of these guys to get together and learn a little bit, to network. It’s not a huge commitment, you’re not wasting your time. In China, this time of social engagement is common: taking classes, grabbing a dinner, or grabbing drinks. I would say the VCs and founders here in China fraternize perhaps a bit more than in Silicon Valley. These guys are always hanging out together, always chatting, always on Wechat. I’m in a multiple Wechat groups where there are 100–500 people, including investors, founders, managers and more. Folks are very open to sharing their personal contacts and getting plugged in… its part of the culture here.

Enterprise Software is Becoming Sexy!

Tina: That’s super fascinating. And we’ve heard a lot about this explosive world and this very vibrant scene in the consumer space. So maybe now is a good time to jump into the enterprise landscape as well, because a lot more people are unfamiliar with that space in China. Enterprise software is hot in the US. A lot of companies take this bottom-up approach, e.g. people in the company adopt the software and then the company later decide whether they should just purchase this. I wonder what China is doing in that space and what your thoughts are on global opportunities for enterprise software.

Adam: That’s a good question. I think a lot of people are looking at enterprise software these days, not just in China but also global VCs. They want to find a way to enter the China market and find these opportunities. Enterprise is definitely way behind consumer Internet in China. You mentioned it as a kind of bottom-up SaaS. They don’t really see too much of that for a number of reasons. One is that in general, SaaS is not really much used in these companies, because a lot of people don’t want to pay for it. This might be a little bit more tricky but when labor is relatively cheap you throw resources to solve a problem. Secondly, a lot of the growth has come from just moving very fast by raising large amounts of money. When there is growth you don’t really think about efficiency nearly as much. Whatever that you can solve using Excel, which is free in China, you probably don’t need a really defined or specific tool for every level of the organization. I guess what you see today is that this is probably still the trend.

That being said, it’s an opportunity in the sense that there are not too many unicorns in this area, probably the biggest companies in enterprise software landscape in China are like 30 to 40 billion RMB. ON the other hand, in the US you’ve got Oracle, Salesforce, DocuSign etc. worth tens of billions of dollars… It is still early innings and consumer behavior won’t change overnight. It’s probably more of a five or ten year tech opportunity.

I’d also say that in terms of enterprise software, we need to look at who the buyers and the users are. For enterprise software, a lot of it is convincing other units and organizations within these companies to buy this product. So it requires really strong sales, with longer cycles. You really need to understand who your buyers are. So in China, most of those SOEs don’t buy much software. For them, every time they deal with a vendor, it’s more project-based, so you have few instances of them buying SaaS solutions to solve certain issues.

But I would say many more private companies are increasingly open to using SaaS or enterprise software solutions in general. There is still a lot of capital in China, but this is cooling down a bit. At a certain point companies can’t just grow profits by raising money or entering a bunch of can just grow by raising more money or entering a number of new markets. At that point, efficiency and profitability becomes important. So there needs to be certain tools that is able to make business process more efficient within those companies.

Secondly, there is a lot more 海归 (Chinese returnees) coming back to China. This is important because a lot of these people have worked in large U.S. companies like Google, Facebook, JP Morgan, Goldman Sachs, etc. Those companies all run very well and use such software. For example, even at Segway Ninebot, Segway Robotics, we were using JIRA, Zendesk, etc. We were selling to US customers, and service is crucial and those interactions needs to be managed well.

When overseas Chinese coming back to China, they realize the importance of efficiency, and also are very used to a lot of these tools. Yet it doesn’t always make sense to use a US tool, because there may be poor access / speed in China… there will need to be Chinese, localized variants of those tools. So I imagine that there are probably more Chinese homegrown enterprise software companies that are already existent but will grow much faster over the next couple of years. It is part of the overall trend.

And in some cases, Chinese companies need to look to new solutions because the existing ones, even American software solutions are just insufficient. For example, Mobike or some other Chinese companies with a ton of DAUs can’t really use classic Oracle database solutions because it’s insufficient for their needs when they have hundreds of millions of DAU. They need something more powerful. These solutions don’t need to be only Chinese. One of my buddies at China Growth Capital, they invested in a Chinese team that has global operations called PingCAP. I’m not an expert in this certain field, but their TiDB and NoSQL approach makes it even feasible for Mobike store and manage their data more effectively.

So just to summarize a little bit, it’s the combination of the fact that there is an increasing need for enterprise software solutions, companies need to be become more efficient, and returnee Chinese are used to using such tools and internal advocates. I think it is going to be a lot more interesting for investors who want to find a new growth area, with demand coming from both Chinese investors and foreign investors trying to break in, which will push the market further.

A Review of AI in China

Tina: Very interesting! So, what’s the state of AI in China?

Adam: My general sense is that it’s a hot area with a lot of money in it. It’s one of those areas where US and China are at the forefront, and there’s a lot of exchange on both sides. Between 2014–2015, there were numerous academics, PhDs, professors that were coming out to start their own companies, and many VCs wanted to back those talents. And then a couple of years ago, you had senior managers leaving the BATs (Baidu, Alibaba, Tencent), in order to pursue AI opportunities. In those early-ish days, there were a number of opportunities in terms of founders to back and low hanging fruit. Obvious examples might be image recognition (e.g. used for security purposes). These days, there are fewer such “hot new deals”, there’s more later stage deals perhaps at the Series C and D stage. When there are some exciting talents that come out and want to start companies, the rounds are typically very expensive. You’ll see seed / Series A rounds at $100m, for example Horizon Robotics or Pony.ai or 爱比科技… basically the founders are incredibly impressive and had good teams so were able to raise big money. So that’s the summary from a talent and funding perspective.

In terms of the applications for AI. The earliest days, around 2014 were about big data analysis. 2015 saw some computer vision applications, NLP and chatbots became popular too. Then there was more interest in AI chips, computing power, and obviously these days there’s even more focus on such areas as China wants to be self-reliant on some of these critical building block technologies. Over the past year, I would say it’s more around applied AI, not just a focus on deep tech but applying it to practical and commercial use cases (e.g. retail solutions, facial recognition for payments). For education, there are a few companies building user adaptive learning programs, customized Q&A sets, etc. Then there’s content as well of course. So Toutiao, which I’m sure many folks have heard about, they have hundreds of millions of MAU, and they have excellent content recommendation engine based on past viewing history, etc. And this is creating big business value.

Moving forward, there’s been a consistent interest and investment into autonomous vehicles, and we’ll see how that plays out. There will probably be a bit more attention applied to IoT products and robotics. Many tech products (software products) that people build are not very tangible, you can’t touch it. But at least for me, especially after having spent time at Segway Robotics, it’d be very cool to have a smart robotic solution both at home and in an industrial environment. Amazon is a building a home robot that should incorporate Alexa, a screen, mobility etc. and we’re very excited to see how that eventually becomes adopted.

How to Out-Compete BAT

Tina: From an early stage investor’s perspective, what are other opportunities that Chinese founders can pursue? When a new trend emerges, I imagine there may be hundreds of companies that compete, so how should founders seek opportunities?

Adam: It is very competitive here, but it is also very competitive in Silicon Valley. For any start-up, speed and execution is key, fundraise also becomes a competitive differentiator. These are all table-stakes in China though. I think there’s a lot of attention placed on BAT, and there should be. These guys are huge sprawling businesses in a number of areas, and also smart, active investors. The fear is that … how can you start a large company without these guys noticing and turning it into the next BAT? That’s an issue I suppose, but if large companies can always win against start-ups, then by that logic Google should have created Facebook, Snapchat, Instagram right? There is always an opportunity for start-ups, for smart teams that incentivized by passion, influence, and a huge potential payout that large companies could not possibly offer. You can’t build such start-ups within large companies as the incentive structure is very different.

I would say that in China, the same drivers and incentive mechanisms hold, but it could be a tad harder for entrepreneurs as BAT are much more open to copying. Staying under the radar can be helpful to your cause. For example, live-video, dating apps like Momo or Tantan, these became extremely popular. At the time though, the addressable market didn’t seem that big or attractive to large companies that need ROI on their efforts… they don’t want to build small things. Toutiao is another example (over $20bn valuation today). When they started off, as a content / newsfeed app, no one understood the model and expected it to make much money… but clearly they’ve since outmaneuvered Baidu / Tencent.

And lastly, another way to seek fresh water is to target second or third cities where there’s generally less competition. China is not just Beijing and Shanghai, and the vast majority of its population is in second, third, and lower tier cities. For example, Qutoutiao, which just IPOed last month… they’re very similar to Toutiao but started off focusing on second and third tier cities. They have an interesting model, where they incentivize readers with money. Instead of buying expensive traffic, in order to build up an active user base and then sell ads…. Qutoutiao significantly lowers its user acquisition cost by paying a small amount of the ad dollars to viewers directly… it’s a very innovative model!

Opportunities for Returnees and Expats

Tina: There seem to be more 海归 (returnee Chinese) coming back to China to start companies. Any advice for returnee Chinese founders?

Adam: I think overall it’s easier for people to come to China for opportunities, whether you’re a returnee Chinese, ABC (American born Chinese), non-Chinese, etc. There’ve been a number of policies passed that allow foreigners to more easily access VISAs and work permits. For 海归， coming back to China has always been a possibility. In the early days, these talents came back armed with foreign knowledge that allowed them to differentiate and create unique value. As China developed further, the view was that 海归 founders lost their edge, because China was catching up and they did not always bring back unique knowledge. In fact, some of these 海归 were not 接地气 enough, they weren’t localized enough and out of touch. I think this is also changing, because as China becomes more globalized, then both US and China converge so there shouldn’t be as much of a culture gap, especially at internet / tech companies. Also, the US still has decades more experience building up massive, sophisticated companies that use enterprise software and processes to be more efficient, that understand how to scale globally and execute on large M&A deals… China can still gain from this expertise.

There’ve been a number of famous 海归 founders recently. For example, Pinduoduo’s CEO Colin Huang was ex-Google. Wang Yi from Liulishuo, the recent IPOed AI-powered language learning app, got his PhD in computer science from Princeton and also worked as a product manager at Google. Tezign CEO Fan Ling has graduate degrees from Harvard and Princeton. And some VCs are even focused on bringing 海归 founders back to China. For example GGV has a fellowship program starting this winter meant to further this effort. So all-in-all, there are positive drivers that should encourage this trend further.

Tina: Thanks for your time Adam!