China Startups – The Gold Rush and Fire Extinguishers (Part 5 of 5)

I just spent a few weeks in Japan and China on a book tour for the Japanese and Chinese versions of the Startup Owners Manual.  In these series of 5 posts, I thought I’d share what I learned in China. All the usual caveats apply. I was only in China for a week so this a cursory view. Thanks to Kai-Fu Lee of Innovation Works, David Lin of Microsoft Accelerator, Kevin Dewalt and Frank Hawke of the Stanford Center in Beijing, and my publisher China Machine Press. 

China Dragon

The previous post, part 4, was about Beijing’s entrepreneurial ecosystem these are my final observations.

Land Rush
For the last 10 years China essentially closed its search, media and social network software market to foreign companies with the result that Google, Facebook, Twitter, YouTube, Dropbox, and 30,000 other websites were not accessible from China. This left  an open playing field for Chinese software startups as they “copy to China” existing U.S. business models. Of course “copy” is too strong a word.  Adapt, adopt and extend is probably a better description.  But for the last decade “innovation” in Chinese software meant something different than it did in Silicon Valley.

The Chinese Social Media Landscape diagram below from Resonance does a great job of illustrating the players in the Chinese market. (Note that the inner ring shows their global equivalents.)

China Social Media Ecosystem

The downside is that with so much venture and angel capital available, investors have been willing to fund the 10th Groupon clone.  For the last few years, there really hasn’t been a demand to innovate on top of the ecosystem that’s been built.

New Rules for China
Not only is the Chinese ecosystem completely different but also the consumer demographics and user expectations are equally unique. 70% of Chinese Internet users are under 30. Instead of email, they’ve grown up with QQ instant messages. They’re used to using the web and increasingly the mobile web for everything, commerce, communication, games, etc. (They also probably haven’t seen a phone that isn’t mobile.) By the end of 2012, there were 85 million iOS and 160 million Android devices in China. And they were increasing at an aggregate 33 million IOS and Android activations per month.

It was interesting to learn about China’s digital divide – the gap between East China and Midwest China, and between urban and rural areas. Internet penetration in Beijing is  greater than 70% while it’s less than 25% in Yunnan, Jiangxi, Guizhou and other provinces. While there are 564 million web users with 420 million having mobile web access, 74% of Chinese Internet users make less than $500/month and are students, blue-collar workers or jobless.

Unlike U.S. websites that are sparse and slick, Chinese users currently expect complicated, crowded and busy web pages. However, there’s a growing belief that the “design preferences” of Chinese consumers are just bad design. TenCents WeChat, (designed for an international market) is the first incredibly popular app in China to dramatically raise the bar for what a good user interface and user experience looks and feels like. WeChat may change the game for Chinese U/I and U/X experience. The one caveat about online commerce is that while Chinese users will buy physical goods online (Taobao is huge), they seem to hate to pay for music or software, and the model for games seems to be moving to free play with in-app-purchases for accessories and powers. An interesting consequence of the rigid censoring and control of mainstream media is that blogging – reading and writing – is much higher than U.S.

My guess is the current wave of “copy to China” will burn itself out in the next few years as the smart money starts to move to “innovate in China” (i.e. like WeChat.)

Competition
If you’re a software startup competing in China, the words that come to mind are “ruthless and relentless.” The not so polite ones I’ve heard from others are “vicious, unethical and illegal.” Intellectual property protection is great on paper and “limited” in practice. The large players like Alibaba, Baidu and Tencent historically would be more likely to simply copy a startup’s features than to hire their talent. The large companies strategy seems to be to cover every possible market niche by copying successful models from others.

The slide below from the Zhen Fund shows the breadth of business coverage of each of the Chinese Internet incumbents.  Each column represents a company (QQ, Sina, Baidu, Netease, Sohu etc.) and the rows indicates their offerings in open platform, group buying, online games, microblogging, Instant Messaging, BBS, Q&A and E-commerce.

Internet Giants Want to do it all

Small startups act the same way, simply cloning each other’s products. Sharing and cooperation is not yet part of the ethos. I can’t imagine a U.S. company setting up some subsidiary here and expecting them to compete while they were following U.S. rules.  In some ways, the best description of the market dynamics would be “imagine you were competing with 100 companies who are as rapacious as Microsoft was in the 1980’s and 1990’s.” Eventually, China’s innovation-driven economy needs intellectual property rights and anti-trust laws that are enforced.

Sea Turtles and VPN – the connections to  the rest of the world
Entrepreneurs in Beijing were knowledgeable about Silicon Valley, entrepreneurship and the state of software and tools available for two reasons.  First, there are continuous stream of “sea turtles”—Chinese who have studied or worked abroad—returning home. (The Chinese government must be laughing hysterically over U.S. immigration policy that’s forcing Chinese grad students out of the U.S.) Many of these returnees have worked in Silicon Valley and startups or went to school at MIT and Stanford. (There is a huge difference between the Chinese who have never left and those who went to school abroad, even for a few months – at least a difference in their ability to relate to me and have a conversation on the same wavelength. It’s clear why families try so hard to send their children abroad. It changes everything for them.)

Second, most websites that a non-Chinese would use are blocked including Facebook, Twitter, Youtube, Google Docs, Scribd, Blogspot, Dropbox, New York Times, etc. Almost every entrepreneur I met was using VPN to circumvent the Great Firewall. When the Chinese government censors (run by their propaganda department) shutdown access to yet another U.S. web site, they create another 100,000 VPN users.  And when the government tools to detect encrypted VPN’s get more sophisticated, (as it did last year), Chinese users just use stealthier tools. It’s an amazing cat and mouse system.

CCP Propaganda Department logo(Note to Chinese Communist party – the best name for your propaganda department should probably not be the “Propaganda Department.”)

Beijing’s Academic Hub
Right next door to Zhongguancun are China’s top two universities, Peking University and Tsinghua University. Northwest of Beijing is also home to other universities, including technical universities like USTBBITBUPT, and Beihang.  Like Silicon Valley, Zhongguancun also has a critical mass of people who are crazy enough to do startups.  Equally of interest is a good number of them end up in the PLA’s GSD 3rd Department (the equivalent of our National Security Agency. ) And some of their best and brightest have ended up in the organizations like the 2nd Bureau, Unit 61398 tasked euphemistically for “Computer Network Operations.”

While I didn’t get much time with the academic community, in talking to students, education seems to still be one of China’s bottlenecks – rote lectures, passive learning, follow the process, exam-based performance, etc.  And while startups and entrepreneurship courses are now being added to the curriculum, “How to write a business plan” seems to be the state of the art. China’s education system needs to give more attention to fostering students’ innovative thinking, creativity and entrepreneurship.

Entrepreneurial Culture

Fear of Failure
Though they’re familiar with technology in the valley, I picked up some important cultural difference from students and startup engineers I talked to. Even though they’re next to Zhongguancun, the hottest place for startups in China, there seems to be a lower appetite for risk, a lack of interest in equity (instead optimizing for a high salary) and very little loyalty to any one company. The overall culture still has a fear of failure. Most of their parents still tell them to work for the government or a big company.

Talent
I heard from a few investors that as the startup ecosystem is relatively new, there’s a battle for experienced engineering talent and lack of experienced C-level execs. The lack of a previous generation of successful startup CEOs means the current pool of mentors to coach this generation is almost non-existent.

Because salaries are cheap, startups seem to try to solve every problem by throwing bodies at it. Startup teams feel like they are 2-5x the size of American teams. There seems to be little appreciation or interest in multi-skilled people.

Turnover of employees in capital in Beijing is very high. Employees work here for a few months and are suddenly gone. There’s a noticeable lack of tenacity in young, new entrepreneurs. They start a project, and if it isn’t a home run, they’re gone. Perhaps it’s the weather. Silicon Valley has great weather and lifestyle, and nobody wants to leave. Beijing has awful weather and pollution, it’s a temporary place to get rich and then leave.

Management 101
The board/CEO relationship still isn’t clearly understood by either party. I’ve talked to entrepreneurs who view the investors as a “boss.”  A good number of startups in Beijing seem driven by the VCs – and not the founders. This might also be a hangover from the command and control system of a state-driven planned economy. Ironically investors told me that the reverse has been true as well. Some startups acted like the VC was a bank. They took the money and then ignored their board. Over time, as investors add more value than writing checks, this relationship will mature.

Creativity
I was surprised that startup teams ask what seems like the kind of questions Americans learn at their first jobs.

Team: “We keep spending money trying to get people to our web site but they don’t come back. We are almost out of money.”

Me:  “Ok.  Why are you still spending money?”

Team: “long…silence…we need people to come to the website.”

On the other hand, for most of them it probably is their first job. And the educational system hasn’t prepared them for executing anything other than a plan. Iterations and pivots are a tough concept if you’ve never been taught to think for yourself. And challenging the system is not something that’s actually encouraged in China.

They also ask questions I just don’t know how to answer. “How do you know how to be creative? What do we have to do to be creative?”  “You Americans just seem to know how to do things even if you’ve never done them – can you show us how to do that?”  This seems to be an artifact of the Chinese rote educational system and its current system of government.

Innovation Ecosystem
On the plane ride home I started to think about the similarities and differences between the innovation ecosystems of Silicon Valley and the TMT segment I saw in Beijing. The motivations are the same – profit – driven by entrepreneurs and venture finance. And the infrastructure is close to the same – research universities, predictable economic system, a path to liquidity, a stable legal system and 24/7 utilities. But the differences are worth noting – it’s a young ecosystem, so startup management tools are nearly non-existent. But there’s a difference in the culture of failure and risk taking –  the current cultural pressure is to “work for a big company or the government.” Outward facing Universities are just starting to appear, and while there’s a free flow of information inside China, it suffers from the constraints of the Great Firewall.

China vs. US ecosystem

But there are two striking differences. The first is the lack of creativity. The Beijing software ecosystem I saw has spent the last decade in a protected market copying successful U.S. business models. “Copying, adopting and adapting,” is not the same as “competing, innovating and creating” in a global market. Perhaps products like WeChat, designed for an international market, might be the beginning of real innovation.

The second difference in ecosystems – the lack of freedom to dissent – goes deeper to the difference between the two systems. In the U.S. entrepreneurs are encouraged to “Think Different.” Our touchstone for creativity is the Apple ad that said, “Here’s to the crazy ones, the misfits, the rebels, the troublemakers,… the ones who see things differently — they’re not fond of rules… You can quote them, disagree with them, glorify or vilify them, but the only thing you can’t do is ignore them because they change things….” This spirit of rebellion against the status quo got us Steve Jobs.  In China the same attitude is likely to get you jail time. Unless you can speak truth to power, you’ll never have an innovation economy.

Conclusion
China is astonishing. The country has risen. Their economy is the envy of the world. The entrepreneurial and “can do” spirit reminds me of what the U.S. was known for. Chinese citizens are proud of their country and believe the world is theirs in the way Americans did in the 1950’s. Their leadership has shown incredible foresight in engineering an amazing economic engine and formidable military. They come so far, and yet…

To take nothing away from what China has accomplished, a visit to Beijing had all the subtle reminders that this version of capitalism has come without democracy or justice; the guards in the Forbidden City armed with fire extinguishers in case more protestors try to set themselves on fire, the security around Tiananmen Square to prevent protestors from gathering, and the “black jails” to keep rural petitioners out of Beijing.  And of course the “great firewall,” attempting to keep information about the outside world from reaching inside China.

The bet the government is making is that if they can keep the economy cooking and distract the masses with ever increasing consumer goods and foreign adventures, maybe it can survive.

All of these are signs of a weak China not a strong one. They are the signs of a leadership frightened not by external enemies but by their own people.

It usually doesn’t end well.

——

all five China blog posts available as a download here

List to the post here: or download the podcasts here

27 Responses

  1. This is like taking China in, in one deep breath without actually going there. The insight from Steve’s article does two contradicting things: it makes you feel curious enough to visit China. On the other hand, the insight feels so complete that you may think there is no point going. The choice is left to the reader.
    I hope that Steve will one day cover Nigeria or Africa

    • Austin,
      The blog posts in no way do the country justice. Find the time and go to China. Lots of lessons there for Nigeria and Africa. They’ve accomplished an enormous amount in such a short time. Lessons to be learned and costs to be calculated. Go see it for yourself. (I’d add Shanghai and the cities in the Pearl River delta to the itinerary.)

      steve

  2. Great post, Steve. I’ve spent 3 weeks in China in January in an HBS-led trip and I agree with what you have written. We’ve visited some tech companies, including Baidu, Rovio, and other small startups in 1st and 2nd tier cities. It is impressive the progress they’ve made in the last years and I think innovation is starting to happen.

    I saw innovation even when they copy/adapt American startups that are forbidden to enter China. In our visit to Baidu, they’ve shown us how they optimized their search system to Chinese, to a point that they offer a better solution than Google would offer in China. They are now using the same logic to be better in other languages and to expand to other emerging markets, such as Brazil. Not sure they will be successful outside China, but it illustrates that they have innovated and have taken a different approach.

    Also, Baidu has launched several other products, such as video and music transfer/purchase that are only possible in China due to the weak IP enforcement.

    Finally, it was nice to see that they are (or at least they wanted us to believe so) the most rebel one can be in China without getting into trouble: on one hand they work close to the government but on the other they keep pushing the limits. They see it as a way to change things slowly.

  3. Great posts on China. Thoughtful, insightful, balanced. Thanks, Steve!

  4. As usual, Steve, thoughtful, well written analysis. There are been successful attempts at teaching creativity, in fact this 2004 meta-analysis shows which approaches are most effective. Perhaps the Chinese should “get out of the building” and tap into the social science. http://www.psychologie.uni-mannheim.de/cip/Tut/seminare_wittmann/meta_fribourg/sources/Scott_etal_2004_Effectiveness_of_creativity_training.pdf

  5. Great stuff, Steve. Two observations here posed as questions; I’d be interested in your thoughts.

    1) I remember that De Gaulle rejected the “internet” – “France will have its own internet,” he said. Of course, this course didn’t last long. Did the delay hurt – or help – France?

    2) As part of the “splatter” of blocking access to U.S. social media and the like, China blocked access to the first MOOCs (Massive Open Online Courses). I was the Teaching Assistant for what is still the world’s largest online class – 160,000 enrollees – Stanford’s “Introduction to Artificial Intelligence”, and I remember well the few (English speaking) Chinese students who got onto the course sites somehow. (And, I’m pretty sure these sites where hacked by “China”.) So, what is the current Chinese position on MOOCs? For the rest of the world, they are going to change education.

    Thanks,
    – Mark

  6. Amaaaaazingly well written article! Super interesting. I am really curious what will happen when Internet controls are removed and Chinese have unfettered access to the West and vice versa. Will the West creep in and eat up market share in China, or will it go the other direction?

    Favorite line: “Unless you can speak truth to power, you’ll never have an innovation economy.” So true. I wonder how you found things in Japan. Over here, the problem is not people being unable to speak truth to power…it’s the fact they don’t seem particularly interested in doing so.

    And you wrote, “China’s education system needs to give more attention to fostering students’ innovative thinking, creativity and entrepreneurship.” I think you’ll find this sentence will serve equally well in Japan.

    You might also find that UI design here in Japan is about the same as you described for China. The main question “designers” seem to try to solve here is, “How much information can I cram onto the top page?” Some of the majors like ANA Airlines have come a long way in trying for some form of UI / UX design improvements, but for the most part it’s just bad design everywhere.

    Sorry for the long comment. Loved this post. Glad the trip was such a success!

  7. Terrific series and observations. The great experiement being run in China is how single party restrictive control will mix with capitalism. We know that democracy mixed with capitalism leads to innovation, wealth and unequal outcomes. We know that single party control mixed with socialism leads to equal outcomes – everyone loses. Time will tell if innovation and sustained economic growth is possible in a society restricted by single party paranoids.

  8. “My guess is the current wave of “copy to China” will burn itself out in the next few years as the smart money starts to move to “innovate in China” (i.e. like WeChat.)”

    Isn’t WeChat a Whatsapp clone?

    http://www.androidauthority.com/tencent-wechat-124659/

  9. Hey Steve!! You disseminated what took me at least a year to understand! and now I understand it even better thanks to your postings. I’m now in Shanghai and i’m seeing first hand those exact type of experiences you’re writing about.

    Also, a note regarding the “propaganda” word. It seems that in Chinese, the word “Propaganda” does not carry the same negative connotation that the word in English does. I believe this has to do with WW2/Cold war/US military-centric thinking that all “propaganda” is to brainwash people, while the original word was based on the more neutral propagating and dissemination of information (which is what the chinese word closely reflects.

  10. First, I’d like to say that this series is a great overview of the Beijing ecosystem. Kudos to you, Steve, to get this together in just a few weeks!

    Just a remark: Why would you mention Weixin/WeChat as an innovator in China? They essentially copied several asian and western apps (whatsapp, talkbox, path) into one. However, they did innovate on top of it by making it more “asian” and adding innovative QR code functionality as well as unique monetization. It’s maybe not innovation but also not blatant copying, and actually path did copy some of it back recently in path 3.0. I even wrote an article about this after my last Beijing trip:
    http://www.thepiratesinn.com/from-copycats-to-cross-competitor-innovation-a-story-of-path-and-wechat/

    Cheers,
    Puja

  11. Here is John Cleese’s answer to the questions “How do you know how to be creative? What do we have to do to be creative?”

    http://www.brainpickings.org/index.php/2012/04/12/john-cleese-on-creativity-1991/

  12. I think that the so called ‘lack of innovation’ in China is caused by a society that values conformism. The imperial regime was conformist and the actual comunist regime is more conformist. China has it’s share of inovative people, but if their ideas are not propagated copied by other because of fear of conflict with the group (family,coworkers,company,state) it s useless.

    • Maintaining proper behavior in the 5 Great Relationships, as defined by Confucius, is still essential in East Asian societies. Lives and careers are easily ruined by violators.

  13. There’s a terrific documentary about the founding of Alibaba in China – Crocodile in the Yangtze. Well worth watching: http://www.crocodileintheyangtze.com/index.html

  14. You can’t learn creativity by attending a passive lecture, it must be practiced.

    Creativity by definition means going against the stream and needs courage to do it because it feels backward, specially at first.

    Johny Ive and Steve Jobs talked about “ideas from early stages must be protected, because they are very vulnerable”. I remember how easy was to attack the first Ipod(“no wireless, less space than a nomad.lame”), iphone(Steve Ballmer video on it is fantastic), microscope(why watching things we already know, but bigger?), digital cameras(never going to replace film, where are you going to see it, on a computer display?), ebooks… today skepticism is focused on electric cars or nuclear fusion.

    When everybody does something badly, and you don’t, you start wondering if it is maybe you who is wrong.

    Like when I started working standing up, at first my muscles hurt a little, only after months(now it is years) of doing that you discover how much better is for your health.

    In Spain there was a real state bubble, and because you know about economy 101 you knew it was a bubble, rationally, but emotionally going against the stream was terrible, as everybody was invested on it. The home owners wanted price to go up ad infinitum, and people that took a loan wanted to have an asset bigger than their debt.

    I would love to hear Steve experience going against the stream in his life. Does he had the experience of doubting a change will come when incumbent only to see it take the world by storm?. How it felt to him when other people doubt about him or his team?.

  15. Thank You Steve for your article ! Lived 3 years in China and never that much approached the start-up league there, even if I heard a lot about it…

    However, the observations you relate are so true. reminded me of the time I used to work there. Lack of creativity, fear of Failure, and talent management are all about face… The pursuit of money also(but pretty new in Chinese society) is understandable in term of face “value” because money = buying expensive and luxury goods= status= respect = pride from the inner circle of the person…

    To understand deeper your observations, reading on Chinese culture face game, and relationship would make it seem more “rational” or logic. It can be odd just looking at it from the outside.

    It would give an enlightenment just as how Malcom Gladwell explained why Asian were better at maths than Westerners..

  16. [...] China Startups: The Gold Rush (Steve Blank) — dense fact- and insight-filled piece. Not only is the Chinese ecosystem completely different but also the consumer demographics and user expectations are equally unique. 70% of Chinese Internet users are under 30. Instead of email, they’ve grown up with QQ instant messages. They’re used to using the web and increasingly the mobile web for everything, commerce, communication, games, etc. (They also probably haven’t seen a phone that isn’t mobile.) By the end of 2012, there were 85 million iOS and 160 million Android devices in China. And they were increasing at an aggregate 33 million IOS and Android activations per month. [...]

  17. Well said! As an entrepreneur looking at China, the we’re my impressions too, but I’d never be able to articulate it so well. Thanks!

  18. I think it would be interesting to do a cross-country comparison on start-up scenes in emerging markets. I think they have a lot of similarities in terms of institutional gaps but probably a lot of differences in terms of cultural preferences and approach to customer relations. I got inspired to write about what I learned on this in Rio after reading this series..http://grobetrotter.wordpress.com/2013/04/13/rio-de-janeiro-brazil-start-up-scene/

  19. Obviously the big unknown with China is how the government handles these fundamental questions; rule of law, trust and open capital markets. Brenner’s The Force of Finance is a great take on the fundamentals required for success… before the startup.

  20. “The large companies strategy seems to be to cover every possible market niche by copying successful models from others” that’s the truth, so the cruel competition drives Chinese entrepreneurs to find out effective ways to build up their competitive advantages.

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