Teams that build continuous customer discovery into their DNA will become smarter than their investors, and build more successful companies.
Awhile back I blogged about Ashwin, one of my ex-students wanted to raise a seed round to build Unmanned Aerial Vehicles (drones) with a Hyper-spectral camera and fly it over farm fields collecting hyper-spectral images. These images, when processed with his company’s proprietary algorithms, would be able to tell farmers how healthy their plants were, whether there were diseases or bugs, whether there was enough fertilizer, and enough water.
(When computers, GPS and measurement meet farming, the category is called “precision agriculture.” I see at least one or two startup teams a year in this space.)
At the time I pointed out to Ashwin that his minimum viable product was actionable data to farmers and not the drone. I suggested that to validate their minimum viable product it would be much cheaper to rent a camera and plane or helicopter, and fly over the farmers field, hand process the data and see if that’s the information farmers would pay for. And that they could do that in a day or two, for a tenth of the money they were looking for.
Fast forward a few months and Ashwin and I had coffee to go over what his company Ceres Imaging had learned. I wondered if he was still in the drone business, and if not, what had become the current Minimum Viable Product.
It was one of those great meetings where all I could do was smile: 1) Ashwin and the Ceres team had learned something that was impossible to know from inside their building, 2) they got much smarter than me.
Crop Dusters Even though the Ceres Imaging founders initially wanted to build drones, talking to potential customers convinced them that as I predicted, the farmers couldn’t care less how the company acquired the data. But the farmers told them something that they (nor I) had never even considered – crop dusters (fancy word for them are “aerial applicators”) fly over farm fields all the time (to spray pesticides.)
They found that there are ~1,400 of these aerial applicator businesses in the U.S. with ~2,800 planes covering farms in 44 states. Ashwin said their big “aha moment” was when they realized that they could use these crop dusting planes to mount their hyperspectral cameras on. This is a big idea. They didn’t need drones at all.
Local crop dusters meant they could hire existing planes and simply attach their Hyper-spectral camera to any crop dusting plane. This meant that Ceres didn’t need to build an aerial infrastructure – it already existed. All of sudden what was an additional engineering and development effort now became a small, variable cost. As a bonus it meant the 1,400 aerial applicator companies could be a potential distribution channel partner.
The Ceres Imaging Minimum Viable Product was now an imaging system on a cropdusting plane generating data for high value Tree Crops. Their proprietary value proposition wasn’t the plane or camera, but the specialized algorithms to accurately monitor water and fertilizer. Brilliant.
I asked Ashwin how they figured all this out. His reply, “You taught us that there were no facts inside our building. So we’ve learned to live with our customers. We’re now piloting our application with Tree Farmers in California and working with crop specialists at U.C. Davis. We think we have a real business.”
It was a fun coffee.
Build continuous customer discovery into your company DNA
An MVP eliminates parts of your business model that create complexity
Focus on what provides immediate value for Earlyvangelists
Our Lean LaunchPad for Life Science class talked to 2,355 customers, tested 947 hypotheses and invalidated 423 of them. They had 1,145 engagements with instructors and mentors. (We kept track of all this data by instrumenting the teams with LaunchPad Central software.)
This post is one of a series of the “Lessons Learned” presentations and videos from our class.
Sometimes a startup results from a technical innovation. Or from a change in regulation, declining costs, changes in consumers needs or an insight about customer needs. Resultcare, one of the 26 teams in the class started when a resident in clinical medicine at UCSF watched her mother die of breast cancer and her husband get critically injured.
One of the great innovations of the 21st century are products that are cloud-connected and update and improve automatically. For software, gone are the days of having to buy a new version of physical media (disks or CD’s.) For hardware it’s the magical ability to have a product get better over time as new features are automatically added.
The downside is when companies unilaterally remove features from their products without asking their customers permission and/or remove consumers’ ability to use the previous versions. Products can just as easily be downgraded as upgraded.
It was a wake up call when Amazon did it with books, disappointing when Google did it with Google Maps, annoying when Apple did it to their office applications – but Tesla just did it on a $100,000 car.
It’s time to think about a 21st Century Bill of Consumer Product Rights.
Google – Well It Looks Better In July 2013 Google completely redesigned Google Maps – and users discovered that on their desktop/laptop, the new product was slower than the one it replaced and features that were previously available disappeared. The new Google Maps was worse then one it replaced – except for one key thing – its User Interface was prettier and was unified across platforms. If design was the goal, then Google succeeded. If usability and functionality was a goal, then the new version was a step backwards.
Apple – Our Code Base is More Important than Your Features In November 2013 Apple updated its operating system and cajoled its customers to update their copies of Apple’s iWork office applications – Pages (Apple’s equivalent to Microsoft Word), Keynote (its PowerPoint equivalent), and Numbers (an attempt to match Excel). To get users to migrate from Microsoft Office and Google Docs, Apple offered these iWorks products for free.
Sounds great– who wouldn’t want the newest version of iWorks with the new OS especially at zero cost? But that’s because you would assume the new versions would have more features. Or perhaps given its new fancy user interface, the same features? The last thing you would assume is that it had fewer features. Apple released new versions of these applications with key features missing, features that some users had previously paid for, used, and needed. (Had they bothered to talk to customers, Apple would have heard these missing features were critical.)
But the release notes for the new version of the product had no notice that these features were removed.
Translated into English this meant that Apple engineering recoding the products ran out of time to put all the old features back into the new versions. Apple said, “… some features from iWork ’09 were not available for the initial release. We plan to reintroduce some of these features in the next few releases and will continue to add brand new features on an ongoing basis.
Did they think anyone wouldn’t notice?
Decisions like this make you wonder if anyone on the Apple executive staff actually understood that a “unified file format” is not a customer feature.
While these examples are troubling, up until now they’ve been limited to content or software products.
Tesla – Our Problems are Now Your Problems In November 2013 Tesla, a manufacturer of ~$70,000 to $120,000 electric cars, used a software “update” to disable a hardware option customers had bought and paid for – without telling them or asking their permission.
One of Tesla features is a $2,250 “smart air suspension” option that automatically lowers the car at highway speeds for better mileage and stability. Over a period of 5 weeks, three Tesla Model S cars had caught fire after severe accidents – two of them apparently from running over road debris that may have punctured the battery pack that made up the floor pan of the car. After the car fires Tesla pushed a software release out to its users. While the release notice highlighted new features in the release, nowhere did it describe that Tesla had unilaterally disabled a key part of the smart air suspension feature customers had purchased.
Only after most of Telsa customers installed the downgrade did Tesla’s CEO admit in a blog post, “…we have rolled out an over-the-air update to the air suspension that will result in greater ground clearance at highway speed.”
Translation – we disabled one of the features you thought you bought. (The CEO went on to say that another software update in January will give drivers back control of the feature.) The explanation of the nearly overnight removal of this feature was vague “…reducing the chances of underbody impact damage, not improving safety.” If it wasn’t about safety, why wasn’t it offered as a user-selected option? One could only guess the no notice and immediacy of the release had to do with the National Highway Safety Administration investigation of the Tesla Model S car fires.
This raises the question: when Tesla is faced with future legal or regulatory issues, what other hardware features might Tesla remove or limit in cars in another software release? Adding speed limits? Acceleration limits? Turning off the Web browser when driving? The list of potential downgrades to the car is endless with the precedent now set of no obligation to notify their owners or ask their permission.
In the 20th century if someone had snuck into your garage and attempted to remove a feature from your car, you’d call the police. In the 21st century it’s starting to look like the normal course of business.
What to Do While these Amazon, Google, Apple and Tesla examples may appear disconnected, taken together they are the harbinger of the future for 21st century consumers. Cloud-based updates and products have changed the landscape for consumers. The product you bought today may not be the product you own later.
Given there’s no corporate obligation that consumers permanently own their content or features, coupled with the lack of any regulatory oversight of cloud-based products, Apple’s and Tesla’s behavior tells us what other companies will do when faced with engineering constraints, litigation or regulation. In each of these cases they took the most expedient point of view; they acted as if their customers had no guaranteed rights to features they had purchased. So problem solving in the corporate board room has started with “lets change the feature set” rather than “the features we sold are inviolate so lets solve the problem elsewhere.”
The result is that consumers in the 21st century have less protection then they did in the 20th.
What we can hope for is that smart companies will agree to a 21st Century Bill of Consumer Product Rights. What will likely have to happen first is a class-action lawsuit establishing consumers’ permanent rights to retain features they have already purchased.
Some smart startups might find a competitive advantage by offering customer-centric products with an option of “no changes” and “perpetual feature rights” guarantee.
A 21st Century Bill of Consumer Product Rights
No changes to content paid for (whether on a user’s device or accessed in the cloud)
Notify users if an update downgrades or removes a feature
Give users the option of not installing an update
Provide users an ability to rollback (go back to a previous release) of the software
The product you bought today may not be the product you have later
Manufacturers can downgrade your product as well as upgrade it
You have no legal protection
Update: a shorter version of the post was removed from the Tesla website forum
The online world can be a dangerous place for the unprepared. And it’s just going to get worse. It’s time to teach Cyber Security as integral part of the high school and college curriculum and to all corporate employees.
I grew up in New York City and for a few years heaven on earth for me was going to Boy Scout camp in the summer near the Delaware River. The camp had all the summer adventures a city kid could imagine, hiking, fishing, canoeing, etc. But for me the best part was the rifle range. For a 12-year old kid from the city shooting target practice and skeet with a 22 rifle meant being entrusted by adults with something you knew was dangerous – because they were beating gun safety into our brains every step of the way.
From the minute we walked onto the shooting range to even before we got to touch a gun, we learned basic rules of handling weapons I still haven’t forgotten. You screwed up and you got yelled at and if you did it again you got escorted out of the rifle range.
While target practice and skeet shooting were fun, safety was serious.
Over the years I would learn how to shoot an M-16 in basic training in the military, go through a basic combat course to go to Southeast Asia (when we acted like this was a lark, our instructor stopped our drill and said, “For your sake I hope the guys shooting at you were screwing around in their combat course.” It got our attention.) When I bought the ranch herds of wild boar still roamed the fields. While we were putting in the miles of fencing to keep them out, I bought much heavier weapons to deal with a charging 400-pound boar and hired an instructor to teach me how to safely use them. Each time gun safety was an integral part of training with new weapons. For me, guns and gun safety became one and the same.
Hacking and Cyber Security For consumers, online surfing, shopping, banking and entertaining ourselves have become an integral part of our lives. And with that has come identify theft, hacking, phishing, online scams, bullying, and predators online. As well as a loss of privacy.
But for businesses, the threats are even more real. Go ask RSA, Northrop, Lockheed, Google, Amazon and almost every other company with an online presence. Intellectual property stolen, customer data hacked, funds illegally transferred, goods stolen, can damage a company and put them out of business.
I think we’re missing something.
In the last 20 years 3 billion people have gained access to the web. Yet for most of them safety online remains a problem for other people. It pretty clear that for a company going online today is equivalent to playing with a loaded gun. The analogy of comparing the net with guns might seem stretched, but I think it’s an apt one. Guns have been around for hundreds of years, to provide food as well as wage war, but it wasn’t until the 20th century that gun safety rules were codified and taught.
I think we need the equivalent of gunsafety training for online access.
We now know the basic tools online hackers use. We know enough to harden sites to stop the simple hacks and to educate employees about basic social engineering and phishing attempts. It’s time to teach Cyber Security as integral part of the high school and/or college curriculum – not as an elective. Companies need to make Cyber Security education an integral part of their on-boarding process.
The Air Force Academy basic Cyber Security course is a good place to start (Stanford and other schools have a similar syllabi.) The class consists of basic networking and administration, network mapping, remote exploits, denial of service, web vulnerabilities, social engineering, password vulnerabilities, wireless network exploitation, persistence, digital media analysis, and cyber mission operations.
The web is not a benign environment
Companies, high schools and colleges ought to make a basic Cyber Security course a requirement of getting online access.
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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.
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.)
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.
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.
(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 USTB, BIT, BUPT, 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.
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.
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
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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, Frank Hawke of the Stanford Center in Beijing, and my publisher China Machine Press.
The previous post described the evolution of the Chinese Venture Capital system. The next two posts are about what I saw and learned in my short stay exploring Beijing’s entrepreneurial ecosystem.
Entrepreneurship in Beijing In the few days I was in China I met with several VC’s, angel investors, business press and spoke to hundreds of entrepreneurs. I was blown away by what I saw in Beijing. First, I was amazed by the physical impact of the city itself. This was a modern city in a hurry to make a first impression – think of what Rome looked like in the time of the empire or New York in the 1920’s – now it’s Beijing announcing that China has arrived.
However if you scratch the surface, you can still find a bit of the old Beijing in the hutongs. Drive 50 miles outside the city into the surrounding villages and you see the distance China has to travel to bring the rural areas into the 21st century. In Beijing we hadn’t seen air so badly polluted since we had been in Agra in India in the winter where I swear there was a day you could wave your hand in front of you and see traces of it in the air (and their excuse was they burn dung for heat.)
Kai-fu Lee of Innovation Works was equally generous with his time. We had a fireside chat with a room full of eager entrepreneurs. And he was generous in sharing his insights about the current state of entrepreneurship and investment in China. And through it all Louis Yuan my patient and wonderful publisher from China Machine Press kept me moving through the events.
But what made the overwhelming impression for me was finding an entrepreneurial software cluster on par with the Internet software portion of Silicon Valley. The physical heart of the Beijing startups is in Zhongguancun in the Haidian District, located in the northwest side of Beijing. Startups here are primarily in what they call the TMT (Technology, Media and Telecommunications) segment. Not only does Zhongguancun have Chinese startups, but global technology companies (Nokia, Ericsson, Motorola, Sony Ericsson, Microsoft, IBM, Sun, Oracle, BEA, Alcatel Lucent, Google) all have offices here or elsewhere in Beijing.
If there ever was any question about the value of China’s Torch Program walk around Zhongguancun. It was the first of the 54 Science and Technology Industrial Parks.
China Venture Capital An entrepreneurial ecosystem is driven one of two ways; either by a crisis (i.e. innovation in the U.S. during World War II,) or during peacetime by profit.
If it’s driven by profit then the ecosystem needs both entrepreneurs as well as Venture Finance.
China now has plenty of both.
China has the biggest Venture Capital industry outside the U.S. To compare the two, in 2011 U.S. venture capitalists invested $26.5 billion in all deals. Out of that total, they funded 967 Internet deals with $6.7 billion.
By comparison, in 2011 Chinese VC’s invested $13 billion in all deals. Out of that total, they funded 268 Internet deals with $3.2 billion. About 1/3 of all China’s Venture Capital investment is made in Beijing and the majority of those investments are in the Technology, Media and Telecommunications (TMT) sector I’ll describe shortly.
As vibrant as the China venture business has been, 2012 was a different story. VC’s pulled back and only invested $3.7 billion in all deals, funding just only 43 deals with $563 million.
Closed for You, Open For Us First a bit of context in what the VC’s in Beijing are investing in. China has essentially closed its internal search, media and social network software market to foreign companies who wouldn’t play with the government rules on the Great Firewall. (China blocks “objectionable” website content and monitors everyone’s Internet access.)
Google retreated to Hong Kong and Baidu took its place. Facebook was too frightening to Chinese censors, so Renren is the leading social media player. Email? Working professionals/white collar use emails, but most users grew up instant messaging on TenCent’s QQ and most are moving to Weixin/WeChat. Twitter? No, it’s Sina Weibo, and if you want games with your chat – TenCent. Amazon and Ebay? Nope in China it’s Alibaba’s Taobao or 360buy.com. If you’re outside of China, you never hear about these companies or interact with them because they’re geared to serve only Chinese users.
This closed but very large market means that greater than 90% of Chinese software startups focus exclusively on the Chinese market. (The <10% that decide to go global early do so by starting outside of China. Another 10% may try to go global when they’re larger and have the resources for two languages, cultures and regulations. )
This has resulted in a completely different consumer software ecosystem than found elsewhere in the world. Given the closed market to U.S. Internet companies, VC’s in China have guided startups to execute the “copy to China” model. Thinking, if it worked in the U.S., copying a known model is less risky than trying something new and untested. The problem is that this space is getting really crowded – from the bottom up as everyone tries the 200th clone – and from the top down, as the major incumbents try to fill every possible market niche.
The table below maps the type of software in China to their global equivalents in each product category in the Technology, Media and Telecommunications (TMT) sector.
A Huge Market Is Finally Real For a hundred years the fantasy of global marketers was, “ if only everyone in China would buy one…” That day is final here. The numbers of mobile subscribers are staggering – 1.18 billon, 260 million are 3G. Chinese Internet companies live in a large closed, self-contained ecosystem with 564 million web users with 420 million having mobile web access. 309 million use microblogs and 242 million shop online. (BTW, market research, financial and other statistical informationare usually unreliable in China, but even taken with a grain of salt these are staggering numbers.)
The table below from web2asia.com shows the number of users of online social networks as of 2009. Did I mention this is a huge market.
Investment in the Technology, Media and Telecommunications (TMT) sector The charts below from David Lin, Microsoft Accelerator detail investments in the Technology, Media and Telecommunications (TMT) sector – almost all of it is centered in Beijing. (Note that these numbers differ from the Zhen Fund data -welcome to statistics in China – but they both provide an overall sense of the market size and direction.)
45% of all Venture Capital Investment in China went into the Technology, Media and Telecommunications (TMT) sector.
The number of deals in Technology, Media and Telecommunications more than doubled in 2011 over the previous five years and slowed back down dramatically in 2012. More than 1,600 VC investments in TMT have been made since 2007, with a record high of 436 in 2011.
Internet investments makes up more than 50% of all the deals in Technology, Media and Telecommunications made since 2011, while, E-commerce investments, in turn, accounts for nearly 50% of the investment deals in Internet. Investments in Mobile Internet makes up roughly 11% of all the deals in Technology, Media and Telecommunications, and have been on the rise since 2011.
Series-A round investments dominates Technology, Media and Telecommunications (TMT) deals, making up 60% of all.
Beijing, Guangdong (including Shenzhen) and Shanghai came out as the most dynamic spots for Technology, Media and Telecommunications (TMT) investments.
Beijing Venture/Angel Ecosystem While Beijing has VC’s and Angel investors happy to write a check there aren’t as many angels/VCs in China versus US per capita. Several VC’s mentioned that there’s a funding gap for seed stage investments. The Angel/Seed network in Beijing feels fragmented and mostly inexperienced (as are a good number of the China VC’s). Kind of reminded me of the drivers in Beijing – they were all driving in a way that made me think they all just got their drivers license – until I remembered that they did. Car sales in China went from 1 million in 2001 to 14 million in 2011.
Other Beijing ecosystem issues I heard about were the things we take for granted: the lack of knowledge sharing (“pay it forward” isn’t part of the culture,) limited mentoring (few experienced mentors,) and a lack of open source education, and no AngelList model. In the U.S. it’s easy to share and browse ideas and deals, but in China there’s a long legacy of guarding knowledge as power, and the justifiable paranoia of someone copying your idea prevents sharing.
Liquidity Unlike the U.S. there are almost no mergers or acquisitions in this market segment. It’s much easier to just steal their ideas and hire their employees. So big companies rarely acquire startups. Liquidity for most Internet startups happens via IPO’s. 70% of exits in China are via IPO (in the U.S. on NASDAQ or the NYSE or on ChiNext, China’s equivalent of NASDAQ) compared to the 90% of exits in US via mergers or acquisitions. Alibaba (commerce), Tencent (games/chat) and Baidu (search) all have market caps over $40 billion.
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, Frank Hawke of the Stanford Center in Beijing, and my publisher China Machine Press.
The Rise of Chinese Venture Capital China’s move away from a state system that solely depended on a command and control economy started in the 1990s. The first wave of startups began when R&D centers and universities began to provide the technology and seed capital for new startups that were spin-outs or spin-offs. This could be a group of individuals leaving a university or research center or an entire department leaving. For example, in the 1990’s 85% of the start-up funds of the new technology companies founded in Beijing came from the research center or university they left.
The second wave of technology investors were Chinese banks, who provided the majority of the later stage investments in the Torch Program. By 1991, 70% of the Torch funded startups were getting bank financing for expansion and later stages of the new ventures, with local governments acting as guarantors. Like the U.S. SBIR and STTR programs, the Torch Program’s funding for new ventures was limited to seed funding the front end. Being designated as a Torch Program startup gave banks comfort to provide loans to these ventures for technology commercialization.
Technology zones with Science and Technology Industrial Parks were the third source of support for new ventures. Inside the zones were Torch Technology Business Incubatorswith startups licensed by the local governments. These local governments financially supported the startups because, by locating in these zones, the new ventures were seen as contributing to local economic development. This helped the startups qualify for funding from banks and venture capital firms.
By the mid-1990s, Chinese leaders realized that the Torch program couldn’t be the source of all capital for startups. At the same time neither banks nor local governments had the cash to finance startups on the scale the country needed. The problem was that in China the government didn’t recognize venture capital firms as a legitimate organizational type. The founding of domestic VC firms began with the establishment of local government-financed venture capital firms (GVCFs), followed by university-backed VC firms (UVCFs). (The State Science and Technology Commission and the Ministry of Finance formed the China New Technology Venture Investment Corporation in 1986, but it was a government agency supporting national technology venture policy objectives, rather than a profit-oriented private enterprise. It went bankrupt in 1997.)
A few foreign VC firms like IDG Capital Partners entered China in the early 1990s. Gradually, from the mid-1990s, the perception of venture capital shifted from its being a type of government funding to being a commercial activity necessary to support the commercialization of new technology. But it wasn’t until 1998 that corporate-backed VC firms could be established, and that started a wave of VC funds backed by government, corporate and foreign capital.
Investing in China Today Fast forward a decade, today the Private Equity and Venture Capital business is booming in China with over 1000 firms actively investing. Most of the early deals were done by offshore venture funds – with their fund registered in countries outside China and using dollars. The latest trends are as Renminbi (“RMB”) funds (the Renminbi is the official currency in China.) In the past foreign funds who wanted to invest in China had to set up funds using dollars with complicated offshore structures with exits through offshore listings. The Renminbi funds have fewer restrictions on what industries the fund can invest in, less regulatory oversight and access to listing a portfolio company in China. There are two types of Renminbi funds: domestic funds and foreign-invested funds. Domestic Renminbi funds are fully owned by Chinese investors, while foreign-invested Renminbi funds may be partially or fully owned by non-Chinese investors. Both types of funds are organized under Chinese law and use Renminbi to invest in Chinese companies.
The other big change was the creation of ChiNext, China’s equivalent of NASDAQ stock exchange for start-ups, in 2009. The market was created to provide startups and their investors liquidity. Over 100 startups were listed on ChiNext the first year of its launch at sky-high valuations (average of 66 times earnings.) About 60% of the startups listed on ChiNext were backed by Renminbi funds, making the investors of these funds one of the main beneficiaries of the exchange.