A decade ago, China would be dismissed as global technology and innovation hub. However, there has been a dramatic change over this time, and especially over the past five years. Just some data to consider comparing China’s technology sector to the USA:

• The market value of listed Chinese internet stocks has risen from 20% to over 50% of the market value of the US internet stocks.
• The venture capital available in China is now more than 80% of what is available in USA, compared to around 10% 5 years ago. In 2014, it overtook Europe as a destination for venture capital.
• The value of Chinese “unicorns” (start-ups with greater than a billion-dollar valuation) is now three-quarters of the value of US “unicorns.” China now has more unicorns than any other country except for the US.

The Evolution of Chinese Technology Sector

Since the turn of the century, Chinese technology sector has gone through three phases. Initially, it was considered as irrelevant to the world, comprising of copycat firms with deep government links. As some of these companies grew substantially such as Baidu, Alibaba, Tencent (sometimes referred to as BAT), in the second phase, they were considered unique species that could only succeed in their protected domestic market. Yet, the savvier observers had already begun to distinguish between those technology firms like Huawei and DJI that were becoming world beaters from the domestically focused internet companies (e.g., BAT).

Now in the third phase, it is increasingly recognized that while benefiting from protected markets, even the domestic Internet companies are developing world class capabilities and innovation. Protecting the domestic market usually leads to sub-optimal outcomes, unless as stated in my Brand Breakout book, it is for a limited time and combined with fierce competition among domestic players. Clearly, intense competition as well as the learning from the US helped early entrants unleash significant innovation.

The Chinese players have been able to selectively leapfrog the American companies that were pioneers globally. For example, the late development of China resulted in a significant lag to the developed world on having an established large bricks and mortar retail store network as well as no substantial legacy technology infrastructure (e.g., PCs) and paucity of credit cards issued. As a result, ecommerce and digital payments via smart phones were more easily adopted by the Chinese population. The ecommerce transaction value in China is greater than in the US, while the mobile payments run ten times of US!

Similarly, observing the profitability limitations of the Amazon business model that was dreamt of as a retailer on the web, Alibaba invested in becoming a platform where it is attractive for brands and manufacturers to sell on it. While clearly Amazon is evolving into a platform, I am sure if they had to start all over again, Amazon would conceptualize itself closer to the Alibaba model. Similarly, in the messaging space, Tencent’s WeChat has been far more successful in converting its installed base into revenues through mobile gaming and freemium compared to WhatsApp.

Finally, the competition in China between the many entrepreneurs and private players funded by venture capital drives greater innovation.  While bike sharing is available all over the world, more than twenty Chinese players entered this sector. The result is companies like Mobike have developed for the Chinese consumers, the easiest interface, most convenient customer proposition, and the cheapest bike sharing in the world.

The Weaknesses of Chinese Tech Sector

From a strict market capitalisation perspective, Chinese firms do rather well in world rankings because their domestic market is extremely valuable. But in terms of overseas success, we need to distinguish between non-internet players such as Huawei and DJI versus the internet firms like BAT.

Huawei, DJI, and even Xiaomi have been successful in their global outreach. Huawei is now the global leader in networking equipment and number three for smartphones. DJI had 70 percent share of the world drones market. In contrast, the internet companies like BAT or Didi have yet to demonstrate their ability to conquer the world. This is especially true when compared to the US players, Apple, Facebook, Google, and Uber. The result is that US technology firms generate 200 billion dollars of profits from overseas markets, while Chinese internet firms generate relatively little revenue from foreign markets. Yes, Alibaba is the largest ecommerce company in the world, but it is solely as a result of China.

Chinese internet firms have no choice but to acquire their way into overseas markets. They are doing so, but acquisition is a strategy fraught with risk under normal circumstances. And more so when it comes to foreign acquisitions. Chinese companies have yet to demonstrate their ability to acquire foreign firms and integrate them successfully. I am sure it will happen one day, but when, and at what cost?

One other challenge that China faces is the lagging semi-conductor industry. China imports ten times more chips than it produces. In fact, this annual import bill of $200 billion a year is second only to oil for China. While China’s share of worldwide chip fabrication capacity has now become about 15% from nothing in 2000, it is a matter of great frustration to the government. The Chinese government has committed to raising this capacity to 50% by 2020, and is therefore committing $150 billion to this sector via a mix of public and private funding.

Beyond the deficit on chips, China lags in generating IP (intellectual protection) revenues. Its outflow is around 20 billion dollars compared to an inflow of just over a billion. This is despite the fact that China is now the largest domestic patent market in the world. Even for international patents, China is second only to the USA. Huawei is the largest corporate patent filer in the world. Yet the deficit on IP royalties demonstrates that the patents filed by China are not as commercially valuable as those by US firms.

The Fight for the Future

I have no doubt that both China and US will continue to fight for supremacy in technology. The advantages of US are many and it would be foolhardy to bet against them. They do have the best ecosystem for start-ups, no lack of the funding, and the ability to attract the best and the brightest from across the world. Both Google and Microsoft are headed by Indians who emigrated to the USA. It is hard to imagine any major Chinese company being headed by an Indian, or perhaps even a foreigner, anytime soon.

One reason that some in the US worry about China is that they have observed the progress of the Chinese technology sector over the past two decades. It has come from nowhere to be a contender. With the Made in China 2025 program, the Chinese government has identified technology sectors crucial to the future and diverted resources in support. Besides clean energy, genomics, space, China is betting big on artificial intelligence (AI) and robotics.

Artificial intelligence is going to seep into every industry and US has a substantial lead. China’s dominance of global manufacturing faces both rising wages and a declining population. To retain their title as the world’s factory and also deliver increasing wages to its population, productivity must increase. China has no choice but to adopt robotics. This is why Chinese firms are acquiring and investing in this sector. I was surprised earlier this year to see little robots running around the lobby of my Shanghai hotel, which I had yet to encounter elsewhere in the world.

Finally, unless China improves its image in the rest of the world, its tech companies will be at a disadvantage to US firms. Many countries do not trust Chinese firms to serve their citizens because Chinese firms are supposed to be close to the Chinese government. Until China builds soft power this is a fundamental problem that cannot be solved without questioning the entire Chinese system with respect to control and transparency. Whatever the outcome, it will be fascinating to watch.

Warmly

Nirmalya

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