Journey of the Silicon Dragon

Let’s start with a small trivia. Can you name this city? It is the second busiest port in the world and home to 297 skyscrapers – the second most concentrated in the world. Your iPhones as well as a majority of the branded electronics products are manufactured there. It is also home to some of the most valuable startups in the world, the most advanced tech parks and innovation centers. Yes, we are talking about Silicon valley here, but from China, not the USA. Shenzhen is the metropolitan place where Silicon valley’s dreams are manufactured as real products.

Shenzhen is the source of fire that has helped the Dragon win over the world economy despite being a ‘non-capitalist’ country and having a closed economy. Today, China is home to 227 unicorns (startups valued at $1 billion or more), nearly the same as the USA’s 233 number, accounting for 39% of the world’s Unicorns. The most valuable startup – ByteDance (TikTok’s parent company) is also from China.

Even more interesting than these stats is the peculiar journey China has taken to reach where it is today. In 1980, China’s GDP per capita was $195 while India had $267. And today, China’s GDP per capita is nearly 5x of India’s . With a poverty rate of almost 90% in 1981, they lifted around 800 millions out of poverty in the next 35 years.

In this article, we try to analyze the factors that woke up the mighty Dragon to triumph over the world, and the direction it is heading towards.

Awakening of the Dragon

1980s Economic reform in China

Prior to 1979, a large portion of China’s economic output was controlled by the state, whereas private enterprises and foreign investors were generally barred. Foreign trade was also limited to goods not manufactured in the country. After the death of the leader Mao Zedong in 1976, Deng Xiaoping took the helm in 1979 – the man responsible for the turnaround of China’s economy.

Deng created four special economic zones (SEZ) in 1980 along the southeastern coast. Few years down the line, the Chinese government also opened these cities to foreign trade and investment. One of the SEZs was Shenzhen – just a stone’s throw away from Hong Kong. But it wasn’t such an easy task to build a city that is radically different from a communist country. They literally put physical fences along the city’s perimeter to separate it from the country. Normal Chinese visitors had to obtain special permits to enter the area. Instead of waiting for businesses to invest in the infrastructure like in other emerging countries, China excessively focused on building infrastructure and production facilities. SEZs were given special freedom to loosen the government’s control over prices and foreign investments. The country’s capitalist experiment did pay off. Shenzhen was flooded with foreign money. Cheap labor, government support, proximity to the huge consumer base, and entrepreneurial culture led to many global companies set up their manufacturing plants in the area. Soon it became the world’s largest manufacturing hub. Shenzhen transformed from being a small fishing village with a 30,000 population to the startup hub of Asia with nearly 12 million population in the next 30 years.

Shenzhen’s gross domestic product (GDP) increased from a mere $28 Mn in 1979 to nearly $429 Bn in 2020, surpassing both Singapore and Hong Kong!

Having discussed China’s economic reform, let us now discuss how the startup ecosystem has evolved over the years.

Wave 1 (BAT – Baidu, Alibaba, Tencent) [1990s]

The majority of China’s startup boom can be attributed to the extraordinary successes of the tech giants – Baidu (read Google of China), Alibaba (read Amazon of China), and Tencent (AI, Gaming giant). Established in the late 1990s, the companies have emerged as dominant global players in Search, eCommerce, Social media, and Gaming industries. Not to disregard the fact that the government’s protectionism and access to foreign capital played a key role in making them parallel to the US FANG giants (Facebook, Amazon, Netflix, and Google).

Wave 2 (XTMD – Xiaomi, Toutiao, TikTok, Meituan, Didi) [2000-2015]

The success of the BAT trio showed Chinese entrepreneurs the opportunities that lie ahead. This led to the emergence of a new wave of tech giants, including Xiaomi (world’s fourth-largest smartphone manufacturer); Toutiao (AI-powered news aggregator), and TikTok (short video app); Meituan (food delivery app); and Didi Chuxing (read Uber of China).

Wave 3 (Tech Titans – DJI, BYD, BGI) [2015-current]

“In less than two decades, China tech innovation has evolved and gone through three phases of development: from copy to China, to invented in China, and now today, the biggest trend to watch is copied from China,” Rebecca Fannin, Author of “Tech Titans of China”

Chinese products have always been mocked as being low-quality copy-cats. Much of the Chinese success has been awarded to the rampant IP theft and democratization of stolen technology due to the lack of IP regulations. Although this is true for most of its part, the picture has changed a lot. China has seen a surge in innovative startups that have helped them become leaders in emerging fields such as AI, and EV. In 2020, the country toppled the US dominance securing first place in the international patent filing race. The world’s biggest maker of telecom equipment, Huawei, has been the top business patent filer for the last three years.

Well, it may be surprising to believe but nearly two-thirds of the global investment in AI was put into Chinese startups in 2018. There were around 14 AI Unicorns in the country around the same time, the number would be even higher today. One of the key players operating in this space is DJI. Their products are widely used in the global production of the music, television and film industries as well as in military applications. With a share of 76% in the drone market, the company has become an invincible player in the global drone market.

All of us are aware of China’s dominance in the EV market. It is home to a number of companies involved in battery, and vehicle manufacturing, which has helped China maintain its position as the largest auto manufacturer since 2009. Most notable among them is BYD, the company which started as an electronics manufacturer building batteries for our 1990s cell phones, is now the largest producer of plug-in vehicles. However, it is not even close to its rival Tesla in terms of publicity!

While we have discussed startups in the tech space, China hasn’t left behind in the life sciences as well. A number of startups focusing on genome sequencing of animals, plants, and microorganisms with practical applications in a variety of fields, have emerged in the last two decades. Consider, for example, BGI – founded in 1999, is currently the world’s largest genome sequencing company. The company declared in 2020 that it plans to make genome sequencing super cheap – just $100 against the prevailing cost of $600! If realized, this could have a substantial impact in various fields impacting billions of human lives – early-detection blood tests for cancer, and prenatal testing of pregnant women, to name a few.

And there are many more giants such as Bytedance and Ant Financial that we have not even discussed here since the list is too long. Although we discussed how the dragon was woken up, you must be wondering what made it possible for it to conquer the world.

Sources of the Dragon’s fire

Audacious support by the Government

China’s infamy as a surveillance state especially on the outside companies has worked in favor of local startups. While governments usually play an important role in facilitating innovation and fostering entrepreneurship, the Chinese state has taken a much more active role by keeping itself at the startup ecosystem’s center.

During the ‘third wave’ of entrepreneurship, China launched the ‘mass entrepreneurship and innovation’ program in 2015 with a vision to lead the world with a focus on technological innovation. The government has taken a number of initiatives to improve the ease of doing business in the country such as reducing the market barriers and cutting down the number of steps required to start a business. With state-backed incubators and massive funds, the state quite often acts as a primary source of funding or as a major shareholder in many startups.

From the policy front, they have adopted the practice of decentralization wherein local governments of the specific geographies or SEZs, are given the freedom to have distinctive strategies. Governments in SEZs provide for housing, office, subsidies, and even salaries for major tech startups considering the unique characteristics of each region. The following infographic shows the top 4 regions that specialize in different aspects of businesses in the country.

Easy access to funding money

Apart from the government funding, a number of Chinese serial entrepreneurs who have also become angel investors have played a critical role in China’s emergence as the technology leader. The evolution of China’s ecosystem, strong local market, and history of multiple blockbusters have also attracted sophisticated investors from across the globe. 2015 to the first half of 2018 was the best period for Chinese startups when supergiant VC deals (of $100M+ size) even overtook the US in terms of a number of deals. During the same period, China had more than 11,800 incubators actively engaged with nearly 620,000 startup enterprises! The insane amount of capital influx also fueled the entrepreneurial activity in the country.

Success of the BAT trio (Baidu, Alibaba, Tencent)

In many ways, the success of the BAT trio as super unicorns during China’s first wave of entrepreneurship has been a critical factor in motivating a new generation of entrepreneurs. The government learned the best ways to boost the startup ecosystem while the founders realized the attractive space the economy provides for the new startups. Many employees from BAT have since started their own companies while some have taken the role of investor – building a strong mafia network in the ecosystem. (Interested to know more about the startup mafia? Read our piece here.)

The BAT trio are among the top 10 institutional investors for startups. Around 23% of the Chinese unicorns have received funding from at least one of the three leading tech titans.

It is nothing less than a magical story where all the pieces have come together for the success of China in the last 3 decades. But now that the times are changing, we need to ask how long China can keep leveraging on the things that have worked well so far? More importantly, what will be its strategy going forward?

Where is the Dragon heading now?

Government interference – A hand overplayed?

While the government’s excessive involvement in the ecosystem has bore fruits for the country’s growth, it has also come with many downsides. China’s whimsical approach towards international trade policies has given rise to uncertainties in the business community. This has resulted in losing investor confidence in the country. The amount that Chinese companies raised from global investors decreased from $93.4 Bn in 2018 to $35.6 Bn the next year. But it’s not only the government that is to blame here. The godfathers of China’s startups – the BAT trio also seems to be meddling with their younger counterparts in the country while themselves struggling to expand outside China.

The fading shine of BAT (Baidu, Alibaba, Tencent)

While the BAT trio has achieved a spectacular feat in China, they haven’t really been able to internationalize their business. Baidu has benefitted the most due to the ban of Google but they could not spread their wings any further. They first entered Japan in 2007 and later in the emerging countries, including Vietnam, Thailand, Indonesia, Brazil and Egypt. While trying to blatantly apply its Chinese strategy in these countries to fight its archrival (Google), they eventually had to shut shops.

WeChat, too was reluctant to change its China-oriented product and eventually got stuck in the country. The only sector where Tencent has been successful globally is gaming. Alibaba on the other hand has tried hard in diversifying its international portfolio. They followed the M&A route to integrate firms across payments, eCommerce, messaging, and logistics industries but apart from eCommerce business, all met with lackluster performance.

Well, it is not all about BAT failing outside borders. Their excessive growth in the country has also come at a cost for the industry. In gobbling up new startups for their expansion, they eventually pose threat to the freedom of young startups. The government also fears and rightly so, that they might become too large to control, and that’s why the state has been trying to cut Alibaba and Tencent’s wings off through anti-monopoly rules.

Does this mean the government’s chains are prohibiting Dragon’s flight? Is the Dragon’s fire fading away? Maybe. But one thing which is evident is that there is a new beast emerging in the country – all equipped to conquer the 21st century – the Tech Titans.

The new era of the Tech Titans

While BAT has been struggling to expand their wings beyond China, new-age startups on the other hand seem to have learned the lesson from this failure. Most of these startups have digital products and offer high degrees of localization. Look at TikTok for example. ByteDance has completely different product offerings in China than in India or any other country.

Another interesting strategy that these startups are following is the Ecosystem approach. Rather than acquiring companies and trying to make them “Chinese”, they are acquiring controlling stakes in the international companies while trying to leverage the synergies between the two. Ridesharing company, Didi, invested in Uber, Grab, and Careem while also merging with Uber in the local market.

So, will China be able to sustain its dominance in the times ahead? We hope the government has embraced radical changes already in the 1980s and will not hesitate to do so again. Also, the ecosystem that has evolved itself from being copycats to being a source of innovations seems all set to become the world’s technology powerhouse.