What I Learnt From the Chinese Innovation Ecosystem

The Caohejing Hi-Tech Park, a 14 sq km technology park which houses numerous international companies to incubator spaces like Fishburners Shanghai
David Lu Picture

Whenever an entrepreneur begins discussing their potential plans to expand to China, or conduct manufacturing there, I always find that there’s a degree of apprehension attached. Most commonly, I find that it’s fear of the unknown, or as the Chinese saying goes “水很深” (thanks Rayn Ong)— which literally translates to “the water is very deep.” No one really knows how deep the water is, so naturally, very few dare to cross.

The analogy I like to use, is to think of Australia as one side of the river bank, and China on the opposite side. The banks are separated by a large mass of water. There are very few bridges that lead across this river, so for many, the only way across is to walk through the water.

The bridges here represent the few links that Australia has into Asia. Folks like Mathew Benjamin, Haymarket HQ and Fishburners Shanghai are doing an incredible job at building these bridges across but frankly, there just simply isn’t enough understanding about China going around for most entrepreneurs to feel comfortable venturing into the Chinese market.

The market here is very, very different to most markets around the world. I don’t believe the term “global” encompasses China. The Chinese market is a separate beast entirely and must be respected as such.

The good, the bad & the ugly

There are some fundamental differences between the Chinese and Australian ecosystem. I’ll start with what I found to be the key selling points of entering the Chinese ecosystem followed by the unique challenges founders are faced with when trying to break into this market.

Scale

What blew me away at every turn of this trip, was the scale at which things were done here in China. I’m not necessarily referring to the scale of the startups here, but the facility and resources that go into supporting the ecosystem. Take the Caohejing Hi-Tech Park (CHJ) as an example. It’s one of many technology parks in Shanghai that spans 14 sq km. Caohejing is home to more than 3,000 domestic and overseas high-tech companies, including over 800 foreign invested enterprises. To give you an indicator of scale, in 2015, the combined sales revenue of CHJ enterprises totalled 258.8 billion RMB. You can read more about Caohejing here.

 

Peter Davison, early stage investor in the likes of Paypal, Pinterest & founder of Fishburners, shares his thoughts on the scale of the Chinese marke.

Evan Gao, the manager of the Fishburners Shanghai space, remarked that one of the companies incubated there had just raised $1 million USD in the space of a week. In Australia, to raise that amount would take the better part of 3–6 months. A week would be unfathomable. There are countless other stories I’ve heard from entrepreneurs and VCs alike where a mentor has taken a liking to a company and promptly writes a 3 million RMB cheque (approximately $600,000 AUD) to companies in the space of a day. At a larger scale, Ofo recently raised $0.7 billion USD lead by Alibaba, and Mobike raised a similar sum of $0.6 billion USD from Tencent in June — all in the space of one month. The burn rate is also quite phenomenal. Both companies having raised in the order of a few hundred million USD as part of their Series D a mere 6 months ago, which just goes to show how fierce the competition for market share is in the Chinese market.

Investors here are willing to make such investments in extremely short time frames because they want to bet on scale. Rather, they have to be quick before the deal gets snapped up by other investors. When you have firms like Sequoia China that sits on a total FUM of $8 billion USD, and many ultra-high net-worth individuals, the landscape can get very competitive, very quickly.

China’s market has the scale that no other country has at the moment. For example, WeChat boasts over 800 million users. There’s a phrase in the SaaS playbook that goes T2D3 (triple, triple — double, double, double) that refers to a company’s annualised revenue growth. In the Chinese market, the figure goes something along the lines of 10x, 10 x— 5x, 5x, 5x. Assuming the case where an Australian company and a Chinese company are both turning over $1m ARR, in two years the Chinese company will be at 100x whereas the Australian company will be at 9x.

That being said, it’s not an easy process to build a business in China. It’s a combination of understanding the local market, knowing the right partners to work with and putting the right strategy in place to execute in this very unique market.

Copycats

The Chinese market is largely famed for being a “copycat” market — develop anything vaguely proprietary and expect to get it replicated in a very short time. There’s a common saying that “Whatever you can do elsewhere in 12 months, you can do it in 3 in Shenzhen” — so don’t expect to have a twelve month window to fend of copycats. Whilst I still think that holds true, I believe the innovation model is rapidly changing. Before, it was very much a case of Chinese companies copying Western models and trying to improve on them, but now, it almost feels like that role has been reversed.

WeChat and Facebook are great examples of this. WeChat offers an array of rich features such as advertising, e-commerce, digital content, online-to-offline services, and finance. In comparison, Facebook Messenger offers none of these, while WhatsApp has just started on finance. In the first quarter of 2016, WeChat generated $1.8 billion in mobile revenue, dwarfing WhatsApp’s $49 million, and Facebook Messenger’s embarrassing nil. WeChat is a classic example that demonstrates the Chinese firm’s ability to innovate.

 

A sea of dockless bikes, featuring the likes of Mobike, Ofo and approximately 20 other competitors.

Moreover, there is a dramatic shift in younger startups. A standout example of this is the bike sharing services I referred to earlier: Mobile and Ofo. These companies and vertical showcase two things to me: first, the disruptive potential of Chinese entrepreneurs and second, the fiercely competitive nature of this market. Who would have thought that deploying millions of dockless bicycles around China would have worked out.

Intellectual Property (IP)

The common thing many foreign founders are scared of is IP leakage. The key message I want to share is that the IP situation is far better than what people think it to be when it comes to China. The fundamental difference between China and many other countries (including Australia) is that IP in China does not follow a first to use, but first to file trademark system (patents and designs are first to file, same as Australia).

A foreign business can register its trademark, have local authorities raid infringing factories, take infringers to court, and have Chinese customs seize infringing goods before they leave China’s borders. But you must prepare early, register trademarks and other key IP in China, and understand how to use the system. It’s important to get good legal advice regarding IP well before you approach the market. Most problems faced by Australian businesses in China are not caused by China, but by inadequate preparation.

Admittedly, I am no expert on IP law, let alone Chinese IP law. Fortunately for all the Australian founders out there, there are some great folks and resources for you to get set up in China. If you’re looking to enter the Chinese market, I would suggest you get in contact with Daniel Zhan, who is the Austrade Landing Pad Manager in Shanghai, an initiative that provides participants with a short-term operational base at the Landing Pad (Xnode) for up to 90 days, amongst other accelerator services. David Bennett is also a good person to get in contact with if you have specific questions regarding IP. He is Australia’s first IP Counsellor to China and is based in Beijing. See the Australian Government IP Protection page here.

Policy

The Chinese Government is taking some fairly radical steps to promote entrepreneurship and innovation in China. There’s a common belief that “only with quantity will you find quality,” which fits very well with China’s large population. I won’t go too much into detail into policy as it will differ across provinces and municipalities so I’ll just focus on the Shanghai government as a case study.

To promote ‘mass entrepreneurship and innovation’, the Shanghai government will compensate local investors for their financial losses. Yep, you heard that right — the government will compensate you for your loss.

In order to eligible for this scheme, the investment must a seed or early-stage startups which have been operating for less than three years. For seed-stage startups the yearly sales can not exceed 5 million RMB and they must not employ more than 50 people. Early-stage startups refer to companies with fewer than 200 people and assets less than 20 million RMB. Compensation for losses is up to 60% for seed-stage and up to 30% for early-stage.

The maximum amount of compensation will be 3 million RMB. A single investment organization can not receive more than 6 million RMB in total compensation per year. The amount of compensation will be calculated based on the difference between the profit investors gained from the investment and the amount of capital that was used to fund the startup.

Naturally, there are concerns from both the community and professional investors. The community are concerned that their taxpayer money is being allocated to investment firms with this policy. Investors on the other hand are concerned that the policy creates market inefficiencies, highlighting that using public money to compensate investment losses is ripe for disaster. This is somewhat similar to scene in Singapore, where the term grantrepreneur has been coined, referring to the entrepreneur who comfortably relies on heavy and frequent grants from the government, without actively having to seek funding.

If you’re interested to look at the official source of the policy, you can find it here.

Disclaimer: I am Shanghainese by heritage so this isn’t meant to be a shameless plug on how great Shanghai is (though it is pretty great and you should definitely visit.

Concluding Remarks

In the short time that I’ve been here, I’ve managed to take away some incredible learnings from Shanghai & Beijing. A huge thanks to Mathew Benjamin, Melissa Ran and Duco van Breemen, who set me up with their contacts in the local ecosystem, without whom, this trip would have been nowhere near as fulfilling as it was. And of course, to the folks in Shanghai who very graciously hosted me at their offices and took the time to chat with me — thank you Evan Gao, Peter Davison, Tim Luan, Allan Chou, Allen Chng, Jasper Gill, Daniel Zhan, Peng Zhang, Will Fan and countless others that made this trip what it was.

If you’ve got any comments, questions or just want to continue the conversation, please fill free to drop me a line at david@textbook.ventures or follow me on twitter @davidjlu.