“It is imperative to develop a small number of high value relationships in the region before you make any major investments.”
As part of Notion’s “Journey East” series, Patrick Norris explores the tech scene in China and reflects on some of the opportunities and risks in doing business there. You can download the full report here.
As an active investor in technology firms with global ambitions, it is vital for us to understand the opportunities, challenges and risks presented by China.
The China Tech Scene
Starting at the top, there are three companies you really need to know: Baidu, Alibaba and Tencent – commonly referred to as BAT. Baidu dominates search, Alibaba has cornered e-commerce, and Tencent is the king of social media and gaming.
Each of these companies is incredibly powerful and frequently makes strategic investments in international businesses – from executing Joint Ventures with international companies coming to China, through to investing in international venture funds. Competition is intense. Each move these tech titans makes sends ripples through the rest of the Chinese tech industry; and they are all hungry for more growth. They set the trends in the market.
While most historical tech investment and focus in China has been on B2C, B2B is increasingly of interest; there is particular appetite for B2B2C players. This is really just a natural development of the domestic economy as labor wages rise, producing an increasing requirement for operational improvement. Some of the largest funds operating in China (including Softbank and Sequoia) are putting a lot of time and effort into B2B investing.
Above All, Find a Local
For foreign startups looking to break into the market, it is imperative to develop a small number of high value relationships in the region before you make any major investments. Access to the right people is hard to achieve but worth the effort – it will save you a lot of time and money.
Chinese government members and powerful family connections are still incredibly important to accessing and successfully operating in China. A highly influential local partner is critical.
Identifying and connecting with trustworthy local investors is more important than ever to doing business in China (i.e. a fund or family office). It is particularly helpful to do extensive due diligence on local teams that you may be seeking to work with, as legally, to operate in China, you will need to conduct a JV or acquire a Chinese company. In addition, since by law 51% or more of a JV must be owned by a Chinese company, there are a plenty of horror stories of international companies losing out in dramatic style.
A Few Words of Caution
There are further considerations to bear in mind when expanding into the Chinese market:
– The Chinese government has stated a domestic strategic goal to cease relying on international technology companies by 2020 in favour of domestic firms making up the bulk of service providers. The regulatory deck is often stacked against foreign tech ventures in favor of domestic players. This factor deserves serious consideration when looking at the long term suitability of China as a place to do business.
– In order to gain access into the Chinese market, large foreign technology companies are often required to base very high value R&D roles within China. For example, the government demanded that Microsoft’s source code for Windows and Office be developed in China. As these burdensome demands have continued to increase from the Chinese government, large tech companies from the US have left the country for IP safety reasons. However, these companies have also left large teams of former employees comprised of Chinese nationals in-country. They have in-depth IP knowledge and are starting to build very cutting edge copycat products. Just as China has long been known for copycat hardware and products, the same trend now extends very much to all technologies.
– Lastly, the degree of competition is incredibly high and exceeds anything in terms of development speed, resource and intensity that most of us have ever experienced in Europe, the US, or even the hotbed of Silicon Valley. The work hours in Chinese tech companies are referred to as the “996” – working from 9am to 9pm, 6 days a week – something unheard of in other tech centres around the world. Elsewhere in this study, every one of our commentators with experience of China has noted the importance of local connections and patronage, both culturally and in the enforced system of JVs. But perhaps most exciting is the pace of change here. The government, particularly under President Xi’s ambitious and unfettered plans, is connecting talent with funding to accelerate China’s technology expertise beyond all expectations.