The China Vortex

One of the things which I frequently hear from first-time visitors to China is that “It is so big!” Sometimes, I hear this even from Texans, an American state which takes pride in being bigger than almost any other state, with the exception of Alaska.

Westerners are not the only ones to fall victim to this thinking; Chinese also are enamored with these numbers. When I hear presentations, the most frequently heard numbers show 420 million mobile phone subscribers, 250 million IM subscribers, at which point the China virgins go gaga and start counting the yuan they are going to make (in their dreams) and planning their retirements (also in their dreams).

By now, I’m sure that you’ve figured out that I don’t buy into this view. Yes, China is big, but so what?

Instead, when you start looking at real revenue and earnings numbers, China is still way down there. And for many companies, both Chinese and western, it’s a difficult nut to crack.

But I don’t think that it needs to be. First of all, let’s get past the population and subscriber numbers. Yes, they are very big, and the only country which can even come close is India. All the thoughts, fantasies and conversation about projections should end there, and marketers should dig deeper to look at revenue and earnings projections, since they are the only real numbers which count.

Marketing 101 says that it isn’t the size of your market and number of units sold, it’s really all about your margins and accessories you can continue to cross-sell or up-sell to your customers after the initial sale. There is the often quoted example of “give away the razor, and sell the razor blades (where you really make the money).”

Since my field is the Internet, I frequently come across all kinds of interesting ideas where Chinese entrepreneurs are seeking funding. Let’s say that I’ve seen a lot of ideas in my lifetime, and I’m picky about what strikes my fancy. When I talk to people, I’m often looking for a “je ne sais quoi” which is different about them, or their products and services, and their ability to execute. China subscriber and user numbers don’t impress me, and make my eyes glaze over very quickly.

I’m much more impressed when people talk about revenue and earnings projections. I’m even more impressed when I find out that these numbers are not pulled out of thin air, and can relate to something the presenter/entrepreneur has worked on and delivered in the past. At this point, we cross the line from fantasy to a doable reality.

The trouble with many Chinese startups is that the founder is so focused on raising money that he forgets to even spin a good story about what he’s going to do with the money! And yet, China is such a hot place to be now that there are people with money who are willing to part with significant amounts of money without even asking for a good story about how they are going to execute!

Part of the reason so many poor ideas get funded is because the burn rate is so low in China that even if the startup fails in the initial stage, the burn can be kept so low that if/when the startup founder has to do a reboot (usually by coming up with a sensible idea), that there is still money left in the till for a repositioning and second chance. In reality though, I think that this is a bad strategy for investors. After all, if the founder/s did not come up with a good idea the first time, and it got funded, what is the incentive for him to come up with a good idea the second time around?

This is why countries like the US and Sweden and other countries continue to be competitive in the Internet startup field even though their initial startup costs and burn rate are much higher than in China. Being cheap and being good are too entirely different things, and often being cheap actually prevents you from being good because it allows, and even encourages, sloppy thinking and poor execution skills.

This is not healthy for the western investors and for the Chinese. This is a sign of a bubble, and is oddly reminiscent of that situation in the US just a few short years ago when many people thought that they could buy a house without a down payment and a job. Fortunately for China, the Internet sector is still a relatively small part of the economy, and while US and western funds may eventually come up $50 billion or so shorter in a few years, it won’t be significant enough to put a crimp in any venture capitalist’s or private equity fund manager’s retirement plans.

What is needed now, at least in the Internet startup area, are entrepreneurs who have actually had experience selling something, and actually understand the purchasing habits of Chinese consumers, and know how to provide a useful service to earn that money and are willing to put revenue projections into their pitches.

There are plenty of opportunities and China is still a big market. I can think of several things right off the bat.

But let’s stop talking population and subscribers, and start talking revenue and earnings, shall we?

Popularity: 67% [?]

Technorati Tags: alaska, burnrate, China, Chinese, earnings, economy, entrepreneurs, founders, funding, im, marketing, mobilephone, privateequity, projections, revenue, startups, sweden, texas, US, venturecapital

The Chinese government has done much to encourage the development of China’s west, particularly Sichuan province, which is the home to some 100 million people, making it larger in population than any single western European country, including Britain, France and even Germany.

From a business and consumers’ point of view, the region holds tremendous promise. Many large western companies, including Intel, Wal-Mart, MacDonald’s and KFC have all moved into the region in the hope of capturing some of the yuan which locals have to spend. From a consumer marketing point of view, and also from the manufacturing point of view, the region holds great promise.

However, this is still not enough. Compared to the east coast region’s of China, it is still far behind.

So what is holding the region behind in development?

In two words, it’s human talent. “Interesting places attract interesting people” is one of my favorite mantras. When I go to a place, I like to find interesting people, regardless of their profession, and listen to what they have to say. I look for different angles and insights from individuals which I cannot easily find elsewhere. Most of the time, I think of these people as very smart generalists.

My experience is that Shanghai and Beijing is full of interesting intelligent and very talented people, which is why I’m attracted to these two cities in China. They are evolving rapidly, which means that these cities have not yet congealed around certain professions in the way American or European cities, or even Hong Kong, have. They are full of surprises, and most of the time, these are pleasant surprises.

My theory is that these two cities draw the best Chinese talent away from the rest of China, leaving the other cities to struggle with the people they can convince to stay there, who usually are not as smart and talented. So, when Chinese or expats talk about Tier 1 cities (Beijing and Shanghai), they could just as easily be talking about quality human talent.

This creates a problem for western China: they have the consumers, and they can have good manufacturing up to the middle of the value-added chain, but they cannot catch up with Beijing and Shanghai at the top of the value chain.

Unless cities like Chongqing can figure out a way to keep the best human talent in Chongqing, the wealth and knowledge gap between the western part of China and the Tier 1 cities will continue to widen. Instead of climbing to the top, they will peak out around the middle and won’t make it into the ranks of world-class cities.

What the Chinese government, and most other governments, fail to understand is that it is not buildings, boulevards and museums which make cities world-class, it is very literally human talent. In spite of China’s huge population, I have only seen two cities, Beijing and Shanghai, which have the potential to make them world-class.

While some Chinese may take this as a slight, it’s worth remembering that the US, which has only 1/4 the population of China, but has a longer history as an economic superpower, has only three cities which can be classified as “Tier One”: New York, Los Angeles and Chicago.

There must be some undiscovered rule which makes this the case.

Popularity: 59% [?]

Technorati Tags: Beijing, chicago, China, chongqing, development, economic, economy, human, losangeles, newyork, population, shanghai, sichuan, talent, US

For most people, blogs are no longer exciting as they were in 2002, when they first burst on the scene. Part of the reason for this is because although the technology for blogging is mature, an economic model for bloggers has not really taken hold. This is especially the case in China, where there are a huge number of bloggers and the Internet has become hugely popular, but the economic rationale has not yet appeared. Several years ago, there was a lot of talk and conjecture about a long tail, and idea which Chris Anderson made popular with his book, The Long Tail.

Unfortunately in China, the long tail looks like a Manx cat. (The Manx is a variety of cat which is born tailless.)

Recently there has been much discussion in the US about the value of ad networks. The economic rationale for ad networks is simple: they buy unsold inventory and place ads in them so that no ads go unsold. Better to place ads anywhere than to have them wasted, right?

Not so fast, says Jason Calacanis. Quoting from ESPN’s recent tough statement banishing ad networks, he says that “the use of ad nets diminishes the value of their (clients’) brand and content by spreading it so widely, ultimately threatening existing relationships with advertisers”.

In his article, Calacanis argues that for that medium-sized publishers, they should take on the costs and responsibility of their own ad sales networks to sell their own inventory, instead of outsourcing to an outside ad network. He argues that a real publisher is in control of three things:

• Your writers
• Your readers
• Your advertisers

Moreover, he puts numbers behind his definition of a mid-sized publisher. If you have more than $250,000 in ad sales, you should hire your own dedicated sales person.

His advice is that if you are a mid-sized publisher:

1. Hire three ad sales people
2. Spend 50% of your time going to ad meetings and conferences
3. Kick out your ad networks and use something simple like Google Adsense to take up your backfill

Another article about how Gawker Media pays their writers left me even more interested in how these numbers would translate for China. Gawker writers are not paid a salary, but simply get an “advance” against pageviews. Basically they have to hit their pageview numbers if they are going to do well. Moreover, these numbers are public.

This raises a really interesting question: How would these US numbers for pageviews and traffic volume translate to make sense in China? And could it be that blog ad networks in China have held down bloggers’ salaries by providing low quality untargeted traffic, and the only way to turn the situation around is to have publishers build their own ad sales teams in-house instead of relying on outsiders to sell their ad inventory so that they can pay their writers a working wage?

I suspect that the answer is “yes”, because only a publisher has the best sense and feel for their own content and audience. Ironically, it could well be that ad sales for medium-sized networks are something which cannot be sold best over the Internet.

Now, that would be a change, wouldn’t it?

Popularity: 64% [?]

Technorati Tags: adnetworks, advertising, blog, blogging, blogs, China, Chinese, espn, gawker, jasoncalacanis, longtail, media, outsourcing, pageviews, sales, traffic, US, web

Although Joseph Stiglitz’s book Making Globalization Work came out more than a year ago, I did not read the book until the past week. However, the book is so important that I must write about it for my readers.

For many people, globalization is a fairly black and white issue: either you are for it or against it. I have been a critic of globalization in its present form here, here and here. While a few who have commented on those articles believe that this meant I was against globalization, that is not in fact the case. I am just against globalization in its present form because all governments have so far acted in what they perceive to be their best national interests, when in fact they are acting in their own very narrow national and often, corporate, interests and have left most of their own citizens behind. This is especially true in the case of the US government which, as Stiglitz outlines in this book, has acted mostly as a proxy for large corporate interests, putting the interests of most Americans and everyone else behind those narrow interests, and without much regard for the consequences.

Stiglitz is very candid about how these interests, for the most part, are in fact contrary to the interests of other countries and the vast majority of US citizens. This is very admirable as Stiglitz played a major role in the US government, serving as chairman of the president’s Council of Economic Advisors in the Clinton administration and then in the World Bank, where he served as chief economist until January 2000. He is remarkably candid in his observations:

For much of the world, globalization as it has been managed seems like a pact with the devil. A few people in the country become wealthier; GDP statistics, for what they are worth, look better, but ways of life and basic values are threatened. For some parts of the world, the gains are even more tenuous, the costs more palpable. Closer integration into the world economy has brought greater volatility and insecurity, and more inequality. It has even threatened fundamental values.

This is not how it has to be. We can make globalization work, not just for the rich and powerful but for all people, including those in the poorest countries. The task will be long and arduous. We have already waited for too long. The time to begin is now.

These two paragraphs work for the citizens of all countries, not just the US and China.

Stiglitz comprehensively covers the problems with globalization chapter by chapter:

• Another World is Possible
• The Promise of Development
• Making Trade Fair
• Patents, Profits and People
• Lifting the Resource Curse
• Saving the Planet
• The Multinational Corporation
• The Burden of Debt
• Reforming the Global Reserve System
• Democratizing Globalization

Step by step, he looks at the current situation and its inequities, and proposes remedies so that globalization will work not just for the rich, but for the poor as well. His remedies are well thought-out and balanced, and also very well presented.

My question is: What are the chances of their adoption? I would say that I am not sanguine about the chances. There are too many variables at work, and so far, politicians have not shown the capability of national leaderships to rise above narrow interests. Even when it comes to narrow interests, they do not do the right things.

For example, let’s look at global warming, a problem which is literally becoming more serious every year. This will quickly lead to a series of cascading events which will rapidly spiral out of control, threatening the very existence of humanity as we know it. While there are very well-meaning people who want to do more to clean up the environment, they lack the basic understanding of economics to understand what needs to be done.

Essentially, we are keeping the costs of energy production artificially low by not figuring in the costs of environmental damage and healthcare upfront. This is the reason carbon emissions in China are running out of control.

Governments’ policies in pursuit of cheap energy are literally destroying future generations all over the world, since they will have to shoulder the costs of cleanup.

If there are future generations.

What is the real cost of economic development if future generations have to pay in shorter lifespans, lower quality of life, and a much more hostile environment where the people who are left are crowded into the relatively habitable parts of the planet?

Making Globalization Work shows that the future does not have to look like Mad Max. But are we smart enough to avoid it?

If you are interested in the future, then you must read this book.

Popularity: 47% [?]

Technorati Tags: , China, environment, globalization, globalwarming, government, policy, stiglitz, US

Environmental experts paint a bleak picture of the future when the subject comes to global warming. Now, it turns out because of the rapid increase in energy needs in China, what were originally worst-case scenarios for global warming will now, almost surely, turn into best-case scenarios.

This is because many of the decisions for new power plants and energy have been pushed from Beijing down to the provincial levels, and simply put, the provinces have more incentive to produce more energy than to decrease carbon emissions. What was a bad situation becomes much worse, not just for China, but for the whole world. While the US has previously been the world’s worst emitter of hydrocarbons, China is on the path to replacing the US to become a hydrocarbon emitting country on a much grander scale, and in a league of its own. This will lead to much greater condemnation of China in the international press and also in China’s more vocal domestic arena of public opinion which uses the Internet as its main venue.

Richard Carson, a professor at the University of San Diego, is the leading expert on China’s carbon emissions, and he has co-authored a paper on his measurements and forecasts for carbon emissions based on his on-the-ground work in China. You can read about it here.

Popularity: 38% [?]

Technorati Tags: carbon, carbonemissions, China, emissions, energy, environment, internet, planning, pollution, scenario, US

When I talk about the west in the title, I’m referring to the western part of China.

A great deal of thought and ink and pixels have been devoted to how the recent violence in the western part of China has affected the country’s image in the runup to the Beijing 2008 Olympics. I’m not going to talk about that because I have nothing new to add to that conversation.

Instead, I’m going to talk about how those events are likely to affect Chinese government fiscal and monetary policy.

These recent events have shown that the income gap between Han Chinese and Tibetans is growing, and that there are significant numbers of Tibetan youth who do not see a bright future for themselves. They are perfect fodder for unrest. Beijing has tried to mollify things by moving significant numbers of Han Chinese into Tibetan areas to start small businesses but, for the most part, Tibetans are still deeply religious, and many prefer a nomadic lifestyle to living in cities where they cannot find work.

This is the trouble with an urbanization policy: it works fine if people are employed. If they are not employed, there are all kinds of social problems.

The biggest problem is that there is no Tibetan merchant class as there is among Han Chinese.

The central focal point of Chinese social policy is low unemployment at all costs, even if the businesses are not profitable. It is better to have people working in a loss-making enterprise than for them not to have a job at all and wandering the streets.

Part of the rationale for the violence was to scare Han Chinese out of the Tibetan regions. Many Han Chinese families may prefer to move back to their places of origin; the Chinese government may offer economic incentives for them to stay.

Faced with this situation, the Chinese government is unlikely to let the yuan rise significantly more this year. If asked to choose between which is more dangerous, social unrest in China, or increasing pressure from the European Union and the US over letting the yuan appreciate, I’m sure that the residents of Zhongnanhai would say that the former is the threat they fear the most, not the latter.

For them, it’s much more important to keep people working at their jobs in China.

Popularity: 25% [?]

Technorati Tags: appreciation, Beijing, China, economics, economy, employment, fiscal, han, monetary, olympics, policy, social, Tibet, tibetan, unemployment, yuan, zhongnanhai

Paul Graham has just published an excellent article called “You Weren’t Meant to Have a Boss”.

He talks about many of the same ideas I have talked about on this blog, and why it’s best to work in small organizations if that is what most appeals to you, and works for your personality. This is particularly interesting because software engineers, especially Internet networking engineers are interested in scaleability. Paul Graham makes the point that large organizations don’t scale for many people; they are happier in small groups.

WARNING: If you work for a large organization, you may not want to read this article.

Popularity: 26% [?]

Technorati Tags: business, engineers, happiness, paulgraham, scaleability, software

A good way to find out how sharp a person is to listen carefully to the questions they ask. Smart people ask very sharp questions which cut right to the core of an issue, while less astute individuals kind of dance around the edges.

Smart entrepreneurs ask the sharpest questions because often the success of their own business depends on the questions they ask. Smart people who work for large organizations usually do not have to ask such sharp questions because they have an employer who tells them what they need to do, and they are usually not paid to ask questions, they are just paid to do things they are told to do, regardless of whether the tasks are smart or not.

I have long been an admirer of the folks at 37 Signals because I think that they are a small and very smart crowd of people. For me, they represent the kind of company which future entrepreneurial organizations should be like: small, smart, fast and lightweight. They are the Davids (as opposed to Goliaths) who want to continue to be small and smart, and focus on serving their customers’ needs.

One of the reasons I admire them is because they were the incubator/developer for Ruby on Rails, which I talked about earlier in this article. What is significant about the 37 Signals team is that they think of themselves more as designers than developers, which gives them a different perspective. Instead of adding features, they are focused more on making software programs easier to use. This is the thinking behind their online application suite offering which includes Basecamp, Highrise, Campfire, Backpack, Writeboard and Ta-da. After doing web development over several years, they have captured their thoughts about web application development in a downloadable PDF book called Getting Real.

A major part of their appeal is that aside from being designer/developers, they also have an appreciation of how the business world works. For this reason, I’m a frequent visitor to their website. Recently, they had a posting to their company blog called Question your work. According to this article, there are several questions which you should always ask:

• Why are we doing this?
• What problem are we solving?
• Is this actually useful?
• Are we adding value?
• Will this change behavior
• Is there an easier way?
• What’s the opportunity cost?
• Is this actually worth it?

All of the questions are very good big-picture questions which should be asked up-front before embarking on any major development project. I have seen many fairly major software development undertakings, as well as marketing projects, which did not answer these questions well, and frankly, a good deal of grief would have been saved if these questions were posed first.

So regardless of where you are, whether you are in the US, China or anywhere else, ask these questions first before you embark on a major business adventure.

Popularity: 26% [?]

Technorati Tags: 37signals, business, China, development, entrepreneurs, marketing, opportunitycosts, questions, software, startups, US

With all the different political and business agendas fighting to get heard, it is often difficult to lose sight of what the truth is. This is true of China with the rest of the world, and also very true of the business world. When this happens, it’s very difficult to step back from the respective agendas, take a deep breath and a fresh look without becoming angry or cynical.

Giving advice and insights are a sometimes difficult skill to learn, but they are very important. I firmly believe that the world would be a better place if people knew how to give advice better. For many people, it’s very difficult to learn this important and under-utilized skill.

Giving advice is especially difficult within large organizations, where the truth may be readily apparent but where the management or leadership does not want to listen. Communications is a two-way street; someone has to speak and someone has to listen.

So what can you do to insure your chances of success and being listened to?

• Pick the right time. Speak only when that person is ready to listen. Often, that means when that person’s idea has failed, sometimes miserably.
• Don’t gloat over the mistake they just made, or say something like “I told you so!” That is a sure way to make sure that your message doesn’t get heard; you will not last in the organization, even though your message may be right.
• Don’t personalize the mistake they made, even though it may have resulted in millions in losses or damage. This doesn’t help either.
• Offer your suggestion in the form of a solution which you have given deep thought to. However, don’t go into detail to explain it unless you are asked to.
• Keep it short. Get to the point, say it in as few words as possible, and unless you are asked to stay, walk away. Senior and executive management have little time to think about things on their own, so leave them alone so that they can think. If your suggestion is a good one, then it will stand up to scrutiny.
• Choose a time when they are alone with you. Never bring up the advice in front of other people; if you do you run the risk of making them appear silly in front of a large group of people, which is never a good thing.
• Don’t bring up advice in meetings; most meetings are not a good place for discussion. Too many groups have competing agendas.
• Learn to write well. One of the most under-utilized tools in an office is the memo. Discuss the situation, lay out your case, and send it to the right people for review and discussion. The goal of a good memo is to start an intelligent discussion; keep that in mind.
• Don’t give advice anonymously. If you believe in your advice and that it has value, stand by it and let everyone know it is yours, and that you are willing to go up or down with it.
• Keep emotion out of it and keep the tone neutral. Use logic to make your point.
• Keep it open-ended so that the listener can offer his/her point of view if they want to. If they do, you may have a conversation, which is a good thing.
• Always be diplomatic.

What other ideas do you have about giving advice?

Popularity: 21% [?]

Technorati Tags: advice, business, China, conversation, politics, west

China Law Blog is a good source of legal information about Chinese business and investment regulations and one of his comments in my previous post got me thinking about why Chinese entrepreneurs don’t like to work not just with American lawyers, but lawyers of any nationality.

Here is his comment in full:

Right idea. Wrong country. What you predict will happen, I am certain of it. I am certain of it because our German and Russian clients have over the last few weeks been calling us (here in the US) like crazy to help with this or that deal they are doing or want to do. The deals range from high tech to old line manufacturing (that’s right) to real estate. When we tell them our legal fees I can almost hear them gasp (particularly the Germans) at how low they seem for those used to paying in Euros. That’s right, step right up, the US is on sale to foreigners ….. Like it or not. BTW, no calls from Chinese and I don’t expect many either, both because they tend not to use lawyers so much and they also tend not to be big buyers of existing US companies. At least not yet.

So why is it that Chinese entrepreneurs don’t like to use lawyers and legal services, even when using them the right way, and intelligently, will help them to greatly expand their businesses?

I have a theory.

For many Chinese, “the law” is whatever the Chinese government says it is. Just because some new kind of business is done in China, does not mean it is legal, it is just tolerated. It usually means that it is so new to the slow-moving bureaucracy that it hasn’t figured out whether it should be legal or illegal, so it’s “tolerated”.

Your business may be tolerated, then the government says it is “illegal”, or it may be tolerated, then the government says it is “legal”. Then it might switch from “legal” to “illegal” and told to shutdown almost overnight. This happens, and continues to happen all the time. This is part of the price of doing business in China.

Here’s another example.

The Chinese government says that new businesses in China have to list their “business categories” and the business they are in. Think about it; does this make sense? From a business point of view, it makes little if any sense. Let’s say a consulting business needs to do a marketing survey. They may run afoul of the law because this is not allowed; they registered as a consulting business but need to do a marketing survey for a client who wants to enter the Chinese market. So while it makes perfect business sense to do this, the bureaucrats and regulators prevent it from doing so, because from their POV (the government regulators), categorizing businesses makes more sense.

Among Chinese business people, there is a large degree of frustration at these sudden changes which come out in the morning, and may change before the sun goes down. For Chinese entrepreneurs, this is the face of the law.

So, in order to succeed, they spend a huge amount of their time avoiding the regulators and getting warned, or even shut down. If the regulation comes from Beijing and they are in Hangzhou, they will go talk with Hangzhou city government officials to avoid getting crushed because local Chinese officials have the power to “interpret” the law. Sometimes this means ignoring what Beijing says, without openly confronting Beijing.

And this is why many Chinese entrepreneurs avoid lawyers, because so much of the time, the government officials are the face of the law, and are not there to represent their rights, but are there to warn them, or even shut them down. So, from their perspective, the law is bad news.

When Chinese companies go overseas, they continue to act this way. They avoid relatively small up-front legal fees, thinking that they can outmaneuver them and the regulators, never thinking that the law can in fact work both ways, and can help them to gain benefits. They are guilty of thinking that they are still in China and behave as if they were still in China.

Moreover, they know that the advantage of Chinese businesses lie in their cost structure, and fear losing it if they go overseas. This means that they act very cheap when they go overseas, and acquire reputations for being cheap and micro-managing their foreign employees, trying to extract every little bit of time and value out of them.

In the long-term, this hurts the reputation of Chinese companies as a whole.

In fact, company cost structures evolve and adapt to the market and society they are a part of. No country can have the same cost structure as China, just as no country can have the same values as America does.

And there is no reason that they should.

Popularity: 29% [?]

Technorati Tags: , America, business, China, costs, illegal, investment, law, lawyers, legal