How US Investment Banking Excesses Helped China’s State Sector

April 25th, 2010

When the banking crisis broke in September 2008, the global economy went into shock and nearly collapsed. The Chinese government was widely seen as being the most proactive in reacting to the crisis, injecting more than US$570 billion into the Chinese economy.

Because China’s four leading banks are all state-owned, all of this money quickly reached Chinese state-owned companies. This stood in stark contrast to the US, where the banks were bailed out, but the money did not make it to companies and individuals, largely because the banks sat on the cash received, mainly to cover their own capital losses, and in many cases, to pay out bonuses to management.

Only recently have the Obama administration and congress started tentative investigations into the investment banking practices which brought the world economy so close to the brink. Since the US economy is now largely based on FIRe (finance, insurance and real estate), and because the financial lobby is the most powerful and well-funded lobby in Washington DC, changes and reforms have been slow in coming. In spite of this, even in the early days of the investigation, there are signs that there was more to it than just investment bankers flogging poorly understood derivatives to unknowing corporate clients, there was deliberate fraud at the heart of it.

Today, the Chinese government and economy have come out of the crisis smelling like a rose. Certain indicators, such as auto sales in China, show China overtaking the US as global leader, and unlikely to relinquish it back to the US. Compared to the US and EU, China seems positively great, and the government has made all the right moves, investing in infrastructure and keeping Chinese consumers happy and spending. Optimists believe that now Chinese consumers and its middle class have stepped in and filled the gap left by the weakening of the US consumer.

Looking a little deeper though, while the Chinese government has succeeded in the short-term, their moves raise long-term questions. Here are some of the problems:

  • Most of the money found its way to Chinese state-owned enterprises (SOEs), many of which are in commodity imports and heavy manufacturing such as autos.
  • China’s economic development is following the US economic development of the 1950s; which is oil-based transport. Imports of coal and oil have dramatically increased in the past year in spite of government efforts to diversify to nuclear, wind and solar.
  • As the Chinese government funnels more money through its state-owned banks into SOEs, the party and the government ironically have less control over them. Recently, the Chinese government has used administrative measures, such as ordering 73 companies out of the real estate sector and, in some cases, dismissing executives on corruption charges, but these are not a long-term solution to a systemic problem.
  • More Chinese university graduates look for jobs in SOEs instead of the private sector, seeking job stability instead of looking for better job opportunities, or a chance to start their own business as in previous years.
  • For the most part, Chinese SOEs are over-staffed and inefficient. But because of the crisis, and the overall makeup of China’s economy, they seemed destined to take up a bigger part of China’s GDP.
  • China’s seemingly unquenchable demand for commodities and raw materials, is in large part, driven by a lack of faith in derivatives. This is directly related to Wall St. investment banking practices which ran wild and unchecked under the Bush administration.

The flip side is that China’s private sector is in its most precarious position since China’s reforms began in 1979. While it has always been difficult for small businesses without strong government connections to raise capital, the situation has become worse recently. Yasheng Huang, in his book Capitalism with Chinese Characteristics: Entrepreneurship and the State touched on many of these issues.

In the internet field, I have noticed, for example, that many of the entrepreneurs and innovators in the field are choosing to emigrate from China instead of starting their businesses in China. China has a thriving Internet sector, but the successes are those which already have venture capital funding, or have successfully gone public. For practical purposes, the early stage innovation part of the pipeline has gone dry.

It is hard to say if this is true for many sectors in China at this stage, but if there is one truth now, it’s that innovation and entrepreneurship are a vital part of every economy. In today’s China, innovation and entrepreneurship are too dependent on government connections for success. For this reason, these relationships are open to exploitation, corruption and abuse.

The Chinese government for its part has been very ambivalent about the private sector. Both the president and premier have made occasional statements about the importance of helping and protecting private enterprise businesses, but disappointingly, few of these statements have turned into tangible policies and measures. Since the Chinese government has been pressing other governments to recognize China’s market as a market economy, why don’t other governments press the Chinese government for clearer policies for China’s own private sector? Some of these questions may be:

  • Do Chinese private companies have equal and open access to raising capital as SOEs?
  • Are their products and services distributed and marketed equally in the domestic market?
  • If they are subject to any kind of unfair competition, then what channels do they have to appeal to?
  • If the answer to any of the above questions is no, then what policy commitments is the Chinese government prepared to make to remedy the situation?
  • While the Chinese government and SOEs are powerful and cash-rich now, the real heroes of China’s reforms are China’s entrepreneurs and innovators, and the hard-working and industrious people. It’s time they got some recognition and fair treatment both inside and outside China.

2010 Tudou Film Festival Award Delivers Tough Message

April 18th, 2010

The winner of the Tudou Film Festival Award was announced today, it went to the Machinima Film η½‘ιšζˆ˜δΊ‰ or War of Internet Addiction. It is a remarkable production, made entirely in the world of World of Warcraft, and took three months and 100 Chinese volunteer gamers to make. It features excellent production values and is smart and clever.

Bill Bishop, publisher of the Digicha blog was the first English blogger to mention it in the non-Chinese blogger world, and afterwards it was picked up by leading English-language publications, including the Wall Street Journal.

For reasons I am not able to fathom, no one has really explained the context and significance of this production. Many who follow the issue of China, the Chinese economy, and modern Chinese social studies should endeavor to understand what the “War of Internet Addiction” really reveals about modern Chinese society. The whole story is much like the Japanese film classic Rashomon by Akira Kurosawa, which highlighted the Rashomon effect, or the view that viewers to an event only see what they want to see, and will deny the validity of alternative interpretations. This denying of alternative interpretations is not only valid in China, but as we will see, also in the west.

In order to underscore the difference of these interpretations, I will present their views in separate sections.

Chinese Government Official View
From the Chinese government’s point of view, many Chinese youth spend too much time at Internet cafes playing games. Among these games, World of Warcraft is the most addictive. This has given rise to a new illness “Internet addiction”, which the government officially believes to be an illness. A whole industry of treatment clinics has sprung up to treat this illness, using methods sometimes as severe as shock therapy.
Young people who spend their time playing WoW all the time should instead spend more of their time studying, or pursuing other more productive activities.
On the business side, World of Warcraft has become a major moneymaker for its China licensees, first The9, then NetEase. So important was regulation of the War of Warcraft franchise in China that a rare public turf war was fought between the Ministry of Culture and the General Administration of Press and Publication over regulation of NetEase, the China distributor. During this bureaucratic fight, the WoW servers’ service was partially suspended in China, causing much discomfort for WoW players in China.

China World of Warcraft Players
World of Warcraft has 73 different levels, and involves a wide variety of players with different roles and skills, working together to overcome obstacles. By working together and fighting together, these players bond and build strong trust, even though the players are playing in a virtual world. Unlike in the real world, where people are always competing against each other in a highly competitive education and social environment, and where there is little if any trust, the players build trust over time as they fight to higher levels. In this respect, World of Warcraft is a true meritocracy; one which does not exist in the real world of modern China. For this reason, most players look forward to meeting and playing with their fellow players on World of Warcraft on a regular basis.
“Why does the Chinese government want to interfere with what we are doing online by playing WoW? We are not advocating political change or violence. We just want to play WoW when we want to.”

The View of Many Western Observers
The fact that so many Chinese youth play WoW shows just how limited freedoms are for Chinese youth, and how intrusive government interference is in the lives of Chinese. This is yet another sign of how closed Chinese society is, even though on a material level, the Chinese government has provided well for the Chinese people.

My View
The Tudou award was actually a three-fingered salute from WoW players and the online community to the official Chinese government view which cannot understand the culture of World of Warcraft from the view of its players. China is run by one highly centralized organization which is not given to understanding alternative interpretations of society which do not conform to its view of reality.
The view of the majority of mainstream western observers, who only see China in terms of freedom and democracy issues are just as blinkered as the official Chinese view, as they are unable and unwilling to understand anything which does not conform to their worldview that while China has delivered a huge number of its population from poverty, continues to deny political freedoms to its own population.
In fact, western society, with the US in particular, has the same problems as modern China, except on an even larger scale. If the whole issue is all only about freedom and democracy, then why does the US have the largest number of illicit drug consumers in the world? Are they so happy that they need to escape into the world of drugs?
Western and Chinese consumer society have satisfied many material needs, but most intelligent people understand that this does not equate to happiness. In China and the west, adults with poor parenting skills seek to assuage their own guilt by showering their kids with all kinds of goodies, then wonder why their own kids don’t like them as people? Parents, the Chinese government and western consumer society are uncomfortable with the idea that many of their children and citizens prefer to spend their time online, in the communities of Facebook, Twitter, Stocktwits and WoW than in their own real world.
For many of us, the virtual world of online is preferable to the real world we live in, and this is why so many spend so much time online. And that is a message many parents, governments and politicians are increasingly going to have to deal with.

Apple, Adobe, Web Analytics and Megalomania

April 15th, 2010

What is it about social media and web analytics which turns CEOs into control freak megalomaniacs anyway?

Last week, it was Apple’s revision of the SDK agreement with developers barring all cross-compilers from use for developing apps heading for the Apple AppStore and which was first pointed out by John Gruber in this post. Most outsiders see this as targeting Adobe’s Flash platform, and it is rumored that Adobe is now contemplating going legal over the issue.

Last September, Adobe purchased web analytics firm Omniture. This was one of the deals where most peoples’ jaws dropped because Adobe’s flagship product is Creative Suite, which is a suite of applications for publishers and creative types.

Omniture’s products are used by business development types, who want to know where visitors are coming from, what sites/search engines refer them, etc. All of this is achieved through the use of tags embedded in each page’s source code. Whenever a request is made to a page, the tag calls a server and logging in that it has been called, including information about the user’s browser, geographic region, etc. With this data, the bizdev types then tell the designers and creatives how to further improve the content and pages, making everybody rich in the process.

Anyhow, that’s the idea.

What made the Omniture acquisition interesting was that in most company organizations, the bizdev and design/creative types don’t work that closely together, let alone use the same production tools. What Adobe proposed through the Omniture purchase was to bring both groups together in its new CS5 product lineup.

But two days before Adobe launches CS5, Apple releases its new guidelines for app development on the iPhone platform, which is aimed at cross compilers, but hits designers using Flash especially hard. For the record, I don’t like Flash myself, it hurts performance, fires up the fan, and is a general nuisance. As far as I’m concerned, real developers use C or a C-derivative language, not Flash.

But banning it!!!??? I believe that apps developed on Flash will probably sell less well in the AppStore, and that the smart Flash developers will say “Hmm, maybe I should start developing using Objective-C and Cocoa frameworks so that I can squeeze that last bit of performance out of OpenGL, etc.” Isn’t wholesale banning a bit much? Why not just let the market deal with the issue?

Now Apple has come out with a new zinger for the new iAd network: developers are not allowed to collect user analytics inside their own applications, while Apple is allowed to insert ads into applications. What does this mean if you are a developer?

  • Apple may insert other ads, even your competitor’s ads into your app, and there’s nothing you can do about it.
  • You cannot collect download and usage data so that you can improve sales of future versions of your app, but Apple can, and they will not share that data with you.

So if you are a smart app developer, what do you do? I’d say that you’d have to put on a business hat, and ask yourself:

  • Do I want broad coverage of a new app to test the waters and see if this app sticks? If so, sell on the App Store.
  • Is my app more narrowly targeted, and has more functionality? Then build a web version of it, and optimize it for the iPhone, iPad and Android platforms.

The most important idea behind the platform concept is that it needs to be fair to all players. The AppStore started great, but now it’s showing wear and tear. And that wear and tear is coming from business decisions by Steve Jobs.

Basically, Apple is showing that it wants to be the ultimate ad planner and ad buyer for mobile digital. But good ad planners and buyers don’t compete with their customers. That’s the most basic rule.

Through this action, Steve Jobs is going not only after Adobe’s Flash platform, but it’s Omniture web analytics acquisition too.

Steve, I thought you were a Buddhist? How about taking up golf and getting in touch with your softer side?

Does China Fit Into the Long Tail Scenario?

April 14th, 2010

Bill Bishop, who is based in Beijing, recently published a very good article and checklist focused on western Internet companies which want to enter the China market on his blog Digicha.com, which is titled Do You Have What It Takes to Do Business in China? In the article, he lists three factors as being most important:

  • Invest in Experience
  • Prepare for Regulatory Complexity
  • Expect Copycats

His three factors, in my opinion, hit the nail on the head. So how does this affect the average US Internet company which wants to make it in the world’s largest single Internet market (listed by number of users)?

When it comes to investing in experience, most US companies choose someone of Chinese extraction who has worked in the US, not knowing that for the most part, the average ABC (American-born Chinese) knows as little about the Chinese market as any man off the street in the US. Even someone from the PRC who has lived in the US for more than 5 years may not know much about the Chinese market, even though they speak the language, because the market has changed so much so quickly. In the meantime, local Chinese companies have prospered, making mistakes, but the smart ones have learned from their mistakes, getting tougher, stronger and more competitive along the way.

Advantage: local Chinese companies

China is going through a period of regulatory change, and in most cases, Beijing is demanding that the provinces hand back many regulatory decision-making powers that were given to them over the past 30 years of reforms. If you are interested in the macro discussion about this in China, I’d suggest that you read more on GE Anderson’s blog; he goes into considerable discussion about this under-reported discussion.

What this means for the western company coming into China is that you might get caught by regulatory decisions and changes from Beijing, even though you hire expensive consultants to help you navigate your way through this maze. This is not to say that the system is biased against westerners; even leading Chinese companies such as Netease have made major mis-steps in dealing with a changing and opaque regulatory environment.

Advantge: Nobody

When it comes to copycats; they are all over the place in China when it comes to the Internet. US lawyers who specialize in IP love to paint vivid pictures of how awful this situation is in China in order to scare their clients into paying large legal fees to get IP rights protection. Any company would be unwise not to make a certain investment, but they would also be wrong to go overboard.

This is because success in China it is all about executing and learning quickly. To give an example which most Americans are familiar with, it would be like the browser war between Microsoft and Netscape in the late nineties. Netscape came out with the first browser, Mosaic (which soon became Communicator), then some time later, Microsoft introduced Internet Explorer. Netscape sued Microsoft, at which point the legal gears started turning. But by the time the legal system had run its course, Netscape was no longer around as a company, having been bought and absorbed by AOL, which had merged into Time Warner. From a legal standpoint, Microsoft lost the battle, but it didn’t matter, because Netscape was no longer there to collect on its winnings.

Now, China is like that, except the market is changing much faster. And when it comes to execution, the Chinese companies can make the changes faster because they don’t have to explain their changes to someone in Mountain View or New York who has never worked outside the US in their whole careers.

Advantage: Chinese companies

At this point, you may be thinking that it would be wrong, even insane, for a western company to enter the China market. That is not my point. Instead, I would argue that most western management teams get overly enamored of the huge promise of the Chinese market, and in the process, overlook what it takes to succeed in ANY market. And, I would like to point out that because of changes in the technology and business ecosystem, there are more opportunities than ever everywhere, not just in China, and the initial investment costs required to test the waters are much lower.

The platform I have found most engaging is the iPhone business ecosystem, which I have been enthusiastic about since the very beginning in March 2008. Since I wrote that article more than two years ago, the iPhone and AppStore have turned into a thriving market all over the world. A few individual developers and software companies have become successful, even wealthy, over this market, which now includes 50 million iPhone users worldwide, and if you include iPod touch owners who also buy apps, now total 85 million.

When I look at this market, I see the long tail which Chris Anderson first talked about. When Anderson spoke about the long tail, he was talking about companies getting more and more of their revenue from small customers, and moving away from the 20/80 rule, which dictated that 80% of business comes from 20% of customers. When western marketers look at China, they see $ signs in their eyes, and think of money flowing into their bank accounts on a daily, even hourly, basis. To a large extent, the Chinese government wants to perpetuate this view; it serves to attract foreign investment into China. But in reality, there has been no western Internet company which has made it big in China. In this respect, the reality of China has never lived up to its promise.

However, I believe that there is a change and opportunity underway for the long tail to finally come to China, in the form of the iPhone platform. (The Android platform is in a state of flux because of Google’s recent troubles with the Chinese government; the three government-owned carriers don’t seem to be know what to do.) In China, the iPhone is sold and distributed through the China Unicom network.

So let’s say you are in the software business, and you want to build your presence in China. You have two choices:

  • You can go the traditional route which Bill Bishop outlined and which many other companies have taken, including Google.
  • You can build games and apps in Chinese, which are distributed through the AppStore, relying on Apple as your channel. But along the way, you can learn about each individual market at very little cost. And you can do this ANYWHERE.

If you go the first route, you may or may not succeed, and you will have spent millions in the process. If we look at what has already happened, the odds are against you.

If you go the second route, you may or may not succeed, but your costs are much lower, and you will learn a lot about what Chinese like, and maybe even make a little money in the process. Then you can decide how much you want to commit to the China market.

Maybe it’s time to look at things a new way.

You decide.