Why The Next Wave of China Startups Will Be Based Outside China

Apple’s newest store in Beijing
Source: AppleInsider

Ever since the Internet wave took off in the early 90s, the prevailing wisdom has been that to be successful in China, a company has to have a strong China presence.

This meant:

  • The founders and investors must have a strong relationship with the Chinese government.
  • The company must be willing to come under Chinese government regulation when it comes to content, and must have editors in place who would quickly remove sensitive content.
  • The founders must deal with all kinds of murky stuff, and because it’s in China, may not be in conformity with international standards for regulation.

As a result, founders, especially as they got closer to an overseas listing, found themselves in a difficult balancing act, between what their Chinese investors wanted (so that they could cash out successfully in the west), and what overseas regulatory authorities wanted.

For most Internet companies, the market of choice for listing was the US. Lately though, this has changed. Hong Kong, Singapore, London have all actively marketed themselves as attractive choices for going public. Part of their attraction, compared to the US, is that they demand less transparency than the US.

For Chinese investors who have the government and party connections, an overseas listing is an important way for them to translate their China political clout into real money sitting in overseas bank accounts. But for overseas startups which operate in China, the costs and management headaches associated with operating in China are a constant burden. Moreover, many of these factors are political issues which are outside their control, such as an upcoming succession in China.

For many Chinese, China is a fast-growing market, but the west and the rest of the world continue to have strong attraction. Some of the reasons for this are:

  • Education opportunities
  • Business opportunities
  • For many, it is the opportunity to operate outside a system which has a huge amount of inherent corruption, and which has failed at reforming itself to suit the needs of a modern public

For this reason, even though China has a growing and dynamic market, many Chinese still jump at the first opportunity to leave China.
These numbers keep growing. For many Chinese, the first chance to see the outside world is as a tourist; over the past decade, this has jumped four times to 70.3M in 2011. After some initial foreign contact, the next goal is to get a western education for their child; this is especially popular with the children of Chinese Communist party members; even the daughter of incoming Chinese president Xi Jinping sends his daughter to Harvard. The demand for western education has become so strong that a whole industry has formed around getting them into the right schools. For many western universities, the temptation to accept cash-paying students in a time of increased competition and higher costs is too much to resist, and the number of Chinese students going to the US keeps breaking new records.

In the past three decades, huge amounts of capital have been secretly moved overseas by Chinese officials and their families.

Up till now, most Chinese websites based in the US focused on political and literary issues which were barred from public discussion in China, such as Boxun. Now though, with a very large wave of recent Chinese immigrants, there is a significant opportunity for an overseas-based Chinese language service which is based on advertising, and delivers its content on mobile.

Since it is based overseas, it would not have the need for a very expensive content-filtering mechanism, and it would also operate outside the political controls deemed necessary from Beijing. At the same time, it would have access to an excellent demographic group from China, which would make it very attractive to luxury and brand advertisers from overseas who want to reach a young and growing overseas-based Chinese demographic. Many among this group may return to China, and would carry these brand affinities with them when they return.

Up till now, most western investors have thought that investing in China required a company registered in China. Now though, since there are so many Chinese all over the world, and because they have so much buying power, it really isn’t necessary to have a company in China in many industries. This is especially true for retail businesses which rely on marketing and advertising to get the word out.

For years, Chinese government officials and China-based consultants have told western companies how important it is to have a China-based company. While the western investment money was coming into China, many of the same Chinese officials were moving their own private money to Hong Kong and the west.

What do the Chinese officials know which the western investors don’t know?

11 Responses to “Why The Next Wave of China Startups Will Be Based Outside China”

  1. Fascinating article … and perfectly spot-on.
    China simply cannot avoid “growing up” … the CCP is crazy to not reform and try to keep up with the change.

    Suppression is not the answer, because the Chinese rich will vote with their feet. Investment, power, capital, companies, high-tech … all these are borderless. GFW cannot contain China from convulsing its way to a better future.

    Thanks, Paul – appreciate your economic point of view, always.

  2. Paul, our experience as a PR and marketing agency focused on Chinese marketplaces bears out your suggestion. Influencing Chinese consumers by addressing their expatriate family and friends, resident in the west, is a valid and effective strategy for many categories and brands. The strategy has certainly worked for a number of our clients over the last five years.

    While there are some good operators in the “China market entry” game, most are bottom-feeders with little or no successes to base their credentials on. Its very much in the interest of these consultants to encourage brands and businesses to incorporate in China, which (as you say) is actually increasingly unnecessary.

    • admin says:

      Do you have links to case studies/white papers for companies which have raised their profiles among Chinese consumers without having an on the ground presence in China?

      • Internal only, Paul, sorry! But if you look at companies offering investment products to mainland Chinese, turnkey export services, education services and similar sectors, you’ll find success stories.

  3. […] my previous article, I mentioned why the next wave of internet startups would be outside […]

  4. howard lim says:

    Great Article,
    This would affect the largely “Wealthy” Chinese I take it? What are the opportunities available for middle class or other people who don`t necessarily have the financial means to pursue education abroad?

    Are there support systems, either through Private or Public contributors, that give kids, who are determined, a chance at improving their situation through higher education.

    That would be nice!

    • admin says:

      The number of Chinese who can afford overseas travel, and foreign education for their only child is increasingly dramatically. Even though there has been a hiccup in the Chinese economy lately, most Chinese still feel generally optimistic about the future.

      ‘Are there support systems, either through Private or Public contributors, that give kids, who are determined, a chance at improving their situation through higher education.’

      In Chinese society, the support system is usually the family, without much else.

  5. Jeff Davis says:

    Paul – you are probably right in that incorporation flight will follow the capital flight which has been going on for years. But I predict that in order to tap into “the Chinese market” with any kind of a revenue model, startups will continue to be required by the Party to have some presence in China. I think that sending the founders to Silicon Valley, getting funded there, starting a business thereand then trying to operate as a WOFE in China will not be feasible. If there is value being created, the Party needs to have a hook into it for the entire model to work.

    • admin says:

      Right now, the missing part is good Chinese-language editorial teams outside of China. Specifically, the kind of editorial teams which know how to create good enough content which can attract brand advertising. If that can be done, and can serve their targeted audience, then it would work.

      A simpler approach is Chinese-language mobile apps launched outside of China; there is no need for editorial. Might start as something simple like location apps, then work its way up from there.

  6. Sorry I’m getting to this late. Agree with your observations Paul — have seen much the same myself. My question — how long as this trend been building and was there any particular trigger or milestone? I left China a year ago, and the situation was much more rational. If it’s internal politics, while the situation reverse after the new admin is in place?

    • admin says:

      I believe that the main issue is that families of senior party officials have their fingers in so many different and competing business interests that the whole thing has become completely unwieldy. This has been exacerbated by the new leadership succession which is coming right up. Another issue: the succession is not clean; those stepping down, or who have stepped down, don’t want to give up all their power, and continue to wield influence in the government. Talking about too many cooks in the kitchen…