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?

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.

“If I were to wait until the Chinese government said I could do something, I’d never be able to make money.”

This is a line I have heard on many occasions from different Chinese entrepreneurs.

In China, there are many areas which are not strictly illegal, but they’re not legal either. Most of the time, these involve fields which are too new for the government to regulate. Any government is a slow-moving giant; they are not renowned for their quickness and being smart. In this business ecosystem, the advantage lies with the fast-moving entrepreneur who can identify a need and move in quickly.

By the time the government has figured out the industry and begins to regulate it, the major players are already established. This is how the online gaming industry started in China with Shanda, and how Giant Interactive became successful with its pay-for-play online gaming model.

When Americans and Europeans go to China, they go out of their way to make sure that every “i” is dotted and every “t” is crossed in all their legal arrangements with the Chinese government. Each executive is effectively protecting himself from litigation and any bad news from the Chinese government.

This is like going to church and asking the priest if you will get eternal salvation by going to church every Sunday and donating one million dollars every year.

In doing so, they are basically asking for Chinese government regulation. Now, do you think the Chinese government is going to favor a foreign competitor or local Chinese company, even one which pushed the boundaries of government regulation in China?

This is one of the great ironies in China.

It’s a little like being a parent; who do you love more, the loyal son who does everything you say but is not creative and imaginative, or the smart son who sometimes frustrates you by coming home late, but is brimming with all kinds of insights and creative ideas and dates all the smart beautiful girls?

If you asked the Chinese government, or at least watch what they do on the policy level, they like the smart and sometimes naughty son.

Unless he gets too smart for his own good, in which case they smack him down.

For many westerners and western companies, it’s hard to figure out why some Chinese have gone to the US for their graduate degrees, worked at name technology companies such as Intel and Microsoft, then come back to China, their homeland, start their own businesses, and fall flat on their faces.

How is this possible? They had everything going for them; they had the best education the US had to offer, worked in a great company, were smart and entrepreneurial, know the language, have connections, and they failed.

More often than not, these people have been away from China for a long time. Over time, they have become used to the American way of life, and while they keep up with what is going on in China, their knowledge and understanding of the country has gone stale. Gradually, they are more at home in America than in China. They jump on the China bandwagon because it is in the media all the time, and they hope to strike it rich.

Then they return to China and discover a country which is not the China which they grew up in. Compared to when they left, the role of the government is much smaller, the country has become more market-oriented in most sectors, and they may have lost many of their former connections. Worst of all, they look at the country through American-tinted glasses and use American society as a point of reference, something which does not work in China at all.

For any business or individual to succeed in China, you must understand China on Chinese terms.

This failure to understand China on Chinese terms is, in my opinion, why so many western Internet companies have failed in China. Moreover, the constant need of local management to report to headquarters outside of China, and to report every purchase they make, and more often, to explain what they are doing, puts a fatal hindrance on the decision-making process because the management is constantly tied up in knots educating someone in headquarters about China.

This makes for another very important point: No successful company in China can be successfully run from outside China; the key decisions and decision-makers must live, breathe, work and sweat in China every single day to make it work.

The single most important bad decision western companies make in China is to force the local China management to consult with headquarters about every matter; this makes the local management look weak in the eyes of their own staff. After all, what is the point in staying with a company if they do not have the power to make decisions even if they are sitting in the corner office?

It all comes down to how empowered people are to make their own decisions, and to be held responsible and accountable for them.

It makes much more sense for them to break out and start their own company, often taking the idea the western company had, but was not able to implement in China because they were constrained by headquarters’ indecision. In the Internet sector, where change is happening so fast, it makes no sense to sue and countersue; that would only make the lawyers happy and not solve the basic issues.

This just scratches the surface of why being Chinese is no guarantee of success in today’s China. Put simply, the society has changed too much too fast, and unless outsiders live here and deal with local Chinese who have never been outside China and speak only Chinese on a daily basis, they will fail.

In business, success cannot be guaranteed, but failure can…

China’s increasingly important global role means that more and more businesses are coming to China. While there has been a significant presence among multinationals for nearly 30 years, now companies are coming in at earlier stages. Now some startups are even choosing to start in China instead of Silicon Valley.

This trend has been encouraged by venture capitalists, who now give a premium valuation to companies based in China.

This raises a very interesting question: “Is it possible for a western-managed business to succeed in China?”

First of all, a few qualifications. While there are many western multinationals in China, most of them have heavily localized their staff and management. The general trend in these companies is to localize staff and management as quickly as possible without sacrificing necessary management skills in the process. So, for the most part, while they are western companies, they are largely Chinese-managed.

Since most of my work is with startups, I’ll drill down in this field. Now the trend is for more American startups to start in China, even though they may not see China as their main market. In the gaming field, for example, China has a huge pool of people with talent and experience in the gaming field. This means that there is a pool of people with talent in programming and art, and understand gaming culture. The areas where the local Chinese population are weak is in product management. Chinese tend to gravitate to managing other people; there is a serious attraction to being able to say that a manager manages x number of people. Product management is more about managing resources, and coaxing cooperation from different stakeholders in the organization. Naturally, this requires more in the area of soft skills. And soft skills are an area where most technical people feel less comfortable with, and generally do not do as well in.

And unlike in the US, product management people in China are generally expected to be much more technical. So there is a difference here.

Hence the shortage of good product management people.

Naturally, this gives an advantage to startups which have experienced product management people. One mainly western-managed startup in Beijing which is strong in this area is ECitySky.

What about other kinds of companies, and what about the market for talent?

It all depends on what you are trying to do, and what audience you are trying to reach.

One tendency in the Internet field is that as the technology tools become more mature, the technology plays second fiddle to product marketing and marketing. Since the Internet has had just as long a history in China as it has in the west, it is getting harder for an experienced technology person to differentiate himself purely on technical skills alone. Increasingly he has to bring soft skills to the table, especially team management skills, to the table to be seriously considered. This means that for most technical people in China, the opportunities are becoming fewer, especially when you consider their significantly higher costs.

On the management and marketing side, it becomes more important to know how to communicate with your main audience in China. If the audience you are trying to reach is mainland Chinese, this means you must be keenly aware of social trends, the different social groups in Chinese society, government policy, what the different groups are thinking about, and the dynamics affecting the different groups.

The only way to get a deep feel and grasp is to know the language on a native level, including speaking reading and writing Mandarin Chinese. Basically, you need to become local. Assistants, translators and PR agencies will only get you so far because they cannot provide the social context to digest and understand the raw data to make good business decisions.

And then, even if you have a native command of Mandarin, that is no guarantee of success. I sum it up this way:

• If you don’t know Chinese (spoken, reading and written) and have not lived long in China, you don’t even know what are the right questions to ask.
• If you speak, read and write Mandarin on a native level, but do not socialize with mainland Chinese except on special occasions, you may know what you don’t know. More importantly, the most capable and intelligent mainland Chinese will not join the startup, instead choosing to start their own startup, often competing with the company they just left. (I’m thinking of many American-born Chinese, Taiwan and Hong Kong Chinese-managed companies which claim to be Chinese, but do not include mainland Chinese who have grown up in China in their management ranks. For the most part, they do not trust mainland Chinese and in private meetings, it is not unusual to hear them complain about things in China. In my opinion, they are doomed from the start.)
• If you have a startup which breathes, by which I mean that management does not have an inner circle dominated by any regional group or background, and freely allows people into senior and executive management based on their creativity, communication skills and ability to execute, then your startup will have the greatest chance of success. This is because a startup depends on moving quickly, and rapidly adapting to changes and competition in the marketplace.

So, in my opinion, when you get past the government regulatory issues, which are slanted to favor Chinese-owned companies in some sectors (especially media, where foreign companies are not allowed), it really is not any harder in China than many other parts of the world.

The biggest barrier for many startups is to get the management right so that it does breathe. Management needs to set the right tone from day one.

The best management hires the best people, empowers them, and let’s them go. At that point, it’s no longer a western- or Chinese-managed company; it’s just well-managed.

Get that right and China’s your oyster.