China’s Misreading Of The Global Economy

August 31st, 2010

More stories come out every day about how China is favoring state-owned enterprises (SOEs) at the expense of China’s private sector. Every day there are stories about SOEs advancing and the private sector in retreat or 国进民退 as it is called in Chinese。Seemingly, the Chinese leadership has embraced the view that China was able to save its own economy in the fall of 2008 by rapidly injecting a stimulus package into the Chinese economy, which meant state-owned enterprises through its own state-owned banks. By doing this when the US government was not able to react so quickly, China was able to fire up its own economy and maintain production and employment when the rest of the world was left on life support.

It sounds good as a story, but is it really true? Certainly the Chinese government is doing some of the right things by getting foreign manufacturers to raise wages, but is the conclusion that SOEs are the right way to go for the Chinese economy the right one?

My argument is that it’s not; it’s actually a return to a corrupt version of Gosplan which the Soviet Union had in the 1980s, and led to economic stagnation.

But first, let’s talk about the Chinese government reaction to the Wall Street financial crisis of 2008. The conclusion which the leadership has drawn is that some companies should be “too big to fail” because they employ such huge numbers of people. Since the single overriding issue for the Chinese government is social harmony (low unemployment + less social incidents), then yes, SOEs do prevent this. But this comes at the price of business efficiency for the whole economy, since, for the most part, they are large inefficient behemoths. And because they receive money from the state-owned banks on a policy basis, as opposed to business criteria, they can continue to do so. The price China pays for this inefficient allocation of capital is high; it means that Chinese consumers have less money to spend on discretionary items, which means that consumer spending is kept artificially low. All because the government is subsidizing its own kind in the name of social harmony.

The greatest single misreading of the situation is that the Chinese government believes that they were able to act quickly and decisively, when in fact, it had more to do with the US’s decision to bail out the financial industry, and then presented the bill to not only today’s Americans, but future generations of Americans. Up until this crisis, the US had the reputation for practicing the most efficient form of capitalism, sometimes with harsh social results. More than Europe, the US has allowed new industries to replace older outdated industries. For the first time this time, the US stepped in to bail out the banking industry at the cost of the whole country. This time, the US government decided that the unadulterated version of capitalism was too much.

China didn’t come out better because of its stimulus package; it looked better because the US betrayed its own economic values and policies.

The right conclusion for the Chinese leadership to draw from the crisis would have been that the 2008 stimulus package was a necessary one-time fix to save China’s economy during a global crisis. But then expanding that to say state capitalism is the best form of capitalism for China’s situation is exactly the wrong conclusion.

Now Beijing has ended up with a bunch of state-owned enterprises at the trough talking about how brilliant the Chinese version of state capitalism is, while Chinese private-sector companies are starved of capital and cannot compete against larger SOEs. Not only that, but the Chinese leadership has bought the line, and is reselling it as some magic fix for turbulent economic times.

Pushed to its logical conclusion, China will end up with:

  • Large companies which are less efficient and less innovative, just when Chinese companies need to move up the value chain;
  • The most talented young Chinese will continue to emigrate because they know that China does not reward innovation and individual initiative;
  • Chinese entrepreneurs will stay in China only long enough to get experience and develop their ideas, then will emigrate because they want their child to enjoy a brighter future;
  • The rich/poor gap, already large, will worsen because of widespread power abuse;
  • The SOEs will get fatter and dumber because they enjoy a monopoly;
  • By showing that they have so much sway over government policy, they risk becoming a target for government and policy criticism, and the Chinese government will largely be seen as a shill for the SOEs;
  • Needed political reforms, such as those recently mentioned by Premier Wen Jiabao, may be pushed back even further into the future;

Judging from the debate going on in China, it looks like the supporters of state capitalism want this to become a stated policy goal. If this were to happen, it would be a betrayal of Deng Xiaoping’s economic policies, which were about putting pragmatism over ideology. Putting state capitalism on a pedestal as if it were the single answer to all of the world’s economic problems would not have been a policy which he would have approved of.

If this were to happen, it would be a tragedy for China, its people and its aspirations. And for the rest of the world.

BarCamp Beijing 2007 Summary

September 2nd, 2007

Yesterday I participated in Barcamp Beijing 2007, which was held at the France Telecom Research and Development Building in Haidian district in Beijing. There were more than 100 participants with some 24 sessions held in three different languages.

It is hard to describe the firehose of information from Barcamp, but I will try to offer some of the highlights.

Michael Sikorsky, CEO of Cambrian House, first spoke about how to raise financing for startups. Based in Calgary Canada, Cambrian House offers a business platform for service providers, and Michael has successfully transitioned from being a tech person to a business person. I was immediately impressed by his praise of Paul Graham, founder of the Y Combinator seed-funding group. Paul Graham is the smartest tech guy who has transitioned to business, and Michael showed how Y Combinator has introduced a new VC business model of seeding startups by mentoring them through the startup process.

I have spoken frequently with Frank Yu about the need to bring something similiar to the Y Combinator seed capital model to Beijing. Chinese startups badly need mentoring, especially in their early phases because most of the founders do not know how to build teams. This is something Paul Graham’s Y Combinator organization has been able to address very well, teaching business smarts to founders from tech backgrounds.

The other main takeaway from Michael’s talk was that it was important for new companies to be “investor-centric” as opposed to “founder-centric”. If a company is set up to be friendly to investors up-front, then it is much easier for it to scale.

Andrew Lih, who is now living in Beijing, spoke about the Wikipedia movement. Andrew is a researcher in new media, and is now working on a book on Wikipedia due for publication sometime next year.

In the afternoon sessions, Karl Mattson, president of Medium Cool based in San Francisco, talked about what kinds of people were needed to build a good company. He put special emphasis on need for background diversity. When most Americans hear the word “diversity”, then tend to think in terms of racial, religious and sexual diversity. What Karl was talking about was the need to get people from different parts of the world, social and educational backgrounds so that they can exchange views by looking at a business proposition from different angles. Failure to do so meant that companies would often have “blind spots” and result in “group-think”, where the same group of people have a narrower and narrower vision.

I have noticed this tendency even in very large and successful US companies such as Microsoft and Google, where the definition of a smart person fits very closely with the founders’ definition of smart. This has resulted in a form of inbreeding, where the companies’ blind spots get bigger and bigger, creating opportunities for new challengers and startups.

Following his talk, Robert Scales, founder and CEO of Raincity Studios, talked about his company’s experience working with Drupal, the open-source community web framework. Robert talked about how Drupal has matured into an excellent solution for all kinds of businesses, with new modules being added on a regular basis. Previously, companies had been wary of using open-source as a solution because of security cares, but now he found that they had gone past those issues and had come to embrace it as a development platform. The best part for his 12-person team based in Vancouver was that because the software is regularly updated, his company only has to concentrate on basic functionality, design and configuration issues for his clients. And if his company cannot perform the work, design and feature requests can just as easily be addressed by another team which is familiar with Drupal. Now, his company is so busy that he has come to China to look for designers and coders to augment his Vancouver team; he mentioned that he is so busy that he has had to turn away business.

In reply to a question from me, Robert mentioned that the average billing amount and timeframe for a project is 3-6 months and 50-100k (Canadian dollars) per project.

My session was on the topic of “Building Management Teams” for startups. I focused on some of the problems which I found most Chinese startups to have:

  • Founders fall in love with their own ideas too much, take criticism personally. This makes companies too slow to ditch old bad ideas.
  • Chinese companies tend to be “founder-centric” instead of “investor-centric”, which means it is very difficult for a company to grow past US5B market cap in size (with the exceptions being Chinese state-owned enterprises or SOEs).
  • Healthy startups have a technology founder, product founder and a bizdev founder, forming a tripod. Most startups in China do not have this setup; instead relying on one person to drive growth and vision. This model does not scale well, and feeds the founder’s ego too much. This puts a cap on future growth.
  • There are too few original ideas; companies tend to copy each other.
  • China has a high-competition, low-trust society. This also puts a cap on Chinese companies’ growth. If someone can successfully address the issue of how to build trust in the online/offline world, they will have something very interesting.

Many photos were taken, including many by Kris Krug, president of Bryght, one of the event sponsors. You can find the list of sponsors from my previous pre-event posting. If you would like to see photos from the event, you can find them on Flickr.

Many participants will be going to Shanghai where Barcamp Shanghai 2007 will be held at the offices of Tudou on Sept 8.

Barcamp Beijing 2007 was a very interesting and exciting event for those interested in technology. It provided an excellent opportunity to meet some of the participants and drivers in open-source and Web 2.0, and gave those from outside China a chance to learn about the Chinese market, and a chance for Chinese to mix with outsiders.

All in all, an excellent experience.

Getting Past The “China Market” Hype

August 13th, 2007

If there is one thing which never ceases to amaze me, it’s the sheer number of overseas investors seeking entry to China, who have a hard time seeing past the most basic facts and figures about the size of the Chinese market.

Most of these firms are American, which are, generally speaking, more addicted to numeric data than their European and Japanese counterparts. Some statements they frequently quote are:

Looking at China’s economic statistics in these terms, it is very easy for executives who have little or no experience selling products outside their own home markets to think that the potential of the Chinese market is something which will fund their own retirement nest eggs.

The great danger is that more often than not, they are unable to see past these initial assumptions about the Chinese market on the board and senior management level. In fact, as many learn to their own dismay, the Chinese market is complicated, filled with traps to capture uninformed executives who fail to grasp the difficult realities of China’s markets.

Let’s take a look at some of these wrong assumptions, followed by the facts:

  • “The size of the Chinese consumer market is huge.” (True, but for the most part, there is no single national market and no way to distribute nationally; you need to negotiate deals city by city and province by province. Every city and every province wants its own unique distribution deal in order to have uniqueness in the marketplace. The main problem is not high costs, but the amount of time it takes to roll out. While the customer numbers may be huge, revenue per customer/user are usually in fact very low in the beginning for most sectors compared to other more developed markets.)
  • “If I partner with a company with national distribution, then my job will be easier.” (True, but the companies which take on partners are usually the ones who are in trouble. Many of these are state-owned enterprises which lack business marketing skills, and are trying to translate their monopoly charters into revenue with the foreign partner’s help.)
  • “Our product is so good that it will market itself”. (If you believe your own PR in this regard, your company deserves to fail.)

For the most part, the most successful companies in China’s emergent consumer market economy are firms like Suning (in consumer electronics), Shanda (in online gaming and entertainment) and Suntech (in solar energy).

What do these companies have in common? They are new, and while they did have some government backing and connections in their very early stages, they have now transformed themselves into privately-owned businesses with their own management team and CEO. For the most part, these companies are very centrally managed by their founder/entrepreneur. Unless a foreign company is able to present a very strong case for partnering with them, they will prefer to build and distribute on their own. Why should they share their profits and revenues with another company, and help to build another brand which may become a future competitor? After all, that’s how they became dominant in their own sectors; they’re not about to make the same mistake themselves.

As China’s economy becomes more market-oriented, China’s state-owned enterprises are struggling to define their roles in this new economy. It is not enough to have a government-granted monopoly charter; they need to become profitable. This pressure for profit usually comes from the Chinese government’s State Council, which is China’s cabinet.

Their preferred solution is to set up a joint venture with a foreign company, which injects startup capital since the Chinese government, as a matter of policy, does not inject capital into joint ventures, instead offering other fuzzy stuff like “markets” and “connections” into the joint venture.

Most of these joint ventures fail because the two sides fail to do the hard work to insure that there is a complete alignment of interests and accountability for their investment in the JV. Most of the time, I blame the foreign partner’s inability to see past the market hype and think and discuss the whole project through with the Chinese government partner and clearly defining which partner has responsibility to perform what needs to be done.

The endless procession of foreign companies who come to China and throw good business sense to the winds without performing proper due diligence in order to secure a footing in the “China market” never ceases to amaze me. Why is it they seemingly only do this in China? Do they think that the Chinese will throw them out of the country for asking good legitimate business questions?

Chinese SOEs are in particular need of modern management skills, especially in the areas of marketing, sales and cost accounting. Foreign JV partners would in fact be helping the Chinese companies reform by holding them accountable to reach specific business goals. The SOEs have strong connections and resources in a potentially large market.

It is only when both sides are honest about their goals and expectations that they can succeed.