Is China a global innovation powerhouse?

Is China a global innovation powerhouse?

Defending the motion

Edward Tse  

Senior Executive Advisor, Greater China, Booz Allen Hamilton

SOEs will continue to play a big part in China, but most of the innovation will come from private companies.

Against the motion

Anne Stevenson-Yang  

Founder and Research Director, J Capital Research

China has the building blocks for innovation but is thwarted by government domination of the economy.The moderator’s opening remarks

Nov 12th 2013 |Vijay V. Vaitheeswaran  

China’s spectacular economic rise is producing some of the world’s biggest and fastest-growing companies. Does this also mean that China is an innovation power on par with America?

Boosters point to the soaring number of patents held by Chinese technology firms like Huawei and Lenovo, the number of Chinese PhDs in technical fields graduating each year and the success of internet firms like Alibaba and Tencent as evidence that China is leapfrogging to the forefront of global innovation.

In contrast, sceptics highlight the lack of rule of law and respect for intellectual property rights inside the country, widespread corporate espionage and cybertheft, and forced technology transfers as evidence that China remains a copycat and a cheat.

In his sunny opening argument in favour of the motion, Edward Tse offers three reasons to think China is in fact an innovative economy. He observes that the country is full of entrepreneurial vim, pointing to Xiaomi (a smartphone manufacturer now valued at $10 billion, more than BlackBerry) as an example of such a “fearless innovator”. Because China is growing so rapidly, he argues, its markets are forcing firms to become nimble and to adapt quickly. He acknowledges the problems posed by the dominance of uninnovative state-owned enterprises, but thinks private enterprises—including multinationals—will nevertheless carry the day.

In a blistering opening salvo, Anne Stevenson-Yang sets out to make the case against what she considers to be “window dressing” innovation in China. The central problem, she argues, is the dominance of the state. Chinese firms are quite capable of clever inventions, but she thinks firms cannot afford to invest in developing new technologies because of unfair competition from cosseted state-owned enterprises. She also believes much innovative energy is squandered by firms overcoming the obstacles created by the dominance of state capitalists over such things as distribution channels.

The question of whether China can innovate well becomes particularly important as the country’s export-led growth model based on cheap labour runs out of steam. Now China’s leaders openly talk about the need to shift from exports to domestic consumption, and of the need to boost services. They are explicitly targeting innovation as a national priority, in the hope of speeding the shift from brawn to brain that is required to prosper in this new century’s ideas economy.

So is China a world-class innovator or not? Are you moved by the arguments offered by the proponent, or persuaded by the concerns expressed by the opponent? Join our debate today and make your voice heard.

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The proposer’s opening remarks

Nov 12th 2013 | Edward Tse  

Innovation, as defined in Wikipedia, is “the application of better solutions that meet new requirements, inarticulate needs, or existing market needs. Innovation differs from invention in that innovation refers to the use of a better and … novel idea or method, and invention refers more directly to the creation of the idea or method itself.”

The key drivers of the innovation process can be classified in three major categories and one can picture them as three concentric circles. At the centre there are people, in the middle there are organisations (including culture, processes, offerings) and in the outermost circle there is the environment (economic climate, market condition and geopolitical).

Starting first at the centre: people. Most studies on innovation have shown that it is often more difficult for large corporations to maintain the same level of creativity and freedom (both conducive to the innovation process) as start-ups. China today is filled with start-ups, so it already has a head start. But these Chinese entrepreneurs are looking at other global success stories and, ignited by a “Why not me” mentality, they forge ahead and are not thwarted by the lack of support, but rather find ways to create success against an ever-changing landscape. With limited resources and even less to lose, they are often more risk-tolerant and ready to make tough decisions with short notice, believing that even if these turn out to be suboptimal, they can always change paths and try something else. Against this background, many of them become the embodiment of fearless innovators.

Xiaomi is an excellent example of this. Knowing that it does not have enough money to do detailed research it innovates, and it has completely redefined “listening to your customers”. The strategy is working—the company went from zero in 2010 to a current valuation of $10 billion. An obvious comparison would be its American counterpart, Apple, which is undoubtedly one of the most successful innovation companies in the past decade, creating significant market impact and changing the competitive landscape. It is important to note that Apple did not invent the mobile phone or even the smartphone, but it recognised unarticulated consumer needs and went ahead and served those needs. The result for the iPhone is complete market dominance for a long period of time. Steve Jobs did not believe in focus groups because he felt that he knew best. Lei Jun is the opposite, believing that customers are the best ones to tell him what products they want—he listened and then delivered. Both Xiaomi and Apple are highly successful companies and noteworthy innovators, but completely different in their approach.

The second factor is organisations. Organisations generally become more reluctant to change as they become more successful and established. Markets start to mature through time and the market leaders often start to decline as they continue to bask in the glory of yesteryear and miss the early signs of change. Before the emergence of China, these well-established organisations, often market leaders in their respective industries, had attained global leadership and were basically on top of the world. China, however, is a rapidly changing market, and this forces the local market leaders to remain astute. With the lure of the global golden ring, Chinese organisations remain hungry and continue to push for growth.

Haier gained rapid market awareness and share by introducing a washer capable of cleaning not only clothes but also potatoes. This development came about through customer demand from a lower-tier city and is a living embodiment of Haier’s “customer centric” management philosophy. Not every company will be like this, but the fact that the market is rapidly changing and there is still more to conquer will encourage more Chinese companies to remain agile and nimble.

The final driver is the environment, and this is the area that causes the most concern for people looking at the future of innovation in China. The criticisms centre on the dominance of state-owned enterprises (SOEs), which basically have little accountability and are not entirely market driven, especially those in closed sectors; the overabundance of government incentive programmes to push for certain technological changes but without the needed oversight; and the heavy involvement of the government in the market.

SOEs will continue to play a big part in China, but most of the innovation will come from private companies (and foreign companies operating in China) and there will be an abundance of these springing up across multiple sectors. Where sectors are open, the competition typically becomes intense as all players, be they multinationals, SOEs or private companies, try to capture a piece of the pie. Government incentives in key industries, eg solar energy, have allowed a nascent industry to attain an enviable global position in a relatively short time. However, without any oversight, as demonstrated by the solar-panel market, there is now a glut. Through time, the government’s involvement will decrease and normal market dynamics will follow, ie market consolidation and rationalisation. China is increasingly becoming more open and the government is pushing for more deregulation, thereby increasing competition against the backdrop of a large and complicated market and operating environment. All these changes will serve to further foster innovation.

China is one of the most populous countries in the world and the road ahead is not easy. However, the key drivers for successful innovation are very much present in China and will continue to guide the next generation of innovators.

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The opposition’s opening remarks

Nov 12th 2013 | Anne Stevenson-Yang  

Two principal types of innovation preoccupy managers of businesses: one creates new value and the other protects existing value.

Some of the examples of innovations, large and small, that create commercial value, respond to market opportunities and improve competitive advantage would include the invention of the computer mouse by Stanford Research Institute, the development of a stronger, oval-shaped ball bearing by Timken, or the development of an online ticketing system common to multiple airlines by a consortium of the carriers.

China has the building blocks for the first type of innovation but is thwarted by government domination of the economy. With a high educational level and intense commercial competition among small, private businesses, heavily populated areas like Zhejiang and coastal Guangdong can be particularly generative of innovation.

Inventiveness, however, is only one requirement for commercial innovation; having the means and incentive to undertake a long and uncertain development cycle is another. Without property rights, the incentive is absent.

The problem here is not the law; should China’s government cease to own and manage businesses, innovation would thrive even amid a complete absence of intellectual property regulation. Instead, companies cannot afford to invest in developing technologies because of competition from protected actors in the state sector. As a result, they find it most adaptive to push new products into the market as rapidly as possible in order to benefit from their brief commercial lives, even if this means capturing technologies through copying or reverse engineering.

This is a defect of the state economy. In China, the most valuable asset a company can own is a set of bureaucratic relationships, and this is why some of the strongest Chinese companies are diversified conglomerates whose critical competitive edge consists of their ability to bring government relationships, and the attendant capital, to bear on any commercial opportunity.

The second form of innovation defends companies from predatory regulatory or competitive practices. Commonly, this type of innovation takes the form of rapid adaptation to a fast-changing and opaque commercial environment, made uncertain by regulatory change. To be competitive, Chinese companies must move quickly, and so they maintain highly decentralised organisations, incentive systems that are indexed to growth, short product-development cycles, locally deployed capital, and an organisational separation between product and distribution that enables the distribution chain to move from product to product easily.

These activities in China absorb much innovative energy. To name just a few:

• Tencent’s QQ tool, which added so much convenience for consumers, was launched against the background of the state-owned carriers and regulatory restrictions that barred direct competition.

• The same was true for Sohu’s early adaptation of short messaging services, or the short-range Little Smart phones that UT Starcom adapted from old Japanese technology.

• The same evasive motives have driven the adoption of third-party payment systems such as Shanda’s and Tencent’s payment cards.

All of these represent high levels of innovation by entrepreneurs, but most are against the background of micro-regulation that otherwise would inhibit enterprise growth and improved offerings to the marketplace.

Although overcoming the obstacles created by distribution channels monopolised by the state in itself generates adaptive innovation, such obstacles tend to kill inventions before they have a chance to be tested in the market.

Once monopolisation works against innovation, the government steps in to create programmes focused on funding streams for incumbents that undermine the very innovation they are designed to support, as they direct research efforts toward predetermined targets.

• Cell phone companies in the later 1990s were given generous funding for R&D to help them compete with international incumbents in the export market. The Chinese companies focused on undercutting the internationals on price and were left behind when international companies moved up the value chain.

• Auto companies now receive huge grants to develop energy-saving technologies and consequently develop redundant capacity in the same lithium-ion batteries, with no development of infrastructure for electric cars.

• Solar companies were given large subsidies in order to make competitive polysilicon, such that they undercut internationals on price but developed products that cannot survive outside the subsidised environment.

Many times, technology is acquired in Chinese companies under government incentive programmes that encourage capital spending, but the technology is not absorbed into any business process. Yili Milk is one example. The company’s packaging plant in Hohhot is as modern as any in the world, but the milk collection is done in unsanitary village stations, because agricultural policy in China makes the aggregation of pasturage impossible.

China’s challenge as a nation is to redirect its entrepreneurial energy away from this sort of “window dressing” innovation and towards new value creation.