China 2.0: A Nation's High-Tech Direction

Almost every major Chinese internet company has opened an office in the San Francisco Bay Area within the last year, said venture capitalist Raymond Yang of China-based WestSummit Capital at the fourth China 2.0 tech conference held in early October. These companies are looking to learn from the internet establishment, and eventually expand into other markets. The Chinese presence has grown so much and so quickly that Yang joked to the Stanford University digerati audience that Silicon Valley has a new moniker: “Bay-jing.”

Other evidence of China spreading its high-tech wings came from venture capitalist David Chao of Silicon Valley-based DCM, who noted that Chinese tech startup mergers and acquisitions are heating up. It used to be that the only way to cash out your investment in a Chinese tech startup was for it to go public on an international stock exchange, he said. Recently, however, China-based firms Baidu, Alibaba, and Tencent have either bought or invested in other internet-related companies, a trend similar to that in Silicon Valley where most venture capital exits are now via mergers or acquisitions.

Sand Hill Road, the famous home base of international high-tech investors, still finds investment opportunities in China, but the competition is more intense, according to many of the speakers. China’s first generation of tech entrepreneurs is now wealthy and experienced enough to invest and guide newer startups, so they don’t need as much Sand Hill expertise, said Tom Manning, another longtime China watcher and investor.

Many of China’s latest entrepreneurs “have done it before, and there is more of a network so the quality [of leadership] is higher,” said Jenny Lee, a partner at GGV Capital who looks for investment opportunities in China. “I don’t see them as competition. I see them as partners.” There are still not enough experienced entrepreneurs to deal with the tremendous potential in China, she added.

Here are a few of the main themes that emerged from the conference.

Still focused on local mobile market opportunities

A few of China’s tech business leaders outlined plans to enter markets outside China, but most said the opportunities within China are too great to think much about global expansion yet. China has nearly 600 million internet users, almost twice the entire population of the United States.

“There’s nothing wrong with not going global because China is a huge market,” said Hugo Barra, former head of Google’s Android unit, who recently joined Chinese phone maker Xiaomi.

He added that “American companies fail all the time” at going global because they don’t focus enough on the user experience, which requires cultural awareness and paying attention to feedback. Xiaomi, he said, requires its engineers to react to issues raised in user forums, and sends software updates weekly to beta users of its phones and monthly to other customers.

The hugely popular Tencent has opened WeChat messaging outside China, so Chinese users of Weixin social networking can interact with them, but the company’s focus is building out its mobile services within China, especially with games, said President Martin Lau, who was a classmate of Yahoo and Google founders when he was a graduate student at Stanford in 1994-1995. Lau said his company redefined the jobs of half its employees to focus on mobile phone services.

For outsiders wanting to invest in China, Fritz Demopoulos, founder of Queen’s Road Capital, advised, “think about what value you bring,” besides cash. He has lived in China 16 years, he said, but still finds there are many “cultural elements to understand. I work with phenomenal, capable locals.”

One thing outsiders can bring is “people who have an international vision” because fewer people in China have that, said Andy Zhong, cofounder of FunPlus Game, and they are still busy focusing on China market opportunities.

China’s mobile consumers lead the way

Mobile is trumping fixed line users, fueled by growth since 2011 of a smartphone gaming-and-socializing culture that promises to grow further as the cost of phones comes down.

China has 465 million smart phone users today, with about 200 million more expected over the next two years, said Barra of phone maker Xiaomi.

European media company Bertelsmann invests in China mobile-internet companies, said Annabelle Yu Long, a board member and head of its Asian investment division, because it believes China is the best place for a traditional media company to “test ideas about the next generation of consumer behavior,” especially related to revamping Bertelsmann’s entertainment products for mobile devices.

With China’s rampant piracy problem, “a cynical person would say nobody in China is ever going to pay for content on a phone,” suggested Chao of DCM Capital. But Yu Long countered that China’s mobile distribution channels will be reinvented, given the incentives for entrepreneurs to make a profit. Lee of GGV agreed, adding that in one case she was aware of 30 of 100 China app users were converted to paying subscribers for content.

Added Yang: “U.S. entrepreneurs are good at changing the world, but China entrepreneurs … find the best way to serve end-user needs.”

Future growth in gaming and other segments

“Gaming is not considered the sexiest business in the Silicon Valley,” said Tencent’s Lau, but it is his company’s leading source of revenue. Advertising, the biggest source of revenue for mobile apps in the United States, is growing in China, but is just 9% of Tencent’s current revenue, he said.

The future profit potential, he added, is in “connecting the phone with all sorts of offline businesses.” The legacy taxi business is already threatened by people arranging car dispatches through smartphones, he said. “A lot of existing businesses in China will be disrupted by the mobile revolution. At some point when that happens, another wave of monetization” will occur.

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SINA CEO Charles Chao believes financial services may be the next business to be changed by mobile in China. (Photo by Saul Bromberger)

Charles Chao, CEO and chairman of SINA, which offers a micro blogging service used by 500 million Chinese, said financial services may be the next business to be changed by mobile in China. “The internet makes everything more transparent.”

One company pushing to grow outside China is FunPlus Game, cofounded by Andy Zhong. Looking for a growth market in the next 3 or 4 years, he settled on Europe. After launching in Turkey, he was surprised by interest in the Middle East. Culture and technical innovation both matter in the gaming business, he said, so the company’s top managers all love gaming, hail from several countries, rotate their country location every 3 to 6 months, and work on cross-country teams to develop game features. In contrast, Lau said Tencent’s strategy was to invest in other gaming companies outside China.

Progress on best practices

Intellectual property theft and fraud are still a concern, said Gary Locke, U.S. Ambassador to China. Investors in China need advisors on how to write disclosure agreements, he said, but he added that the situation is improving because China’s own technology companies now have IP to lose. “I think [government] leaders realize [that] to move into a higher wage society, they will need to step up intellectual property rights.”

Private equity firms are also concerned with running afoul of the U.S. Foreign Corrupt Practices Act when dealing with Chinese government and business entities, Manning said. Ken Wilcox, chairman of Silicon Valley Bank, agreed. The bank is the only U.S. bank yet licensed to operate directly in China. “At least once a week someone tells me about a niece or nephew at Stanford who would like to work at the bank,” said Wilcox. “We keep meticulous records because J.P. Morgan’s experience [of being investigated by the U.S. Securities and Exchange Commission for hiring children of Chinese business partners] is what all of us experienced, just in a more extreme fashion.” Such a request may seem “polite, correct, and sensible” to someone raised in Chinese culture but dangerous to Americans, he said. “The longer I live in China, the more I see the real cultural differences are subtle.”

Still leading in hardware manufacturing

China’s skills in managing supply chains make it a leader in the hardware end of high-tech manufacturing, speakers said. Labor costs are rising in China, but it is still a challenge in neighboring countries to achieve China’s level of efficiency, said Sidney Lu, chairman and CEO of Taiwanese contract manufacturer Foxconn Interconnect Technology, which makes computer cables and connectors in China. In the hardware area, China is “constantly innovating on the factory floor” added Michael Marks, a private equity investor, founding partner of Riverwood Capital, and a former CEO of manufacturer Flextronics. The consensus of speakers was that Silicon Valley is still better at technical innovation, but China may be better at factory floor innovation. China is also moving quickly to catch up on business model innovations that please regular-Zhou customers.

Stanford graduates quoted in this story are Thomas Manning, MBA ‘79; David Chao, MBA ‘93; Martin Lau, MSEE ‘95; and Annabelle Yu Long, MBA ‘05.