How the Chinese N-curve will set the standard for innovation
Whether in retail, mobility, manufacturing, healthcare, finance or education, China is innovating at incredible pace and quickly getting ahead of the rest of the world. I do expect China’s new normal to soon influence our Western normal but am leaving that conclusion to the reader. Which models we could potentially embrace is completely our choice, but I hope my book will reveal some insights to reflect on and learn from. Below a first short extract of my book (the Dutch version will come out in May, the English version will appear later this year).
Chinese startups are restless
In China, startup founders first look at market demand and customer needs. Millions of Chinese consumers constantly seek out a higher quality of life, which acts as the spark for entrepreneurs to start a business, especially when the founder and his friends experience a similar frustration as consumers. Together, they establish a new technology company. Their path to success is very pragmatic and aims to swiftly scale towards a leading position in the market in order to prevent anyone else from removing them from their throne. It’s like a rat race to the top.
In China it’s the fast fish that typically eat the slow fish, not the big fish that eat the small fish as was mostly the case in the West so far. According to Klaus Schwab, the founder of the world economic forum, this trend is becoming a global new normal in the cyber-physical 4.0 world of tomorrow. The urge towards extremely fast customer acquisition is the most common growth model of startups in China. To achieve this, lots of money and tireless execution is a prerequisite, while innovation often becomes a secondary goal. Chinese high-tech startup founders reach out to investors much before a product-market fit is proven. We recognize the model from internet companies like Facebook, Airbnb or Uber, but in China this happens across all industries. Investors in China rely much more on their confidence in the founder and have an appetite to invest early on to make money. Often, they will invest millions, sometimes billions of dollars in a team that is not much older than 30 years. The cash is needed for these disruptive entrepreneurs to win the gladiator fight with their competitors.
You will have probably heard of the S-curve. It perfectly illustrates how innovation moves in the West. First, there is a focus on innovation without much funds. Then there is accelerated revenue and market growth, while the spending ratio of innovation decreases gradually. Finally, innovation continues at the same levels, but the additional revenue generated from it slows down.
Now, Chinese innovation moves very differently, much more extremely. The first phase on the N-curve is marked by raising as much cash as possible to quickly become the de facto standard in the market. Chinese startups first explore outside-in from market needs to product innovation, while most startups in the West seem to think inside-out from product innovation to market positioning. I have experienced this myself many times when raising funds from both Chinese and Western VCs (venture capitalists). In Europe, I raised money at any time I could convince a VC about the prototype, the team and a smart strategy. In China, I could barely get any VC attention with that pitch until I started talking about our network, customers and top brands who had signed up already. Suddenly our appeal changed completely, and I managed to raise funds from a Chinese corporate VC.
In the West, when a tech startup successfully goes to market, I often notice other startups in the same space to position themselves differently, as if there is an unspoken gentleman’s agreement for each startup to co-exist orderly next to each other. They all claim to be best and most innovative, each one correctly placed within their own self-acclaimed market segment. Everyone becomes a de facto market leader. This is most visible on their website designed with highly elaborated branding and positioning, with brochures and data to support their claims. They are not much concerned to present their entire business model and strengths to the whole world. Chinese startups barely have a comprehensive website, at most a contact page and description of the founding team and list of awards they won. Chinese startups don’t share much information that competitors could use against them. In China, from the get-go you quickly are faced with dozens to hundreds of competitors who are ready to fight you to the death - especially in a consumer market. You have to kill off many well-funded and connected highly qualified competitors to survive, as if you were playing a shooter videogame. Innovation in this harsh environment will more often than not slow you down. In consumer sectors, the first phase of innovative startups typically last 2 years. Quickly raising lots of money is the most efficient way to get to the top fast. After 2 years, the ultimate winner usually takes 50% of the market share, the runner-up 25% and a dozen fast followers will be left to divide the rest.
The war for quality and customer loyalty
The second phase of startup growth in China starts after the duopoly winners have surfaced. The battle between hundreds of players have pushed the product price down and customer expectation way up. The dozen or so surviving startups have accumulated lots of customers and raised lots of money so far. At that point, a couple of very large companies now attempt to enter the newly defined and seemingly stabilized market, often by acquiring or investing in the fastest followers. This is the second phase of the innovation curve where the big ecosystems like Alibaba, Tencent or Baidu are now helping their investee startups to fight each other, and innovation is now the battle axe. Money is not an issue. This is now a war for quality and client loyalty.
In the second phase of the N-curve, a dozen startups, each backed by a big player spend in full swing on innovation. They establish R&D teams abroad, hire hundreds of PhDs and developers, and acquire technology or expertise from overseas. This is the war for talent. That phase represents the ideal moment for startups to sell-out to the heavyweight players as startups in China view this moment as the ideal exit-strategy opportunity. No wonder funding of startups in China all flows towards founders who acted as senior management in a big company before as it increases the chance for an exit later on. This second phase drains their bank accounts very fast. They spend money like crazy but are convinced they have to in order to maintain their lead. If necessary, the giants and VCs can always invest more millions.
Speed is the new innovation
They trust that once their new innovations will come to life, they can grow much faster than their competitors. This will initiate the third phase of the growth on the N-curve which often occurs when the startup is more or less 4 years old. This is the period of consolidation and standardizations in the market, as well as the moment when the government has caught up and now regulating all actors. Now it’s all about integration with other services and players to broaden the ecosystem and customer base. In that third phase, their growth experiences a second hockey stick, similar to the growth phase of Western scale-ups. Please note that this Chinese second hockey stick growth is much steeper and higher than that of Western scale-ups because this second take-off is fueled by many more resources: abundance of financing options, very large customer base and market proven products or services. I call this the N-Curve of innovation in China. The “N” from China’s New Normal, not surprisingly the title of my new book.
As we compare the Chinese innovation with the Western s-curve-driven one, Chinese technology startups will rather invest into the market development first and switch into innovation after making lots of customers. Western tech startups on the other hand innovate typically from day one in their first phase and invest more into the market in a second phase once they developed a high-quality innovative product. In the second VC funded growth phase of startups, the business goals of Chinese and Western scale-ups mirror one another. Western scale-ups utilize VC funds towards sales, branding, marketing, infrastructure and standardization of the products and related services. Chinese scale-ups have done most of that in their first N-curve growth phase and use their funds and revenue now to hire technology experts, make higher-quality products and optimize production processes.
In our modern digital world, access to and insights from customers deems more important than having a factory or perfect product. The days where deep breakthrough innovations change the world are becoming rarer. You can only invent so many formulas of shampoo to improve the quality of hair. The times when innovation could only happen by multinationals pumping millions into research is fading. In the new world of big data and A.I., months of research done by the smartest of professors will become possible in real-time with lots of test data, commodity algorithms and cheap computing power.
The speed of product availability and relevance to consumers is becoming more important than the need for the highest quality product. The biggest innovation challenge the West will face in the next decade could be to aim for suboptimal quality standards. The German gründlichkeit is a less viable option in a VUCA-world which is a global phenomenon: Volatile, Uncertain, Complex and Ambiguous. China is an extreme-VUCA environment and inspires its innovators to change the standard of innovation. Chinese startups first aim for ‘just good enough’ with a first release of a new product which attracts many early adopters, and fast. It’s those demanding customers who push the Chinese startup to improve their products quickly and deliver fast enhancements and upgrades. By the time European startups raise VC money after four years on average, Chinese high-flying startups typically have matched the same quality of products hunted down by millions of consumers and gathered tons of data insights to build the right product for any new market. We tend to run too many marathons in the West, while Chinese run relay races together.