China has risen rev 5

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China has risen rev 5

  1. 1. POST 1 of 5 China – The Sleeper AwakensI just spent a few weeks in Japan and China on a book tour for the Japanese and Chinese versions of the Startup Owners Manual. In these series of 5 posts, I thought I’d share what I learned in China. My post about Japan will follow. All the usual caveats apply. I was only in China for a week so this a cursory view. Thanks to Kai-Fu Lee of Innovation Works, David Lin of Microsoft Accelerator, Frank Hawke of the Stanford Center in Beijing, and my publisher China Machine Press.Summary: I’ve lived in Silicon Valley for 35 years, I’ve taught in entrepreneurial clusters in NewYork, Boston, Helsinki, Santiago Chile, St. Petersburg, Moscow, Prague, and Tokyo, but thevisit to the heart of the Beijing startup world Zhongguancun has truly blown me away.Each of these clusters has wondered how to become the next Silicon Valley. Beijing is alreadythere.----------What a long strange trip China has been through. After the creation of the Peoples Republic ofChina in 1949, all industry was nationalized, agriculture was collectivized, and the private sectorwas eliminated. All companies were owned by the state, all planning was centralized, and thestate determined the allocation of resources. This was the China I grew up with – the one whereprivate enterprise was a crime and marketing wasnt a profession.To say China has transformed itself is perhaps the biggest understatement one can make. Chinahas embraced state capitalism in a way Wall Street can only dream about.Startups, Venture Capital and the Communist Party: how did this happen in China?The best analogy to describe the relationship of science and technology and the Chinese startupscene is to understand its parallels with the United States during the Cold War with the SovietUnion. During World War II, the U.S. mobilized scientists in a way no other country had. For45 years - post World War II until the fall of the Soviet Union - the U.S. viewed science andtechnology as a strategic asset. We made major investments in it, understanding that establishingbasic and applied science leadership was necessary for us to build advanced weapons systems todefend our country and deter and if necessary, wage and win a war with the Soviet Union.These investments took the form of building national research organizations, several for basicscience (NSF, NIH) and others for applied weapons research (DOD, DARPA, DOE, etc.)Research universities also became an integral part of the military ecosystem as the federalgovernment pumped billions into supporting science.Startups, entrepreneurship and commercial applications are happy byproducts of those militaryinvestments. For example, as the semiconductor business started, the largest customers forFairchild’s and Texas Instruments new integrated circuits were the Apollo Guidance Computerand the guidance system for the Minuteman II ICBM.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  1  of  26  
  2. 2. China is following the same path…Over the last three decades, to achieve strategic parity with the United States and to construct amodern military, the Chinese have made massive investments in building their science andtechnology infrastructure. China has gone from a land-based army to one that can support itsterritorial claims to the South China Sea and Taiwan with anti-access/area-denial weapons. Thisevolution required a transition, moving from a reliance on the numerical superiority of its landarmy toward a force boasting sophisticated aircraft and naval platforms, precision- strikeweapons, and modern C4SIR (Command, Control, Communications, Computers, Intelligence,Surveillance and Reconnaissance) capabilities. Its Second Artillery Corps not only controlsChina’s ICBMs, but also its short range missiles pointed at Taiwan, Vietnam, Philippines, andU.S. bases in Guam and Okinawa. And its new terminally guided ICBMs have put U.S. aircraftcarriers in harms way in any regional confrontation. Its air force and navy have gone from a self-defense force to one that can project regional power effectively to the first island chain andbeyond.China’s military modernization depends heavily on investments in China’s science andtechnology infrastructure, reform of its defense industry, and overt and covert procurement ofadvanced technology and weapons from abroad.Building China’s Science and Technology infrastructureScience and startups have come a long way since the 1980’s when the Chinese governmentowned everything and controlled it through a central planning system. But before startups couldhappen, China’s basic science, technology and finance infrastructure and ecosystem needed to bebuilt. Here’s how a national policy for science and technology emerged.Beginning in the 1982, China started a series of science and technology programs in five areas:support of basic research, high technology R&D, technology innovation and commercialization,construction of scientific research infrastructure, and development of human resources in scienceand technology.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  2  of  26  
  3. 3. The majority of the science and technology programs are driven by MOST (Ministry of Scienceand Technology) and NSFC (National Natural Science Foundation). As we’ll see later, the MOF(Ministry of Finance) also has had a hand in funding new ventures.54The diagram below from OECDs Report on Chinas Innovation Policy puts the ministriesinvolved in science in context. (Note that it does not show the military technology ministries.) Figure 3.2 Public governance of S&T and innovation in China: The institutional profile Table 3.1 Fu Program State Council Key Technologies State Council Steering Committee of S&T and Education 973 863 NNSFC NDRC Knowledge Innovation COSTIND Other MOC MOF MOST MOE CAS CAE MOP Ministries TOTAL Total as a share of total public S&T expenditures Oversees State IP Attracts overseas Office NSFC defence-related Chinese Scholars, R&D and Innovation Productivity Provides manages post-doc military Fund for Small Promotion policy programmes applications Technology-based Center advise of commercial Firms Key Technologies technologies Funds Defines policy Provides support to basic on patents and university-related research other IPR issues R&D, science parks Promote the developme and human resource of key technologies development needed for industrial an Defines and Provides tax reliefs to Supports Conducts social development implements exports of high tech innovation research and sectoral R&D products, and preferential in SMEs promotes policies treatment of FDI innovation through the K in high tech sectors Knowledge Innovation million RMB (2004) Program Total funds raised Government funds O Formulates strategies, priority areas, policies, laws and regulations for S&T Gov. as % of total O Promotes the building of the national innovation system O Conducts research on major S&T issues related to economic and social development O Guides reforms of the S&T system Main tasks Origin of MOST O Formulates policies to strengthen basic research, high-tech development and industrialisation and S O Designs and implements programmes to fund basic and applied research, to induce firms to innovate, to create science parks, incubators, etc. O Develops measures to increase S&T investments O Allocates human resources in S&T and encourages S&T talents Funds raised (million RM O Promotes international S&T cooperation and exchanges % government O 3 core programs: The National Key Technologies R&D Program; the National % enterprise Main tools High-Tech R&D Program (863 Program); the National Program on Key Basic Research of MOST Projects (973 Program) % bank loans O Two group programs (Construction of S&T infrastructures; Construction of S&T industrialisation environment) % overseas % others NDRC: National Development and Reform Commission COSTIND: Commission of Science, Technology and Industry for National Defence MOC: Ministry of Commerce MOF: Ministry of Finance MOE: Ministry of Education MOP: Ministry of Personnel MOST: Ministry of Science CAS: Chinese Academy of CAE: Chinese Academy of NSFC: National Natural Science and Technology Sciences Engineering Foundation of China Source: OECD based on data from MOST and other sources.  • Basic research: National Natural Science Foundation (equivalent to the U.S. National Science Foundation,) ~$1.75 billion budget. The 973 program (National Basic Research Program) part of the Ministry of Science and Technology.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  3  of  26  
  4. 4. • High technology R&D: 863 Program (State High Technology R&D Program) headed by ex leaders of Chinese strategic weapons programs, and the National Key Technology R&D Program.• Technology innovation and commercialization: National New Product Program, the Spark program for rural innovation, and probably the most important one for startups in China , the Torch Program• Science research infrastructure: National Key Laboratories Program, and the MOST program for the construction of research facilities, R&D databases, and a scientific research network• Development of human resources in science and technology: Programs for attracting returnees or overseas Chinese talent: from the Ministry of Education - the Seed Funds for Returned Overseas Scholars, Chunhui Program, and the Cheung Kong Scholar Program. From the Ministry of Personnel - the Hundred Talents Program. From the National Science Foundation - the National Distinguished Young Scholars Program.    Part two the next post, describes China’s Torch Program, the largest government-runentrepreneurial program in the world.Lessons Learned• China is working to build basic and applied science and technology leadership• Like the U.S. and the Soviet Union in the Cold War they are using science and technology to build advanced weapons systems• Unlike Russia they’ve found the path for a thriving system of commerce in between State Owned Enterprises• Technology startups are a side effect from these investments-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐  Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  4  of  26  
  5. 5. POST 2 of 5 China’s Torch Program - the glow that can light the worldI just spent a few weeks in Japan and China on a book tour for the Japanese and Chinese versionsof the Startup Owners Manual. In these series of 5posts, I thought I’d share what I learned in China. Allthe usual caveats apply. I was only in China for aweek so this a cursory view. Thanks to Kai-Fu Lee ofInnovation Works, David Lin of MicrosoftAccelerator, Frank Hawke of the Stanford Center inBeijing, and my publisher China Machine Press.The previous post described how China built itsscience and technology infrastructure. This post is about the how the Chinese governmentengineered technology clusters.--The Torch ProgramIn size, scale and commercial results China’s Torch Program from MOST (the Ministry ofScience and Technology) is the most successful entrepreneurial program in the world. Of all theChinese government programs, the Torch Program is the one program that kick-started Chinesehigh-tech innovation and startups.Torch has four major parts:Innovation Clusters, Technology Business Incubators (TBIs), SeedFunding (Innofund) and Venture Guiding Fund.Innovation ClustersIndustries have a competitive advantage when related companies cluster in a geographicallocation. Examples are Hollywood for movies, Milan for fashion, New York for finance andtoday, Silicon Valley for technology entrepreneurship. The early clusters occurred byhappenstance of geography or history. But the theory is that you can artificially create a clusterby concentrating resources, finance and competences to a critical threshold, giving the cluster adecisive sustainable competitive advantage over other places. Israel, Singapore and now Chinaare the three countries that have successfully put that theory into practice. The Torch program created Innovation Clusters by creating national Science and Technology Industrial Parks (STIPs), Software Parks, and Productivity Promotion Centers. The first Science and Technology Industrial Park was Zhongguancun Science Park in Beijing. It has become China’s Silicon Valley. (This was the area I visited in this trip to China.) In addition to the one in Beijing, China has set up 53 additional industrial parks and in them are ~60,000 companies with 8 million employees. Industry or technology specific versions of theseclusters have been set up; for example Donghu in Wuhan - specializing in optoelectronics,Zhangjiang in Shanghai - focusing on integrated circuits and pharmaceuticals, Tianjin - biotechSteve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  5  of  26  
  6. 6. and new energy, Shenzhen – telecommunications and Zhongshan – medical devices andelectronics.The Science and Technology Industrial Parks contributed 7% of China’s GDP and close to 50% of all of China’s R&D spending. In addition to the 54 Science and Technology Industrial Parks, the Torch program also set up an additional 32 Torch Program Software Parks. Another key part of China’s cluster strategy was collaboration between research and business, as well asbetween large enterprises and tech-based small and medium enterprises. It did so by building anational network of a 1,000+ Productivity Promotion Centers. They provide consulting,promotion, product testing, hiring, training and incubation services to startups.Technology Business Incubators (TBIs)While the Innovation Clusters designated specific areas of the countries where high tech was tooccur, it’s the Technology Business incubators located inside these clusters where the startupcompanies physically reside. Much like incubators worldwide, they provide startups with officespace, free rent, access to university technology transfer, etc.By 2011, there were a total of 1034 Technology Business Incubators across China, including 336as National incubators, hosting nearly 60,000 companies. (20% of the National Incubators wereprivately-run and their percentage is steadily increasing.) In recent years Business Incubatorshave developed into diverse models. For example, the Ministry of Education and the Ministry ofScience and Technology teamed up to put 45 incubators in universities. There are close to 100specialized incubators for companies founded by returned overseas Chinese scientists andengineers. There are a dozen sector-specific incubators (a Biomedicine Incubator in Shanghai,Advanced Material Incubator in Beijing, a Marine Technology Incubator in Tianjin, etc.) Theseincubators are mostly clustered in the eastern coastal regions, and disproportionately target TMT(Technology Media and Telecom) and Biotech.Some of the startups coming out of these incubators have become large international companiesincluding Lenovo, Huawai, Suntech Power, etc.Seed Funding (Innofund).The best analog for China’s InnoFund is the U.S. government’s SBIR and STTR programs. Setup in 1999, Innofund offers grants ($150 - $250K), loan interest subsidies and equity investment.Innofund is designed to bridge early stage technology companies that have innovativetechnology and good market potential but are too early for commercial funding (banks or VCs.)Innofund applicants have to be in high-tech R&D, have less than 500 people, at least 30% of theemployees have to be technical and the majority of the company owned by Chinese. The ultimategoal of Innofund is to get the startups far enough along in technology and market validation soother sources of financial capital (banks, VC’s, corporate partners) will invest.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  6  of  26  
  7. 7. Since its establishment, there’s been over 35,000 applications with 9,000 projects approved andclose to a $1 billion allocated.Most Venture Capitalists in China viewed the Innofund the same way most U.S. VC’s treat theSBIR and STTR programs – they never heard of it, or they think it takes too much time to applyfor too little money. And with the same complaints; tedious, relationship driven applicationprocess, bureaucratic reporting requirements, and outcomes often measured in quantity and notquality. However, for startups who have gotten an Innofund grant, it does provide the samepositive cachet as an SBIR and STTR grant – the government has reviewed your technology andthought it was worthy.Venture Guiding FundIn 2007 the Ministries of Science and Finance raised the stakes to get VC’s focused on funnelingmore VC money into growing startups – they set up a Venture Guiding Fund. The VentureGuiding Fund invests directly into VC funds, co-invests with VC’s, and covers some VC bets. Itdoes this with four programs: 1) A fund of funds, holding < 25% equity in VC firms, requiringonly a fixed rate return; 2) the fund will co-invest with other VC firms matching up to 50% ofother VC firm’s equity investment or a maximum of $500K; 3) Risk subsidies for VC firms,where the fund will be compensated for the cost and loss of VC firms which have madeinvestments in technology-based startups; and 4) Grants for portfolio reserves, where the fundwill provide grants for technology-based startups which are being incubated and coached by VCfirms.Torch SummaryIn the last decade Torch managed to break free of Chinas state central planning bureaucracies.Of all the Chinese innovation programs, Torch is the one that was run like a startup – iteratingand pivoting as it learned and discovered. This enabled Torch to evolve with Chinas rapidlyglobal economy.Part 3, the next post describes the rise of Chinese venture capital.Lessons Learned• The Torch Program is the worlds largest “lets engineer entrepreneurial clusters” experiment• Torch has four major parts: Clusters, Business Incubators, Seed Funding, and Funds to support Venture Capital firms• Torch was the rare government program that was run like a startup – iterating and pivoting as it learned and discovered.-------Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  7  of  26  
  8. 8. POST 3 of 5 The Rise of Chinese Venture CapitalI just spent a few weeks in Japan and China on a book tour for the Japanese and Chinese versionsof the Startup Owners Manual. In these series of5 posts, I thought I’d share what I learned inChina. All the usual caveats apply. I was only inChina for a week so this a cursory view. Thanksto Kai-Fu Lee of Innovation Works, David Linof Microsoft Accelerator, Frank Hawke of theStanford Center in Beijing, and my publisherChina Machine Press.The first post described how China built ascience and technology infrastructure to supportadvanced weapons systems development. The previous post described how the Torch programbuilt China’s innovation clusters. This post is about the rise of Chinese venture capital and how ithelped build the countries entrepreneurial ecosystem.The Rise of Chinese Venture CapitalChina’s move away from a state system that solely depended on a command and controleconomy started in the 1990s. The first wave of startups began when R&D centers anduniversities began to provide the technology and seed capital for new startups that were spin-outsor spin-offs. This could be a group of individuals leaving a university or research center or anentire department leaving. For example, in the 1990’s 85% of the start-up funds of the newtechnology companies founded in Beijing came from the research center or university they left.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  8  of  26  
  9. 9. The second wave of technology investors were Chinese banks, who provided the majority of thelater stage investments in the Torch Program. By 1991, 70% of the Torch funded startups weregetting bank financing for expansion and later stages of the new ventures, with localgovernments acting as guarantors. Like the U.S. SBIR and STTR programs, the Torch Program’sfunding for new ventures was limited to seed funding the front end. Being designated as a TorchProgram startup gave banks comfort to provide loans to these ventures for technologycommercialization.Technology zones with Science and Technology Industrial Parks were the third source of supportfor new ventures. Inside the zones were Torch Technology Business Incubators with startupslicensed by the local governments. These local governments financially supported the startupsbecause, by locating in these zones, the new ventures were seen as contributing to localeconomic development. This helped the startups qualify for funding from banks and venturecapital firms.By the mid-1990s, Chinese leaders realized that the Torch program couldnt be the source of allcapital for startups. At the same time neither banks nor local governments had the cash to financestartups on the scale the country needed. The problem was that in China the government didntrecognize venture capital firms as a legitimate organizational type. The founding of domestic VCfirms began with the establishment of local government-financed venture capital firms (GVCFs),followed by university-backed VC firms (UVCFs). (The State Science and TechnologyCommission and the Ministry of Finance formed the China New Technology Venture InvestmentCorporation in 1986, but it was a government agency supporting national technology venturepolicy objectives, rather than a profit-oriented private enterprise. It went bankrupt in 1997.)A few foreign VC firms like IDG Capital Partners entered China in the early 1990s. Gradually,from the mid-1990s, the perception of venture capital shifted from its being a type of governmentfunding to being a commercial activity necessary to support the commercialization of newtechnology. But it wasnt until 1998 that corporate-backed VC firms could be established, andthat started a wave of VC funds backed by government, corporate and foreign capital.A great summary diagram below from OECDs Report on Chinas Innovation Policy traces theevolution of Chinas Innovation Ecosystem.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  9  of  26  
  10. 10. Figure 3.1 ChinaÕs innovation policy: institutional reform and learning curve The incubation The experimentation Structural reform Deepening Toward a firm-centered phase phase of the S&T system of the S&T reform innovation system (1975-1978) (1978-1985) (1985-1995) (1995-2005) (2005+) Systemic efficiency threshold ? Private Decision Stock Exchange ownership to join started in recognized WTO (2001) Shenzhen (1990) First (1999) Company 2006 national S&T Provisional Law (1994) conference and adoption Bankrupcy of the Medium and Long Law for Action Plan for Term S&T Strategic Plan SOEs (1986) Promoting Trade by S&T (2000) Launch of Innovation Fund for the open Technology-based SMEs (1999) door policy (1978) Innovation policy CAS Knowledge learning curve Technology Innovation Program (1998) Special economic Spreading zones created (1980) Program (1990) 973 Program (1997) Torch Program Share of transactions conducted at market prices (1988) (% of transaction volume) National Key 100 Technologies R&D National Natural Adoption of the Deng Xiao Ping Science Foundation Revitalizing the nation 80 Retail sales Program (1984) outline report of China (1986) through science and for reform (1975) State Key education strategy 60 Laboratory 863 Program (1986) (1995) Producer goods Program (1984) 40 Spark Program (1986) 20 University reform (1985) 0 Start of the reform of the 1978 1985 1991 1995 1999 2003 S&T system (1985) Source: National Reform and Development Commission. Government Government Government Government Government Universities Firms Universities Firms Universities Firms Universities Firms Universities Evolution of Firms the innovation system Public labs Public labs Public labs Public labs Public labs Context End of the cultural revolution. Launch of the reform The reform of the economic Fast economic growth, pressure Mounting concerns regarding Urgent need for modernisation of the economic system system expands into the S&T from technology-based the sustainability of the of the economy. sphere competition in domestic and current growth trajectory international markets Type of learning Learning from self reflection and Learning by doing bottom-up Learning by designing and Accelerated learning from Toward endogenous institutional criticism experimental reforms implementing top-down systemic international good practices learning and evidence-based institutional reforms fostered by WTO membership policy making, including and obververship in OECD CSTP international benchmarking Policy focus Remove conceptual / Address the shortcomings Reform public research Enhance firmsÕ innovation Complete the shift from ideological barriers to of the soviet model of a S&T organisations (PROs),including capabilities & commercialisation a PRO-centered inovation system S&T development system, especially the lack the university system and the of public research to a firm-centered one. Better of science-industry links. conversion of public labs mobilise S&T for achieving Initial reform of the university specialised in applied research sustainable development system into business entities Funding instruments Direct public institutional Initial experimental Reduced public institutional Further differenciation of the Improved mix of instruments to support changes of institutional support to applied research public support system support more efficiently both funding, by relaxing the in public labs. Launch of the first through the launch of new market-led and mission-oriented control of funding channels large public competitive support programmes. Emergence of new S&T development and innovation programmes publicly sponsored funding channels, e.g. venture capital Source: OECD.Investing in China TodayFast forward a decade, today the Private Equity and Venture Capital business is booming inChina with over 1000  firms  actively  investing. Most of the early deals were done by offshoreventure funds – with their fund registered in countries outside China and using dollars. The latesttrends are as Renminbi (“RMB”) funds (the Renminbi is the official currency in China.) In thepast foreign funds who wanted to invest in China had to set up funds using dollars withcomplicated offshore structures with exits through offshore listings. The Renminbi funds havefewer restrictions on what industries the fund can invest in, less regulatory oversight and accessto listing a portfolio company in China. There are two types of Renminbi funds: domestic fundsand foreign-invested funds. Domestic Renminbi funds are fully owned by Chinese investors,while foreign-invested Renminbi funds may be partially or fully owned by non-Chinese© OECD 2007investors. Both types of funds are organized under Chinese law and use Renminbi to invest inChinese companies.The other big change was the creation of ChiNext, China’s equivalent of NASDAQ stockexchange for start-ups, in 2009. The market was created to provide startups and their investorsliquidity. Over 100 startups were listed on ChiNext the first year of its launch at sky-highvaluations (average of 66 times earnings.) About 60% of the startups listed on ChiNext wereSteve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  10  of  26  
  11. 11. backed by Renminbi funds, making the investors of these funds one of the main beneficiaries ofthe exchange.Part 4 Zhongguancun in Beijing - Chinas Silicon Valley and part 5, the Gold Rush and FireExtinguishers describe the Beijing entrepreneurship ecosystem.Lessons Learned• China’s venture capital system has made a remarkable journey from the “state owns everything” to the free market• It’s done it in a series of evolutionary stages, each new one learning from the lastSteve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  11  of  26  
  12. 12. POST 4 of 5 Zhongguancun in Beijing - Chinas Silicon ValleyI just spent a few weeks in Japan and China on a book tour for the Japanese and Chinese versionsof the Startup Owners Manual. In these series of 5 posts, Ithought I’d share what I learned in China. All the usualcaveats apply. I was only in China for a week so this acursory view. Thanks to Kai-Fu Lee of Innovation Works,David Lin of Microsoft Accelerator, Frank Hawke of theStanford Center in Beijing, and my publisher ChinaMachine Press.The previous post described the evolution of the ChineseVenture Capital system. This post (and the next) are what I saw and learned in my short stayexploring Beijing’s entrepreneurial ecosystem.Entrepreneurship in BeijingIn the few days I was in China I met with several VC’s, angel investors, business press and spoketo hundreds of entrepreneurs. I was blown away by what I saw in Beijing. First, I was amazed bythe physical impact of the city itself. This was a modern city in a hurry to make a first impression– think of what Rome looked like in the time of the empire or New York in the 1920’s – now it’sBeijing announcing that China has arrived.However if you scratch the surface, you can still find a bit of the old Beijing in the hutongs.Drive 50 miles outside the city into the surrounding villages and you see the distance China hasto travel to bring the rural areas into the 21st century. In Beijing we hadn’t seen air so badlypolluted since we had been in Agra in India in the winter where I swear there was a day youcould wave your hand in front of you and see traces of it in the air (and their excuse was theyburn dung for heat.). David Lin and the Microsoft China Accelerator was gracious enough to host two wonderful days of events for me. I trained the Startup Weekend Next Beijing mentors and instructors, presented to several hundred entrepreneurs, and had a great fireside chat with Zhen Fund founding partner Xu Xiaoping in front of another roomful of entrepreneurs. Kai-fu Lee of Innovation Works was equally generous with his time. We had a fireside chat with a room full of eager entrepreneurs. And he was generous in sharing his insights about the current state of entrepreneurship and investment in China. And through it all Louis Yuan my patient and wonderful publisher from China Machine Press kept me moving through the events.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  12  of  26  
  13. 13. But what made the overwhelming impression for me was finding an entrepreneurial softwarecluster on par with the Internet software portion of Silicon Valley. The physical heart of theBeijing startups is in Zhongguancun in the Haidian District, located in the northwest side ofBeijing. Startups here are primarily in what they call the TMT (Technology, Media andTelecommunications) segment. Not only does Zhongguancun have Chinese startups, but globaltechnology companies (Nokia, Ericsson, Motorola, Sony Ericsson, Microsoft, IBM, Sun, Oracle,BEA, Alcatel Lucent, Google) all have offices here or elsewhere in Beijing.If there ever was any question about the value of China’s Torch Program walk aroundZhongguancun. It was the first of the 54 Science and Technology Industrial Parks.China Venture CapitalAn entrepreneurial ecosystem is driven one of two ways; either by a crisis (i.e. innovation in theU.S. during World War II,) or during peacetime by profit. If it’s driven by profit then theecosystem needs both entrepreneurs as well as Venture Finance.China now has plenty of both.China has the biggest Venture Capital industry outside the U.S. To compare the two, in 2011U.S. venture capitalists invested $26.5 billion in all deals. Out of that total, they funded 967Internet deals with $6.7 billion.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  13  of  26  
  14. 14. By comparison, in 2011 Chinese VC’s invested $13 billion in all deals. Out of that total, theyfunded 268 Internet deals with $3.2 billion. About 1/3 of all China’s Venture Capital investmentis made in Beijing and the majority of those investments are in the Technology, Media andTelecommunications (TMT) sector I’ll describe shortly.As vibrant as the China venture business has been, 2012 was a different story. VC’s pulled backand only invested $3.7 billion in all deals, funding just only 43 deals with $563 million.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  14  of  26  
  15. 15. Closed for You, Open For UsFirst a bit of context in what the VC’s in Beijing are investing in. China has essentially closed itsinternal search, media and social network software market to foreign companies who wouldn’tplay with the government rules on the Great Firewall (China blocks “objectionable” websitecontent and monitors everyone’s Internet access.)Google retreated to Hong Kong and Baidu took its place. Facebook was too frightening toChinese censors, so Renren is the leading social media player. Email? Workingprofessionals/white collar use emails, but most users grew up instant messaging on TenCent’sQQ and most are moving to Weixin/WeChat. Twitter? No, it’s Sina Weibo, and if you wantgames with your chat - TenCent. Amazon and Ebay? Nope in China it’s Alibaba’s Taobao  or  360buy.com. If you’re outside of China, you never hear about these companies or interact withthem because they’re geared to serve only Chinese users.This closed but very large market means that greater than 90% of Chinese software startupsfocus exclusively on the Chinese market. (The <10% that decide to go global early do so bystarting outside of China. Another 10% may try to go global when they’re larger and have theresources for two languages, cultures and regulations. )This has resulted in a completely different consumer software ecosystem than found elsewhere inthe world. Given the closed market to U.S. Internet companies, VC’s in China have guidedstartups to execute the “copy to China” model. Thinking, if it worked in the U.S., copying aknown model is less risky than trying something new and untested. The problem is that thisspace is getting really crowded – from the bottom up as everyone tries the 200th clone – and fromthe top down, as the major incumbents try to fill every possible market niche.The table below maps the type of software in China to their global equivalents in each productcategory in the Technology, Media and Telecommunications (TMT) sector.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  15  of  26  
  16. 16. A Huge Market Is Finally RealFor a hundred years the fantasy of global marketers was “well if everyone in China would buyone…” That day is final here. The numbers of mobile subscribers are staggering - 1.18 billon,260 million are 3G. Chinese Internet companies live in a large closed, self-contained ecosystemwith 564 million web users with 420 million having mobile web access. 309 million usemicroblogs and 242 million shop online. (BTW, market research, financial and other statisticalinformation are usually unreliable in China, but even taken with a grain of salt these arestaggering numbers.)The table below from web2asia.com shows the number of users of online social networks as of2009. Did I mention this is a huge market.Investment in the Technology, Media and Telecommunications (TMT) sectorThe charts below from David Lin, Microsoft Accelerator detail investments in the Technology,Media and Telecommunications (TMT) sector - almost all of it is centered in Beijing. (Note thatthese numbers differ from the Zhen Fund data -welcome to statistics in China - but they bothprovide an overall sense of the market size and direction.)Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  16  of  26  
  17. 17. 45% of all Venture Capital Investment in China went into the Technology, Media andTelecommunications (TMT) sector. 1 •  $14.04 billion raised for 219 Venture funds •  1143 deals totaling $10.57 billion VC Investments During 2007-H1/2012 VC Investments During 2011-H1/2012 by Sector (1143 12 976 deals) 842 775 728 8.9 14% 2 TMT 8 637 7% Manufacturing 5.9 45% 438 5.5 5.3 8% Consumption & Services 3.9 3.6 Energy 4 10% 167 Healthcare 1.6 Others 16% 0 2006 2007 2008 2009 2010 2011 2012H1 Amounts (USD B) DealsThe number of deals in Technology, Media and Telecommunications more than doubled in 2011over the previous five years and slowed back down dramatically in 2012. More than 1,600 VCinvestments in TMT have been made since 2007, with a record high of 436 in 2011.Internet investments makes up more than 50% of all the deals in Technology, Media andTelecommunications made since 2011, while, E-commerce investments, in turn, accounts fornearly 50% of the investment deals in Internet. Investments in Mobile Internet makes up roughly11% of all the deals in Technology, Media and Telecommunications, and have been on the risesince 2011.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  17  of  26  
  18. 18. Series-A round investments dominates Technology, Media and Telecommunications (TMT)deals, making up 60% of all.Beijing, Guangdong (including Shenzhen) and Shanghai came out as the most dynamic spots forTechnology, Media and Telecommunications (TMT) investmentsSteve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  18  of  26  
  19. 19. Beijing Venture/Angel EcosystemWhile Beijing has VC’s and Angel investors happy to write a check there aren’t as manyangels/VCs in China versus US per capita. Several VC’s mentioned that there’s a funding gap forseed stage investments. The Angel/Seed network in Beijing feels fragmented and mostlyinexperienced (as are a good number of the China VC’s). Kind of reminded me of the drivers inBeijing – they were all driving in a way that made me think they all just got their drivers license– until I remembered that they did. Car sales in China went from 1 million in 2001 to 14 millionin 2011.Other Beijing ecosystem issues I heard about were the things we take for granted: the lack ofknowledge sharing (“pay it forward” isn’t part of the culture,) limited mentoring (fewexperienced mentors,) and a lack of open source education, and no AngelList model. In the U.S.it’s easy to share and browse ideas and deals, but in China there’s a long legacy of guardingknowledge as power, and the justifiable paranoia of someone copying your idea preventssharing.LiquidityUnlike the U.S. there are almost no mergers or acquisitions in this market segment. It’s mucheasier to just steal their ideas and hire their employees. So big companies rarely acquire startups.Liquidity for most Internet startups happens via IPO’s. 70% of exits in China are via IPO (in theU.S. on NASDAQ or the NYSE or on ChiNext, China’s equivalent of NASDAQ) compared tothe 90% of exits in US via mergers or acquisitions. Alibaba (commerce), Tencent (games/chat)and Baidu (search) all have market caps over $40 billion.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  19  of  26  
  20. 20. The next post, the Gold Rush and Fire Extinguishers – Beijing entrepreneurs, startup culture andsome conclusions.Lessons Learned• China has the biggest Venture Capital industry outside the U.S• For software, the action is in Beijing• China has closed its search, media and social network software market to foreign companies• Beijing’s VC’s primarily invest in the Technology, Media and Telecommunications segment• Liquidity is via IPO’s not buy outsPOST 5 of 5 The Gold Rush and Fire ExtinguishersI just spent a few weeks in Japan and China on a book tour for theJapanese and Chinese versions of the Startup Owners Manual. Inthese series of 5 posts, I thought I’d share what I learned inChina. All the usual caveats apply. I was only in China for aweek so this a cursory view. Thanks to Kai-Fu Lee of InnovationWorks, David Lin of Microsoft Accelerator, Kevin Dewalt, FrankHawke of the Stanford Center in Beijing, and my publisher ChinaMachine Press.The previous post, part 4, was about Beijing’s entrepreneurial ecosystem these are my finalobservations.Land RushFor the last 10 years China essentially closed its search, media and social network softwaremarket to foreign companies with the result that Google, Facebook, Twitter, YouTube,Dropbox, and 30,000 other websites were not accessible from China. This left an open playingfield for Chinese software startups as they “copy to China” existing U.S. business models. Ofcourse “copy” is too strong a word. Adapt, adopt and extend is probably a better description.But for the last decade “innovation” in Chinese software meant something different than it did inSilicon Valley.The Chinese Social Media Landscape diagram below from Resonance does a great job ofillustrating the players in the Chinese market. (Note that the inner ring shows their globalequivalents.)Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  20  of  26  
  21. 21. The downside is that with so much venture and angel capital available, investors have been willing to fund the 10th Groupon clone. For the last few years, there really hasn’t been a demand to innovate on top of the ecosystem that’s been built. New Rules for China Not only is the Chinese ecosystem completely different but also the consumer demographics and user expectations are equally unique. 70% of Chinese Internet users are under 30. Instead of email, they’ve grown up with QQ instant messages.They’re used to using the web and increasingly the mobile web for everything, commerce,communication, games, etc. (They also probably haven’t seen a phone that isn’t mobile.) By theend of 2012, there were 85 million iOS and 160 million Android devices in China. And theywere increasing at an aggregate 33 million IOS and Android activations per month.It was interesting to learn about China’s digital divide – the gap between East China andMidwest China, and between urban and rural areas. Internet penetration in Beijing is greaterthan 70% while it’s less than 25% in Yunnan, Jiangxi, Guizhou and other provinces. While thereare 564 million web users with 420 million having mobile web access, 74% of Chinese Internetusers make less than $500/month and are students, blue-collar workers or jobless.Unlike U.S. websites that are sparse and slick, Chinese users currently expect complicated,crowded and busy web pages. However, there’s a growing belief that the “design preferences” ofChinese consumers are just bad design. TenCents WeChat, (designed for an international market)is the first incredibly popular app in China to dramatically raise the bar for what a good userinterface and user experience looks and feels like. WeChat may change the game for Chinese U/Iand U/X experience. The one caveat about online commerce is that while Chinese users will buyphysical goods online (Taobao is huge), they seem to hate to pay for music or software, and themodel for games seems to be moving to free play with in-app-purchases for accessories andpowers. An interesting consequence of the rigid censoring and control of mainstream media isthat blogging – reading and writing – is much higher than U.S.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  21  of  26  
  22. 22. My guess is the current wave of “copy to China” will burn itself out in the next few years as thesmart money starts to move to “innovate in China” (i.e. like WeChat.)Competition If you’re a software startup competing in China, the words that come to mind are“ruthless and relentless.” The not so polite ones I’ve heard from others are “vicious, unethicaland illegal.” Intellectual property protection is great on paper and “limited” in practice. The largeplayers like Alibaba, Baidu and Tencent historically would be more likely to simply copy astartup’s features than to hire their talent. The large companies strategy seems to be to coverevery possible market niche by copying successful models from others.The slide below from the Zhen Fund shows the breadth of business coverage of each of theChinese Internet incumbents. Each column represents a company (QQ, Sina, Baidu, Netease,Sohu etc.) and the rows indicates their offerings in open platform, group buying, online games,microblogging, Instant Messaging, BBS, Q&A and E-commerce.Small startups act the same way, simply cloning each other’s products. Sharing and cooperationis not yet part of the ethos. I can’t imagine a U.S. company setting up some subsidiary here andexpecting them to compete while they were following U.S. rules. In some ways, the bestdescription of the market dynamics would be “imagine you were competing with 100 companieswho are as rapacious as Microsoft was in the 1980’s and 1990’s.” Eventually, China’sinnovation-driven economy needs intellectual property rights and anti-trust laws that areSteve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  22  of  26  
  23. 23. enforced.Sea Turtles and VPN – the connections to the rest of the world Entrepreneurs in Beijingwere knowledgeable about Silicon Valley, entrepreneurship and the state of software and toolsavailable for two reasons. First, there are continuous stream of “sea turtles”—Chinese who havestudied or worked abroad—returning home. (The Chinese government must be laughinghysterically over U.S. immigration policy that’s forcing Chinese grad students out of the U.S.)Many of these returnees have worked in Silicon Valley and startups or went to school at MITand Stanford. (There is a huge difference between the Chinese who have never left and thosewho went to school abroad, even for a few months – at least a difference in their ability to relateto me and have a conversation on the same wavelength. It’s clear why families try so hard tosend their children abroad. It changes everything for them.)Second, most websites that a non-Chinese would use are blocked including Facebook, Twitter,Youtube, Google Docs, Scribd, Blogspot, Dropbox, New York Times, etc. Almost everyentrepreneur I met was using VPN to circumvent the Great Firewall. When the Chinesegovernment censors (run by their propaganda department) shutdown access to yet another U.S.web site, they create another 100,000 VPN users. And when the government tools to detectencrypted VPN’s get more sophisticated, (as it did last year), Chinese users just use stealthiertools. It’s an amazing cat and mouse system.(Note to Chinese Communist party - the best name for your propaganda department shouldprobably not be the “Propaganda Department.”)Beijing’s Academic HubRight next door to Zhongguancun are China’s top two universities, Peking University andTsinghua University. Northwest of Beijing is also home to other universities, including technicaluniversities like USTB, BIT, BUPT, and Beihang. Like Silicon Valley, Zhongguancun also hasa critical mass of people who are crazy enough to do startups. Equally of interest is a goodnumber of them end up in the PLA’s GSD 3rd Department (the equivalent of our NationalSecurity Agency. ) And some of their best and brightest have ended up in the organizations likethe 2nd Bureau, Unit 61398 tasked euphemistically for “Computer Network Operations.”While I didn’t get much time with the academic community, in talking to students, educationseems to still be one of China’s bottlenecks – rote lectures, passive learning, follow the process,exam-based performance, etc. And while startups and entrepreneurship courses are now beingadded to the curriculum, “How to write a business plan” seems to be the state of the art. China’seducation system needs to give more attention to fostering students’ innovative thinking,creativity and entrepreneurship.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  23  of  26  
  24. 24. Entrepreneurial CultureFear of FailureThough they’re familiar with technology in the valley, I picked up some important culturaldifference from students and startup engineers I talked to. Even though they’re next toZhongguancun, the hottest place for startups in China, there seems to be a lower appetite for risk,a lack of interest in equity (instead optimizing for a high salary) and very little loyalty to any onecompany. The overall culture still has a fear of failure. Most of their parents still tell them towork for the government or a big company.TalentI heard from a few investors that as the startup ecosystem is relatively new, there’s a battle forexperienced engineering talent and lack of experienced C-level execs. The lack of a previousgeneration of successful startup CEOs means the current pool of mentors to coach this generationis almost non-existent.Because salaries are cheap, startups seem to try to solve every problem by throwing bodies atit. Startup teams feel like they are 2-5x the size of American teams. There seems to be littleappreciation or interest in multi-skilled people.Turnover of employees in capital in Beijing is very high. Employees work here for a few monthsand are suddenly gone. There’s a noticeable lack of tenacity in young, new entrepreneurs. Theystart a project, and if it isn’t a home run, they’re gone. Perhaps it’s the weather. Silicon Valleyhas great weather and lifestyle, and nobody wants to leave. Beijing has awful weather andpollution, it’s a temporary place to get rich and then leave.Management 101The board/CEO relationship still isn’t clearly understood by either party. I’ve talked toentrepreneurs who view the investors as a “boss.” A good number of startups in Beijing seemdriven by the VCs – and not the founders. This might also be a hangover from the command andcontrol system of a state-driven planned economy. Ironically investors told me that the reversehas been true as well. Some startups acted like the VC was a bank. They took the money andthen ignored their board. Over time, as investors add more value than writing checks, thisrelationship will mature.CreativityI was surprised that startup teams ask what seems like the kind of questions Americans learn attheir first jobs.Team: ”We keep spending money trying to get people to our web site but they don’t come back.We are almost out of money.”Me: ”Ok. Why are you still spending money?”Team: “long…silence…we need people to come to the website.”On the other hand, for most of them it probably is their first job. And the educational systemhasn’t prepared them for executing anything other than a plan. Iterations and pivots are a toughconcept if you’ve never been taught to think for yourself. And challenging the system is notsomething that’s actually encouraged in China.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  24  of  26  
  25. 25. They also ask questions I just don’t know how to answer. “How do you know how to becreative? What do we have to do to be creative?” ”You Americans just seem to know how to dothings even if you’ve never done them – can you show us how to do that?” This seems to be anartifact of the Chinese rote educational system and its current system of government.Innovation EcosystemOn the plane ride home I started to think about the similarities and differences between theinnovation ecosystems of Silicon Valley and the TMT segment I saw in Beijing. The motivationsare the same – profit – driven by entrepreneurs and venture finance. And the infrastructure isclose to the same – research universities, predictable economic system, a path to liquidity, astable legal system and 24/7 utilities. But the differences are worth noting – it’s a youngecosystem, so startup management tools are nearly non-existent. But there’s a difference in theculture of failure and risk taking - the current cultural pressure is to “work for a big company orthe government.” Outward facing Universities are just starting to appear, and while there’s a freeflow of information inside China, it suffers from the constraints of the Great Firewall.But there are two striking differences. The first is the lack of creativity. The Beijing softwareecosystem I saw it has spent the last decade in a protected market copying successful U.S.business models. ”Copying, adopting and adapting,” is not the same as ”competing, innovatingand creating” in a global market. Perhaps products like WeChat, designed for an internationalmarket, might be the beginning of real innovation.The second difference in ecosystems – the lack of freedom to dissent – goes deeper to thedifference between the two systems. In the U.S. entrepreneurs are encouraged to “ThinkDifferent.” Our touchstone for creativity is the Apple ad that said, “Here’s to the crazy ones, themisfits, the rebels, the troublemakers,… the ones who see things differently — they’re not fondof rules… You can quote them, disagree with them, glorify or vilify them, but the only thing youcan’t do is ignore them because they change things….” This spirit of rebellion against the statusquo got us Steve Jobs. In China the same attitude is likely to get you jail time. Unless you canspeak truth to power, you’ll never have an innovation economy.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  25  of  26  
  26. 26. ConclusionChina is astonishing. The country has risen. Their economy is the envy of the world. Theentrepreneurial and “can do” spirit reminds me of what the U.S. was known for. Chinese citizensare proud of their country and believe the world is theirs in the way Americans did in the1950’s. Their leadership has shown incredible foresight in engineering an amazing economicengine and formidable military. They come so far, and yet…To take nothing away from what China has accomplished, a visit to Beijing had all the subtlereminders that this version of capitalism has come without democracy or justice; the guards inthe Forbidden City armed with fire extinguishers in case more protestors try to set themselves onfire, the security around Tiananmen Square to prevent protestors from gathering, and the “blackjails” to keep rural petitioners out of Beijing. And of course the “great firewall,” attempting tokeep information about the outside world from reaching inside China.The bet the government is making is that if they can keep the economy cooking and distract themasses with ever increasing consumer goods and foreign adventures, maybe it can survive.All of these are signs of a weak China not a strong one. They are the signs of a leadershipfrightened not by external enemies but by their own people.It usually doesn’t end well.Steve  Blank   China  –  The  Sleeper  Awakes                            rev  5   page  26  of  26  

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