Beini Zhou, portfolio manager of the Matthews Asia Small Companies fund, takes a look at encouraging developments in China's grassroots-level entrepreneurship
China has long been perceived as a breeding ground for business copycats, and has struggled with rampant intellectual piracy. Many businesses there have indeed been founded based on business models that originated in the US or Europe. But what's been overlooked in recent years is China's rising "innovation machine," particularly in the technology sector.
China's new generation of entrepreneurs, represented by Jack Ma, is making waves and increasingly competitive against Western counterparts. They also continue to leapfrog their Western peers in creating innovative business models.
The current wave of innovation among small companies in China has been underpinned by further spending on research and development (R&D), and favorable government policies toward R&D have helped. R&D spending in the country has been rising at double-digit rates in recent years, far outpacing most other countries.
As labor costs continue to rise, and China's ability to play labor arbitrage relative to neighboring countries continues to be eroded, it's imperative for its entrepreneurial ideas and firms to climb the value chain.
So, whereas past generations of entrepreneurs set up manufacturing shops, churning out cheap shoes and apparel, the new generation is setting up shop in areas such as health care, electronics or online services. Previously, I could analyze business models in China by comparing them against US or European counterparts as reference points.
But these days, I am frequently struck by how often no equivalent business model exists yet in the West. For example, companies are developing e-commerce business models based on such things as residential communities or the selling and distributing of semiconductor chips online.
Even traditional hardware manufacturing businesses, long dominated by China, have moved on to new frontiers in recent decades. Many small independent and community-operated, tech-related workspaces-or hackerspaces-have popped up across the country in recent years.
These collaboration spaces allow entrepreneurs who are interested in design and technology to tinker and create everything from drones to robots. What's different from prior generations that exported apparel (given massive government subsidies) is that today's entrepreneurs are equipped with open-source software, emerging 3D printing technology and Silicon Valley-style venture funding-or even peer-to-peer lending.
Increasingly in recent years, we've seen multinational companies acquiring small China-based firms across many business segments.
Market Competitive Dynamics
Multinational companies also want to access local technology and R&D resources. This might seem very counter-intuitive. In most industries, multinational companies own the most advanced technology, while local small, local Asia firms remain in catch-up stages.
Market-competitive dynamics in Asia are often such that multinational companies occupy the high end of a market while locals take the low end. Over the years, however, multinationals have been creeping down the market to capture a bigger swath of the market in emerging economies. Concurrently, local small companies have been rising upmarket.
To attack the mid-to-low end of the market, some multinationals have attempted (many unsuccessfully) to simply dumb down the higher-end products they offer in the U.S. or Europe. Often, product development from the ground up is needed, rather than tweaking edges or eliminating features from an existing higher-end product.
Therefore, in recent years multinationals have begun to acquire local small companies in China outright-often a more cost-effective approach than taking time to organically develop their Asian business.
But there is more. Technology gained through these acquisitions isn't just used for local markets, but also exported to other emerging markets. Furthermore, with reverse innovation, technologies and products developed by entrepreneurs in China are increasingly brought back to the value segment of the market in the U.S. and Europe. In this way, small Chinese companies are no longer copycats; their impact is increasingly felt worldwide.
Recently in Davos, Chinese Premier Li Keqiang delivered a speech in which he remarked, "Mass entrepreneurship and innovation, in our eyes, is a gold mine that provides a constant source of creativity and wealth."
After decades of running the economy by central command and control, China's leaders are now eager to promote grassroots-level entrepreneurship. If the current trend continues, foreign investors in China will not lack interesting opportunities that could possibly lead to the next Amazon or Google of China.
For our latest perspectives on investing in Asia visit global.matthewsasia.com/seemore
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change, and may not reflect the writer's current views. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information.
