Has the Technology Explosion in China Gone Too Far?
Part 1 — Aggressive capital activities in China created a startup culture that ignores value creation
Two weeks ago, I kickstarted a series in which I will examine the impact of big technology companies’ on the societies and economies of China and the United States before ultimately proposing solutions that will prevent those companies from leading us to dystopia (you can read the introduction here).
The first few articles of this series are going to focus on the economic and social consequences of the fast-growing technology industry in China. Let’s get started.
Recently, I made a trip back to China for a consulting project. While I was only gone for a little over two years, the growth of the technology industry was staggering and in many ways exceeded that of the United States.
Not only does it have almost every piece of technology service that is offered in the United States, such as ride-sharing apps (Didi) and food-delivery services (Ele.me), it also have technology services that are not widespread in the U.S., such as an insanely popular bike-sharing industry (led by MoBike), mobile credit and payment platforms (led by AliPay and WeChat Pay), and mobile financial services (led by Ant Financial Services, a subsidiary of Alibaba).
As a Chinese customer and citizen, I am extremely happy about these recent developments as these services have made my life much easier.
However, as a social scientist and entrepreneur, I can’t help looking behind the scenes of this explosion and what I’ve seen has led me to develop a sense of unease regarding the longevity and stability of technology prosperity in China.
At the center of my worry are two major factors:
First of all, the aggressive investment behaviors of large technology companies and venture capital funds in startup scene created a culture of capital-seeking that make startup ignores value-creation for real customers.
Secondly, the consolidation and monopolization of several technology sectors in China has limited the choice of customers. Combine this with the increasing political involvement of large technology companies, political suppression by the Chinese government via technology has become a very alarming possibility.
Today we are going to focus on the consequence of an over-hyped capital market while next week we are going to examine the potential dangers created by monopolization.
China has become the home of unicorns
While admittedly the investment market has cooled off significantly since 2016, the Chinese technology industry is still consistently creating unicorns.
Two of the most recent unicorns are Mobike and ofo, bike-sharing companies that allow citizens to pick up bikes anywhere on the street, scan them with their phone for payment, and drop them off on the city street once they are done.
According to recent data from Crunchbase, both Mobike and ofo raised over 500 Million USD from 2016 to 2017. However, more surprising than their fundraising success is the fact that they are backed by major technology companies that don’t have much to do with bike-sharing.
Recently, ofo closed its D-round of an undisclosed amount with Ant Financial, an affiliate company of Alibaba. Judging from the fact that it collected 450 million dollars during its C-Round, we can project this latest round likely exceeded that amount.
Mobike, on the other hand, was heavily backed by Tencent, who that invested over 600 million dollars in the Series D and E rounds of the company.
These are by no means isolated cases. In recent years, the Chinese technology industry has created enormous amount of unicorns as fast, if not faster, than the stories presented above.
Some examples include the food delivery service Ele.me, which raised over 3.36B USD worth of capital, with at least 2.25B coming from Alibaba and the ride sharing companies Didi Chuxing and Kuaidi Dache (now merged), which raised over 12.94B and 700M respectively from companies such as Tencent and Alibaba before merging.
Unicorns have gradually become “flying pigs”
An extremely active capital market is not in and of itself a bad thing. As long as the startups are actually creating value for customers and have long-term revenue prospects, they will accelerate the growth of the economy and encourage innovation.
However, the Chinese technology industry is veering further and further away from this model.
A Chinese proverb says “When the wind starts, even pigs can fly.”
This proverb accurately describes the condition of the Chinese economy. Increasingly, the long-term revenue potential of Chinese unicorns has become less and less clear, making me wonder whether those companies are true unicorns, or just “flying pigs”.
Let’s go back to the bike-sharing industry. While there is a large amount of hype surrounding the bike-sharing industry in China, it is questionable whether the business models of the two companies previously mentioned are truly sustainable.
Those two companies, ofo and Mobike, are currently charging only 1 Yuan (.14 USD) for half an hour of biking. With costs of at least 250 yuan and sometimes ranging up to a couple of thousands of yuan, it will take at least couple of months for companies to recover the cost each bike and this doesn’t even take into account the human capital needed to develop the application, bikes lost, and other factors.
Furthermore, economists have begun to question whether bike-sharing has long-term revenue potential at all I have attached an article below that goes more in depth on this topic.
In summary, due to the fact that there is no real “sharing” aspect to this service, and that it creates an uncertain amount of value to customers, it is unlikely that bike-sharing will be a profitable venture in the future.
The same issue is faced by Ele.me, a billion dollar company that I mentioned above. It was founded almost 10 years ago (in 2009) and has raised over 3 billion USD and yet the company is still “on the path to being profitable” according to the CEO.
While it is reasonable to argue that the companies named above might find sustainable revenue models in the future as a product of their massive user bases, companies such as Twitter and Snapchat prove that this is not always an easy task to achieve.
With such a large number of startups in China suffering from the same problem, the failure of even one of them to find a profitable model might create a huge disruption in the Chinese economy.
After all, once the wind stops, the first to fall to their death are the flying pigs.
Overinvestment creates a capital-seeking culture in the startup community
Another indirect consequence of overinvestment in the Chinese startup market is the creation of a culture of capital seeking over value seeking.
In a healthy startup lifecycle, the founders offer a product or service that fulfills some need of its customers, and only seeks capital to expand this idea so that it can serve more people.
However, in the current Chinese startup ecosystem (in the U.S. as well, but that’s a topic for later), many companies are able to attain investment with only a business plan or product and without needing to showcase concrete validation of their ideas.
This culture of capital-seeking shifts entrepreneur’s attention away from solving their customer’s actual problems to pitching and pleasing investors. This necessarily hinders the actual societal value that they can generate.
One illuminating example is the “shared charging spot” controversy.
Recently, a few companies were created that offered a “shared charging spot” service to customers. These companies quickly raised over 120 million USD.
However, since then a few premier venture investors in China have strongly questioned the financial viability of the “shared charging spot” idea since most airports and coffee shops in China already offer a free charging service to their customers.
While it remains to be seen whether the “shared charging spot” industry is actually viable, the controversy it created very clearly illustrates the rash nature of investment in the Chinese startup ecosystem.
Detachment between capital and value creates economic bubbles
As you are reading this, you might be wondering why the culture of overinvestment and capital-seeking is bad for the Chinese economy.
The short answer is that it creates bubbles that further destabilize the Chinese economy.
This has even happened in the US during the 2000 dot com bubble, which was caused by investors that were too eager to invest in the internet or high-tech industries and as a result created a gap between the perceived and actual economic value of the startups. This caused a “bubble” to emerge.
Eventually, bubbles will always burst because the market always adjust itself, but when this happens the political and economic fallout will be unimaginable.
If you are already alarmed by the potential negative consequences created by the overinvestment of large VCs and technology companies in China, you better sit tight, because what we talked about today only covers half of the problems present in the Chinese tech industry.
Next week, we are going to cover another equally concerning phenomenon: the consolidation and monopolization of large technology companies in major sectors.
We are not only going to examine the potential economic consequences of this monopolization of the Chinese technology sector, but also the social and political consequences that, taken together, pose a threat to the liberty and freedom of expression of citizens in China.
Meanwhile, please comment below if you have any questions or comments about this article. See you next week!
If you have questions about anything covered in this article, feel free to email me at firstname.lastname@example.org.
Please give us any feedback you may have in the comments section.