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China, a hotbed for innovation

China is fast transitioning from low cost manufacturing to a higher value innovation-led economy. The brief below looks at this momentous transition. It draws from a recent book (1). By Georges Haour.

 

Estimated Reading Time: 9 Minutes

Introduction

Western assessment of the innovative capabilities of Asian countries have erred in the past, concerning Japan, then Korea. These two countries have managed to rapidly emerge as advanced industrial powers and to sustain their position. Japan remains a formidable innovation powerhouse, especially in the technical arena.

"China is on its way to become a major, global source of innovations."

When it comes to China, anticipating the next few years is fraught with difficulties. It is a huge and diverse country going fast through major transitions. After extensive field work and time spent in China, my conclusion is that China is on its way to become a major, global source of innovations. This is mainly due to private firms, essential engine of the wealth-creation process, as well as from start ups. 

These, however, operate in a unique environment, in which the public sector is extremely powerful. China’s government is intent on promoting entrepreneurship and innovation as a way to create new activities and jobs, while satisfying an increasing internal demand.

After debunking the metrics typically used to describe China’s innovation scene, I will look at the key characteristics and patterns, expected to inform China’s evolution in this area in the near future.

Metrics on China’s innovation

Innovation is about quality of output and not quantity of input. It is therefore extremely difficult to describe and to anticipate. Several of the elements commonly used are discussed below:

Investments in R&D

These are taken as a percentage of the country’s GDP (Gross National product). In the case of China, the increase of this figure of merit is spectacular, from 0,5 % in 1995 to 2% in 2014, which is the current level of the countries of the European Union. The objective is to reach 2,5% in 2020.

Given the rapid growth of China’s economy, numbers in absolute terms are even more impressive. In 2015, R&D investments in China totalled $ 300 bio. Following the ongoing trend, this number may overtake that of the USA as early as 2023. The list of technical areas benefitting from these investments is similar to that in Europe, the USA or Japan.

Patents output

The top patent owners in China are the telecommunications companies ZTE and Huawei, as well as the car-maker Chery. In any country, overall patent statistics is only a proxy indicator of innovation. In 2015, China is estimated to have granted 250 000 patents. The quality and the business potential of the inventions, however, are more important than the number of patents.

"In 2015, China is estimated to have granted 250 000 patents. "

In the case of China, this indicator is even more questionable, as the government has given incentives to firms and academics for filing patents. Also, “utility patents”, good for 10 years as opposed to invention patents, which are valid 20 years, are of highly questionable value. As a result, it is a rough estimate that roughly two thirds of China’s patents do not have much business value. On the other hand, the handling of patent litigation by the courts is steadily improving, so that non-Chinese firms can place increasing confidence in the process. Let us note that, currently, well over half of the litigation cases take place between two Chinese firms.

Non technical innovations

The metrics above concern technical innovations. Many important innovations do not have much to do with technology; one example is the self service, which revolutionized retail stores in the 1950s. Indeed, most advances in the services sectors are not patentable. Thus, one firm may copy the service offered by a competitor.

"In China, many innovations concern specific aspects of the business model."

In China, many innovations concern specific aspects of the business model. For example, the way Haier, the manufacturer of refrigerators and air conditioners, guarantees one day delivery by imposing this condition to the transporting sub-contractors. Mobile phone–maker Xiaomi hardly advertises and mainly sells on internet. Furthermore, as will be seen below, product innovations are often the result of numerous, very small adaptations of existing products; these changes are not patented, but are the reason for the success of the offering in the Chinese market.

In brief, metrics used to assess the innovation level in China are not extremely relevant.

Patterns for China becoming a global innovator

The patterns, expected to be followed by China in the coming years, include several elements, as discussed below.

Chinese society is entrepreneurial

Chinese society is, by and large, highly entrepreneurial, eager to make money and able to extract value very effectively. Chinese consider innovations in a totally market-oriented way. They are ready to experiment and rapidly correct their product. Technical aspects constitute only a tool to be successful in the market place.

Improve and adapt for lower cost

Copying while improving many different elements of the products to while making it much better suited to the Chinese market, represents a fully legitimate way to operate. Innovating to reduce cost by copying and improving explain the success of many Chinese companies, such as Baidu (copy of Goggle), or Alibaba’Tao Bao, initially inspired by eBay, Xiaomi for mobile phones. They offer offerings with the very good price to quality ration required by China’s demanding customers.

Meta innovation

In this process of improving/adaptation, suppliers to the assembling company play an important role. They engage vigorously to provide improvements, so that the innovations are rapidly formulated and built on across many firms. The Shenzen region is particularly effective in this process.

China is the ultimate internet country

Chinese people are fully engaged with internet, with some 700 millions users in the country. Mobile internet services flourish everywhere. Already close to 400 million of Chinese customers are using their mobile phones for most of their payments. Tencent’s Wechat pay is one of these actors.

Several startups in the service area

Numerous start ups are addressing opportunities in the area of services. This concerns Fintech (internet-enabled financial services), where China is leading (see Ant Financial, for example). Shanghai and the business accelerator XNode are key actors in this segment. Other concern mobility and scouting for talent.

China's government

China’s government is obsessed with providing a context favourable to innovation-led growth. Like Japan and Korea, innovation is perceived as a crucial ingredient of wealth-creation and economic development. Most of China’s top leaders have a technical background. Current President Xi was initially trained as a chemist, then obtained a PhD in Law.
The 13th plan is squarely putting science & technology at the center of China’s growth. It also addresses areas for improvement, such as the complex technology transfer from public laboratories all the way to commercial use.

"The 13th plan is squarely putting science & technology at the center of China’s growth"

Innovation policies range from favouring the digital revolution, machine to machine interaction and the Internet of Things (IoT), “smart cities”, fiscal incentives for “innovative firms”, as well as an arsenal of programmes to foster R&D and technical developments. These include “3D printing” and further informatisation of manufacturing.

Protect China’s future champions

Non tariff barriers and practices favour domestic firms, so they are more free to learn and grow within the large domestic market. Under the cover of a policy of promoting “indigenous innovation”. This is particularly the case of equipment to produce renewable energy. For example, China wants to be a strong actor in wind and solar sources of energy, but its protectionist policies may, in fact, hinder innovation, at least for specific segments. The recent law on cybersecurity, to go into effect in June 2017, participates, in part, of this dynamics.

Private Chinese firms

Private Chinese firms are contributing a rapidly growing share of innovations. They are very active in the ICT-information and communication technologies and electronic games. The weight of the SOE - State owned enterprises is decreasing, both as a factor of the GDP and in the production of innovative offerings.

The Shenzen area

The Shenzen area is densely populated with innumerable firms able to rapidly produce prototypes and components. In this environment is flourishing the “makers” movement, a bottom up dynamics, inventing and rapidly commercialising all types of devices. This movement has received strong encouragement from the government, underlining the message that entrepreneurial spirit is central to tomorrow’s China. In Shenzen, it is estimated that 3 000 firms are in the area of robotics.

"Within China, firms compete fiercely and copy each other relentlessly. This alone is a reason why, when innovation begins in a sector, it will spread and be maintained"

A few large Chinese firms have ventured to become global. Huawei, Lenovo, Haier, Good Baby are notable examples. This number will grow, as, in 2014, Chinese investments going abroad have equalled the flow of investments going into China for the first time. We are at the beginning of rapid increase of the outflow of China’s investments, especially towards Europe.

Within China, firms compete fiercely and copy each other relentlessly. This alone is a reason why, when innovation begins in a sector, it will spread and be maintained. At the same time, the commercial success secured by a given offering is expected to be relatively short term. Thus, a rapid succession of “puffs of commercial success” may be expected. This means that new offerings will thus have a short “shelf life” in the market.

Conclusion

A strong entrepreneurial spirit, a relentless market-orientation, an agile and rapid implementation in a vibrant economy demanding excellent quality to price ratios: these are the basic descriptors of the Chinese society.

"China is the ultimate internet country, by the sheer number of users, as well as by the intensity of its usage."

China is the ultimate internet country, by the sheer number of users, as well as by the intensity of its usage. Already the biggest market for on-line shopping, China is expected to soon lead in on-line financial services.

Combined to that is a strong government, relentlessly committed to foster innovation-led growth. In the recent past the leadership has consistently praised and encouraged entrepreneurial spirit, that of the “makers” for example, who, extremely rapidly develop prototypes and commercialize devices, particularly in Shenzhen.

Looking at these characteristics, barring mishaps, Chinese firms are therefore expected to turn the country into one of the world’s major source of innovations. Innovating in the way innovations are carried out comes with China’s specific strengths and weaknesses, but the “West” has much to learn from the “Chinese way”. That China is becoming a major source of innovations is good for China and good for the world.

Reference

  1. Created in China: how China is becoming a global innovator, by Georges Haour and Max von Zedtwitz, (Bloomsbury, London, 2016). Publication of the translation in Mandarin by CITIC Publishing, in Beijing: later November 2016.

by Georges Haour (Haour@imd.org).

Georges Haour is Professor at IMD in innovation management and technology commercialisation. For several years, he has been associated with the incubator/innovator firm Generics (now Sagentia), in Cambridge, UK, as well as with the BT incubator “Brightstar”, in Ipswich. He works with start ups (mostly medtech) in the Geneva, Cambridge and Paris regions.

He also acts as an adviser to firms & organisations on effective R&D/innovation management for competitiveness and growth.

Dr. Haour has 8 patents, 110 publications and five books.

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