The Next Silicon Valley

In a recent episode of his excellent podcast, “Masters of Scale,” LinkedIn co-founder Reid Hoffman said something interesting:

“Beyond Silicon Valley itself, I believe that the next Silicon Valley is…undoubtedly China. Shenzhen is just one of several cities in China that blow other contenders for the next Silicon Valley out of the water. I would argue Beijing, Shanghai, Hangzhou, and possibly Chengdu, are all far ahead of any of the cities we’ve discussed so far…The fact is, China’s tech industry is evolving so rapidly, it catches veterans off guard.”

“There’s a common thread running through their successes. First they have an enormous number of users through which local companies can scale their services. And second, they work fast. Scale favors the swift and you can find few startup scenes as fast-moving as China’s.”

Hoffman continues: “But I would argue that the greatest asset of China’s tech scene, is not just the speed by which massive companies have taken over the market, it’s the talent that now resides in those companies: the executives, programmers, designers, and marketers, who know how to scale a team from a few founders to several thousand employees. They form a critical mass that can scale the next generation of promising startups at blistering speeds.”

For anyone that’s working on-the-ground in China today and bearing witness to the extraordinarily hectic pace of innovation and new business-building that’s happening here, Hoffman’s observation comes as no surprise.

For many startup founders outside of China, however, the market remains a black box. The distance, the language, the culture, the politics: all are formidable barriers that make most entrepreneurs pause. But according to Raymond Chang, a serial entrepreneur with more than two decades of experience starting and scaling companies in China, if you want to grow your business fast, you should seriously consider expanding into China.

“China has the scale that no other country has at the moment. It’s not an easy process to build a business in China. You need to be patient, and you need to know the right people to work with. But for companies that have the right strategy in place, building a presence in China can 10X your business—or even more”, says Chang, who leads NXT Ventures Management, a Boston-based venture capital firm.

In addition to managing an investment portfolio of more than 50 companies, Chang often shares his extensive experience starting and running successful businesses in China with MBA students at Yale and Babson College. Chang launched China’s first home shopping network, and he introduced broadband internet to Taiwan through a venture that attracted a stake from Microsoft and listed on Nasdaq.

I spoke to Chang recently about whether startups should factor China into their growth plans, and if so, what advice would he give them before deciding to make such a move.

The following are edited excerpts from our conversation:

1. Focus on your domestic market first.

As a startup, it’s all about focus, focus, focus. China, Asia, and other international markets should not be your primary focus from day one. Unless, of course, China is your primary focus, in which case you should build a Chinese company.

But if you’re a US company and eventually you would like to go global, you shouldn’t try to tackle both markets from day one. You should prove your business model domestically first, and once you have that in the bag, then you should look at the Asian opportunities, say, 2-3 years down the road.

We find a lot of entrepreneurs lack focus. Even though their products or services may have global appeal, they try to do a little too much from the outset.

We usually tell them “Wait, slow down, you haven’t even proved your business model in your domestic market, and now you want to go after what?” A lot of companies try to do too much from day one. We tell our portfolio companies to focus on building the US domestic market first.

2. Find the right strategic partner.

Right now we’re helping a mobile gaming company with two successful games launched in the US and $40 million revenue in the bag. Now they believe they are in the position to tap into the Asian market.

We would agree that now is probably a good time for them to think about international expansion. But what we are also telling them is don’t try to do it alone. When it comes to going into the Chinese market, try to find a local strategic partner.

You have to be very smart about how you enter the market, and what kind of local distribution partners you want to work with. The partnership could be maybe a simple distribution model, or it could be joint venture, or it could be a simple licensing deal. You need to be very flexible and ready to structure whatever types of deal is necessary, because you never know who you may end up working with.

One option is to tie-up with an established player, but frankly, the problem with working with a big name is that you may become just another name in their portfolio and get lost. It might be better for this gaming company just to for example find a smaller online gaming company that perhaps is at the tail end of their own existing IP and looking for the next big hit. That may potentially be a better opportunity.

Another opportunity is skipping online gaming companies completely and working with a distribution platform, like 360 Mobile Assistant, Tencent’s Myapp, or Baidu Mobile Assistant, China’s top three Android app platforms. The company may end up attracting more eyeballs and users by getting their game featured as an “editor’s choice.”

And the economics are better. If you tie-up with a major player, they may end up taking 90% of the revenues and leave you with just 10%. If you go for a platform play, you could take 80% of the revenues, and just pay the platform 20%.

3. Localize your product.

You need to be ready to localize the product, or in this case, the content, to fit local tastes. The Chinese gaming market tends to be more action-packed and sometimes the graphics are more bloody than the games that are popular with US-based gamers, for example. You have to be ready to localize the content to fit local tastes.

Another example of localizing a product to fit Chinese consumer tastes is the air filter company we invested in. Because the pollution problem is so severe, Chinese households often have a few air filtration units.

In China, touch pad panels are really popular. But the air filter company, which is based in the US, is all about medical grade knobs and buttons. They want the medical device look. But that’s a very different design approach than what we see in China, where consumers prefer to use sleek, digital touch panels

So I told the air filter company in the US that if they really want to create an air filter that will sell in China, it has to fit local tastes. It doesn’t matter if their machine is 10 times better, if it looks ugly in the eyes of Chinese consumers, it won’t sell.

4. Get ready to fend off copycats.

Whatever product or service you decide to bring to China, you’ll need to be 100% ready to fight against local copycats. For example, in the case of the air filter company, they’ve registered their trademark in China and believe they have all the protections they need. But I told them that in China, IP protection only goes so far. They need to make sure their cost structure will be as low as the local players, so in the event they decide to knockoff their products, they can still compete.

Unlike in the US, where they may have a 2-3 year window to grow and build their brand, everything in China happens 10 times faster. So from day one, if they’re going to go into China, they should forget about manufacturing the filters in the US. They need to move it to China from day one, so their cost structure will be just as competitive as any of the local players.

And they shouldn’t think that they’ll have a 12-month window. They literally have a 2-3 month window because if their product sells, 10 copycats will be out in the market within 2 months.

5. Be prepared to play the long game.

If you think it’s hard to make money in the US, it’s probably harder to make money overseas. Don’t expect to make money from day one. You need to be patient, especially in an overseas market like China. It can be very bloody. It may be 5-7 years before you see any dividends.

The good thing is, if you can figure this thing out, the market in certain industries and product categories is several times the size of the US market. For example, in mobile games, if you have $15-20 million in revenue you’re probably one of the top performers in the US. But in China, if you’re not at $200 million, you’re nowhere near the top.

Is China part of your expansion plans? What risks do you see in expanding to this fast-growing market? Please share your thoughts in the comments.