China and the Innovation Economy

Last year I attended a NESTA conference in London devoted to the subject of UK-Chinese innovation collaboration. I was struck by the emphasis and importance the Chinese leadership placed on innovation and research, for many years China has been an absorptive economy, taking on other countries ideas, building them, improving them, and let us be honest, stealing them (think of mass scale counterfeiting).

But the central government now recognise the need for the country to become a leader in research and innovation, as it is these traits which can help the country glide toward becoming a high income country, through improvements in efficiency and productivity, moving away from brawn, to using brains. Right now the innovation/research story of China is best described as patchy; there are some areas and institutes of high repute, such as the Beijing Institute of Geonomics and the country’s space program. But these are generally concentrated on the eastern seaboard in a few cities, while the rest of the country lags behind, a sea of mediocrity.

This may appear to be a largely internal Chinese story, but in fact China’s drive to improve the quality and quantity of its research and innovation output is going to have a major impact on the rest of the world.

As Chinese industrial companies become more innovative, they will move up the value added manufacturing chain creating more complex and valuable items, moving industry away from building low value items, such as simple plastic toys, shoes, textiles and all the other things currently built for next to nothing in China. Indeed this is already happening, with costs rising in Chinese factories as workers demand and owners have to acquiesce to better pay and conditions. For factory owners both foreign and Chinese the idea of higher costs naturally means that they will look elsewhere to locate factories. The race is on to become the next China, or in reality it is the race to become the next Chinas… the market is large enough for a number of countries to take over the country’s “low tech” manufacturing.

China will also be reaching out to “sea turtles” people born in the country who have gone abroad to study and work. These people are usually smart, mobile and well connected, just the type that can help China innovate. To attract the sea turtles home China will have to improve areas like the quality of life in major cities, clearing up air and water pollution, and as well as improving public amenities, education and transport. Many foreign companies have benefited from well-educated Chinese workers, but could face the threat of them being tempted back.

Often the simplest way to gain an edge in innovation is to buy companies and institutions that are already on the cutting edge of research and innovation. We have already witnessed this trend with Chinese firms hungry for new ideas shopping in the US and Germany for high quality manufacturing and research companies. With weak economic performance in Europe and the US there are plenty of bargains to be found and China has bags of cash plus a liberalising foreign exchange regime, which makes it easier to take funds out of the country. While there have been some high profile deals already like the Danish electronics firm Bang and Olufsen (not all have been successful, i.e. Geely/Volvo), but this is just the start, Chinese firms have only just begun their overseas expansion.

This was confirmed to me when I met Minxin Xin Pei of Claremont McKenna College at a private briefing in London, he was discussing the changes that would result from the new leadership team, which had just been confirmed. He felt that the emphasis would now move towards private companies leading the “go-global charge” – which is currently dominated by state owned enterprises. Private companies are now taking more of leading role in China’s overseas charge and many of them will be keen to absorb innovation and innovative companies.

                        Where are the Opportunities?

High tech companies are likely to be targeted by Chinese companies – anyone offering top quality products can sell their company or their technology, ideas, design or software to Chinese firms.

Branding: despite China’s success in exporting goods, it has yet to produce an internationally renowned brand, even in electronics manufacturing like Samsung, Apple or Nokia – it may produce the goods, but owning the brand, can be even more lucrative, 90% of the value created by Apple goes to the United States, while factories in Shenzhen, Southern China which produce so many of them, end up with around 10% of the value. While we won’t expect countries to sell their national champions like Samsung, Apple and others being sold off, Chinese firms will seek brands which are available where possible, until they get more adept at producing their own.

The Chinese leadership recognise the need for the country to become an innovation leader, this means the promotion of renewable energy companies and other similar industries, moving away from heavy manufacturing and textile to these “sunrise” industries. Those companies which can work in partnership with Chinese companies to achieve these aims will prosper, building relationships that can result in developing innovative ideas or technology together can create fruitful synergies.

In 2005 the Chinese company Lenovo made a big splash by buying iconic (but by then behind the times) US company IBM’s PC business (which by then was not exactly cutting edge). The deal was also one of the first big Chinese overseas acquisitions and caught many people by surprise as the idea of a Chinese company doing seemed almost unnatural.

Fast forward a decade and Chinese firms have become stronger in the technology field at home with leaders such as Tencent innovators in their sectors.

However there are weaknesses in China’s technology and software firms, whether that is because of China’s one party system which stifles innovation or the focus of its economy on heavy industry to the detriment of other area, or perhaps its university system which has focused on quantity rather than quality and lacks (with exceptions) an innovative edge. Whatever the reason China is on the hunt for further technology and software knowledge, patents and expertise, some of that will come from home grown talent, but this can take time and for a cash rich Chinese companies this can be done by buying up European, US and other countries software firms, which thanks to another tech boom are widespread.

                           Huawei – Company Profile

Huawei Technology is perhaps the best well known Chinese tech firm acting like Apple creating and developing the technology which is then produced by other China based manufacturing firms. Huawei has grown rapidly, its unusual worker controlled structure resulting from when the owner needed to raise money early on in the company’s history so he turned to his workers who provided cash in return for shares. The workers are also heavily involved in the company’s research, around 40% of the total active in this crucial field, a truly team effort.

Now the company is spreading its wings abroad at a fast rate selling its brand of inexpensive technology to developed and developing markets. However there is a dark side to the company – it has been accused of spying, deliberately inserting software into devices so that it can keep tabs on diplomats, businessmen and politicians that have been given free laptops, tablet and phones. Huawei has been blacklisted in the USA and it remains to be seen whether it can recover its reputation.

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