China’s Tech Pivot (Part I): From Behemoth Platforms to Little Giants  

The stellar growth of China’s consumer internet industry since 2011 is now familiar territory. But all bull runs must end, and it wouldn’t be a complete exaggeration to have written the epitaph of the consumer internet’s growth in 2021.

At a minimum, that decadal sprint, which created some of the most valuable global companies along the way, is likely to slow to more of a jog.

That the curtains are closing on the golden era of the Chinese consumer internet isn’t simply a result of the big tech smackdown of 2021. Factors such as a saturated market, consumer discontent, and abuses of market power have all contributed to the industry’s predicament.

As such, the next paradigm in China tech will be defined by a pivot towards hardware, core innovation, and enterprise solutions. Tech startups, and their funding, will be judged on their ability to enhance the real economy, not simply sell products or services in new digital formats. This is the first in a series that will examine this “pivot” and its associated challenges.

The Peak: Sun Sets on Consumer Internet Growth

Before getting to the pivot, it’s worth examining how the fires of a red-hot sector have been doused.

Capital-rich Chinese internet giants favored a business model centered on “blitzscaling”—burning cash on rapid and aggressive horizontal expansions into numerous sectors where services or products can be digitized (e.g. finance, education etc).

Scale and speed were big advantages in capturing market share in a hyper competitive sector. But what was an effective business model during the “blue ocean (蓝海)” phase (Chinese version of a white space) of the sector became more problematic as the market matured.

That market saturation has shown up in online sales and slowing revenue growth of the internet giants (see Figures 1a and 1b).

Figure 1a. Online Sales Growth Slows in Maturing Market, 2015-2021Source: National Bureau of Statistics; China Internet Network Information Center.

Figure 1b. Consumer Internet Giants’ Revenue Growth Have Slowed Source: Company financial reports.

Profiting from an increasingly saturated market is difficult. To improve marginal returns typically requires either cutting costs or squeezing customers in some form or both—and squeeze they did.

Small-time merchants felt the brunt of it. Meituan and Alibaba, for instance, were both penalized for using exclusivity agreements that forced merchants to only sell on their platforms or pay a significantly higher commission rate to remain.

What’s more, complaints started filing in from both consumers and the legions of gig workers. Since 2015, the consumer internet industry has ranked second only behind the services industry in terms of consumer dissatisfaction (see Figure 2).

Figure 2. Top Sectors for Chinese Consumer Complaints since 2015 Note: Consumer complaints range from false advertising and privacy violations to data mishandling.
Source: China Consumers Association.

Gig workers complained about inadequate compensation, dangerous working conditions, and harsh delivery penalties. In a horrific episode, a delivery worker set himself on fire when a dispute over wages couldn’t be resolved.

As a result, public sentiment started to sour on big tech, viewing platform companies as more exploitative and anti-competitive. No surprise that domestic support had been building for government action against these companies long before the crackdown of 2021, even if the ferocity of the campaign surprised observers.

Meanwhile, Beijing also capitalized on the opportunity to advance its own vision for a technological future focused on core innovation and bolstering basic science and industrial technologies.

The Pivot: “We wanted 5nm chips, instead we got digital red envelopes”

That paraphrase of the famous Silicon Valley motto perhaps best captures the Chinese leadership’s thinking on technology. To thrive under this new paradigm, China’s chastened tech giants will have to align their business models more with national interests and pivot towards enterprise solutions and core innovation.

Some of this has been happening already among the “BAT.” Baidu has been focusing on cloud computing and transportation. Alibaba, too, is increasingly reliant on its cloud computing business for growth—­the segment made up a record 11% of its 4Q2021 revenue—while it is also starting to make chips for its data centers. Finally, Tencent unveiled chips optimized for gaming in November 2021.

Equally as important, public and private funding are also being redirected toward foundational innovation such as semiconductors, manufacturing and industrial solutions, and biotechnology (see Figures 3a and 3b).

Figure 3a. State-backed Funds’ Investments in 2021 Focus on the Real EconomyNote: These funds are typically investment arms of state-owned enterprises, central ministries, and/or local governments.
Source: ITJuzi.

Figure 3b. Vast Majority of STAR IPOs Are in “Atoms” Sectors, Not “Bits”
Source: STAR Market IPO documents.

A prism through which to view this pivot is a recently launched state-backed incubator program called “Little Giants.” Run by the Ministry of Industry and Information Technology (MIIT), since the program’s debut in 2018, 356 of the 4,762 approved companies on the MIIT list have already “graduated” from the incubator to list on the A-share market (see Figure 4).

Figure 4. Listed Little Giants Align with The Pivot Source: A-share IPO documents.

MIIT apparently plans to expand the Little Giants program to include 10,000 companies by 2025, with the hope of cultivating dynamic companies that embody the ethos of zhuan jing te xin (专精特新)—broadly meaning niche innovation and specialized technical solutions.

The Little Giants moniker is meant to serve as a signal to investors seeking high-potential firms. It may also help them get preferential access to domestic capital markets, including the newly founded Beijing Stock Exchange.

But commercializing enterprise technology and core innovation is much more complicated than consumer internet apps. Success of the Little Giants is far from guaranteed, and one of the most important challenges is human capital. That will be the subject of Part 2 of this series on China’s tech pivot.

AJ Cortese is a senior research associate at MacroPolo. You can find his work on industrial technology, semiconductors, the digital economy, and other topics here.