China’s Tech Pivot (Part III): Innovation Without Commercialization?

While China needs to solve the people problem when it comes to the tech pivot, it faces another daunting challenge: commercialization. Compared to the consumer internet, building and scaling industrial enterprise technologies is much more arduous and takes place mostly behind the scenes.

In the app economy, it simply requires a one-size fits all product to tap a total addressable market of hundreds of millions. Once there is a minimally viable product, an app gets pushed out quickly and scale is reached rapidly. In the industrial enterprise economy, commercializing technologies, whether it’s hardware or software as services, requires customization, specific targets, and a customer base across niche industrial verticals.

To illustrate the challenge of commercialization, we analyzed the 93 Little Giant firms listed on the Beijing Stock Exchange, a domestic bourse established in November 2021 specifically to finance high-tech enterprises.

No surprise that this cohort of core innovation startups ascribe to a product-intensive strategy because they are under pressure to develop the next big technical innovation. This can be seen in these companies’ resource allocation between research and development (R&D) and sales and marketing (S&M).

Given an immature and underdeveloped industrial technology market, these firms could be left holding onto their technologies with little idea of how to cross the commercialization “Valley of Death”. Indeed, the embryonic industrial enterprise economy means that the state sector will likely have to step in as a market for these core innovation startups.

That is, these firms’ technology solutions may target the public sector as customers before scaling across industry verticals. It also means that these firms’ relationship with the state will likely be characterized as more symbiotic rather than contentious.

The “If You Build It, Will They Come?” Problem

Since the Little Giants aspire to lead in high-tech verticals, prioritizing R&D over commercialization makes sense from the firm perspective. This helps to attract higher quality talent and create better products over the long term. Of the Little Giant firms listed on the Beijing Stock Exchange, nearly 65% are focused on products, based on their spending (see Figure 1).

Figure 1. Little Giants Spend More on R&D Compared to Consumer Internet GiantsNote: Ratio calculated using 2021 R&D spending and S&M spending. Positive value indicates spending ratio in favor of R&D, negative value indicates spending ratio in favor of S&M.
Source: Corporate 2021 annual reports.

Such a “product first” mentality is similar to the approach taken by many successful Western industrial tech giants. Where they differ is that the US and EU markets were more mature, and had existing enterprise customers already familiar with, and able to pay for, industrial tech solutions.

That customer base, in contrast, is still nascent in China—a phenomenon that has even led to desperation tactics. For instance, an audit of a Little Giant firm Hujiang New Materials revealed that it had inflated its sales figures by “selling” to customers that were inactive shell companies owned by relatives of management.

This puts the onus on sales and marketing to educate potential customers on technology solutions and to have an after-sales customer success operation to ensure that the technology has uptake within the firm. Core innovation startups’ engagement with potential customers needs to account for the industry’s dynamics as well as specific technical details, as purchase decision-makers and end users of that technology have different considerations.

Back in 2014, all Tencent had to do to acquire millions of mobile payments users in a single evening was to have WeChat Pay sponsor the Chinese New Year Spring Festival Gala red envelopes. That cheap and fast acquisition of users is a far cry from the customer acquisition strategy that Little Giants need to employ. Targeting and retaining niche, industry-specific customers is much more costly in an enterprise economy still in its infancy.

Moreover, Little Giants will struggle to communicate their brand and product differentiation because they simply don’t have the brand powers of the consumer internet giants. Part of this can be attributed to the low profiles of their founders, a departure from the charismatic, celebrity founders like Jack Ma, Lei Jun, and Richard Liu who dominated the consumer internet era and created 11 of the top 15 most valuable brands in China.

The Public Sector to The Rescue?

In the near term, then, these Little Giants’ best bet to make it across the commercialization “Valley of Death” may be the public sector.

China’s tech pivot already has the full backing of the central and local governments, which will improve these firms’ access to financing and talent pipelines. But perhaps the most tangible way the state can catalyze these startups is by filling in demand in an underdeveloped market.

Selling to the public sector through government procurement or deals with state-owned enterprises (SOEs) isn’t that novel but it may be the only option for some Little Giants that can’t yet rely on the private sector. Although far smaller than the private sector, the public sector market could have a galvanizing effect for some of these firms.

Take Little Giant firm Lanxin Mobile, a cloud-based big data startup founded in 2012. It has rapidly ascended to become a key provider of software services to central government ministries and SOEs in less than a decade. Keda Automation Control, too, has carved out a niche by applying Internet of Things services to the state mining industry (see Figure 2).

Figure 2. Cozying Up To Public Sector May Be Good Strategy for Some Little Giants

These dynamics suggest that whether Little Giants want to or not, they may be forced to establish a more symbiotic relationship with the state than the consumer internet giants that came before. On the other hand, the public sector has limits, and companies that want to grow will necessarily have to play outside of the state’s orbit.

In the final chapter of this series, we will examine the capital market reforms, labor regulations, and education policies that Beijing hopes will alleviate the considerable challenges facing China’s tech pivot.