The Factors Behind China’s Growing Strength in Innovation9 July, 2018 / Articles
In 2006, 26-year-old Frank Wang started up DJI in a dorm room at Hong Kong University of Science & Technology. The legend goes that Frank’s father had given him an expensive remote-controlled model helicopter for doing well in school. When the helicopter predictably crashed shortly after, Wang became determined to build a better controller. As part of his graduate thesis, he perfected an electronics flight controller, a critical element of drone technology. Today, Shenzhen-based DJI, of which one of us is a board member, holds a global market share of 70% in consumer drones and offers a window into the future of competition from China.
Western media has been quite critical of the Chinese miracle. The usual argument is that China has significant technology gaps, and that it has a long way to go before it can catch up with the West. But DJI is testament to China’s transformation from copycat to high tech innovation. In 2017, DJI’s sales were around $2.7 billion, with the company growing at a compounded annual rate of over 100% between 2013 and 2017. DJI generates 30% of its revenues from China, the US, and Europe, respectively, and 10% from South America. The company is valued at over $10 billion and, since Wang owns a 45% stake, he’s the world’s first drone billionaire.
Several well-funded Silicon Valley entrepreneurs — GoPro, 3D Robotics, and Lily — have entered and left the consumer drones market. They could neither match DJI’s features nor its prices. Such is the power of China’s valuable and difficult-to-replicate competitive advantages.
DJI benefits from the Shenzhen manufacturing ecosystem and produces drones at a very low cost. In 2016, DJI had 1,500 people in R&D, or 40% of a workforce of 4,000 – a luxury only available to a company that can tap into low-cost engineering talent. DJI’s first hit product was the Phantom in 2013, and ever since, DJI has introduced new products at a rapid-fire pace.
As the example of DJI demonstrates, Chinese companies are busy innovating based on three valuable and difficult-to-imitate advantages that will allow them to compete effectively with, and, in some areas, even overtake their Western rivals. The three advantages that Chinese companies possess are:
A Next-Generation Manufacturing Ecosystem. China’s Pearl River Delta region, for instance, has a world-class manufacturing ecosystem for electronic components, with the requisite physical infrastructure, logistics, and manufacturing capabilities, while the U.S. has virtually dismantled its hardware-manufacturing capabilities.
Having a manufacturing ecosystem confers several benefits. One, Chinese companies can conduct rapid prototyping and shorten the time for new product introductions. Unlike in the U.S., Pearl River Delta Region has component suppliers co-located. A prototype that takes two weeks to develop in Silicon Valley can be created overnight in Shenzhen. New products often require many prototypes — the Dyson vacuum cleaner required over 5,000 prototypes, for instance — so that’s a significant advantage in moving from the lab to the market. Two, economies of scale in component manufacturing provide Chinese companies with a 50-60% cost advantage, while still ensuring quality.
A Pool of Medium-and-High Skilled Workers. As everyone knows, labor costs in China have been rising, leading to low-cost manufacturing shifting to countries like Vietnam and Bangladesh. Still, China enjoys cost advantages in two major talent categories: R&D and marketing and sales. Engineers build new features and functionalities while management graduates can sell products at low cost and even create new business models and commercial innovations. Other than explicit cost advantages in terms of nominal wages, Chinese engineers and managers work a lot harder. According to a Siemens report, the annual number of working hours of engineers at Huawei, the largest Chinese telecommunication equipment company, stands at 2750, twice as long as those of their Western counterparts.
The U.S. also churns out engineers and MBAs, but they cost a lot; higher education is extremely expensive in the U.S. China has grown its local pool of engineers and MBAs by investing in universities. It also provides several incentives for overseas Chinese to return.
A Large Domestic Market. China has a population of over 1.3 billion people and a single dominant language in Mandarin (nearly a billion speakers), which, coupled with a fast-growing economy and a rising middle class, results in a vast home market. It enables its companies to test their products with ease and go from 1 to 100 with velocity. By perfecting their business models locally, Chinese companies can go abroad with greater confidence. Haier became a low-cost, high quality manufacturer of major appliances in China, an advantage it has parlayed to become one of the global market leaders today.
In addition to these advantages, there are technology enablers as the world has seen breakthrough innovations in hardware technologies in many areas, such as improvements in imaging, semiconductor chips, and batteries, thanks to Apple’s smart phone. And digital tools, such as AI and analytics, are coming of age.
In sum, China is on the cusp of the next wave of business model innovations that integrates three advantages — manufacturing ecosystem, low-cost skilled workers, and a vast domestic market — to offer hi-tech, high quality, and low-cost products that the U.S. and other developed countries will find difficult to match. Much of the current attention is on the trade disputes between the U.S. and China. But this should not distract from the long-term benefits for U.S. companies to engage with China.