Where China is creating the novel and the useful, where it wants to, and what is driving or slowing the nation’s quest to become an innovator

Mi Home


Back in the Hutong
Thinking Geek
1427 hrs.

Visiting Xiaomi’s Mi Home store near company headquarters in Beijing.

At first glance, the store’s appearance bears a passing resemblance to the retail outlets of a famous Cupertino fruit company. As with many Xiaomi’s products, though, what is surprising and delightful about the Mi Home store lies beneath the surface.

If I can sum up the difference simply, it is this: Apple stores are a celebration of the devices. Mi Home stores are an on-ramp into a what can best be seen as a modern lifestyle enhanced and simplified at a hundred points by digital devices.

Apple talks about the digital home, but it is mostly smoke and mirrors. Xiaomi is actually delivering in a relevant and affordable way, and the Mi Home stores make that plain.

A growth-focused Apple would be advised to take notes – for their product development teams, not their lawyers.

When Lux and Tech Collide

However, the cost of providing customers with devices and gadgets to gain access to new tech and maintaining them is not a small expenditure for most luxury fashion businesses. What’s more, when a customer is enthusiastic about testing a hi-tech headset in a store, it does not necessarily guarantee that he or she has the desire to purchase a $1,500 handbag.

Source: Village: How to Combine Tech and Luxury Fashion in China the Smart Way | Jing Daily

I confess that when I began my career thirty-odd years ago, I saw the luxury fashion industry as an easy target for ridicule: alien rituals and strange affectations aside, I found it hard to give credence to a group so focused on the capricious whims of the planet’s most pampered posteriors. That perception was both short-sighted and immature.

The opportunity I had to watch China’s luxury market sprout and blossom has given me a different perspective. Luxury consumers are an informal yet exacting standards body. I have found that the more that we can conduct any consumer-oriented business or marketing activity in accordance with the standards of this rarified niche, the better we can serve all consumers.

That’s why I was fascinated by this London panel talking about the use of technology (specifically augmented reality (AR) and virtual reality (VR)) to sell more luxury fashion.

One truism I’ve never forgotten about luxury customers: they all want the most fulfilling possible experience delivered with the least possible friction. The gratuitous application of kludgy technology (and, let’s face it, while AR and VR are getting better, neither are ready to fulfill their promise) seems to be a guaranteed way to chase luxury buyers out of your store.

Which leads to a second truism: The well-to-do are not early adopters. They’re the demanding knife-edge of the mainstream user, the guardians of the far side of the chasm twixt “niche product” and “widespread adoption” into which so many promising inventions fall.

If you can tweak a technology or product to the point wherein you can match the exacting standards of the luxury consumer, the big-time awaits. Smartphones went mainstream when the iPhone passed the lux test; satellite radio went wide after Damlier, Toyota, Nissan and BMW were able to make them accessible to finicky upscale buyers; and electronic cars went mainstream when Tesla introduced its luxury roadster and Toyota made the Prius hip with the well-to-do.

China is no exception to this rule. The Chinese luxury consumer often shares as much of her psychographic profile with her counterparts in Europe and North America as she does with her home-girls in Shanghai or Bengbu. Until you can offer her a great experience with the minimum of friction, forget about being first-to-market: go back to the lab.

Did Apple and Uber make the right call on Didi?

Late last year I noted that life after Uber would not necessarily be a picnic for Chinese ride-sharing giant Didi. While an 85% market share looks unassailable, it will need a lot more money to secure its position.

I was prepping a post on why that is the case, but Dr. Richard Windsor at Radio Free Mobile beat me to it. Read the whole post. His bottom line:

Rising prices and lower reliability is likely to drive many users back into the arms of the taxi industry thereby achieving exactly the result for which the rules were created.

Windsor believes that the only logical response for Didi is a change in strategy, but finds it hard to see how any strategic choices open to Didi justify its $34 billion valuation. Fair enough.

Now, second-order effects time. Uber and Apple are Didi investors. As I mentioned in December:

Didi is a rapidly-growing company with a need for a huge war chest in order to secure its market position. Payback to investors will be some time down the line, and others will decide when and if Uber [or Apple] will ever see a dividend. Even if it does, the question will remain as to whether that dividend was a fair compensation for the price and a fair return to investors on the risk.

If you are an investor in either Uber or Apple, and you count the company’s holdings in Didi as a part of the firm’s underlying value or future earnings, have a look at Windsor’s post. You may want to re-run your numbers.

The rule for disruptive companies in China, regardless of provenance, is this: your future depends on more than just being able to make a handsome profit off of disruption. You have to convince a host of powerful individuals and groups that China is better off with the industry disrupted than with the status quo.


China and “Datathermal Energy”

Hutong West
Letting the Sunshine In
0909 hrs.

Much of my March was spent working with clients who are thinking through some of the issues facing the growing data center market in China. For the uninitiated, a “data center” is a place that houses anywhere from one to tens of thousands of servers. This blog sits in a data center, your bank information sits in a data center, there are a lot of them, and these places are growing.

Little wonder. One delightful quote from Smithsonian.com suggests why.

“From the year 2003 and working backwards to the beginning of human history, we generated five exabytes–that’s 5,000,000,000 GB – of information.

By last year, we were cranking out that much data every two days.

By next year, we’ll be doing it every 10 minutes.”

That quote was from two years ago. Draw the curve in your mind, and you can figure that, conservatively, today we could be generating five exabytes of data every five minutes. Not all of that is going to sit in phones, laptops, external hard drives, thumb drives, or those little SD cards that we stick in our digital cameras. Much of it has to sit in data centers.

The Great Heat Sink

Which is fine, until you consider that data centers suck energy the way blue whales suck krill: in massive quantities, and with large amounts of undesirable waste at the end of the process. In the case of data centers, that waste comes in the form of heat, which then demands more energy to power cooling, which in turn generates heat. The bigger data centers get, the more heat we are talking about. And data centers are getting quite large indeed, measured in millions of square feet of servers stacked like so much electronic cord wood.

Some data centers have started addressing heat as a resource, rather than a waste-product: IBM’s Swiss data center heats a pool; Telehouse in the UK is heating homes in London’s Docklands district; and Notre Dame’s Center for Reserch Computing is heating the flowers of a local municipal greenhouse with the heat from a rack of high-performance computing nodes.

Not everyplace where there are data centers needs heat, though. Some places simply need energy. As any engineer will tell you, where there is heat, there is potential energy. The key will be to capture enough heat so that it can be efficiently turned into energy, for example through steam turbines. Energy generated like this – through the waste heat of data centers, we will call “data-thermal energy.”

Data-Thermal China

China is a natural place for the development of data-thermal energy. The country is early enough in the cycle of development for data centers to start designing its largest server farms to capture and channel heat efficiently. And scale will not be an issue in China. Leaving out government-run data centers entirely, some commercial data centers, like one 6.3 million square-foot beast under construction in Langfang just outside of Beijing, will have more floor space than the Pentagon.

The ability to capture and use waste heat efficiently also opens the prospect of cutting down on air-conditioning costs. If the heat can simply be blown – or sucked – away from the servers and into a central collection point for energy generation, the need to actually cool the air should abate a bit.

There is considerable engineering work to be done, but this is a worthy (if not essential) direction of thinking for the people designing and growing China’s server farms. It will demand imagination and discipline: the old way of doing things – stack ’em high, chill ’em down, and blow the hot air out the window – is cheap and pervasive. As the costs of energy grow and sustainability becomes more important, however, Big Data will need to start seeing itself as a utility, not just a customer.

Setting China’s Innovation Bar

Hutong West
Disrupting my reading
1953 hrs. 

Now that I am spending more time in Silicon Valley and its satellite outposts of innovation in the US, the question posed to me over more meals and espressos is “do you think China will ever become innovative?”

After a lot of time to think about that question on planes an in hotel rooms, the best answer I have to that is another question.

“How do you define innovation?”

One expert with whom I shared a panel about a year ago said that innovation is like pornography: “I can’t define it, but I know it when I see it.”

That’s witty, pithy, and, I have found, gets your audience on-side. Which is nice when your audience is a client writing big checks for your advice. Unfortunately, it is also wrong.

A Relevant Definition

You can define innovation if you think about it. Franz Johansson has thought a lot about it, and the way he defines it as something that is both novel (new, never seen before) and useful.

That’s actually a pretty good starting point, but global experience proves something may be novel, useful, but not particularly relevant. The XboX Kinnect is novel and useful, but not particularly relevant if you live in China, where video game consoles are essentially banned. The Founder Group was built largely on an innovation laser typesetting of Chinese characters, a remarkable breakthrough in China but largely irrelevant to three-quarters of the planet. A review of the history of the Xerox Palo Alto Research Center (PARC) offers a list of innovations that never found the proper context that made them commercial, meaningful, and worthwhile.

A good working definition of an innovation, then, is something that is novel, useful, and relevant to a given audience.

What is more, innovation need not be in product: breakthrough innovations in process can be incredibly disruptive: think Fred Smith’s breakthrough with overnight freight processing that created FedEx, or, classically, Henry Ford’s moving assembly line.

Through a Filter, Darkly

We tend to view innovation in China through the lenses of two fallacies. The first lens is based on our view of China, and the second on our view of innovation.

Our view of China suggests that because China does not have a consistent record of innovation in recent years, and because many Chinese companies and entities proclaim they are being innovative when (by our definition, anyway) they are not, that China does not innovate.

This could be disproved, except for the second fallacy, which is our view of innovation. We tend to look at innovation like John Nash in “A Beautiful Mind,” seeing only landmark breakthroughs and totally original ideas as true innovation. This is a natural prejudice: our lifetimes have witnessed so many breakthroughs that our personal standards are high.

But they are unrealistic. The advances that turned the technologies used for mainframe computers into the personal computer revolution were not breakthroughs, but they were profound innovations nonetheless.

When we reframe our standards and work with the definition of innovation above, we can view China’s current innovation – and its prospects – differently.

Innovation Happens – Even in China

China is not yet an economy that is driven by its own innovations, but by those of others. Nonetheless, there are indicators that innovation is taking place in Chinese enteprises. Huawei’s investments in R&D following the telecom bust in 2002 have been yielding industry-leading innovation for three years in its networks business. BYD is using old battery technology in an innovative way. And Yuneec is on the verge of doing for general aviation aircraft what Tesla has done for the family sedan.

All of which goest back to my clients’ question. If Chinese enterprises are disrupting the mobile communications, automotive, and aviation industries, what industry is next? The best way to answer that is to watch for the little innovations, the process innovations, the incremental breakthroughs that turn out advances that are novel, useful, and relevant. Find those, and you will find the next point of disruption.

Congress, Huawei, and ZTE

In the Hutong
Catching up post holiday
1108 hrs.

If you have been following the news, you will have heard that a U.S. Congressional committee has issued a report urging U.S. firms not to do business with either Huawei or ZTE. Those two companies, respectively the second- and fifth-largest manufacturers of telecommunications equipment in the world, are accused of a range of offenses. In my opinion, the real offenses for which those companies have been placed in the Congressional mush-pot have little to do with the reasons outlined in the Congressional report. The companies real offenses are:

  1. They are from China, and this is an election year;
  2. They are the first companies in 70 years to challenge American companies for dominance in a core US industry that have not been from an ally or a client state;
  3. They have failed to be sufficiently transparent when doing business in a country that demands transparency from all companies, and even more from those that hail from competitor economies.

If Huawei and ZTE are guilty of anything, it is that they have built their U.S. businesses and ambitions before they have laid a foundation of trust with the American public and its elected officials. Ideally, no company should have to do that as a prerequisite do doing business in America, but trust is the price for any company stepping into a new country. The two companies are learning a lesson that must be absorbed by every Chinese company expanding overseas. China as a nation may or may not be successful in its efforts to reform the global system to suit its ambitions. Even if it is, though, Chinese companies must still conduct themselves in a manner that is acceptable to the governments and consumers in the markets they seek to enter.

At the same time, there is also an effort underway to tar Huawei and ZTE as a malevolent presence in the telecommunications industry, an effort that steps beyond fact and into the realm of speculation and rumor. As I noted in Making the Connection: The Peaceful Rise of China’s Telecommunications Giantsit behooves both the U.S. government and the U.S. telecommunications industry to stop relying on politics and the F.U.D. pump to preserve their markets. Instead, it is essential that American companies focus on Huawei as a competitive threat where it counts: in the market. A failure to do so only postpones their inevitable implosions.

I’ve spent much of the morning talking to reporters about the report, so I won’t belabor this. If you are interested in some balance about the issue, I talked about this this with Kaiser Kuo, Jeremy Goldkorn, and Will Moss on the Sinica podcast recently. Take a listen – I think the podcast covers the issue far better than 60 Minutes did. For a more U.S. policy-oriented viewpoint, I also covered this in The Pacific Bull Moose, my U.S. politics blog.

Does the Internet Make Polling Redundant in China?

Hutong West
Planning a trip to In-n-Out
1410 hrs.

I have a friend who is in China trying to expand the business of a major global organization that conducts opinion polls. Not surprisingly, he is finding the effort a bit rough going.

Part of the problem is a question as to whether or not polls are a tool that could work in China, a matter I touched on in my rather wonkish recent piece about market research. Another is the political sensitivity of what the Chinese government calls “social research.” Having an organization not controlled by the government or the party conducting polls among the Chinese people about social and political issues is extremely sensitive. Indeed, until recently such research was supposed to be approved in advance by the National Bureau of Statistics. (I believe this still to be the case, but enforcement is spotty.)

But the other part of the problem is whether traditional polling is even necessary in China anymore. While a poll takes days or weeks to set up, conduct, analyze, and disseminate, China’s social media offers a realtime glimpse at the Chinese zeitgeist that would be adequate for many (if not most) purposes. Indeed, I’ve watched demonstrations of public opinion dashboards based on real-time online analysis, and the process of gathering that data is becoming increasingly automated. Right now, companies in the advertising, marketing, and PR industries are deep into this business, and it is probably only political caution that is keeping Baidu, Sina, and Tencent from openly offering realtime “mood of the public” analysis to anyone willing to pay for it.

The only real question, then, is how long it will take American politicians to replace organizations like Harris, Roper, and Gallup with less expensive, real-time tools? While I suspect polling will never go away, the industry is in for some disruption over the next four years. Election 2016 is bound to be much more about Twitter, Facebook, and Google Analytics than about the old polling organizations. I would bet that at least one, if not all three, of those organizations either launches new, commercial election products in the coming quadrennium, or they buy companies that already have them.

The Innovator’s Dilemma with Chinese Characteristics

Hutong West
Catching up
2009 hrs

In what has to have been one of the most important moments of my life, while running errands today in the car my wife touched my hand, looked into my eyes, and said “the time has come in our lives for you to focus on what is important: your books, your blogs, your research, your speaking, and your teaching. Let me worry about the other stuff from now on.”

Talk about a lump in the throat. I do not deserve a partner like her. With that kind of support, however, I’m rolling up the sleeves.

With this post, I am beginning an effort to write the posts I have been dying to write, but have put off over the years because of other obligations. Not everything will be timely, but it will all be relevant. I can promise you, though, that I’ll keep most of them short and pithy. To keep these grouped together, I will mark each of them with my “FITG” (“flag in the ground”) category.

Is China like Japan, Only Bigger?

In a thoughtful article in The New York Times from January 2011 [see, I told you I’d been waiting a long time to write these – dw], Steve Lohr suggested that perhaps the U.S. trade disputes and commercial competition with Japan were mere warm-ups for what we would face in China. It’s a provocative thesis, but the passage that got me in the article was this one:

“The bet for I.B.M. in Japan, as it is for companies like Boeing and General Electric today in China, is that they can stay ahead, innovate faster than the potential competitors they are helping,” says Edward J. Lincoln, professor of economics at the Stern School of Business at New York University, and director of its Japan-U.S. Center for Business and Economic Studies.

I’m on record in this blog for suggesting that the way for companies to keep ahead of the Chinese was with a flow of innovation. But when I read Professor Lincoln’s words, my brain goes straight to Clayton Christiansen’s Innovator’s Dilemma. Piling innovations on top of each other to stay ahead is great, but at some point your customers are going to wake up and ask exactly how much of this innovation they really need, or whether buying “good enough” products will do just fine?

Bells, Whistles, and Value

What triggered me was the reference to Boeing. I’ve been compiling notes and research on a book about Chinese aerospace over the years, and the issue I keep coming back to is that at some point Boeing’s innovations – as remarkable as they may be – may not mean enough to a Chinese, Latin American, or African customer to make a 11o passenger jet worth 25% or 30% more.

In construction equipment, for example, the global manufacturers have created so many process innovations that their earth movers, graders, and loaders will last for a decade or more. But those innovations don’t pay off with many Chinese customers: they amortize the cost of the equipment over a year or two, so they would rather buy cheap equipment, burn it up, and then sell it used to companies in the poorer parts of China than pay a premium for the longer-lasting equipment.

With airliners, many carriers in the developing world have been getting by with used Boeings and Airbuses for years because they simply could not afford to equip their airlines with the newest planes. But at some point, a company (like China’s COMAC, for instance) will come to those carriers and say “look, we’ll sell you our new airliners for just a bit more than you have been paying for the used Boeings and Airbuses. You get new planes rather than used ones, and it doesn’t cost you much more. Sure, they don’t use the latest technologies, but you don’t really need composites and Garmin avionics – you’d be perfectly happy with aluminum planes with old-fashioned dials for instruments. Your maintenance costs will drop substantially, and you’ll have happier passengers.”

Apologies to Debbie Fields of Mrs. Field Cookies, but sometimes, good enough is good enough.

What KIND of Innovation Stream?

So what do companies like Boeing need to do?

Part of the answer is to go back to Franz Johansson’s definition of “innovation” from his book The Medici Effect. A true innovation, Johansson noted, has two characteristics: it is novel (i.e., new or never been done before), and it is useful. That last bit, he noted was the part most people missed. But I think companies like Boeing and GE manage to get both the “novel” and “useful” bits right, but that is not enough: just ask the guys who make earth moving equipment. Something is missing.

I once had a jolly debate by mail with an auto reviewer for the L.A. Times who felt that Mitsubishi’s inclusion of an inclinometer in the instrument panel of its off-road vehicles was useless. I thought it was quite useful, as it is possible to get disoriented when bouncing around off-road, especially in low light. He responded by suggesting that maybe I needed my inner ear checked. I ended the conversation before calling him an effete Limey, which is just as well. Twenty years on, I think we were both right. For him, the doohickey was useless, but for me, it was useful.

Herein, I think, lies an answer to the challenge innovative companies are going to face with Chinese competitors. An innovation must be novel, and it must be useful, but it also must be relevant: it must be meaningful to the specific customer given that customer’s preferences and proclivities. In fact, the more relevant an innovation is, the less truly novel it need be.

This simple question reframes the thinking around innovation and around the value proposition an innovation offers. Instead of assuming that, say, because Singapore Airlines will value an innovation, Air Afrique will value it equally, we automatically assume that some of our customers will value an innovation and that some will not, and we start seeing innovations as targeted rather than as generic. This means that there will be multiple streams of innovations that are targeted to customers with different needs and preferences.

So yes, as Professor Lincoln said, to keep ahead of the competition who are innovating on your heels, innovate faster. But keep the innovations relevant, or you may turn around and realize that you missed a turn, but the competition didn’t.

There is More to Tablets than Cheap vs. Dear


English: motorola xoom tablet
Image via Wikipedia

How Apple Can Keep Control of the Tablet Market – BusinessWeek.

GigaOM‘s Darrell Etherington believes that the way for Apple to sustain its dominance in the tablet market in response to challenges from the Kindle Fire is to offer a smaller, cheaper tablet. The case he makes – that a cheap tablet with a tightly integrated “content ecosystem” is the best response – is not a bad one, but it misses the wider point.

The issue with tablets going forward will not be large versus small or high-end versus low-end, but general versus specialized. The iPad, the Motorola XOOM, and the Samsung Galaxy Tab are examples of high-end, tablet format computing devices that are designed to perform an array of tasks. The Kindle Fire, despite the other things you can do with it, is designed to offer a quality book, music, and possibly movie experience. At doing other things, even browsing the web, it is somewhat weaker.

And this is not a bad thing. Not everybody wants a tablet to act like a laptop without a keyboard, and in fact the great untapped opportunity is in finding ways to target the format for specific experiences or vertical markets where the iPad or XOOM would be too much machine for the job.

Where is China’s Motorhead Messiah?

In the Hutong
Trying to break delicious.com
1549 hrs.

As we swing into the political season ahead of the unveiling of the 12th Five Year Plan, the question on many minds is whether (and to what extent) “indigenous innovation” is going to be at or near the top of China’s policy imperatives in the coming half-decade. This is not an idle concern.

The past several years have given the government and the Party plenty of time to not only think more carefully about the value of innovation for its own sake, but also of the unintended consequences of embracing the appearance of innovation as much (if not more than) innovation itself. What is more, I detect here in the capital a growing realization that not all worthy innovations come out of the labs of state-owned enterprises.

And none too soon. A recent article in Fast Company (“Motorhead Messiah“) on the work of independent automotive engineer Johnathan Goodwin underscores the last point (apologies for the long pull-quote):

Goodwin, a 37-year-old who looks like Kevin Costner with better hair, is a professional car hacker. The spic-and-span shop is filled with eight monstrous trucks and cars—Hummers, Yukon XLs, Jeeps—in various states of undress. His four tattooed, twentysomething grease monkeys crawl all over them with wrenches and welding torches.

Goodwin leads me over to a red 2005 H3 Hummer that’s up on jacks, its mechanicals removed. He aims to use the turbine to turn the Hummer into a tricked-out electric hybrid. Like most hybrids, it’ll have two engines, including an electric motor. But in this case, the second will be the turbine, Goodwin’s secret ingredient. Whenever the truck’s juice runs low, the turbine will roar into action for a few seconds, powering a generator with such gusto that it’ll recharge a set of “supercapacitor” batteries in seconds. This means the H3’s electric motor will be able to perform awesome feats of acceleration and power over and over again, like a Prius on steroids. What’s more, the turbine will burn biodiesel, a renewable fuel with much lower emissions than normal diesel; a hydrogen-injection system will then cut those low emissions in half. And when it’s time to fill the tank, he’ll be able to just pull up to the back of a diner and dump in its excess french-fry grease—as he does with his many other Hummers. Oh, yeah, he adds, the horsepower will double—from 300 to 600.

“Conservatively,” Goodwin muses, scratching his chin, “it’ll get 60 miles to the gallon. With 2,000 foot-pounds of torque. You’ll be able to smoke the tires. And it’s going to be superefficient.”

He laughs. “Think about it: a 5,000-pound vehicle that gets 60 miles to the gallon and does zero to 60 in five seconds!”

The dutiful production of a string of novel and interesting inventions may fluff the national ego and build an increment of soft power among the global geekocracy. But as the modern histories of America and Japan suggest, is the rapid industrialization of innovation, the process of taking something out of a lab or garage and making it accessible to the widest number of people, that creates economic value.

If China is going to reinvent its economy as a cradle of high-value innovation, it has to start figuring out where its Goodwins are, and how to bring them in from the cold.

I suspect that there are hundreds, if not thousands, of Johnathan Goodwins scattered around China, each with a brilliant idea that could propel a company, a sector, an industry, or even perhaps the entire economy. But something is keeping them from standing up. And it is that same thing, I reckon, that keeps Johnathan Goodwin from giving up on GM and Ford ever paying for his ideas and instead coming to China to sell them to SAIC, or Beijing Auto.

Time to stop bankrolling high-cost, low-return projects to try and reinvent the microprocessor or build a cheaper 757. Fix the Goodwin problem, and China will become a global leader in innovation.

As the 12th Five Year Plan rolls out, read through the fine print and see if the country is starting to move in that direction. Otherwise, expect “indigenous innovation” to become nothing more than a fig-leaf for import substitution and subsidies for SOEs to continue reinventing wheels.

Indigenous Innovation: “How” not “If”

In the Hutong
Celebrating Hump Day
1022 hrs.

London-based China hand and attorney Geraldine Johns-Putra makes a rational case against the thrust of China’s indigenous innovation policy over at View to China, and in so doing opens a barrel of invertebrates.

I am of two minds (as I think she is) on indigenous innovation. On the one hand, I would love to see China become a global innovation leader. On the other, I see the rhetoric around the policy drawing the nation away from addressing the issues that need to be solved before China can get there, including:

  • Should government or enterprise be the primary driver of innovation?
  • What is the role of universities vs. government vs. enterprise in conducting the primary research that leads to innovation?
  • Is China’s “indigenous imitation” approach to innovation merely a phase, or will it be chronic?
  • Is innovation being hampered by the way banks allocate capital?
  • To what extent are China’s own innovators being driven offshore – or away from innovating – by loose IPR protection?
  • How do we focus on creating the truly novel and useful rather than simply reinventing the wheel (i.e., TD-SCDMA and the Godson chip?)
  • Where is the nexus between national priorities, global challenges, local capabilities, and commercial opportunity that would be the most fruitful fields of endeavor?
  • Where are other countries dropping the ball, particularly after over a decade of cuts in R&D in major Japanese, North American, and European companies?
  • And the tough one: to what extent is “indigenous innovation” merely a cover phrase for import substitution?

China is not alone in its discomfort with paying for foreign technology. The idea that key domestic industries should be held hostage to absentee technology landlords who demand hard cash merely to use their inventions was as odious to American policymakers a century ago and to Japanese leaders in the 1930s as it is to the leaders of South Korea and China today.

It is as upsetting for China to watch so much of its national purse flow into the pockets of foreign companies for intangible inputs as it is for Americans to see their national treasure siphoned into the purses of the OPEC nations. The rational response is some form of substitution.

We, as non-Chinese, need to appreciate that rather than vilify China for its refusal to support techno-rentiers, we should instead be driving a meaningful discussion on how “indigenous innovation” can be made to work not only for China, but for the world.

Zen and the State of BYD Innovation

Starbucks Guomao 2
Tinny jazz, burnt coffee
1149 hrs.

Amid all the debate about China’s supposed “lead” in green technologies, it is worthwhile reading this article from Matt Forney and Arthur Kroeber from the Wall Street Journal last fall, wherein those two China hands offer telling insights and point a course for BYD.

“But the true competitive advantage of BYD, as with most Chinese firms, is its ability to commoditize technology products, thereby making them cheaply available to a wider range of customers. This is a useful function, and it will be critical in ensuring that new-energy products can rapidly increase market share against traditional carbon-based technologies. But there is little evidence that Chinese companies are ahead in this new-energy innovation race.”

For the moment, I tend to agree. As Christina Larson recently pointed out in Yale360, while China is extending its role as the world’s factory floor into green technology products, the country and its business leaders all too often still confuse imitation with innovation.

“The first essential fact to be aware of is that most news stories about China’s greentech gains are about manufacturing. China is becoming the wind-turbine factory to the world for much the same reasons it has long been the TV and t-shirt factory to the world: lower wages, lower land prices, fewer regulatory and other requirements, etc. This isn’t particularly surprising, and it shouldn’t be seen as a reversal of the status quo. What’s changed most dramatically in the last five years has been growing global demand. With significant government investment, Chinese factories have planned for and stepped up production accordingly.”

To summarize the sentiment, China’s growing role in greentech is about efficient manufacturing, not innovation. BYD is no exception.

Not the Imitator Forever

What we must guard against, however, is the belief that this will ever be the case. Leaving aside whatever process innovations BYD has developed to crank out its batteries, BYD may well not be doing much innovation today, but the Buffet touch and properly applied capital could help it build on its core competency and make a jump into developing genuine innovations.

There are plenty of “ifs” implicit in the preceding sentence, and BYD is unlikely introduce disruptive innovations in the next few months. But just as we should not be surprised that BYD is not an innovator today, we should not be surprised if and when that changes.

A smart businessman does not wait for his competitor to emerge before taking measures to protect his advantage. He assumes the competitor is there, and acts accordingly to build and extend his lead and to lay the groundwork for the constant renewal of that leadership. Forney and Kroeber remind us not to buy the hype coming out of BYD. I suggest it is wiser for BYD’s presumed competitors to foster a little paranoia and start figuring out how to beat them before it becomes a problem.

And Forget the Motorheads

Forney and Kroeber also note that Car and Driver magazine was scathing in their review of early BYD electric vehicle portotypes, with the magazine’s columnist saying “We drive faster in our driveways.”

Yes, that’s a great line. And it brings a smile to my face as I gaze lovingly out my window at my V6-powered suburban assault vehicle.

Levity aside, though, it would also be unwise to accept the verdicts of the automotive press on BYD’s cars. Auto reviewers are notorious testosterone junkies, and any vehicle that does not incite an involuntary glandular response is dismissed out of hand. For three quarters of a century, that worked, because North Americans (and plenty of Europeans and Japanese) were making their personal transportation decisions with the back half of their brains.

But we are entering an era where a growing number of buyers are overruling their glands in favor of an emotional response linked to a fear for the future of the planet. A niche market this may be, but BYD does not need much more than a niche, a low price, and some volume fleet sales to establish the first generation of its cars in the United States.

Those with a sense of automotive history will remember that both Toyota and Nissan were ridiculed (or worse) by the American automotive press throughout the 1960s. Yet ignoring their detractors, they created the American predilection for Japanese imports, beginning with fringe consumers, then slowly and painfully learning how to appeal to U.S. drivers based on changing consumer tastes and priorities.

Matt and Arthur (and probably Car & Driver) look at BYD and think “Yugo.”

Me, I look at BYD and think “Datsun.”

Dissecting the National People’s Congress: The PLA and Independent Innovation

In the Hutong

Looking for the burnout cream

1641 hrs

Even the most focused minds and incisive bladders must collapse under the weight of a 15,000 word address, and apart from our hyperlinked and multitasked MTV attention-spans, we in the West lack the tolerance for protracted oratory. We think, my Lord, if Lincoln could move a nation with 272 words in the Gettysburg address, what possible good could come of much more?

By now, China’s leaders know this, and I’ve developed a theory that they intentionally structure their speeches to hide the good stuff in the back half. So when I got the text of Wen Jiabao’s 2009 Report on the Work of the Government (i.e., The State of the Nation with Chinese Characteristics) I went straight to the back.

And I was not disappointed.

The Army’s Buried Lede

Hidden there, not far from the end, was an interesting little piece that grew in significance over the past week.

“In the coming year, we need to make our army more revolutionary, modern and standardized, focusing on enabling it to fully carry out its historic missions in the new stage and in the new century. We will strengthen ideological and political work in the army. We will effectively transform our military training based on mechanized warfare to military training for warfare under conditions of greater IT application, and continue to enhance the army’s ability to respond to multiple security threats and accomplish a diverse array of military tasks. We will modernize weapons, equipment and logistics support across the board. We will improve defense-related research, the weapons and equipment production system, the military personnel training system, and the army’s logistics support system that integrate civilian with military purposes and combine military efforts with civilian support.

[Emphasis mine]

There are two points of interest in this brief but important paragraph that are worth noting which, when related, speak to the future of China’s technology industries.

Information Warfare by Any Other Name

First is China’s plan bring the PLA into the 21st century, easing the emphasis on mechanized forces that has guided global military thinking for the past 90 years, shifting instead to an approach with a greater emphasis on information technology. The details of what exactly this means is unclear. There are few aspects of modern warfare that are not suffused with chips and networks, and “greater IT application” can mean anything from computers in tanks, to the ability to disrupt the information infrastructure of other militaries and nations, to the emerging concept of “network-centric warfare.”

I’m betting that China will dive into all of the above.

Mind you, the change will not happen overnight. Even if it seeks to leapfrog the U.S. and other military powers, the PLA like most armies is led by men and women who think of war in terms of infantry assaults, tank battles, and missile attacks. These folks will not be anxious to surrender the more visible (and intimidating) proofs of military strength: after all, armies (and navies, and air forces, and space forces) will always need to bear a nation’s credible threat of physical destruction.

Premier Wen’s statements are, however, a clear message to the leaders of the PLA that while they will get upgraded toys in the near term, the PLA’s destiny is to become a force capable of winning battles without firing a shot.

Getting to the PLA of Tomorrow

The implications for China’s technology industry should be obvious in that first bolded sentence, but that’s not enough for Wen. Two sentences later he hints further at his vision for a new Chinese military industrial-complex, noting that defense related R&D, manufacturing, and “the integration of military and civilian purposes” are also at the core of China’s vision for its military.

Now, I emphasized that last bit because by itself this is an important policy statement, but in combination with the IT-led direction of China’s military, it points to more than just military procurement policy but the future of China’s technology industries.

Bear with me.

When it comes to modernizing the PLA, China has a choice of developing its own technology or buying from others. That choice is going to go away. In most cases, China will be largely left with having to develop its own.

First, the number of nations willing to sell military technology to China will decline, with countries ratcheting back sales either because they see China as a rival in the defense business (Russia, maybe France), they see China as a potential threat to themselves or an ally (United States, Japan, India), because Washington doesn’t want them to (Germany, Britain, and Israel), or because they don’t have anything to offer Beijing (most of everyone else.)

Second, the Central Military Commission (China’s combined equivalent of America’s Joint Chiefs of Staff and the National Security Council) will be unwilling to leave control over critical national defense systems in the hands of foreign nations or foreign companies. This is understandable: the United States, Russia, and a dozen other countries operate under the same principles.

Third, some intelligent and opportunistic policy makers in Beijing will realize that if the country invests in developing its own technologies, the entire exercise strengthens the country’s civilian commercial sector. And this is where Wen’s throwaway comment about “the integration of military and civilian purposes” gets interesting.

It is no secret that the United States’ much-vaunted technology industries were founded on innovations that came from projects funded by the Department of Defense. In effect, America’s aviation, aerospace, computer, electronics, software, wireless communications, and the Internet sectors owe much of their global success to the breakthroughs and profits brought by defense contracts.

By all indications, the Premier seems to be pointing China in a direction where it, too, will pursue defense spending with a twin agenda – a more secure China, and a technology industry heavily fertilized with profitable defense projects. And China would not only be wise to follow America’s lead, they would be within their rights – the WTO makes wide provision for protectionist practices in industries deemed vital to national security and defense.

The World is Theirs

There is a qualitative difference between dumping a lot of money onto Chinese tech researchers and imploring them to go forth and innovate, versus giving them a contract to fix a specific problem or develop a specific system. At the very least you get a product out the back end. If you are lucky, you get something that works for the military, and if you are really lucky, you wind up with a development that has huge civilian potential.

Just one example of many: Boeing’s entire commercial jet airliner business owes its existence to a set of technologies created to build the largely-forgotten B-47 bomber. That one project begat the prototype for the Boeing 707, which begat the hugely popular 727 and 737, and the rest is history.

It is easy to see how the path from a few high-tech defense projects to the creation of global tech powerhouses may not be a smooth one for China. But one only need look at companies like Huawei to appreciate that the more robust China’s defense industries become, the more of these sorts of international competitors will emerge from the murk of military work with competitive – and perhaps innovative – products.

Caveat Inventor

I have said elsewhere that China will try to forge its own path as it seeks to create an economy based on innovation. I expect that part of that model will involve the peaceful application of technologies created for the purpose of national defense.

But I also know that I would be naive if I believed that China would steadfastly insist on creating its own military innovations when it would be easier, faster, and cheaper to “borrow” those created elsewhere. The pressure for results and the urgency of the goal will cause many companies to take what could be politely called “R&D shortcuts.” This is to be expected – history has proven that an uptick in industrial espionage is a natural side-effect of the emergence of a new world power, particularly in the case of one still wrestling with the concept of intellectual property rights.

An pound of prevention is in order. Those companies with technology to protect would be doing themselves – and ultimately China – a great service by recognizing the potential for industrial espionage and taking aggressive measures. You get to keep your technology, and China enjoys the deeper benefits of doing the basic spadework that genuine independent innovation would require.

Another Tech Iconoclast

Starbucks Pinnacle Plaza, Houshayu Village

Ahh, spring

1025 hrs.

Many of us non-Chinese (and a healthy percentage of Chinese returning from abroad) indulge ourselves with the conceit that we are somehow helping to build a bridge (or, really, many bridges) between China and the rest of the world. And to be fair, some of us are doing a better job than others.

For his part, Ken Carroll of Chinesepod has discovered a new and brilliant way to do so, and Patti Waldmeir of the Financial Times does a profile on Ken and his work that I found inspiring on this chilly early spring morning in Beijing.

Innovation doesn’t just happen in labs, and it doesn’t always need mountains of capital or government edict.

Just a good idea, strong execution, and a little word of mouth.

The ARJ-21 and China’s Long, Slow Climb to the Skies

In the Hutong

No place else I’d rather be

1158 hrs.

Covering this year’s Zhuhai Air Show, The Economist takes a look at China’s first domestically-produced jetliner, the AVIC1 Commercial Aircraft Corporation‘s ARJ-21, and on the eve of the regional jet’s maiden test flight takes a moment to consider its commercial prospects. Their verdict: don’t count China out.

Many foreign analysts doubt that Western airlines will ever be prepared to buy Chinese aircraft. But, as in other fields, China is playing a long game.

Much of the debate about the ARJ-21 thus far has centered around two issues: first, whether the ARJ-21 will attract buyers beyond the Chinese airlines who are compelled to purchase it (and GE, who is making a pile selling engines for the jet); and second, whether China will ever develop a globally competitive civil aviation industry.

Both questions miss the point. What is most important about the ARJ-21 is the lessons it teaches us about the process China goes through to catch up with the rest of the world in technical, complex, high-value industries.

Watch Process, not Product

If you look at all of the technical sectors in which China has built commercially viable businesses, you can discern a clear process by which the nation’s industrial policy kick-starts these efforts. In the case of cars, computers, mobile phones, and now commercial jetliners, the pattern is dependably consistent. Let’s call it the Four C Model.

First, comes what I call the “capability” phase. the government typically announces a national project to build its own version of an technical product. It turns to a government research institute or a similar organization, which in turn pulls together the team from across the nation’s universities and enterprises. Eventually they manage to produce a one or more prototypes, but there is no real possibility of commercializing the product.

Upon review of the initial prototypes and the development process, typically a range of issues is identified that prevented the commercialization of the product. As a result, during the next “collaborate” phase, China sets up an enterprise to build the product using foreign designs, components, and know-how. The result is not quite commercially viable, and may only sell to local customers because of tariffs, tax-breaks, or other subsidies that make the local product appealing to local customers.

Next comes the “component” phase, when a local company creates its own design or modifies another, and many of the parts, but key, mission-critical components come from overseas. In this phase the product is adequate and by most measures comparable to foreign products, but with no track record only the most adventurous foreign customers are ready to trust the product.

Finally, all of the technical kinks are worked out, there are several Chinese companies involved in the effort, and with a demonstrable track record behind it, China is ready to go head-to-head with global companies. This is the “competitor” phase, and it usually marked by brisk sales and the beginnings of a true competitive advantage.

Not Quite a Competitor

In the case of the ARJ, China’s effort to build its own jetliner has reached the “component” phase, and it has taken 35 years to get this far.

In the early 1970s, China began a project to prove to the world it was capable of making its own jetliner. the result was the now almost-forgotten Shanghai Y-10, which was as close to a clone of the Boeing 707 that the nation could produce in the late 1970s. Two prototypes were produced. They flew in the early 1980s. China made its point. And the jets never saw commercial service: they were essentially flying monuments to China’s aspirations. This was the “capability” phase.

Not long after, China got involved in negotiations with McDonnell-Douglas Aircraft for a joint-venture to assemble their MD-80 class jets in Shanghai. The JV went through brutal political turbulence and costly delays, and in the end the venture sold only a fraction of the jets it had hoped. McDonnell-Douglas was sent packing, but China was left with an entire generation of aircraft engineers, a lot of very helpful tooling, and the groundwork to take the next step. Thus ended the “collaborate” phase.

After nearly a decade of thinking, planning, proposals, and counter-proposals, and even another shot at collaborating with other Asian aspirants, China launched the ARJ-21 (Asian Regional Jet – 21st Century) project. This is the “component” phase, and at this point China is serving as re-designer (the jet is basically a shortened MD-80, or DC-9, with a new wing design from Russia), project manager, and system integrator.

Tough Room

China’s aviation policy-makers and industrialists knew the ARJ-21 would be playing in the most competitive end of the civil aviation pool. The regional jet field is dominated by Canada’s Bombardier, with its CRJ series, and Brazil’s EMBRAER, with its ERJ series, both of whom have complete lines of aircraft, global technical support, and who built their business on solid reputations for making dependable aircraft.

Three very old names in the aviation industry, British Aerospace, Dornier, and Fairchild, have already been driven out of the aircraft manufacturing business after losing out to Bombardier and EMBRAER, and Boeing’s 717 was squeezed out of its market niche with a plane strikingly similar to the ARJ-21. Four other very old names in the aviation industry, Antonov, Tupolev, Sukhoi, and Mitsubishi are all getting ready to pounce on the ARJ-21’s markets with brand new regional jets of their own.

So there is not much hope for the ARJ-21 beyond China. And prospects inside of China are not that great, either.

Fat Planes Wanted

The idea behind a regional jet is that you have flights under two hours duration connecting cities under 1,800 kilometers or 1,100 miles apart where you cannot economically fill, say, a Boeing 737, or where the field might be a little short for a small jetliner.

In China, however, the problem is that we have a limited number of airports, a limited amount of airspace, and a whole lot of people who want to fly. There will be some market for regional jets, but in the medium to long term China needs larger jets that make the best possible use of the limited resources in Chinese aviation (i.e., concrete and airspace) to move the maximum number of passengers at the lowest possible cost.

Finally, let’s not forget that perhaps the most serious competitor to regional jets in China doesn’t even fly. China is in the early phases of a madness for high-speed intercity rail transport. The threat posed by trains as fast as Japan’s Shinkansen and France’s TGV is most serious to the shorter air routes served by the ARJ. As the price of jet fuel goes up (and, despite current trends, it surely will), that threat grows all the more critical.

Back to our Model

There are other issues, such as a total cost of ownership for the ARJ-21s that are going to be higher than carriers are being let to expect. With all factors in consideration, the ARJ-21 faces some roaring headwinds.

But again, what is important is not the plane itself, but where China’s jetliner manufacturing industry will be after the ARJ-21. And here is where it starts to get really interesting.

Just as the ARJ-21 goes into full production, Airbus will be completing its A320 assembly plant in Tianjin. Between the two, China will for the first time have two factories cranking out airliners. The benefits to the industry will be enormous. China will have created overnight a workforce of engineers, machinists, and all of the other specialties involved in aircraft assembly.

In short, by 2014, the groundwork will be in place for China to make the next jump, and the ARJ-21 team will have had five years learning what it takes to support an airliner in the field, sometimes even in the most challenging locations.

What is more, right about that time, Boeing and Airbus will be under pressure from their customers around the world to develop successors to their single-aisle jetliners in the 110-170 passenger range. Both have made it so far by updating and extending their 737 and A320 lines. Five years from now, that may not be enough.

At that point, the door will open for China to enter the fray with its own design, and they will have the benefit of being able to work with the world of suppliers and subcontractors – both in China and overseas – that Boeing and Airbus have helped create. And with Boeing and Airbus forced to contend with powerful unions determined to secure for their members a comfortable American or European middle-class lifestyle, China may well offer a nice cost advantage as well.

All things being equal, then, China may well be able to compete in the small airliner market by 2020.

A Lesson, not a Product

Again, though, this makes the ARJ-21 a stepping-stone, not the destination itself. As such, the success or failure of the ARJ-21 project cannot be measured solely on the basis of aircraft sold. Rather, it must be judged on its by-products, on the extent to which it prepares the nation’s aerospace industry to take the next, all-important step and become a global competitor.