MESSENGER - DISRUPTIVE INNOVATION

P3

CONTENTS INNOVATION IN FINANCE

P3 The World of Internet Finance: DISRUPTIVE INNOVATION P6 The Common Man’s Wealth Management Tool P8 GAME CHANGERS: China’s Privately Owned Banks

china's innovators P11

XIAOMI: Please don't call me Apple

P15

TENCENT: The Internet's Emperor Penguin

P20

ALIBABA: All Things to Everyone

P11

innovation required

P15

P25

Lost in Familiar Territory

P28

ELECTRIC CARS: A Not-so-Rosy Outlook

P29

Electric Vehicles in Beijing, An Infrastructure Dilemma

is the game up for luxury?

P33

Luxury in China: Time to Rethink

P35

Everything Must Go

P23 P23

There is No Chinese Facebook

P37

The Property Market Bust

2

P33

Editor’s Message – The Innovative Issue China is a hotbed of innovation, especially in the tech and e-commerce fields. But much of this innovation takes place in a vacuum of regulation, often having a disruptive effect on the current market in which the innovations are deployed. This disruption often benefits consumers, but entrenched institutions sometimes become nervous about unfamiliar players encroaching upon their territory. This issue of MESSENGER looks at some of the most disruptive examples of innovation throughout China, and the companies causing such positive disruption.

Editor-in-chief: Stuart Wiggin

3

China is arguably the world’s leader in a rapidly growing industry of Internet finance; though it would be fair to argue that the country’s progress and innovativeness in this area are the side-effects of an inefficient and unfair banking industry. Online wealth management products are giving normal people their first taste of investment while at the same time offering an incredible level of convenience that physical banks are just not able or willing to offer. But how disruptive is this rapidly evolving form of financial innovation?

By Stuart Wiggin The key to Internet finance has been mobile technology and the main players are the country’s biggest tech giants; Alibaba, Tencent and Baidu. Each company offers their own online wealth management products which can be accessed via mobile apps, and each company is employing slightly different strategies by playing to their existing strengths.

Prior to search engine giant Baidu’s launch of its own wealth management product in association with Huaxia Fund Management Company, Zhang Liyuan of Baidu’s public relations department stated that the decision to make such a move “(was) based on knowledge about our target group, together with the technology of big data and the level of innovation within the Internet industry.” Likewise, e-commerce giant Alibaba had its own target group and provided a product, known as Yu’E Bao, which allows consumers to invest their spare cash into money market funds via its Alipay online payment service.

Jiang Saichun, Chief Analyst at Desheng, a fund research center in Beijing, points out that while Alibaba relies on its huge e-commerce resources, Baidu does not have an e-commerce system, and serves more as a platform for connecting resources within the financial industry. Meanwhile, Tencent offers a product called Caifutong, which is closely related to its other 4

products, QQ instant messaging service and the WeChat mobile messaging app.

The importance of mobile technology with regards to the future of Internet finance was clear to see this past Spring Festival within China, as millions of Chinese people linked their debit cards to their WeChat accounts. At the time, people did so in order to pursue payment options and gift giving services via the mobile-only messaging app, but the collection of data stands Tencent in good stead when it comes to convincing people to use their wealth management product, as users will be one simple push of the button away from doing so.

Liu Baocheng, Director of the Centre for International Business Ethics at UIBE, points out that this kind of innovative idea can cause such a “disruptive surprise” within the industry as a whole that it will likely result with traditional banks having to innovate by themselves in order just to keep up. Liu goes on to add that the government is likely to be very supportive of such “disruptive innovation,” adding that, “Just a year ago, it was beyond imagination that the government could be so tolerant about such processes.” However, observers will have to wait and see what impact further regulation has upon Internet finance. As Liu explains, “Innovation normally takes place in the vacuum of legislation

and then legislation will catch up.

So both the financial operators and the financial users are anxious to see what can be turned out in the new (government) regulation.”

Prior to whatever regulation the government does decide to implement, Internet finance in its current state will have an undeniable effect on China’s traditional banks. At present, Internet finance highlights certain areas where traditional banks fall incredibly short, with the most obvious shortcoming being that banks fail to make small transactions convenient for their customers.

Alex White, Assistant Professor at Tsinghua University’s School of Economics and Management points out that banks do not compete on interest rates because they are regulated. As a result, “The banks have had relatively little pressure to provide a great product for consumers and consumers have been kind of stuck with the banks. And now, as these new innovative Internet finance options become available, consumers will start to demand better services because they have some place to go to pay for things other than just using their bank accounts.”

As for what changes traditional banks will implement in order to increase the convenience of small transactions is anyone’s guess, but they will no doubt attempt to tackle the issue of frustration among customers, brought about by long waiting times and increased transaction costs. However, it will be difficult for banks to appease a segment of customers that were previously of little value to them in the grand scheme of their overall business.

Due to a longer value chain, transaction costs within traditional banks can be high. In comparison, internet finance allows users to

INNOVATION IN FINANCE

carry out transactions much faster, cutting out a number of intermediaries. Furthermore, Internet finance products are also able to rely on cloud computing and massive data support which means that credit ratings could be carried out immediately without having to employ a third party to carry out assessment; as is the case with traditional banks.

It is also likely that Internet finance could alter the way that banks engage in lending, especially with regards to small and medium sized enterprises. Professor White of Tsinghua University highlights the activities of Renrendai, a company which has emerged online and grown rapidly within a relatively short period of time, which is challenging the position of banks within the money lending market. “(Renrendai) does peer-to-peer lending and has apparently facilitated over a billion dollars’ worth of loans largely going to startups and other types of organizations that would traditionally have trouble getting a loan from an ordinary bank. This seems like something that has tremendous potential. But at the same time, we don’t really know how the government is going to regulate this peer-to-peer lending, and that will probably have a big effect on how it turns out.”

As the tech firms behind these Internet products venture into the world of private banking (See page 8), the competition in the loans market is likely to intensify.

However, as Liu notes, whatever difficulties that traditional banks are set to face, it is the customers that will benefit in the long run, as “it is a reciprocal type of competition that can really shake up the awareness to this new window of opportunity for the traditional banks.”

Aside from all the talk about innovation and increasing competition, there is a tendency within Chinese media to neglect the issue of risk surrounding online wealth management products. Cao Can, assistant professor of Economics at Renmin University and founder and CEO of asset management company Shengya Capital, believes that the biggest risk is that “investors don’t know what they’re doing; they simply entrust the money to these tech firms.

These tech firms can actually blow the money on investments that are not collateralized by good assets.”

Cao also feels that the tech giants involved could reach too far when it comes to their foray into the world of finance. “Let’s not forget, companies like Baidu are in the tech industry; they’re not in the financial industry. These are separate industries. If these tech industries get too involved with investing money, they could lose their focus on their main job.

A lot of these tech firms invest their money in small and medium sized enterprises, which can pose higher risk than traditional investments.”

On top of the financial risk, there is also the issue of privacy, as millions of people log their personal details and financial data into mobile applications. Regulation will help provide a safety net for any consumers that fall victim to data theft in the future, but Professor White explains that regulation will not necessarily lead to a secure system. “For regulation to mandate that the companies provide consumer protection but that doesn't necessarily mean that the companies will adopt the most secure technologies.”

White points out that the companies involved in China’s burgeoning Internet finance industry have a very strong incentive to provide secure products because if they fail to do a good job they stand to lose a lot of money. However, one need only look at existing cases in the US and Europe to see that this isn’t always the result. In the case of popular US retailer TARGET, the credit card information of 40 million customers was stolen after their systems were hacked into.

And yet, the US provides very strong protections for the consumer against fraud. Conversely, in Europe, the protections are much less strong; and it is much harder and takes much longer for an individual to get credit card charges reversed if they did not make them in the first place.

However, the chip and pin system is widely used throughout Europe, making the system itself much more secure.

But despite the issues of financial risk and data loss, so long as there is so much liquidity in the system and so long as traditional banks continue to offer such low deposit rates, consumers will continue to look to online wealth management products as an easy and sufficient tool to protect their savings from inflation.

5

INNOVATION IN FINANCE

The Common Man’s Wealth Management Tool A survey earlier this year, carried out by the China Youth Daily newspaper, revealed that 66 percent of Chinese people are planning to divert some proportion of their bank deposits to Internet finance products in the future. The survey was conducted online and had more than 10,000 respondents. Alongside the high percentage of people planning to move funds into Internet finance products, the survey also revealed that 84 percent of all respondents have already invested in some kind of Internet wealth management product in the past.

82 percent of all respondents said they are content with their investment income and most listed higher return rates and greater convenience as the major reasons for choosing Internet finance. Almost two thirds of respondents were born in the 80s and 90s.

According to the survey results, this group seems more interested in taking "new" risks, with some stating that online investments not only save time, but also enable them to perform small-asset investments between 10 and 20 thousand yuan, which could never be realized in China's traditional banks.

Xu Xiao, a resident in Luoyang city, central China's Henan Province, began her latest hobby after spending 22-thousand yuan, or 3,600 US dollars, buying into Yu'E Bao, a popular online money-market fund. Each morning, the 28-year-old checks her Alipay account, China's equivalent of Paypal, through an app on her mobile phone to track the rate of return on her investment.

Despite the fact that the interest amounts are small, Xu is overjoyed every time she sees her new “investment earnings.”

"It's very convenient. I don't need to go to the bank to make investments. All I need to do is get on the internet through my mobile phone and away I go. The interest rate is much higher than that of the banks," explains Xu. The product in question, Yu'E Bao, is designed to make it easy for Internet users to invest idle cash from their Alipay accounts and earn a higher rate of interest compared to what a traditional bank savings accounts offers. Xu's attitude towards the product is typical of most Yu’E Bao investors, and it is the enthusiasm they hold towards the product that has made the concept such a success in China.

Yu'E Bao is an internet money-market fund co-developed by Tian Hong Asset Management Corporation 6

and Alipay, the online payment arm of e-commerce giant Alibaba (See page 20). At times, Yu'E Bao offers over 6 percent in annualized returns, while the big four Chinese commercial banks only offer around 3 percent yields for a oneyear-term deposit. The most attractive feature of the product though is that the investment threshold is only one yuan and investors can redeem their money at any time.

According to Tian Hong Asset Management Corporation, 51 percent of which is owned by Alibaba, Yu'E Bao became the largest money market fund in China within four months of its launch date last June. In just 260 days, the Internet money fund accumulated 350 billion yuan and gathered a colossal customer base of 81 million users, surpassing the number of China's share investors.

It’s no wonder then that other internet companies have rushed to follow suit and offer similar financial offerings. Baidu, China's biggest Internet search provider, is one such company that moved into financial services, launching an online finance product called Baifa in October, 2013. Baifa's rumored annual yield of 8 percent attracted so many prospective customers, Baidu reported that their financial service brought the company about 1 billion yuan within five hours of launch.

Online retail giant, JD.com, has also decided that Internet finance will be one of the main engines for driving the company's future growth. Just as the Internet has changed the landscape of retail business around the world, insiders believe it will reshape China's financial sector. Professor Qian Jun, of the Shanghai Advanced Institute of Finance at Jiaotong University, believes that the widespread use of internet finance will play a positive role for the finance industry in the future.

“I believe (Internet finance will

benefit) two sectors. One is the payment sector; basically, it facilitates transactions. You do things online much quicker, and we see there is already a big boom in this sector. The other sector which is more interesting is that of online lending, because they are increasingly behaving like banks; they collect money and they invest the funds.”

Though the issue of online lending suggests that the companies offering the services could actually become private banks competing within the market alongside state run banks (See page 8), the leap is not exactly a big one. “We know a lot of Chinese investors have the capital, but other than the stock market, which is not doing great, or the real estate market, which is clearly risky, they don't have a whole lot of opportunities (for investment). Furthermore, for many good small firms, they have a very hard time securing loans from banks.

This is where internet financing and other forms of alternative financing can play a big role," notes Qian However, as Qian points out, internet financing is still something of an unknown phenomenon and warns investors that they are essentially sailing in unchartered waters. “As we learned in the 2008 global financial crisis, the main danger within the financial sector is

With investment opportunities in China belonging mainly to the rich and superrich, the advent of online wealth management products accessible via mobile devices is allowing the man on the street to dabble in the world of finance.

systemic risk, so anything that is systemic, you need to be very, very careful.” At present, services such as Yu’E Bao and Baifa act as intermediaries on an individualbased system, where there is no problem in terms of information exchange.

But as Professor Qian adds, “If the intermediary firms bring in a lot of money from very different sources, and they lend to an equal number of firms and investors all over the place without knowing either the lenders nor the creditors well, then you get into this sort of shadow banking problem due to problems related to the complexity and lack of information. In this case, the government should, for sure, be very careful in terms of regulating both the size and the procedural side of Internet finance."

7

China’s Privately Owned Banks Chinese depositors and companies seeking loans will soon find themselves presented with a longer list of options thanks to the establishment of China's first batch of privately-owned banks.

China's banking watchdog has confirmed that five privately-owned banks, funded and operated by ten private companies are now effectively in the pipeline.

The move has been widely regarded as the latest follow-up to the plan announced by China's reformminded Premier Li Keqiang which seeks to allow greater private capital involvement in the nation's profitable banking sector.

Among the known investors, Chinese Internet giants Alibaba and Tencent, which have already been offering financial services in the form of Yu’E Bao and WeChat payment, are set to jump into the private banking sector. It is still not clear how these privately owned banks will affect China's banking business in the long run, but it is quite certain that competition will intensify and market forces will play a more significant role in the allocation of banking resources as technology looks to become central to their operation.

In an attempt to gain a clearer perspective on the reasons behind introducing such banks and what impact they will have on the market, MESSENGER presents the views of Winston Wang, Managing Director of international private investment firm Shipston Limited, and Rui Meng, professor of finance and accounting at the China Europe International Business School, providing both the academic opinion and an industryinsider opinion on China’s private banks.

Winston Wang, Managing Director of international private investment firm Shipston Limited points out that the introduction of private banks into China’s financial 8

system will be a “revolutionizing move in terms of creating more competitive financial markets” within the country; not least because private banks will provide a lifeline to China’s small and medium sized enterprises (SMEs) that currently struggle as a result of the existing system.

“We’ve seen a lot of challenges to the old model; the existing system. We have a lot of money supply, but actually most of the money is channeled to the large scale state-owned enterprises. A very significant part of the economy, the small and medium-sized companies don’t have adequate access to capital. The low efficiency of this system is very obvious to most people. So, introducing private capital into this segment is going to, or is at least supposed to create more access to those that need more capital, and create a more dynamic economy.”

Wang is keen to point out that the country has already liberalized its lending rate, and is expected to liberalize the deposit rate shortly, though some reports state that such a move won’t come for at least another 1-2 years. Nonetheless, once the deposit rate is liberalized, Wang notes that that will differentiate the products of the banks; playing a major role in the make-up of a system which involves both private and public banks.

However, Wang points out that the business model of private banks will be vastly different from their state-owned counterparts.

“Right now, it’s almost like an

INNOVATION IN FINANCE

oligopoly situation in the banking industry. There are very few banks in play. When you add more private banks into the picture, they will have to move down the value chain because the larger clients are already the clients of those large banks. In order to make profit, they will probably have to cater to smaller clients.”

Wang believes that the central point of the reforms is to create competition so the smaller businesses hopefully will have better access to capital. At present, Wang explains that China’s finance industry isn’t following the usual tenets of a market economy, i.e. that all players should be treated equally and that those institutions unable to compete should be phased out of the system, thus improving efficiency.

“We’re not able to do that (at the moment) because some of the banks are already too big to fail. This is the same case in western economies; but that’s not the ideal scenario. So what I believe the regulators are trying to do is start with the new entrants. Some other institutional reforms will be needed to accommodate the new reality, such as the deposit insurance schemes. The banks will have to ensure a certain amount of the deposits of the depositors, so in the case of any trouble people still have some kind of recourse to their problems. This kind of preparation, a pre-written will of what will happen if the banks run into trouble, will set people’s mind on market-friendly terms. At this moment, most people believe that whenever there is any problem then the state will come to the rescue.”

Even though the huge state-owned banks will remain “too big to fail” as private banks navigate the market in the initial stages, Wang is optimistic that there will be a ripple effect of sorts. “I think the government is trying to create a real competitive financial industry.

Going forward, when the competition becomes more and more full, I hope the playing field will become more level.”

The new private banks will be physically located in the country’s major cities, Beijing, Shanghai and Guangzhou. However, many commentators point towards the need for greater access to finance in rural areas of China. But locating private banks in rural areas poses a number of difficulties going forward. “You will find that in more developed regions the financial services are more professional. You have more talent and the institutions will operate in a more professional manner. In relatively poorer regions, the financial institutions tend to be less sensitive towards following the rules or to comply with best practices. So this is really a dilemma, if you start with the poorer regions and encourage more players in that area, they tend to be

a little bit less professional and more likely to run into problems.

It’s not an easy choice.”

As for the participation of web giants Alibaba and Tencent as investors, Wang thinks their involvement can only have positive results for the industry as a whole.

“They are internet companies; they tend to be more innovative and more forward looking. Their technology is quite disruptive to the current status quo. For a lot of the existing players, they may be viewed as trouble makers, but for the country as a whole and for the economy as a whole, I believe they’re bringing real dynamism, real competition.”

Furthermore, Wang sees their decision to jump into private banking as a logical step given their existing business model. “Operating their own financial arms to facilitate the existing transactions they’re doing to make it more convenient, more effective, cheaper for average consumers, it’s in the best interest of the existing customers of these internet companies. There is an inherent logic for them to extend into the financial segment.”

Rui Meng, professor of finance and accounting at the China Europe International Business School is certain that the government is acutely aware of the need to alter the state of the current financial system and distribute funds accordingly so as to spur growth.

“Obviously the current financial system does not function properly. So, introducing privately owned banks is one of the mechanisms to solve this problem in the financial system. The new government 9

intends to break the monopolies shared by the current state-owned banks. So, in order to boost economic growth, they need resources allocated by the financial system, especially for small and medium-sized businesses and enterprises located in rural areas.”

immediate success. Initially, Rui believes that Tencent and Alibaba will mainly target potential clients from e-commerce sectors, as this is the field they know best.

Furthermore, Rui believes that China’s financial markets can only be altered via external impetus purely because the state-owned banks have very little reason to reform when the current system serves them so well. As Rui explains, the monopoly position of China’s state-owned banks means “they can enjoy a very high interest spread - the interest difference between the lending rate and the deposit rate. But that really hurts the real sectors. Most of the time, money only flows in and out of the banking system, (it doesn’t) flow into the real business sectors. So, in order to break these monopolies, it’s difficult for the existing interest group to reform by themselves. They need external force; one such external force (will come) from the privately owned banks because they will be more efficient and more flexible.”

“But once they accumulate enough knowledge, they can expand their client base from ecommerce to SMEs. I think this is the objective behind this reform.

The regulatory bodies really want to encourage these new banks, the privately owned banks, to help the capital allocation to SMEs or to those people living in rural areas. These two internet giants have comparable advantage in their technologies and also client bases. But they lack financial industry experience or expertise.”

However, Rui warns against people assuming that private banks will offer more favorable interest rates than state-owned banks. “It’s difficult for privately owned banks to raise interest rates because the interest rate is, in theory, regulated by the People’s Bank of China.

In order to get licensed they have to be subject to the same rules or regulations. In my opinion, it will be difficult for them to raise interest rates significantly.” As a result, private banks are likely to gain most of their revenue from middle business, rather than the interest spread. Privately owned banks are likely to focus on efficiency and convenience, because “competing on the interest spread is not their comparative advantage.”

Assuming that the government wants to foster a competitive and fair market, it is understood that privately owned banks will not be treated differently from a regulatory perspective and will be regulated in much the same way but must have clear provisions for orderly dismantlement in case of bankruptcy. Upholding regulatory standards is critical to the success of the economy as Rui explains. “As long as they are banks, they have to be subject to the same set of regulations or rules. So just because you have different ownership, you cannot implement different kinds of regulation or monitoring mechanisms.”

With a view slightly different to that of Winston Wang, Professor Rui feels that the advantages offered by Tencent and Alibaba, when it comes to achieving increased capital allocation to SMEs or people living in rural areas, are sizeable but will not guarantee 10

Most importantly of all, Rui emphasizes the need for a comprehensive ownership structure, in reference to the fact that each privately owned bank will require at least two investors. “The capital adequacy ratio (the ratio of a bank’s capital to its risk) for the bank is very low. It’s around 10 percent. In other words, the leverage ratio for the banking industry is about 900 percent... One risk is that the owner of a privately owned bank benefits themselves; in other words, accepts the deposits and lends the money to themselves and uses the money to invest in high risk projects. In case of bankruptcy, because (the bank is) too big to fail or because of national security reasons, the government has to lend a hand.

There are serious moral hazard problems. In order to counter these moral hazard problems, we have to design the ownership structure carefully. You cannot let one company dominate ownership. One way is that you introduce at least two big players to form the ownership so that they can monitor each other. Balance can mitigate the problem of moral hazard.”

Constantly compared to the Silicon Valley giant Apple, China’s Xiaomi is making waves in the domestic tech market and is a household name when it comes to smartphones. The company is now attempting to tackle Apple’s dominance in the tablet market. But what ethos lies beneath one of China’s most innovative young companies, and what is the story behind it?

By Cui Chaoqun 11

CHINA'S INNOVATORS

At an event touting Xiaomi’s latest product release, a promotional video projected onto a big screen shows the company’s young staff from the logistics, repair service and customer support departments. Different from other tech companies, which allow their engineers and designers to talk about the products they produce, Xiaomi puts its focus on its people and its users. This is the secret of Xiaomi’s business success.

Established 4 years ago, Xiaomi, one of China’s most exciting techhardware producers, managed to catch the public’s attention with its innovative and affordable cellphones. Utilizing a creative android experience and delivering high performance, the Xiaomi phone quickly gained a huge number of fans. Xiaomi sold 18.7 million phones in 2013, more than double the amount of sales for the previous year.

In China, as social media has developed, the term “Fan Economy”, used to refer to the fact that the consumption ability of fans can be turned into cash, has become an important factor within the world of marketing. “Fan economy” is also a key term for Xiaomi’s approach to marketing. For instance, the company’s annual product release event, held on May 15 this year, was more than just a product presentation; it was a carnival for fans of the company.

Tickets to the product release event sold out in just 10 seconds online. As Xiaomi’s global vice president Hugo Barra has previously stated, Xiaomi carries out all its marketing via social media. Xiaomi’s forum has some 8 million users, who give the company feature suggestions, file bug reports and user feedback. Fans are involved in every aspect of the product, from research through to development, testing, marketing and even PR; and are considered the foundation of the company.

12

Natural comparisons are often made between Xiaomi, an innovative young company willing to push the boundaries, and Apple, a company which possesses exactly the same traits. Xiaomi’s founder Lei Jun spoke to Business Insider in an effort to address this comparison. "We're actually an Internet company,” said Lei, “We've already got a business in mobile phone hardware and we want to add to that an Internet platform. We can earn money from that once it's established."

Lei insists that Xiaomi and Apple are totally different companies.

According to Lei, Xiaomi is more akin to a combination of Apple, Google and Amazon; having once stated that Xiaomi selling mobile phones is similar to Amazon selling Kindles, though it is really more like Amazon with some elements of Google. Clearly, comparisons to the western tech giants are unavoidable, even from the higher-ups within the company.

The Xiaomi tablet and the Xiaomi TV were the highlights of this year’s product release. At present, Apple’s iPad is the dominant player in the Chinese tablet market, with a 36 percent market share in 2013.

According to Lei, Xiaomi is hoping “to put pressure on Apple.” This may be an ambitious statement from such a young company, but the price point for the 64GB Xiaomi tablet, at 1,699 yuan (272 US dollars), will certainly be attractive to many who are unable to afford Apple’s pricier products.

Clearly, the obvious attraction of Xiaomi’s products is the price, alongside their ease of use; and these are exactly what Xiaomi fans appreciate about the company’s products. Upon receiving a Xiaomi phone, first-time users will immediately gain a flavor of the company’s no-frills approach.

The phone, available for sale online only, arrives neatly packed in a plain cardboard box.

After opening the box, customers will see the slogan “Born for the Fever” printed on a piece of plastic film attached to the phone’s screen. The slogan unveils the mindset of those who produce Xiaomi products. The phone can be easily rooted, meaning that users can gain privileged control and optimize the phone’s performance or user interface. For most android phones, rooting a phone’s software is not officially endorsed and is a difficult process. Xiaomi, however, encourages users to root their products to unleash the full potential of the hardware.

As for Lei Jun, rather than wear jeans and a t-shirt, the founder of Xiaomi adopts a business-type appearance at the Xiaomi product release. It appears as if he is attempting to distance himself from the image of Steve Jobs or Tim Cook; as he himself has admitted, he is tired of the comparisons.

Unlike Jobs, Lei finished his studies at university. He is one of the co-founders of Kingsoft, one of the best known software companies in China, and is also an angel investor within the Chinese economy - the Ron Conway of China. He has invested in various projects including Joy.com (later acquired by Amazon), UC web browser, and Vancl. com (B2C web site).

As both a CEO and an investor, Lei managed to earn a reputation for himself within the tech industry.

This reputation meant that when he came up with the idea of making phones, he was able to attract top talent to what was actually just another startup. At the age of 40, Lei Jun started to build his team for Xiaomi. He invited a number of veterans from the industry, including Lin Bin, VP of Google China’s Engineering Research Institute; Zhou Guangping, Senior Director of Motorola Beijing R&D Center; and Li Wanqiang, GM of Kingsoft Dictionary.

COVER STORY

Above - Xiaomi's flagship store located at its headquarters in Beijing. Despite having physical stores, Xiaomi handsets can only be purchased online.

Below - The Xiaomi TV is part of Xiaomi's offerings alongside its popular range of smartphones

13

Despite such a heavyweight staff, the company encountered many difficulties in their initial stages, especially with regards to sourcing, as material suppliers were reluctant to sell products to another startup company. Li Wanqiang has since joked that if he had known there would have been so many difficulties in making phones, he would have quit straight away.

After weathering the early storms, Xiaomi has developed into a company with over 4,000 employees, generating revenue of 31.6 billion yuan last year. "Xiaomi's priority is not revenue, not profit, nor market share," Lei Jun has stated, "We focus on making the product that makes users scream." But Xiaomi has come under criticism for its marketing model -- offering a limited number of phones that quickly sell out, leading some critics to accuse the company of purposely selling only a small number of units in order to drive up hype and demand. After the online release of the RedMi, a Xiaomi cellphone designed for the low-end market, many users were greeted with 404 error pages at the start of the sale.

Within a few minutes, 300,000 RedMi models had sold out.

ply chain during an interview with CNET.com.

However, Xiaomi denies any socalled attempts at “hunger marketing” and instead places the blame on the production capacity of its manufacturers. "When we try to expand our production line and try to increase our orders of basic components from our suppliers, we're essentially relying on them to increase their production capacity and decide to shift their allocation to us," Hugo Barra explained whilst talking about Xiaomi’s sup-

Nonetheless, despite the fact that many have been left disappointed when attempting to purchase Xiaomi’s products, the company has still become a household name within China. “When the typhoons come, even a pig can fly in the sky,” said Lei Jun when commenting on the success of Xiaomi.

Essentially, Lei is a big believer of doing the right thing at the right time. The huge domestic demand for smartphones and the fast development of China’s e-commerce sector were the typhoons which allowed for Xiaomi’s success.

Xiaomi has disrupted the mobile phone market in China, putting pressure on Apple, Samsung and other manufacturers. The company has set ambitious goals to expand its market vertically and horizontally. Xiaomi’s other products range from smart TVs and tablets to wireless routers, television media players and other sideline products. The company has also begun selling phones in Singapore and plans to enter the Southeast Asian market. Even though the company was able to employ a successful marketing strategy in China, the global market will be the true touchstone for Xiaomi’s products.

Xiaomi’s International customer service department 14

TENCENT: THE INTERNET'S EMPEROR PENGUIN

Written by Fei Fei 15

If you want to make sense of IT or e-commerce in China, there is one player observers simply cannot overlook - Tencent.

Laying its foundations through its instant messaging (IM) service, Tencent’s business has penetrated into almost every sector related to the internet and technology, including online games, mobile applications, software development, websites, internet finance, blogs, and videos.

It even launched its own Androidbased application store MyApp (yingyong bao) at the beginning of 2014, advancing into yet another new area of business. Apart from developing its own products, Tencent is also buying stakes in a number of domestic and international companies. Its acquisition of the state-owned Navinfo was approved by authorities in May; and earlier in April, Tencent announced an agreement with Leju, an online real estate services provider, after buying a 15-percent stake in the company. However, Tencent’s expansion is still ongoing.

It would have been almost impossible to imagine that Tencent’s online IM software known as QQ, identified by its penguin logo, would have laid the foundations for one of the world’s biggest tech companies today. In 1998, a boom year for the IT industry in China, Ma Huateng along with a friend founded a small IT company in Shenzhen, south China’s Guangdong province. This was the humble beginnings of Tencent.

The next year, the company developed online chat software called OICQ (Open ICQ). Despite being an imitation of the world-famous ICQ messenger software, Tencent’s first offering soon proved 16

its popularity with over 200,000 users registering within 2 months of its launch in China. In the following several updates for OICQ, the small team behind the chat software added a number of functions including online chat rooms and file transferring.

By the end of 1999, more than 1.3 million people were using OICQ, accounting for more than 80 percent of the IM market in China. According to data released by the China Internet Network Information Center (CINIC), there were only 5.37 million internet users in the same period throughout China at that time.

However, Ma did not have much time to savor Tencent’s early success as their budget was no longer sufficient enough to cover the fast growing number of registrations and constant server updates. As a result, they decided to attempt to sell OICQ for 1 million yuan, but no one was willing to take a gamble on the software, especially in the context of the IT bubble having just burst in China.

provided by IDG has not been specified in reports, PCCW from Hong Kong and IDG together invested some 2.2 million U.S. dollars in Tencent in April 2000; a sum that eventually saved the burgeoning company. Ma Huateng later expressed his gratitude in an interview, mentioning that no one else was willing to take the IM software off their hands for just 1 million yuan. Ma also pointed out that business, as he sees it, is not about short-term income; it requires true vision in order to grasp future trends.

Desperate for funds, Ma sought investment from overseas. It is understood that Ma turned to one of his personal friends who then introduced him to a business partner called Yang Fei at the American company International Data Group (IDG). Yang was apparently impressed by the technology and design behind OICQ and eventually agreed to invest.

However, it’s safe to say that PCCW and IDG made a bold move by investing in Tencent, who actually had to change the name of its IM software from OICQ to QQ after receiving two letters respectively in 1999 and 2000, from a legal firm in the U.S. claiming that the name of Tencent’s IM software constituted product infringement, as many users mistakenly took OICQ to be part of ICQ.

Though the amount of funding

The incident, however, had no

CHINA'S INNOVATORS

number of people that use or have previously used QQ helped to build the very basis of Tencent’s booming business today, which is undeniably focused on mobile.

Back in 2000, Tencent decided to cooperate with China Mobile to launch an IM service on mobile devices. Though only gaining a quarter of the profits from the deal, The number of QQ users online is proudly presented Tencent achieved on the official website for the popular messaging over 10 million software. yuan in net profit by the end of 2001.

Ma had stumbled impact on users’ enthusiasm for upon a sustainable way of develthe little penguin. Internet users, opment for Tencent going into the especially young people, found future.

The company soon started QQ to be an irresistible product, to develop added-value services the likes of which they had never seen before. Some ten years ago, affiliated with QQ. Some of the services that Tencent offered are QQ gave high-school students, such as myself, the chance to gos- listed as follows: sip online without being overheard by teachers and parents, and form -QQ Show, a virtual personification system that allows users to groups with friends in order to stay updated with the latest news design their own online outfit.

Most virtual garments and acceson campus. A QQ registration sories are not free. You can pay number could almost have been with virtual money, known as QB, considered a fashion item. with each QB unit worth 1 yuan.

When those same high-school -Qzone, a blog website where usstudents left for college, QQ enabled users to video chat with their ers can decorate their space with flying stars, flowers and other friends and family. Faced with the colorful and shiny items. Likewise, possibility of making expensive most of these items are not free. long-distance phone calls, many The more you pay, the fancier your Chinese parents decided to regisblog, or QQ Zone, appears. ter their own QQ account num-QQ Memberships, providing bers, broadening the user base of exclusive functions and services China’s most popular messaging to paid QQ users. Membership software. As a result, QQ was no price deals rank from 10 yuan per longer exclusive to China’s youth.

After hitting 1 billion users in 2012, month to 600 yuan per year.

Tencent stopped publishing regWith bigger revenues, Tencent istration numbers. But the huge

started looking into software development. Internet browsers, video players, music players, computer security software and IM software specifically for companies, dictionaries and keyboard input methods were all on Tencent’s radar. But as Tencent looked to expand its offerings, a number of new IT companies were emerging, offering diverse fresh ideas and innovative solutions. The glut of companies meant that Tencent’s products had a difficult time standing out.

This difficulty of standing out was highlighted in Tencent’s attempt to produce its own internet browser.

Aside from the popular Internet Explorer, and today’s offerings from Firefox and Google Chrome, China also has a number of domestic developers, including 360, and Sogou. Initially launched in 2000, Tencent’s browser, Tencent Traveler, failed to make an impact in an already busy market.

Many users have since claimed that Tencent Traveler was a product that attempted to follow the trend while failing to target any specific group. However, the main reason it failed as a product was due to its poor performance when it came to operation system compatibility. Tencent increasingly started to look like a reactionary company. It seemed that whenever a new product became popular, Tencent would quickly respond, making something similar but ultimately inferior.

But Tencent continued “borrowing” ideas.

In 2011, the company launched the mobile messaging application WeChat. After several updates, the application incorporated similar functions available in other popular mobile messaging apps such as Whatsapp and Line; allowing users to send audio or text 17

messages, pictures, videos and emoticons to each other free of charge.

As WeChat allowed QQ users to link their accounts to the app, the number of users quickly jumped to 600 million by November 2013; making WeChat the largest messaging application in Asia. The impact it brought to e-commerce and social networking was also phenomenal.

WeChat has an in-app social networking platform called Moments where users can share photos and texts with their friends. However, the content remains private, is limited for viewing via the app and is only available to those on one’s contacts list. Sina Weibo, the Chinese equivalent of Twitter, has seen an abrupt decrease in its active user base after WeChat’s Moments function became popular among WeChat converts.

Traditional media panicked after seeing how fast information was able to spread on WeChat; realizing that they had to adapt in order to stay afloat. With companies and institutions able to open their own public WeChat accounts, staff members working at media companies around the country have had to include WeChat as part of their job load, as they look to write anecdotes or new items on a daily basis in order to reach the maximum number of people.

The challenge for users and companies looking to make use of WeChat is that the content being posted has to be mobile-friendly, unlike that of Weibo or Twitter where users only share links and photos. Short texts and multimedia demonstrations which 18

take very little time to view are effective forms of communication when using WeChat as a tool for spreading information; something that news organizations find difficult to adapt to.

In the world of e-commerce, WeChat has also ruffled a few feathers. E-commerce giant Alibaba has been deeply influenced by WeChat’s ascendance.

At the beginning of 2014, Tencent via WeChat, and Alibaba were involved in an intense war with regards to taxi booking applications. Each company was offering bigger discounts (around one U.S. dollar per fare) to those users who booked taxis using their respective app.

Likewise, WeChat and Taobao, part of the Alibaba group, also started to trial mobile financing

by providing financial services on their mobile applications; battling for a bigger share of the market by providing greater returns to investors. Despite the frenzied competition in areas outside of the IT industry, Tencent is constantly looking to develop the next new thing as the individuals in charge of the company are acutely aware that users quickly move on to the next trend.

Media companies still struggle to make use of WeChat and when faced with emergencies such as the recent case of this missing Malaysian flight MH370, social networks such as Weibo and more traditional television broadcasts were still the sources that most people turned to for information. For this reason, it is uncertain as to whether WeChat can be truly seen as a social networking platform in the sense that Weibo is.

Nonetheless, Ma Huateng has built a Tencent empire within China by monetizing two groups of application users; its QQ user base and its growing mobile WeChat users.

But Tencent’s realm does not extend beyond the borders of China at present.

Neither QQ nor WeChat have been able to make waves in the international market or among non-Chinese groups.

That may be because there are already local alternatives for foreign users and Tencent’s products do not have anything new to offer, but it also has something to do with the fact that Tencent is just too good when it comes to localizing its products in China.

Ultimately, the company has made it harder for itself to effectively sell its own products to foreign cultures.

19

20

By Duan Lei In China, if you don't know where to buy some specific goods, such as "poetry for the soul" or even a boyfriend/girlfriend for rent, you can always search for it on taobao.com, the country's leading customer-to-customer website.

Taobao, together with Tmall, a business-to-consumer (B2C) site, was formed by the e-commerce giant, Alibaba group.

Already bigger than a combination of eBay and Amazon put together, Alibaba is growing much faster in recent years, especially since it single-handedly created a new festival within the country; Singles Day, celebrated annually on November 11th. The event has proven to be so popular among China’s tech savvy youth that last year, the firm’s sales exceeded 5.7 billion US dollars on Singles' Day.

Will Alibaba become China's most valuable internet company?

Alibaba finally unveiled its prospectus for a listing on the New York Stock Exchange on May 6th, 2014, amid doubts over timing, as the value of tech stocks listed in America has fallen by around 150 billion US dollars since peaking in early March.

In the filing, Alibaba revealed that it values itself at roughly 110 billion US dollars while analysts

predicted that the highest valuation would probably reach 250 billion US dollars. Despite the current tech stock rout in the US, it's expected that the Alibaba IPO would be the largest IPO since Facebook. The market value of Facebook now stands at around 150 billion US dollars.

Alibaba has always been a strong competitor in the Chinese internet market. The total trade volume of Taobao and Tmall reached 250 billion US dollars last year, accounting for 80 percent of China's e-commerce market. But, with the rapid development of mobile internet technology, the company is now facing a threat from its long-term rival Tencent (See page 15), which launched WeChat, a popular mobile social messaging application which now has over 300 million users worldwide. The lack of strong mobile products is

a headache for Alibaba. Last year, the company invested around 83 billion US dollars into new tech companies, such as e-commerce search engine Taotaosou and taxi-hailing application Kuaidi Dache (Call a Cab Fast). The new products certainly led to more innovation underneath the Alibaba umbrella but their offerings seem to be far from enough to allow Alibaba to compete with Tencent on the mobile front. On March 10, 2014, Tencent announced that it would be joining up with JD, China's second largest e-commerce website. Under the terms of the cooperation, Tencent bought a 15 percent stake in JD.com at a cost of 214.6 million US dollars, making it one of the largest shareholders of the company. At the

Jack Ma, the charismatic head behind Alibaba, is known for being a businessman and a philanthropist; a rare combination in the world of Chinese business.

21

CHINA'S INNOVATORS

same time, nearly all of Tencent’s online commerce business would be taken over by JD. The partnership is clearly designed to break the domination of Alibaba in the e-commerce market. But what makes this story even more interesting is that JD recently completed its listing on the NASDAQ on May 22. The market value of JD is around 28.6 billion US dollars, while Tencent's market value has exceeded 100 billion US dollars, nearing that of Facebook.

According to foreign media reports, Alibaba will launch its IPO in the US this August. Only then will it be possible to know which company can claim the title of most valuable in China.

Alibaba's secret weapons Jack Ma, founder of Alibaba, has long advocated that the company devotes itself to building and nurturing a healthy eco-system, in which small retailers and large companies can all find their own place to grow. Within the huge empire of Alibaba, there are a number of important weapons that help it maintain its competitiveness.

Alipay Alipay is a Paypal-like online payment service which has become the world's most popular online payment tool. Statistics show that the payment transactions of Alipay reached 519 billion US dollars in 2013, twice the total trade volume of Alibaba. Only 37.6 percent of the transactions came from Alibaba, meaning that Alipay has become a very popular payment service even among many other Chinese e-commerce companies.

However, Alipay is currently not part of the group being floated in New York; it is held by a sister financial firm controlled by Jack 22

Ma and a handful of associates, having been spun out of Alibaba in 2010.

Besides offering a payment service, Alipay has also tested the waters of internet finance (See page 6). Alipay’s online investment product Yu’E Bao, which allows users to invest money left over within their Alipay account, was launched last June. As of January 15, 2014, Yu’E Bao had received over 250 billion yuan (about 41 billion US dollars) worth of investment from over 49 million small-scale investors, according to Tian Hong Asset Management Co.; the operator of the investment product. However, the service also triggered conflict between Alipay and China's banking system, which led Alibaba to state in its IPO filing that it was worried about the possibility of Chinese officials interfering with Alipay due to its expanding influence and reach in the world of internet finance.

Aliyun/AliCloud In recent years, the higher-ups within Alibaba have been trying to change the definition of the company from that of an e-commerce giant to one based around technology. Aliyun, or AliCloud is one such important and successful move in the attempt to achieve such a redefinition. AliCloud is a cloud computing and data sharing platform, which provides Alibaba with a convenient method by which to control millions of pieces of data for its registered users.

With this information, business owners can preciously predict the consumer's purchase behavior and make smarter decisions based on it. For example, statistics from Tmall show that 1.5 billion packages were delivered during last year's Single's day festival, 60 million of which were handled by express couriers on

the day of November 11th, and the express delivery time was cut by half compared to the same period last year. In 2013, 75 percent of all Alibaba's transactions during the festival were dealt with by AliCloud.

Aside from providing support to its online business, AliCloud also provides Aliyun TV and mobile phone products as well as cloud computing and data management services to other companies. Statistics reveal that last year, Alibaba earned over 121 million US dollars through its AliCloud services.

Not content with being the e-commerce king domestically, Alibaba has also tried to expand its foreign market. In 2013, the company earned nearly 767 million US dollars outside of China. At the beginning of 2014, it announced that it would be investing 15 million US dollars in US online luxury marketplace 1stdibs. Reports claim that Alibaba will focus on developing a mobile application product for the website.

Ultimately, the path ahead for Alibaba will not be easy since buying its shares is like betting on a continued surge in what is already the world's largest e-commerce market. No matter how people look at it, Alibaba's IPO is the most anticipated financial event of the year. The company is holding a very cautious attitude and is not appearing overly confident for fear that it might not meet its lofty expectations.

News that Alibaba is opening a US store – 11Main.com – is exciting and a clear example that they want to expand their operations overseas; but it will also be a litmus test as to whether their approach to e-commerce can prosper in a market like the US, where overheads and logistics are far more costly.

A Brief Journey through the Chinese Internet

By John Artman For those of us from Englishspeaking nations (especially the US), we automatically assume that since we created the Internet, it must have been replicated in our own image across the world.

Silicon Valley, out of marketing necessity, has done nothing to disabuse us of this hubris.

“If technology is worth anything,” they say, “it is only because it will change the world for the better.”

Indeed, it is impossible to deny that megabit connections, mobile devices, and information at our fingertips have all made the world smaller and translated dying communal arrangements into thriving online groups where physical boundaries play no role. But if Silicon Valley was honest with itself, and with us, they would readily admit that technology, in its most basic form, is a business proposition.

While physical boundaries no longer restrict communication; language and culture continue to heavily inform, constrain, and influence our behavior, whether online or off. As a business proposition then, why do we continue to assume that different markets, informed by different histories, languages, and cultures, would even remotely resemble one another?

I am continually amazed by a USbased tech blogosphere that can, in the same article, say that Sina’s Weibo microblogging service is “China’s Twitter” and then go on

to document their myriad differences. Differences that, by their very nature, only go to prove that Weibo is almost nothing like Twitter.

and WhatsApp can do. It’s never safe to make a simple comparison between a Chinese web service and something from the West,” say Mr. Millward.

There is No Chinese Twitter

Mobile for the Masses

According to Steven Millward, editor at Tech in Asia, a technology blog focused on Chinese and other Asian markets, “[These] analogies are only true for the moment they launch. After that, China’s web services tend to expand so quickly that the comparison becomes invalid and the situation evolves to be very complex.”

Of course, that doesn’t apply to just Sina’s Weibo, but also to almost any other online business that may come to mind, in particular, Tencent’s WeChat. Originally, a mobile chat social networking application similar to WhatsApp, it has now expanded into many other areas. However, it is perhaps most remarkable for being the first social network available only for the mobile device.

When Sina Weibo launched, it quite closely resembled Twitter.

As a platform, it was basic and was built upon an existing desire to post small updates to a public audience. While it may now be the most successful microblogging platform, it was certainly not the first; nor was Sina the only large Internet company looking to expand its offerings. In order to fend off not only competing offerings, but also competing types of social products, Sina Weibo has expanded its services to an extent where many China-based commentators will readily say that it is, actually, superior in many regards to Twitter.

“Sina Weibo grew rapidly to include photo albums, cloud storage, social gaming, group messaging, and a great deal more, so that it was eventually doing most of what Twitter, Facebook,

While many companies struggle to engage users on their mobile phone, social networks and ecommerce platforms included, WeChat managed to capture the attention and wallets of 272 million active users as of November 2013. In January of this year, WeChat managed to do what e-commerce giant Alibaba had failed: get access to over 5 million users’ bank account details. Both Alibaba and Tencent have mobile payment applications. Both used the Chinese tradition of giving New Year’s money (hongbao), but with WeChat’s user base and some inventive gamification, Tencent gave users massive incentive to link their bank account details to the social networks payment system, thus proving the viability of m-commerce, or online-tooffline (O2O), in China.

23

Banking for the Win Winning the New Year’s battle, however, is by no means akin to winning the war over online payments and mobile finance. In June 2013, Alibaba, parent company of Taobao, China’s largest e-commerce platform, launched China’s first mobile finance product. Yu’E Bao. Over the course of 18 days, Yu’E Bao attracted 2.5 million users who collectively deposited RMB 6.601 billion (1.07 billion USD) with no marketing. Now linked with their payment platform Alipay, users of Yu’E Bao can see in almost-realtime how much interest (higher than traditional banks) they have accrued in the money-market fund and then use money in that account to pay for products and services whenever they like.

It’s not just the potential returns that attracted so many users to Yu’E Bao and similar products, but as Frank Yu, founder of marketing and gamification platform Kwestr, and curator of the Beijing Startup Digest, illustrates, “Go into a brick and mortar bank ICBC on a Saturday afternoon, get a number and wait in line [which can take up to an hour or more] to do a simple transaction. You will become a believer in online banking after that.”

With almost 550 billion yuan (88 billion USD) in funds as of the first quarter of 2014, and with other players such as Baidu, China’s largest search engine, and Tencent getting involved, regulation is soon coming. According to Jeremy Goldkorn, director of Danwei.com a research service focused on Chinese media and Internet, “Mobile and Internet banking, finance and investment services are going to be the predominate way retail bank customers and investors interact with their banks and investment schemes, no doubt about it. The main question for me right now is how much the state will regulate new Internet-first players in finance 24

and banking such as Tencent, Baidu and Alibaba.”

While regulatory agencies have taken a wait-and-see approach, the People’s Bank of China was not hesitant in March when they effectively stymied Alibaba’s and Tencent’s expansion of their mobile finance and payment into virtual credit cards with an outright ban on mobile payments using barcodes and QR codes. Whether the decision came over security concerns or whether it was a move to protect state-owned UnionPay’s monopoly on credit cards, the temporary ban did show that the government is not afraid of stepping in when needed.

“China’s central bank is worried about too much money being channeled through things like Alipay and WeChat Payments. Recent curbs on purchase levels per transaction and per year threaten this aspect of e-commerce in China,” says Mr. Millward. “That could hobble such services in the future, leaving them focused on smaller transactions in places like coffee shops and supermarkets.”

Hailing the Future When you need a taxi fast, mobile technology now provides stranded individuals with a foolproof solution. The US has Uber and Lyft.

China has the Tencent-backed app Didi Dache (Beep Beep, Get a

Cab), and the Alibaba-backed app Kuaidi Dache (Call a Cab Fast). The front in the battle for Chinese users’ hearts and wallets ended only in May when both companies ended driver and passenger subsidies that could have totaled 15 yuan per ride (fares in Beijing start at 13 yuan and increases by 2.3 yuan per kilometer after the first two.)

What began in 2012 as virgin market with a myriad of companies promising convenience and ease in a cab-calling environment characterized by over-worked drivers and cutthroat hailers has been increasingly dominated by two companies backed by Tencent and Alibaba.

Combined, Didi and Kuaidi account for almost 97 percent of the O2O (Online to Offline) cab hailing market.

The victory for both companies, however, had little to do with the amazing increase in users of these taxi-calling apps, but more to do with the increase in users and usage of mobile wallets to pay for real things. Both Alibaba and Tencent are locked in a battle, not only between themselves but also with traditional providers, to determine the future of how people will pay for real world goods and services.

According to Leesa Shrader, of the Consultative Group to Assist the Poor, a global partnership of organizations that seek to advance financial inclusion, “Both Alipay

INNOVATION REQUIRED

and WeChat are working to make financial services become lifestyle services, finding ways to be part of the user's financial routine, like paying for a friend’s dinner, ordering taxis, paying in convenience stores and topping up transportation cards.”

America’s WeChat Clearly, the Chinese Internet is a vibrant, competitive, and even cutthroat environment. The most amazing feature, however, is how often outside observers assume that the online world must mirror the state-owned enterprise-dominated real world. Indeed, Duncan Clark, chairman of BDA, an investment consultancy specializing in Chinese and other Asian markets, says that the biggest misconception of the Chinese Internet is “that the Internet is not competitive here, run by companies anointed by the State. The reality is it's a highly competitive market with a surfeit of entrepreneurial talent engaged in a 'white heat' of competition. Of course the players that emerge on top have to find a way to coexist with governmentled companies or policies to survive.”

Every person interviewed for this article echoed these sentiments.

What quickly emerges from their comments is that, while alien on the surface, the Chinese Internet can be understood easily as long as we take it for what it is. From the first connection to the Internet in 1994, the Chinese Internet has taken the learned wisdom of Silicon Valley and turned it on its head. It is time we start giving the entrepreneurs credit for navigating what Mr. Yu calls “a wild and wooly frontier.”

Sooner or later, we’ll no longer talk in terms of “China’s clone of a US tech success,” but rather the other way around.

Lost in Familiar Territory

By Stuart Wiggin

China’s domestic auto makers are struggling to find their niche even though vehicle sales are still on the rise.

Car ownership in China is constantly rising and as more people become wealthier in the country’s so-called second and third tier cities, sales figures will continue to increase and China will continue to consolidate its status as the world’s biggest auto market. And while electric vehicles present Chinese auto makers with a clear opportunity to lead the way, globally speaking, the high pricing and low demand alongside the state of the country’s charging infrastructure at present consign these vehicles to little more than a footnote in the ongoing conversation about today’s auto market in China (See page 28). Instead, any discussion about the Chinese auto market tends to focus solely upon traditional gasoline powered cars, which in China are doing a roaring trade.

Last year, according to figures released by the China Association of Automobile Manufacturers (CAAM), sales surged by 13.9 percent to 21.98 million vehicles; of which 17.93 million units were passenger vehicles. And yet, despite these breathtaking figures, there are concerns that the situation is far from rosy for domestic manufacturers.

Last year’s sales performance, smashing the 20 million mark for the first time, has given rise to the idea that this year will also prove fruitful for both domestic and international car makers. And while the number of units being sold is up on last year’s corresponding figures, we are unlikely to see a repeat performance close to 14 percent growth in annual sales. In the first quarter of 2014, 6 million

units were sold overall, 5 million of which were passenger vehicles, representing a 10 percent growth in sales. Estimates that this year will see around 24 million units sold is certainly good news for the industry but not everyone is benefitting from the growth.

Thomas E. Callarman, Professor of Operations Management and Director of the China European Business School Centre for Auto Research, points to the worrying trend of overcapacity among China’s domestic manufacturers as a sign that the auto market is not paying off for everyone. “If you look at the American and European auto industries, one of the things that caused the downfall is the overcapacity and the extra costs that the companies incurred because of that. In China, you have serious overcapacity particularly among the domestic manufacturers where the utilization rate of the capacity is just slightly over 50 percent. So, it’s basically wasted cost to have that much capacity.”

According to Xing Lei, Chief Editor of China Auto Review, China has about 35 to 40 million units in capacity. If this year’s estimates of 24 million come to pass, then China will have sold roughly two thirds of its overall capacity by the end of the year. Xing notes that the industry requires a capacity utilization rate of 75 percent in order to be profitable; something that the country falls well short of.

And yet, as Xing says, “If you look at specific companies, the foreign giants, GM, Ford, and Volkswagen; they don’t have enough capacity.

They’re still adding plants.” The issue, therefore, looks doubly worrying for domestic brands which appear to be losing ground rapidly to foreign automakers.

25

Domestic brands face a number of hurdles when it comes to keeping up with their foreign counterparts.

Economies of scale are obvious reasons to cite when explaining why foreign brands operate at an advantage within China, but local brands are now facing a new problem. Traditionally, domestic manufacturers operate at the lower end of the market and their attempts to upscale have not produced the desired results. But as China becomes richer, and more and more people aspire to owning their first ever car, foreign automakers are making a concerted effort to try to enter the lower end of the market, which will squeeze domestic manufacturers even more.

Ultimately, the underlining factor is that Chinese car brands are failing to convince consumers that they are selling trustworthy products.

That’s not to say that domestically produced cars are inferior to foreign models, as Xing Lei is keen to point out, “If we take out the logo and put another badge, a foreign brand badge (onto a domestically made car), it would be the same.

I think (domestic manufacturers) have done really well but still it’s an issue of branding.” But perceptions are everything when it comes to selling units, and as Callarman states, though Chinese manufacturers have essentially learnt how to produce cars from western manufacturers, this isn’t enough to overcome issues of trust when it comes to the brands themselves.

It is something of a mystery as to why Chinese manufacturers still lag behind their foreign counterparts in terms of design and technology, especially when you take into account that foreign manufacturers are only able to operate in the Chinese auto industry as part of a Joint Venture alongside domestic companies. Furthermore, one might expect that domestic manufacturers would have a better grasp on what the Chinese market actually wants. These facts are not 26

lost on Oded Shenkar, Ford Motor Company Chair in Global Business Management and Professor of Management and Human Resources at Ohio State University, who believes that domestic manufacturers have not taken advantage of the opportunities afforded to them and as a result will require state assistance in order to make up the gap between themselves as foreign brands.

“China is literally the only place in the world where it is possible for local manufacturers to actually team up with not only one but multiple foreign makers, which creates tremendous learning opportunities.

And yet, I would say the learning has been somewhat limited. Keep in mind that the local producers did know the market better, but the foreign makers have been (in China) now for many years; a quarter of a century,” explains Shenkar.

“They’ve had enough opportunity to learn about the Chinese market; so (being local) is not as much an advantage (for domestic manufacturers) as it used to be. And certainly it is a surprise for the government that the local makers are not even holding their own, and I do expect the government to take certain measures to help turn this situation around.”

Elsewhere, domestic brands are now looking at acquiring foreign companies as a way to improve their position within the home market and improve their offerings to Chinese consumers. The most high profile merger involving a Chinese automaker was that of Geely acquiring Volvo in 2010, a move that Callarman applauds thanks to Volvo’s history of producing high quality, safe cars. Whether the acquisition is successful or not in the long term, according to Xing Lei of China Auto Review, depends on the level of integration and whether Geely can actually get anything out of the process.

This is a sentiment echoed by

Steven White, Associate Professor at the School of Economics and Management, Tsinghua University, who points out that it’s much easier to buy tangible assets via mergers and acquisitions than it is buying innovation. “You’re buying capabilities that depend on people – the integration stage is the problem; bringing them together, bringing people together as part of the learning process.” White cites the “fantastic disaster” of the Shanghai Automotive Company’s acquisition of SsangYong in Korea as an example of how fraught buying innovation can be. “A 500 million dollar investment ended up being a billion dollar write-off. The fundamental problem was that they were not able to learn anything.”

Geely’s move was daring, not only because of the pitfalls that exist when purchasing knowledge, but also because of the fact that Volvo was losing money at the time. The hands-off approach that followed meant that Volvo’s European operations ticked over thanks to the financial help of Geely. But Geely’s main goal is arguably improving its competitiveness within China; the auto maker’s most important market.

Already, there appears to be signs of friction between the two sides over debate regarding the model of branding and image reflected in new car development for China.

After initially taking a hands-off approach, as noted above, Geely’s founder and Chairman Li Shufu has discussed a possible strategic move that is exposing cracks within the operation. According to Steven White of Tsinghua University, Li Shufu is pushing for a Volvo brand that can compete with the likes of Mercedes, Audi and BMW. However, people at Volvo have hit back saying they have developed a niche for quality and safety, not luxury, and that, “They don’t believe they have the ability to com-

pete in the luxury brand segment.”

Even though this is an ongoing discussion at the moment, it still highlights the fact that the process of making strategic choices with a foreign acquisition is anything but smooth, especially when both sides are approaching the market with different goals.

But despite any possible disagreements over direction and brand image, Jeffrey Towson, Professor of Investment at Peking University and author of ‘The One Hour China Book’ feels that the marriage between Geely and Volvo will ultimately be beneficial to both parties due to the need each one has for the other. “Geely has to win in China; they can’t be a Chinese manufacturer that doesn’t have significant market share in China.

You look at all the domestic manufacturers of auto in China, they’re all losing market share in the last two years to foreign auto makers who are coming on very strong.

So, they absolutely need Volvo to win here.”

And as Towson continues, Volvo requires Geely to a similar degree.

“Volvo is losing sales on almost all of its cars. They’ve got one or two brands that are going (well).

Europe is not going well for them.

In the US they’re having problems.

China is an opportunity, so they need China.”

Ultimately, China’s car brands are weak; not only in foreign markets but also within China. Trying to upscale is proving difficult and acquisitions are not guaranteed to help as there is always a question of how much learning and transfer will take place. Nonetheless, consumers will continue to buy new vehicles and if foreign brands can crack the lower end of the market, domestic auto makers will feel even more lost despite the fact that they are surrounded by familiar territory.

27

By Stuart Wiggin China's endeavor to hit its ambitious energy-saving and emission reduction targets requires efforts to be made across all industrial sectors, not least the auto industry.

Enshrined in the country’s 12th "Five Year Plan", the development of new energy cars has raised hopes that indigenous new models, powered purely by electricity or hybrid engines, will make China's roads less polluted, while allowing consumers to save more at the pump.

A number of China's indigenous new energy cars debuted at the 2014 Beijing International Auto Show, including the Roewe 550 Plug-in by Shanghai's SAIC, and the E6 by BYD. But new energy cars in China still face a bumpy road ahead despite a series of preferential policies being put in place by the government. Inadequate battery capacity is still a huge obstacle when it comes to electric cars making long distance journeys in China. Likewise, there is still a lack of charging stations in the country's big cities, let alone medium and small-sized cities.

In terms of overall market prospects for new energy cars in China, the total sales volume so far is still very small; standing at less than 18,000 units including fully electric (EV) and plug-in hybrid vehicles.

The market for such cars is likewise very small, especially when you factor in the surprisingly high cost of the car despite the addition of price subsidies. Another major problem is the fact that China needs to build a charging infrastructure in order for these cars to be viable. This is not the case in many western countries. In the US, 28

for example, many consumers own or rent independent houses which have access to a garage. Therefore, the US and other countries in Europe do not have an infrastructure issue because people can charge their cars in their own homes. It is this reason that helps to explain why hybrid cars enjoy strong momentum in the US, as they do not require a strong charging infrastructure.

Yale Zhang, managing director of Auto Foresight (Shanghai) Co. Ltd, a market and industry research firm points out that in China, full hybrid vehicles do not qualify for government subsidy, meaning that the EV and plug-in EV cars that do qualify require a very strong infrastructure in order to be of use.

Furthermore, Yale also highlights a further problem for the growth of the electric auto industry in China, namely that people want their vehicles to be able to travel long distances. “The majority of Chinese consumers are still first car buyers, buying the first car ever in their family. They still need to have a traditional petrol engine car so that they can drive long range.

If their first car is an EV, they limit their driving range to 100-400 km and that is something the average consumer cannot accept.”

Technology bottlenecks are the number one issue when it comes to selling electric cars. The lack of a breakthrough with regards to battery technology has really prevented EV and plug-in EV cars from really making a considerable dent in the auto market. Even when using one of the larger batteries, such as the BYD 6 battery, which weighs 2.3 tons, there are still a lot

of limitations. For example, using the air conditioning cuts a car’s driving range by a third while using the heating cuts the range by up to a half. In China, where the summer and winter seasons are often very extreme in terms of temperatures, these problems become even more defined. As a result, electric cars in China are little more than an interesting footnote within an industry that highly relies on the sale of petrol-powered vehicles.

While many people talk about an insufficient charging infrastructure, the truth is that Infrastructure is not that big an issue. Installing such infrastructure does not require a huge amount of investment and Yale Zhang notes that a lot of companies and venture capitalists are willing to enter this area and invest. Many industry insiders believe that if the government truly devotes itself to the infrastructure issue, it could be overcome with ease. However, as long as the cars themselves are not meeting the expectations of consumers, in

INNOVATION REQUIRED

terms of efficiency and use, then no amount of charging stations will help to convince people to part with their cash for an electric vehicle instead of a petrol one.

Oded Shenkar, Ford Motor Company Chair in Global Business Management and Professor of Management and Human Resources at Ohio State University, believes that the government would be keen to see growth in the electric car market for two reasons. Firstly, it would help to address the pollution problem within major cities, and secondly, according to Shenkar, “there is the belief that if this is going to be the technology of the future, maybe here lies the opportunity for Chinese car makers to become significant players.”

But are EV models really so green that they could help to address the country’s pollution problems? Certainly, within major cities like Beijing, the use of electric vehicles would help to reduce smog considerably. However, 80 percent of China’s electricity is produced using coal, meaning that a shift from gasoline fuel to electric vehicles will not reduce the amount of carbon emissions at all. Yale Zhang even suggests that such a shift would lead to a slight increase for carbon emissions within China.

Ultimately, electric vehicles shift pollution from the city to the suburbs; to wherever the coal burning plants are situated. And while that may be preferable for those living in the cities, it doesn’t really address the country’s worsening pollution problem.

Electric Vehicles in Beijing: An Infrastructure Dilemma

By Zhang Peng

Over the past few years, Beijing's city government has tried to promote the widespread use of alternative-energy vehicles, or what they call "green" cars, through a variety of favorable policies. However, in a recent green-car lottery, only 1,428 bids were submitted by individuals wanting to drive one of these more environmentally sound vehicles; falling short of the 1,666-car quota set by the city. Clearly, alternative-energy vehicles are yet to catch on in China’s major cities.

Besides the lofty price-tag for electric cars, one of the oft-mentioned obstacles to their widespread usage is a shortage of charging stations even in the major cities. China’s capital, Beijing has so far built 65 electric vehicle charging stations, with a total of 1,274 charging posts. These facilities are able to provide charging services for around 3,500 green cars at the same time.

However, the pace of development for these charging stations is moving at a snail's pace.

Furthermore, the majority of existing charging stations in Beijing are only available for public transport vehicles, including electric sanitation trucks, electric buses and electric taxicabs.

Charging stations for privately owned green cars are difficult, if not impossible, to locate.

To compound this situation, almost all the existing charging stations in Beijing are distributed under various bridges; making them even harder to find. But the most telling sign of how well electric vehicles are doing in China is the fact that a number of Beijing’s existing charging stations are not being used properly, with some even lying idle.

BYD unveiled several of its latest electric vehicles at the Beijing Auto Show earlier this year.

Located at the bottom of Lianfang Bridge in the Shijingshan District of Beijing, the Lianfang Charging Station is mainly used for charging electric sanitation vehicles. However, upon my visiting the station, it was clear that the entrance was firmly shut and none of the charging posts were being used. Dozens of sanitation trucks parked at the station were covered with a thick layer of dust in an appar29

ent sign that the vehicles have not been used for days, if not weeks.

Completed in June 2012, the Lianfang Charging station is designed to provide charging services for 2-ton sanitation vehicles. With 10 charging posts installed, the station is able to charge as many as 20 sanitation vehicles simultaneously.

A similar situation is also apparent at the charging station under Huixinxi Bridge in Beijing's Chaoyang district. Once again, when this reporter visited the station, there

also the case that not all existing charging stations are being utilized to full effect.

The same cannot be said for those stations intended for electric buses. The Qijiahuozi EV Charging Station, located in Chaoyang district, mainly provides charging services for electric city buses. The 10 charging posts at the station are able to provide charging services to 20 electric buses at the same time and it only takes three hours for a bus to be fully charged. The sta-

Vehicles lie idle at the Lianfang charging station in Beijing.

were almost no staff members working and only one security guard looking over the facilities.

The security guard on duty stated that the station has been up and running for several years, but the facilities are not frequently utilized.

Few sanitation vehicles occasionally visit the Huixinxi charging station for charging purposes.

However, according to the security guard, the charging station is still not open to privately owned green cars. While many state that the current charging infrastructure in place within the capital is not sufficient enough to meet the needs of electric car owners, it is clearly 30

tion also doubles as a parking lot for the electric buses. As a result, most of the charging posts at Qijiahuozi are frequently in use.

However, staff at Qijiahuozi EV Charging Station and Beitucheng EV charging station, which also serves electrical buses in Beijing’s Chaoyang District, revealed that the frequent use of the facilities is mainly a result of shortcomings with the batteries used in the buses. After being charged several times, a buses’ battery life tends to become shorter and shorter.

Electric taxicabs, which are in use

in Beijing’s Yanqing County, experience a similar problem. Drivers of the electric taxis revealed that their taxicabs can only run for a maximum of 130 kilometers after being fully charged, which decreases the more the drivers charge their batteries. Regular charging times for electric taxis are around 8 hours for a full charge. Drivers can opt for a quick charge which takes 30 minutes and provides 80 percent battery power; however, such a method damages the battery with frequent use. Likewise, it takes

Lianfang charging station in Beijing remains eerily quiet.

them as many as eight hours to fully charge their vehicles, which means that their working hours are solely determined by charging times.

The Fengbei charging station, located under the Fengbei Bridge in the Fengtai district of Beijing, may be one of the most frequently utilized charging stations for sanitation vehicles within the capital.

As many as 13 charging posts are available for use in the station that can charge a maximum of 26 sanitation cars simultaneously. Duan Feng, an employee at the Fengbei station explained that, "Cars in the

INNOVATION REQUIRED

station need to be charged for one hour after consuming 10 percent of reserved electricity and it will take more than 12 hours before the vehicles are fully charged. Generally, drivers have to leave at least a 30 percent charge in the battery when they get off work.�

According to Duan, the cost of charging an electric sanitation car is around 0.89 yuan for one kilowatt-hour, which is much cheaper than the cost of powering traditional cars. However, there is a

a problem with how the city is approaching electric vehicles. No matter how many favorable polices the government issues, and how many subsidies it provides, the scattered development of the city’s charging facilities will remain a significant issue which will need to be resolved if left unchecked Firstly, there aren’t enough charging stations within the capital, which will obviously hinder the usage of electric vehicles. Secondly, aside from building more charging

It has been reported that the Beijing municipal government intends to establish 100 large-scale direct current charging stations for private drivers, which will include a total of 1,000 charging posts. Facilities on this scale would certainly help to alleviate pressure should more people buy electric vehicles. Several existing charging stations in Beijing are gradually opening up to private drivers. The State Grid Corporation now allows private drivers to purchase a card, which allows electric

Huixinxi charging station is tucked away beneath the bridge.

shortage of charging stations even for these sanitation vehicles. When asked whether the charging station would make its facilities available to private owners of electric vehicles, Duan said that as the number of private electric vehicles gradually increases, it is possible that all the charging stations in Beijing will be available for private owners.

However, at present, the standard of the charging facilities in different charging stations varies, and the prerequisite for the existing stations to open up to private owners is a unified standard of facilities.

Duan's comments clearly highlight

stations, the overall layout and location of these stations needs to be considered by the government. The location of the stations should be more accessible and more stations should be available to private drivers. Thirdly, technical problems, including short battery life, long charging times, and the lack of standardized charging facilities need to be addressed by the government and the industry as a whole. Establishing as many charging stations as possible is not a wise or useful choice. Instead, authorities should promote the efficient use of those stations that they do decide to build.

vehicle owners to charge their cars at designated charging stations by simply swiping said card.

Although, it is taking a long time for electric vehicles to capture the imagination of the public, and though there are still many major problems related to the charging facilities and the hardware within the cars, it does appear that Beijing is taking some solid measures to help propel the development of its existing charging stations, but many are still asking whether they are enough.

31

32

IS THE GAME UP

Luxury in China: Time to Rethink

By Bejan Siavoshy With an economy that boomed for over a decade, a manufacturing sector that produced the largest number of exports in the world, and average income levels tripling in just over eight years, by 2009, one thing was certain; China didn’t just have money—it had money to burn.

And with an influx of disposable income comes a widerreaching taste for the finer things in life.

In the face of a global economic downturn, China had a sector of its economy that was thriving, where other countries saw a free-fall; that was in its luxury market, which grew 16 percent, amounting to 64 billion yuan, in 2009, according to figures from McKinsey. While that number is down from the 20 percent in growth that China’s luxury market saw in the previous year, it far exceeded that of other countries during the same time period.

Likewise, by 2010, China overtook the U.S. to become the secondlargest consumer of luxury items in the world, just under Japan, which it is poised to overtake by 2015 if growth remains steady, according to a report released in December of 2013 on China’s luxury market by management consulting firm, Bain and Co. But the operative word is still “if.”

While big brands of all types, from Mercedez to Haagen-Dazs, enjoyed the gold rush that China provided for luxury goods producers in the past few years, 2013 saw China’s shimmering luxury market start to dull. The 2013 China Luxury Goods

Market Study showed that the country’s luxury market crawled to a growth-rate of just two percent, down from seven the previous year, causing many who were betting big on China’s luxury sector to rethink their strategies.

A China Daily piece from Feb. 2014 showed that Gregory J. Furman, founder and chairman of the Luxury Marketing Council, said luxury retailers won’t look to pull out of the Chinese mainland, but brands are going to most likely avoid investing as aggressively in the country’s retail sector as before. This coincides with many luxury brands that announced plans to carve out a piece of the domestic Chinese market by opening retail stores to scale back or outright abandon those measures. A Bain and Co. report entitled, “China Entering New Era of Luxury Cool-down,” revealed that just 100 stores among the 20 brands in the report opened stores on the mainland in 2013, down one-third from 150 the previous year.

The slowdown, which the Bain report said would continue into 2014, could be attributed to a number of things.

The first is Chinese leader Xi Jinping’s government “frugality” campaign that was launched in an effort to curb graft and overt public spending. Being that luxury items, from top-shelf liquors to high-priced watches, were often given as “gifts” to authority figures in China, the Hurun Report’s Chinese Luxury Consumer Survey 2014 shows that gift-giving expenditures dropped by 25 percent last year.

The Bain report stated that men’s watches—a popular item to gift among officials—accounted for about one-fifth of China’s luxury market. Amid the government’s frugality campaign, high-end watch sales for men declined 11 percent in 2013. Likewise, menswear was a growth-point in the domestic luxury market, but became a slightly declining part of the market in 2013.

Additionally, women’s cosmetic,

beauty and perfume products took a similar hit, with Bain’s report showing that sales in these products fell to 10 percent in 2013, down from 15 percent a year prior.

Another factor driving down the consumption in luxury items is the amount of Chinese looking to shop abroad. Luxury news outlet Jing Daily said that the better services luxury retailers provide abroad, cheaper prices, the differentiation in products offered overseas versus domestically, and the easier avoidance of counterfeit products are all key factors driving China’s big spenders to purchase luxury items outside the country. The Bain report shows that over two-thirds of luxury consumption by mainland Chinese was done overseas.

Additionally, it is China’s higher-income population that is footing the bill for most of its luxury consumption—and over 64 percent of that population has either emigrated or is looking to emigrate elsewhere, according to the Hurun report. With an increase in money, people tend to covet an upgrade in quality-of-life experiences; China’s luxury consumers are no different. Another factor that has bitten into the country’s luxury market growth last year is that more Chinese are opting for high-end vacations, spa sessions and activities over purchasing just another big-ticket item.

However, many experts say that the appeal of China’s luxury market is far from gone; it is just no longer easy to enter. With luxury brands flooding in amid the luxury sector’s domestic growth, competition has become fierce. In a Forbes piece in January 2014, Roy Graff, an expert on Chinese luxury travel and hospitality and founder of China Edge, said that the flood of entrants into the Chinese luxury market has impacted growth for established brands.

And with the competition has also come a shift in the tastes of Chinese luxury consumers. While the 33

country’s luxury market has been characterized by a taste for gaudier high-end products in the past, China’s new luxury consumers shun logo-laden designs and instead covet higher quality, subtle products that are bigger on a lauded heritage and craftsmanship than on showiness. This change in taste has led to brands like Hermes and Chanel overtaking their long-standing rivals, Louis Vuitton and Gucci, according to a New York Times piece from March of this year.

While China’s traveling luxury consumers are causing key shopping destinations to clamor for their business, back home, e-shoppers are poised to become key consumers across many sectors, and luxury is no different. Citing data from market research firm iResearch, Vancouver-based website developer Strangeloop pointed out that China will have 570 million online shoppers by 2015, two-thirds of its total expected internet user-base; in contrast, the U.S. is expected to have about 200 million e-shoppers online in the same year.

34

A report by research firm KMPG entitled “China’s Connected Consumers” showed that the Chinese e-shoppers surveyed reported spending an average of about 1,397 yuan (229 USD) on their most recent luxury item bought online.

Likewise, one in six respondents reported spending an average of 2,000 yuan on their last online luxury purchase, respectively. The KMPG report predicts that, by 2015, China’s e-commerce market will generate 540 million USD—7.5 percent of all retail transactions in the country.

With changes taking place in China’s luxury market, the going might get tough for retailers in the short-run, but experts say it is not the time to abandon ship, but rather a time to reconsider floundering strategies and evolve with consumers. Focusing on e-retailers, Strangeloop’s research also highlights how luxury brands are failing China’s e-shoppers with long wait times on websites. Citing Nielsen figures, page-load times for a website between 0.1 and 1 second give users a “seamless flow of thought.”

Anything past 10 seconds and a webpage has lost the attention of the user.

Strangeloop monitored the pageload times of 100 luxury brand webpages in urban China and found that the majority of these websites take an average of 16.2 seconds to fully load, noting that, “Many luxury brands are failing to deliver an optimal online experience to their growing Chinese market. Brand owners ignore this disconnect at their own peril.”

Roy Graff echoed similar sentiments about luxury retailers’ need to adjust to the changing market in China when he said this to Forbes: “Brands must better manage a global inventory and sales system that understands how Chinese approach luxury purchasing. The Chinese customer is now global.

The sooner those companies understand this, the better. In most cases, China is a separate profit center, competing with other regions for the same customer.

Thus, they do not share data across national borders.”

MESSENGER checks in with Gu Wei, editor of China Wealth and Luxury for the Wall Street Journal Chinese language edition, to get a snapshot of China’s fashion industry.

Earlier this year, high-fashion clothing and accessory brand Hermes did something that luxury retailers are loath to do; they held their first ever discount sale in China as a result of excess inventory. Traditionally speaking, in order to uphold brand image and maintain allure in their products, luxury fashion houses steer clear of holding sales or selling items in shopping malls outside of a flagship store. However, in April, Hermes did exactly that by holding a sale at the Hyatt Regency Hangzhou in eastern China, offering discounts of up to 50 percent in an effort to clear inventory some two to three years old. Despite being the world’s largest luxury market, is something about to give?

There are signs that the good times may be, not quite over, but perhaps flat-lining. However, China is still far and away the number one market for any luxury brand and would-be big name. High disposable incomes and extravagant tastes fuel the high sales of luxury brands. Furthermore, the need for particular styles dependent upon

where a person lives in China means that the variation among products is huge.

According to Gu Wei, editor of China Wealth and Luxury for the Wall Street Journal Chinese language edition, this year’s growth in the luxury fashion market has been a lot slower than previous years. “Luxury brands are all quite confused about the long term future. They are still hopeful, because as Chinese (people) get wealthy, there are more middle class (consumers), there are more rich (people); there should be more demand for luxury. But in the short term, because gifting demand got hit a lot by the crackdown on anticorruption, there has been lower demand.”

Gu refers to a wider anti-corruption drive spearheaded by President Xi Jinping, which he initiated upon taking office. However, there is also a general emphasis among government departments and government related enterprises against extravagance for the sake of extravagance, which is clearly having an impact upon the sale of luxury goods. And yet, despite the lower demand in gifting, Gu says that certain brands are reporting that general demand from real consumers is still strong.

Certain items and brands have been hit harder than others as

a result of the government anticorruption drive. As Thomas Lam, head of research and consultancy in Greater China for Knight Frank told CRI, for some luxury watch brands in China, the sales performance dropped by as much as 20 to 30 percent last year; a result, Lam says, entirely brought about by anti-corruption efforts.

But Gu is bullish about the prospects of China’s fashion industry, especially in relation to women’s fashion. She points out that socalled “Fresh brands” or niche brands continue to do well in China, as they are relatively new and appreciated by rich Chinese who are looking for a different way to express themselves. Ultimately, the smaller brands that Gu is referring to are still managing to turn in positive sales figures regardless of external forces.

Alongside these “Fresh brands,” Gu also points towards the performance of affordable luxury items with lower pricing points, brands such as Coach, as evidence that the fashion industry is still enjoying the fruits of China’s economic growth. ”Coach Bags are made in China, so the costs are lower.

These (kind of) brands pay attention to what consumers want and need rather than designing items that consumers should want.”

Despite the move by Hermes to 35

IS THE GAME UP

go against the cardinal rule of holding a cut-price sale, Gu strongly believes that fashion houses should not give in to short-term pressures and should instead find more subtle methods for clearing leftover inventory. “Big discounts or obvious discounts will be really bad for the brand. It may lead to short-term sales increases but in the long term that’s bad for the brand. So what we see is a discrete kind of discounting. They could either sell their unused inventory to some discounted branch, like a VIP shop for example, or they could select their VIP customers and have a sale a bit early. But the last thing they want to do is put up a big ‘For Sale’ sign in their stores, because that would cause them to lose their prestige.”

As China’s fashion industry matures, and as consumers mature too, designer brands are rethinking their sales strategies. “We definitely see a trend of consolidating stores. In the past, it was all about a rush to open new stores.

A - it’s too much of an investment, and B- there’s a problem of being too ubiquitous,” notes Gu. “The whole point of luxury is to create a point of desire. They need people to travel to certain places to buy them. If people see that (another store) is just opening across the street, it kind of loses its prestige.

As China becomes a more mature market, luxury brands are thinking, how do we drive more sales out of existing stores? How do we consolidate our sales?”

As for those luxury brands attempting to break into the Chinese market for the first time, the task of marketing and customizing products is not straightforward.

Customization is something of a balancing act as Gu Wei explains.

“You don’t want to create a line just for the Chinese market. If it’s just for Chinese, Chinese people may actually not want it. The whole point of buying western 36

luxury is to be aspirational and fit into this global lifestyle.”

Here, Gu highlights another subtle change among Chinese consumers. Initially, Chinese people wanted to show off their new wealth. Of late, buying luxury fashion items is seen as more of an aspirational purchase, allowing individuals to stand out. “Chinese consumers are quite fickle and they’re changing at a speed faster than anywhere else in the world,” according to Gu. For this reason, she emphasizes that it is incredibly important for brands to learn why Chinese people want to buy luxury items, adding that in Japan, people buy luxury goods in order to fit in.

However, in China, the market is subtly different as people are willing to go against the grain.

As for marketing, Gu believes that brand strategies depend on how sophisticated consumers are. As she explains, Chinese consumers are becoming more sophisticated over time. Gu identifies three clear stages that consumers identify with when looking to purchase luxury fashion items. “At first, they can’t really tell what is better; they rely on marketing, and they rely on big names to tell them that this stands for quality. But over time, they learn to tell for themselves.

Right now (China is) at stage two.

Stage one being: people carrying luxury items with big logos to tell themselves and others that they are rich enough to afford them and that they like quality. At stage two, you don’t see people carrying logos anymore, but it’s pretty obvious which brand they’re going for.”

Judging by the rapid progress of the fashion industry and the increased maturity among Chinese consumers, it won’t be long before China’s fashion buyers reach stage three; the point at which you can’t tell where an item comes from or which brand it is just by looking at it, or what Gu likes to refer to as “the understated, real luxury.”

The Property Market Bust

Mike Bastin of China's University of Economics and Business provides a brief assessment of China's so-called property market bust.

37

New data shows more Chinese cities are reporting month-on-month drops in new home prices. The National Bureau of Statistics says that among 70 major Chinese cities, 8 recorded declines in April; double the number recorded in March.

Price gains were recorded in 44 cities, down from 56 the month before. For existing homes, prices increased in 35 cities month-onmonth in April, down from 42 cities in March.

Mike Bastin, visiting professor at China’s University of Economics and Business discusses China’s small-scale property bust with CRI. Overall the current trend in the real estate market is a reflection in the cooling of the Chinese economy generally. I don’t think there’s any time for panic here. It’s also telling us that these are very, very different market segments that we’re now seeing. Certainly, first-tier property prices and second- and third-tier property prices are reflecting very different segments.

38

I don’t believe a bubble is really bursting nationwide. Certainly, in certain second- and third-tier cities and those areas, there has been a construction boom, prices are unsustainable and the economy cannot support those prices. So certainly, we’ll see quite massive reductions and a massive decrease in investment in those areas. In first-tier cities, it is likely that prices will cool but remain robust.

It’s useful to remember that the typical Chinese homeowner, even with second and third homes, is relatively under-mortgaged. They haven’t incurred heavy borrowings like a typical western homeowner, so they’re not under pressure, necessarily, to sell even at a loss to avert any loss in terms of mortgage repayments. Chinese homeowners have bought with a long-term interest and rental income in mind anyway; I don’t think they’re trying to make a quick kill in the short term, even if that was the case on paper.

Related sectors, supporting industries, cement, steel, furniture, will be affected. Together with the property market, they comprise around 20 percent of the Chinese economy. So there will be a detrimental impact on the overall economy most definitely, and in second- and third-tier cities that will be most marked. So, this will contribute to a further cooling of the national economy, but again I don’t think it’s time to panic.

Local governments will start to relax the curbs on property purchases (and) down payments, and they’ll try to (provide incentives). I don’t believe that will have much impact, to be honest; with an excess in terms of supply in these areas, there’s nothing much you can do about that. The national government will be quite relaxed about this, as long as this is a further cooling and no more; which I believe it is.

(Mike Bastin shared his thoughts with the Beijing Hour radio show and CRIENGLISH.com)

Chinese Language and Culture College

Contains 210 frequentlyused measure words Includes nominal measure words, verbal measure words, concurrent measure words, etc.

Compiled according to the HSK examination outline Features multiple retrieval methods CROSSING THE GENDER LINES The unkind w world of transgenderism in transgenderi China

picture dictionary of chinese measure words

PROSTITUTES AN AND POETS Muses and ba bards from the worl world’s oldest profes profession

SEX EX AND LAW A AW INN CHINA Handcuffs andcuffs in e bedroom the and nd not in a good ood way

36, Wang Fu Jing St. Beijing, 100710, China Tel: 86-10-65258899 ext.407 Email: duanxiayun@cp.com.cn

CHINAPORNWARS.COM CHINAPORNWAR Online porn ssurvives under the and thrives un censor’s axe

cover.indd 1

11/21/13 10:33 PM

SHARING STORIES, SHARING CULTURE

Contains 210 frequentlyused measure words

2013 ISSUE 4 BI-MONTHLY 2013年 第4期 �第41期／双月刊

发现中国，共享世界

MMA IN THE MIDDLE KINGDOM Bruisers pay their bills with broken bones

Includes nominal measure words, verbal measure words, concurrent measure words, etc.

THE WAY OF THE POLE They’re not strippers; they’re athletes

Compiled according to the HSK examination outline

MEDAL FATIGUE Olympic success comes at a price

HOOLIGANS

FFOR OTHE OR

Features multiple retrieval methods

A peek into the culture and causes of football hooliganism in China

picture dictionary of chinese measure words 2013年 第4期 �第41期／双月刊

36, Wang Fu Jing St. Beijing, 100710, China Tel: 86-10-65258899 ext.407 Email: duanxiayun@cp.com.cn

2013 ISSUE 4 BI-MONTHLY

¥ 19.00 USD 7.0

2013-02cover.indd 1

A collection of classic lines from works by ancient Chinese philosophers, writers and poets

11/22/13 10:33 PM

2012 ISSUE 2 BI-MONTHLY 2012年 第2期 �第33期／双月刊

2012 ISSUE 6 BI-MONTHLY 2012年 第6期 �第37期／双月刊

Will a new law requiring real-name registration mark a turning point for Chinese microblogs?

Release ease date: June 2012

www.cp.com.cn

2012 ISSUE 6 BI-MONTHLY

Address: 36,Wang Fu Jing Street, Dongcheng District, Beijing,100710,China Tel: 010-65278537 65126429, Fax: 010-65249763

2012年 第6期 �第37期／双月刊

010-65258899-543

A TIBETAN TAPESTRY From spiritual journeys to renting a yak, we have a jam-packed guide to Tibetan culture

ALL HAIL THE QUEEN OF WEIBO An interview with Yao Chen, China’s most popular microblogger MARCH OF THE QQ PENGUIN How an instant messaging service changed the face of the Chinese internet

¥ 19.00 USD 7.00

¥ 19.00 USD 7.00

www.theworldofchinese.com

39

CRIENGLISH.com social media facebook.com/crienglish

twitter.com/crimobile

weibo.com/crienglish

cri_english

Executive Editor :

Xie Qiao

Editor-in-chief :

Stuart Wiggin

Design :

Cui Chaoqun Stuart Wiggin

Layout:

Cui Chaoqun

Email : crieng@cri.com.cn Tel : 86-10-68891617 / 68891580 website : www.crienglish.com