Most of us use products made in China every day and are aware of its growing economic power as a factory to the world. But China intends to become a developed nation by mid-century, and integral to this ambition is its intense focus on innovation.
In a few decades, Chinese companies have evolved from imitators to imaginative and effective innovators. As part of my research with my colleague George Yip on this issue, we identified three key phases in China’s development:
- From “copying” to “fit for purpose”
- From “followers” to “world standard”
- From “seeking new resources” to “seeking new knowledge”
Chinese companies now pose a challenge to established multinationals as they enter the markets of the developed world to become insiders. Since China’s former leader, Deng Xiaoping, implemented market-oriented economic reforms to China in 1979-80, the driving forces of this transformation have been the customer and the culture. Chinese customers have a rapidly growing demand for products as the nation’s large, diverse population seeks better lives. This has stimulated many companies to develop affordable products for those needs. And a culture of entrepreneurship in the business sector has been facilitated by a far-sighted government with a strong drive for independence and economic development.
The Chinese government has fostered an innovation ecosystem across the country, consisting of some 100 science and technology parks, universities and government research institutions, which provide support for new enterprises. The Chinese government and businesses invested some $190 billion in research and development in 2013, which is around 40% of the annual R&D investment in the United States.
China’s research and development expenditure represents just more than 2% of its gross domestic product, which is slightly more as a share of GDP than that of Western Europe. The government’s priority for technological development is matched by the entrepreneurial spirit and drive of Chinese entrepreneurs.
In the first phase of development, Chinese companies started by copying products and processes from Western firms, or by producing components for the supply chains of multinational corporations. Chinese suppliers to multinationals were forced by their business partners to achieve high standards of quality at low cost.
While demand from domestic consumers was initially for very cheap products, Chinese producers quickly learned to develop products that were “good enough,” combining fit for purpose with low cost. For example, an enterprising startup created the “Apple Peel,” a component which the customer could use with an iPod Touch to turn it into a mobile phone much like an iPhone.
Contrary to the low level of competition in China’s state-owned sector, private companies operated in sectors that were more open and competitive. Chinese firms’ better understanding of local customers enabled them over time to compete effectively with multinationals in the Chinese market.
Although local firms lacked the research and development capabilities of foreign companies, they were guided toward more innovative processes by the extensive technology networks and innovation ecosystem developed by the Chinese government. With the experience they gained in satisfying customer demands and dealing with intense competition, Chinese firms were also able to diversify into other markets and more advanced products.
An example of this is Joyoung, a Hangzhou-based domestic appliance company, which began as the inventor of an appliance that makes soy milk, later copied by many other companies, including foreign firms. Joyoung built on its success with its soy milk appliance to become a large diversified maker of small household appliances. This competitive experience in the fast-growing markets of China led Chinese firms to the second phase in their evolution.
In this phase, Chinese firms ambitiously set their sights on achieving global standards, particularly those companies active in export markets, as exemplified by domestic appliance firm Haier. From the beginning Haier was focused on innovation, and is now the biggest company by revenue in the appliance sector. A legendary innovation of Haier’s is a washing machine that washes potatoes as well as clothes, a response to farmers’ needs.
Many of China’s companies have now reached global standards of quality. However, very few have strong brands that are recognized outside China. This is one of the reasons for the third phase in their evolution.
Building on the capabilities they developed in the domestic market, coupled with the cash generated by their successes, Chinese businesses are now moving outside of China.
In contrast to the earlier expansion of Chinese firms investing abroad in petroleum and other natural resources, this third phase is very much about exploiting innovation developed at home and applying it to the consumer and industrial markets of the West.
Chinese businesses are seeking brands, market access, and technologies that may be missing from their home-developed portfolios. Their entries into foreign markets are often by acquisition, and European firms (particularly middle-sized German companies) have been popular targets.
Others have set up research and development centers in the United States and Europe, located in centers of innovation such as Silicon Valley. A good example is the telecom equipment and smartphone maker Huawei. Over many years of international expansion, Huawei has developed a global network of 16 research and development institutes and 36 joint customer innovation centers. Huawei and ZTE, another major Chinese telecom company, are consistently among the top 10 patent filers each year in the international patent system application process.
Chinese firms have also adopted a number of management practices that are less common in the West. Our research identified 10 of these, ranging from deep understanding of their customers, rapid decision making, rapid prototyping, and learning from mistakes, to a ready willingness to deploy extensive resources to innovate. While these are not of themselves particularly new, they are a source of competitive advantage in the Chinese environment, where foreign companies have not applied them consistently.
Foreign companies have much to learn from China as it becomes a leading market in the world. They can develop capabilities in China that they may have neglected, including bold experimentation, speedy implementation, new product category creation, a focus on “lean value,” and developing mixed teams and global leaders.
There is a tidal wave of competition approaching the developed world from China. The best way multinationals can prepare themselves for this is by participating directly in the Chinese innovation ecosystem.