Innovation Perspectives

China Europe International Business School - Centre on China Innovation

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Home >Innovation Perspectives
Innovation Perspectives

The 'Three Phases' Of Chinese Innovation

Written by George Yip
Co-authored with Bruce McKern

In the space of less than four decades Chinese companies have moved from outright imitation to pure business innovation , in parallel with and contributing to the country's extraordinary growth. The ‘three phases’ of this shift, while not strictly sequential, provide a narrative of relentless refinement of China’s innovative capacity.

From copying to “fit for purpose”

Most Chinese companies had to start from scratch, and they began by copying and then by making small improvements to an existing product or process. Many Chinese companies started with nothing but a desire to emulate what already existed. They were called ‘shanzhai,’ or ‘mountain bandits’ . They copied brand-name products, from fashion accessories to phones. The products were cheap and the quality was low, but customers did not much care so long as they were affordable.

But the Chinese market changes very fast. As customers became more discriminating, entrepreneurs learned to move from imitation to incremental innovation , improving their products and their processes. These early innovators were often greatly aided by an open market for standardized components, such as Intel microprocessors and other components for personal computers, MediaTek wireless chipsets for mobile phones, and later Google’s Android mobile operating system.




Incremental innovation is a big step beyond imitation – it marks the recognition by companies that innovation is at the heart of long-term competition . The Chinese companies based in the Pearl River Delta and elsewhere that began by making components for global supply chains in the information, computing and telecommunications industries quickly developed capabilities in incremental innovation that have made them key players in supply chains for products sold in the developed world. These innovation capabilities provided many of them with the base to develop products for the exploding domestic market.

The special demand characteristics of the Chinese marketplace meant that in this ‘phase one’ of innovation Chinese companies became adept at producing products or services designed with just the product attributes Chinese customers were willing to pay for, and no more. This “good enough” strategy worked both in markets that serve lower income consumers and in industrial markets, such as food processing, mobile phones, household appliances and electrical machinery. These companies learned to eliminate unwanted features, economize on materials (and sometimes durability), reduce wastage and streamline processes. Their products and services are not inferior, but fit for purpose. They meet customers’ needs, whereas Western-designed alternatives may have costly features which customers aren’t prepared to pay for.

From followers to world standard

The “fit for purpose” pattern represents innovation driven by market necessity. But many Chinese companies have chosen a more ambitious route of innovation by choice: innovation that drives the market rather than being driven by the market .

There are many examples of Chinese companies that began by supplying the fast-growing Chinese market with products that depended primarily on the low cost of labor, but that now depend primarily on innovation . These include companies such as construction equipment makers Sany and Zoomlion, online travel companies Ctrip and TongCheng (also known as 17u.com), TCL in consumer electronics and mobile phones and Tencent in on-line games, instant messaging, and e-commerce. Some of these companies invested heavily in technical talent from the start, while others have turned to innovation as a strategy for future competitiveness. Several are now active in global markets, competing against the very multinationals that served as their role models.

One of the most visible of these is the appliance manufacturer, Haier. In 1984 Haier was state owned, and on the verge of bankruptcy. Today it is the largest white goods producer in the world. Along the way Haier acquired vital refrigerator technology from German company Liebherr, and Western management ideas wherever it could find them. By 2012 its revenue had reached $24 billion, with an 8.6% global market share. Haier has moved from supplying under-served niches, such as bar fridges and wine coolers, to offering a full range of high-quality appliances.

From seeking new resources to seeking new knowledge

Under the government’s “go global” policy of the last ten years, Chinese companies – and especially state-owned enterprises (SOEs) – have been pushed to enter foreign markets. Currently the official plan is to balance the stock of inward foreign direct investment with the stock of outward foreign direct investment (OFDI) by the year 2015, and to encourage overseas expansion by private-sector companies. This includes the creation of R&D centers overseas. China’s government is fully committed to helping Chinese companies to become insiders in foreign markets. (Although the FDI target for outward FDI stock won’t be reached for many years, the outward flow of Chinese direct investment in 2014, at $103 billion, was not far below the inward flow of $120 billion).

With foreign exchange reserves close to $US4 trillion, China has the money to buy the foreign industrial capacity it thinks it needs. Yet so far, outward investment has been overwhelmingly in the minerals and energy sectors in emerging economies where primary producers are found. So is China still fully fixated on the world’s natural resources when it comes to foreign investment, at the expense of building up the kind of offshore manufacturing and services capacity that will give it an innovation platform abroad? We think not: behind the headline figures, there is something very intriguing taking place.

Recent acquisitions support the view that a noticeable shift is under way. For example, Lenovo recently bought Motorola Mobility, Dongfeng Motors (around 31st among global automobile firms by R&D expenditure) made a bid for Peugeot-Citroën, while in the best-known case of all, Swedish carmaker Volvo was bought from Ford by Zhejiang Geely, an automobile company with enormous ambitions but lacking a strong brand and design expertise. Last year two-thirds of China’s offshore investments were in services, where Chinese firms still have much to learn.

Although Chinese companies have good manufacturing skills they lack understanding of sophisticated markets – and they know this . They also know they often lack the full range of scientific and engineering expertise needed for more demanding customers. This has led to a new phenomenon: the creation of Chinese corporate R&D centers in the US and Europe, through direct investment and acquisition . Their motive is to embed their companies in the innovation ecosystems of the developed world to acquire and develop foreign technologies, brands and marketing know-how.

It has been fascinating to watch China’s transformation over the years. It will be even more fascinating to see what comes next.

George S. Yip is Professor of Strategy and Co-Director of the Center on China Innovation at China Europe International Business School. (gyip@ceibs.edu). Bruce McKern is Visiting Fellow, Hoover Institution, Stanford University, and Visiting Professor of International Business and former Co-Director of the Center on China Innovation at China Europe International Business School. (bmckern@ceibs.edu).