Can China Innovate? How Chinese Overseas Investment, Virtual Reality and the Creative Industries might reform China

by Philipp Grefer

 

Whatever China´s, or as one might argue – the Chinese Communist Party’s - ambitions, dreams or goals might be - you can usually find them in the current five year plan. To paraphrase Professor Hu Angang, Dean of the School of Contemporary China Beijing´s elite Tsinghua University and a key thinker in state theory: If you only remember one thing from the latest 13th five year plan (2016-2020) it should be “innovation”. To achieve this innovation, the government is increasing its spending on research & development (according to an OECD report China will overtake the US and Europe as the biggest spender on R&D by 2019) and trying to reform its education system. But while higher R&D expenditure might attract top talent, reforming China´s education system, with its strong focus on rote memorization and teaching to the test, will be a much harder task. In the meantime, the 4 million Chinese students who have studied abroad since 1978 (half a million in 2015 alone) and who are returning at a rate of about 70-80% in recent years, and are often lured back by very competitive salaries, may help to fill the “education gap”. Indeed, while Xu Xiaoping, one of China´s best known tech investors laments Chinese parents’ obsession with the Gaokao (higher-education exam) at the expense of an innate passion for their children, and criticises the “lack of soul” in Chinese products and services, some of China´s woes in this sector might be cured by simply buying knowledge and “soul” from abroad: “Tired of paying licensing fees and royalties, Chinese firms have increasingly, and with their government’s encouragement, sought to buy, rather than rent (or steal), breakthrough innovation capabilities through acquisitions of both technology and talent” writes the Harvard Business Journal in its analysis, which, despite pointing out how China is strengthening future innovation capabilities, is ironically titled “Why China Can´t Innovate”.

This brings us to a related topic:

 

CHINESE FOREIGN DIRECT INVESTMENT (FDI)

As Sophie Yu from CICC elaborated in her NEU China speech there has been a steep increase in Chinese FDI in recent years. In the first half of 2016 it has already surpassed USD 100 billion and has been doubling every year since 2014.

While previously, Chinese investment was mostly directed towards raw materials or high end-manufacturing companies, in the last two years a shift towards investment in more creative and tech companies has taken place.

 

Take Chinese gaming company Kunlun Tech as an example (disclosure: this author worked at Kunlun and Yu advised the company on a recent investment in the UK), which Yu describes as “one of a new generation of multibillion dollar companies”. It’s likely that very few westerners have ever heard of Kunlun, yet it already became a sophisticated investor with stakes in both domestic and international companies across social media, live broadcasting, P2P and internet security web-sectors. Similar to social media behemoth Tencent (Weibo, WeChat, QQ etc) Kunlun makes most of its money from (online) gaming, which generates enough cash flow to allow it to expand into other areas. Thei strategy of Kunlun got rewarded with its IPO in February 2015 on the Shenzhen Stock Exchange with a market cap of $5bn+ today. 

 

VR / AR - THE NEW FRONTIER AND A DRIVER OF INNOVATION?

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So far Chinese companies have been playing “catch up” with their western counterparts in already existing industries, leveraging what Joseph Schumpeter calls the “latecomer´s advantage: the ability to learn from and improve on the work of one´s immediate predecessors”. However, emerging industries such as AR or VR provide them with an almost level playing field with their western competitors right from the start. With a projected worldwide revenue of $162 billion USD by 2020 up from 5.2 billion in 2016 (source: IDC), China´s VR market is projected to grow from $860 million in 2016 to $8.5 billion by 2020 (Source: iiMedia). It is no wonder then that Kunlun, who recently set up California based Kunlun AI, and its peers are also investing in these technologies. As another case in point, Tencent invested 80 million RMB (around 12 million USD) in a Series A Round in ZANADU, the world leader in VR lead travel experiences, headed by NEU China speaker Wu Zan. Zan told the audience how Huawei, one of China´s biggest cellphone makers, is planning to ship 15 million units of its Meizu 8 phone packaged with VR Goggles this year alone and he expects there to be 50 million VR users by the end of 2016. All the major distribution platforms like Tencent, Youku, IQiyi - each with more than 300 million users in China and 10 million premium subscribers - as well as headset makers; Huawei, Xiaomi and Baofeng who are also trying to enter the distribution game, are just waiting for the new medium to take off. However, the distribution pipes laid by these companies need to be filled with content. Herein lies the problem at the moment:

 

LACK OF CONTENT?!

 

NEU speaker Stanley Chen, VP of Noitom, the world’s leading motion capture company, has not seen a “killer app” emerge yet, while Christian Grewell, professor at New York University in Shanghai, mentioned the still very high prices of VR equipment as an entry barrier to VR. However, at this very moment a plethora of ever more advanced content is being produced either in China or abroad (the HTC Vive X accelerator just opened in Beijing and the other players mentioned have been making huge investments in VR content), while the prices for the necessary hardware to use VR are constantly decreasing. So when a “killer app” finally hits a market with consumer friendly prices, there is not much reason to think why VR shouldn’t explode the same way AR did with Pokémon Go. Every day, news about more investments or VR partnerships, such as the recent announcement of US based Jaunt VR’s partnership with Shanghai Media Group appears, while real estate developers open their spaces to VR Arcades and companies such as IQiyi announce VR as the core of their future business.

China, with its 1.4 billion population of which 800 million are monthly active WeChat users (source: Tencent June 30, 2016) has a relatively long history of video gaming in Internet Cafes or at home (according to CNNIC, there were 391 million users playing online video games in China in 2015 and online game revenue is expected to grow to 251 billion RMB (approx. 37 billion USD) as suggested by IResearch), a lack of entertainment options in non first- or second tier cities and a populous - be it young or old, poor or rich -  that is not afraid to early adopt new technologies, should be at the centre of this development.

“The creative industries in China are still in their infancy. The infrastructure is not quite there yet, but people are hungry for content” says Sophie Yu. If China is able to create interesting content, for old or new media, which is not only attractive to its own population, but also worldwide, might well decide if China can take the lead in innovation instead of just following it.

In the meantime, there is a huge opportunity for both foreign and domestic companies to create content for this new medium, or at least acquire huge injections of capital from Chinese investors on a shopping spree.

 

With contributions from Christian Grewell, Sophie Yu & David Ball