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Leading Edge Forum
Clash of the Titans: Can China Dethrone Silicon Valley?
Authors Simon Wardley David Moschella
Editor Anne Pappenheim
Production Manager Keren Hayden
Graphic Designer Andy Scrivner 4 Contents
Executive Summary...... 2
Introduction...... 9
Purpose...... 10
Climate...... 13
Landscape...... 18
Doctrine...... 25
Analysis of Structural Factors...... 34
Leadership...... 35
Leadership: A Future View...... 44
Competing with China...... 46
1 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Executive Summary
Over the last few years, much of our research has focused on helping clients in two closely related areas: understanding the myths and realities of digital disruption, and mapping the evolving nature of technology-driven competition. Thus far, virtually all of this work has sought to assess the impact of digital innovation on both the strategy of the individual firm and the structures of established and emerging industry ecosystems. Important changes are obviously taking place within both domains.
But what if the biggest future disruptions and most important competitive dynamics will not take place between firms and industries, but between nations and cultures? The IT industry has been dominated by Silicon Valley for so long that it can be hard to imagine otherwise – at least for many Americans. But clearly the rapid rise of China (and to a lesser extent India) makes entirely different scenarios possible.
To assess this possibility, at the beginning of 2015 we decided to develop a point of view regarding this potential clash of the titans. Given that there are many think tanks, pundits and consultancies that are much more regularly engaged with China than we are, this was a daunting task. But our belief was that if we could frame the rise of China within the context of some of our proven LEF models, we could get beyond the obvious strengths and weaknesses of both titans, and make an original and meaningful contribution to what will surely be a long-running debate.
We believe we have been successful in doing this. When we combined our China analysis with the findings of our disruptive research, we were struck by how closely the timings of the expected maturation of Chinese technological capabilities coincided with our forecasted timings for the next major waves of disruptive change. In other words, it appears that, unlike the rise of other Asian tigers in the past, China is ‘skating directly to where the puck will be’, to quote the famous Canadian hockey player, Wayne Gretzky. Additionally, China’s rise is coinciding with the arrival of major new types of hardware – goggles, drones, robots, 3D printers, internet of things (IoT), etc. This also plays very much to China’s core strengths.
These two observations are of potentially great importance because they suggest that major new global technology opportunities will emerge just as China becomes most ready to compete for them. At a minimum, this makes significant shifts in global IT leadership possible to a degree we haven’t seen since the challenge from Japan some 35 years ago.
Our overall timeframes for disruption, as well as our sense of China’s ever-improving capabilities, are the focus of this Executive Summary. As always, we encourage clients to review our full report, which describes many specific Chinese plans, capabilities, companies and initiatives. This analysis makes it clear that the clash of the titans has already begun, even as the American and Chinese economies become increasingly intertwined.
2 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Waves of disruption
Anticipating the disruptions of the future
Global Extent of science economic Web Biotech disruption Genetics Amazon Nanotech Google Mobile Robotics eBay Bio-manufacturing Skype Apple Printed electronics IoT Wikipedia Uber Machine intelligence Netflix Yelp Machine evolution LinkedIn Brain interfaces Fitbit Facebook Synthetic food iHealth Twitter Autonomous vehicles 3DP Pandora Precision farming Drones Lending Club Smart cities PCs Watches Main- AirBnb Fuel cells Goggles frames Microsoft ... Cyber warfare Thermostats Minis Intel China/India? Novell ... IBM DEC
1960 1980 2000 2020 2040
From the works of Kondratiev to Schumpeter to Perez, our economic systems demonstrate waves of change or business cycles.
The foundation of such changes are usually linked to technological waves clustered in small groups.
The figure above is taken from a recent LEF report1 and depicts our belief that disruptive change tends to come in waves. But in regards to the future competition between China and Silicon Valley, the most important message of the figure is the great wave of technology-driven changes expected over the longer term. In many ways, the mainframe, minicomputer, PC, internet, mobile and IoT eras can all be seen as part of the process of establishing a ubiquitous Matrix2 of digital capabilities upon which all manner of new value can be created, as science and IT are brought to bear on just about every realm of human activity.
We believe that the total amount of societal know-how needed to develop, deploy and maintain this new world will greatly exceed the capabilities of any one nation, so there will be plenty of room for players from all around the globe. However, given the IT industry’s unusual history of very strong de facto market leaders – IBM, Microsoft, Intel, Cisco, Apple, Google, Amazon, Facebook, etc. – the question is: who will be the giants within this global science future, where will they come from, and what markets will they serve?
Indeed, in many ways the biggest competitive battlegrounds might not be the head-on struggle between China and the US, but rather over who will provide this future digital infrastructure to the developing world. The recent success of Xiaomi in mobile phones in India and Indonesia may well be an indicator of things to come.
3 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Anticipating disruptive change
Points of change 2015 2015-2020 2020-2025 2025-2030 2030-2035 2035-2040 2040-2045 2045-2050 Now Near Far IaaS War (End) PaaS War SaaS War Big Data War War Robotics War War Sensor-as-a-Service War Currency War IoT War Immersive War 3D printing War Social change War GMO War Genetic engineering War Agents War Printed electronics War Hybrid printing War Materials War Bio manufacturing War Epigenetics War
Whilst much of the market cannot be anticipated as it is directly related to individual actors’ actions (Hayek’s theory of The Pretence of Knowledge), there nevertheless remain points of change known as ‘wars’ (e.g. the shift from product to commodity and utility) that can be anticipated in advance.
The figure above looks more specifically at the timing of some of the key technology changes we expect. The figure is drawn from our 2014 reportOf Wonders and Disruption3 where we discussed how disruptive market shifts tend to go through decades-long cycles consisting of three distinct phases:
• Peace – mature markets tend to have well-established industry leaders, with stable growth and profitability
• War – a new technology or approach (such as cloud computing) directly attacks a previously peaceful marketplace (such as servers and data centres), seeking to establish new leaders and business practices
• Wonder – once established, a new approach (such as the electrical grid) enables all manner of wondrous – but hard to predict – new uses (such as radio, television and air conditioning) that eventually mature into a new peace phase, from which the cycle can eventually begin anew
The figure forecasts the timing of a wide range of emerging technologies from thisPeace, War and Wonder perspective. We put the graphical emphasis on the War phase because the onset of this phase is much more predictable than the wondrous applications it will eventually enable. But the key point is that most of the major disruptive changes shown won’t really kick in until 2025-35. This means that we need to think about where China will be then, and how effectively it is preparing for these developments. In this regard, our research shows that China is now very well positioned for these future global leadership battles.
4 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Supplier positioning
Market cap of top 20 internet companies by country of origin, Oct 2015 ($Bn)
Over the last two decades, China has 26% rapidly expanded up US the value chain from its ($448Bn) former self as a toy and China luggage manufacturer 1% to some of the leading 73% Japan companies on the 0% internet, a vast array of ($1260Bn) Russia high-tech exports and the world’s largest domestic internet market.
As suggested by the figure, China has already made dramatic progress, at least from a market capitalization perspective. While most of the market’s attention has understandably been given to the major Chinese technology brand leaders such as Alibaba, Xiaomi, Baidu, Tencent, Huawei, Lenovo and Aliyun (Alibaba’s cloud), in our research we were equally impressed by the breadth and depth of activity across just about all of the areas in which we anticipate change.
It is important to understand that China’s business structure is not like the keiretsu model of Japan or the chaebol structure of Korea. Both of these approaches feature giant, highly visible multi-national firms, with a relative lack of start-up activity, especially compared to the US. In contrast, China – like Taiwan and Hong Kong – has an enormous web of small technology firms and emerging digital ecosystems not easily visible to outsiders, making Chinese competition both potentially more agile and definitely harder to track (and research).
In the full report, we describe China’s ever-improving ecosystem capabilities in a number of representative areas including cloud computing, virtual reality, robotics, cars, aerospace, solar power, high-speed trains and 3D printing. While it is clear that these will be some of the key battlegrounds of the future, opinions vary widely on the outcome (sometimes even within the LEF). But as the strengths of the US and Silicon Valley are very well known, in our report we focus almost entirely on the scale of the potential Chinese challenge.
5 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
China’s growing structural advantages
Factor Class Sub-class Today 2025
Existing belief Purpose Hubris and optimism Mobility and inequality
Manufacturing capability Human capital R&D scale Climate Financial capability Economic capability Government capability Constraints
Internet Cloud Robotics Points of technology Landscape change 3D printing
Factor Class ImmersiveSub-class Today 2025
Existing belief IoT Purpose Hubris and optimism Factor Class Sub-class Today 2025 Mobility and inequality Other Existing belief Purpose Hubris and optimism Manufacturing capability FactorMobility and inequalityClass Sub-classGovernmentToday Human play capital 2025 StructureR&D scale ManufacturingExisting capability belief Climate Financial capability Purpose HumanHubrisDoctrine capital and optimism Industrial Economicpolicy capability R&DMobility scale and inequality Breadth of strategicGovernment play capability Climate Financial capability Constraints EconomicManufacturing capability capability Entrepreneurship GovernmentHuman capability capital Internet ConstraintsR&D scale Cloud Climate Financial capability Robotics Internet Points of technology Economic capability LandscapeAdvantage to US Advantage3D printing to China Neutral Government capabilityCloud change Immersive Constraints Robotics Points of technology IoT Landscape 3D printing change Internet Other Across a rangeImmersive of factors, from purpose to economic climate to landscape to doctrine, China is Cloud IoT increasingly positionedRobotics to take advantage.Government play Points of technologyOther Structure Landscape 3D printing change Doctrine Industrial policy Immersive GovernmentWhether play this will translate intoBreadth success of strategic is a matter play of discussion and often bias. Structure IoT Entrepreneurship Doctrine Industrial policy Other Breadth of strategic play EntrepreneurshipGovernment play TheStructure figure above is grounded in the principles of Purpose, Climate, Landscape and Doctrine set out Doctrine byIndustrial Sun Tzu policy in The Art of War (published 513BC). In this view, the US is primarily viewed as a declining Breadth of strategic play andEntrepreneurship indebted economic power; Silicon Valley suffers from hubris and inequality, is hollowing out, and is increasingly dependent upon foreign talent. In contrast, China is systematically investing in strategic capabilities, leveraging its vast domestic market and preparing to target emerging global opportunities. Our report amasses considerable, and often persuasive, evidence along these structural lines.
But of course, there is a flip side to this narrative, rooted in the idea that we have all seen this movie before. Whether it was the USSR (Sputnik and five-year plans), Japan (consumer electronics and the Ministry of International Trade and Industry), or an integrated European super-state (GSM phones, the Euro and the world’s largest common market), various experts have repeatedly warned the US that far-sighted government initiatives, combined with often-controversial forms of strategic protectionism, would inevitably gain the advantage over the more laissez-faire American approach.
Additionally, we cannot assume that just because China is developing many structural advantages it will inevitably lead any particular industry. There are still many unknowns. But the key question is: given the structural differences we observe, and being mindful of past experiences, can we anticipate who is likely to prevail over the long term? 6 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
China’s growing structural advantages The battle for leadership
Factor Class Sub-class Today 2025 Factor Class Sub-class Today 2025 Existing belief Purpose Hubris and optimism Factor Class Sub-class TodayTechnology 2025 Cloud Mobility and inequality Existing belief Transportation Auto Purpose Hubris and optimism Manufacturing capability Train Mobility and inequality Factor Class Sub-class Today Human capital Aero2025 Leadership R&D scale ManufacturingExisting capability belief ClimateRenewableFinancial capability Nuclear Purpose HumanHubris capital and optimism Economic capability R&DMobility scale and inequality Government capability Solar Climate Financial capability Constraints Wind EconomicManufacturing capability capability GovernmentHuman capability capital Biomedical Internet ConstraintsR&D scale Cloud Climate Financial capability Robotics Internet Points of technology Economic capability LandscapeAdvantage to US Advantage3D printing to China Neutral Government capabilityCloud change Immersive Constraints Robotics Points of technology IoT Landscape 3D printing change Internet Other Immersive “The victorious strategistCloud only seeks battle after the victory has been won.” IoT Robotics Government play Sun Tzu Points of technologyOther Structure Landscape 3D printing change Doctrine Industrial policy Immersive Government play Breadth of strategic play Structure IoT Entrepreneurship Doctrine Industrial policy Other Breadth ofAs strategic we know,play America thus far has always had the last laugh, and it is all too easy to list the things EntrepreneurshipGovernment play thatStructure might block China’s progress – corruption, censorship, environmental degradation, an aging work Doctrine force,Industrial bloated policy state enterprises, financial and legal opaqueness, language barriers, tense neighbouring Breadth of strategic play countryEntrepreneurship relationships, and more. Rattling off the US strengths – great universities, powerful companies, access to global talent, a unique VC community, the free flow of ideas, the California lifestyle, the English language – is equally easy.
But our bottom line is that China is different from the USSR, the EU, Japan and the other Asian tigers, not just because of its colossal market size and its strategic state engagement; nor even its growing sense of confidence, purpose and ambition. The largely under-appreciated additional reasons are that China is aligning itself with where the global market is headed, and that it is taking much more of an entrepreneurial and ecosystem-based approach. This is unlike, for example, Japan in the 1980s, whose vertically integrated conglomerates put too much of their energy into where the market already was – mainframes, supercomputers, consumer electronics and DRAMs.
By examining the value chains of specific industries and taking into account how technology is evolving as well as the structural differences between nations, we have sought to forecast which country we expect to lead, as shown in the figure above. Whilst America currently enjoys considerable advantages, by 2025 we expect the picture to be much more balanced, with many of the scales tipping towards China.
7 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Societal models and evolution
China’s economic model is not new. Japan, Singapore, Taiwan and South Korea also rapidly modernized and became globally competitive by adopting an authoritarian, state-supported, pro-business, export-led economic model grounded in investment, education, engineering and social control. This strategy was articulated many years ago by the late Lee Kuan Yew, the founding father of an independent Singapore, and more than anyone else ‘the man who remade Asia’, as the Wall Street Journal rightly put it. LKY’s advocacy of a modern one-party state and Asian values was an enormous influence on Deng Xiaoping.
However, while all four of these tigers quickly moved into the upper echelons of the developed world, they have never managed to rise to the top in terms of disruptive innovations and the resulting industry leadership (although Japan came close). Globally, all four have focused mostly on advanced commodity hardware while barely participating in the software and services industry outside of their home markets. Importantly, all of these countries liberalized their societies slowly but fundamentally over time.
China faces challenges on all of these fronts, with three main differences. In addition to its immense size, China plans to nurture its own set of global internet services players such as Alibaba and Didi Kuaidi. Perhaps most importantly, hardware – 3D printers, goggles, robots, drones, IoT, etc. – is entering a less commodity-like phase. As device innovation and manufacturing prowess become more strategic, China’s position will strengthen.
Meanwhile, the whole world is watching to see if China will significantly loosen its often-repressive societal control. Here, China’s challenges are greater than those faced by the other major Asian economies, who were largely under the western/American umbrella, and thus had a smoother path toward reform. We tend to agree with those who argue that global leadership requires both hard and soft power, and that the latter is generally incompatible with many of China’s current policies. On the other hand, there are quite a few countries – think Russia, much of the Middle East, and elsewhere – that may find China’s approach to domestic control of the internet appealing, possibly resulting in a multi-polar technology world.
Of course, no one really knows how these issues will ultimately play out. What we do know is that if China can manage its internal challenges, it has a much greater chance of dethroning Silicon Valley than anyone in decades. For the last 50 years, the great majority of high-tech winners have been US firms. Over the next 50, this looks likely to change considerably. Right now, the clash of the titans looks like a pretty equal fight, and one that will only accelerate the global pace of technology innovation. Let’s hope the China/US rivalry stays contained within the marketplace, and doesn’t spill over into other, more worrisome, realms.
Some initial advice This LEF report argues that taking China seriously may very well change the nature and purpose of your company over time. To succeed, you will need to accept that you will have to adapt to China’s hyper-competitive environment, and that you will face new forms of competition, new styles of management and different rules. Perhaps most fundamentally, you should not look at China as an emerging market in which you can simply re-apply old business models because you have some weakness in existing markets. China will not save your firm from the ravages of US and European maturity and commoditization. In short, you shouldn’t treat China as just another geography; you should adapt yourselves to it.
8 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Introduction
Purpose “There is no general who has not heard of these Landscape five matters. Those who master them win; those who do not are defeated. Climate Therefore in laying plans compare the elements, Doctrine appraising them with the utmost care.” Sun Tzu Leadership
In this report we will examine the impact of strategic play at a national and global level. Obviously, this is a highly complex and daunting topic. But can we somehow cut through the complexity to find useful patterns that can be exploited? In previous LEF reports we’ve concentrated on specific technologies (e.g. cloud); how companies evolve (the next generation); the importance (and lack) of situational awareness and how to use weak signals (peace, war and wonder) to identify future points of change. All of this work has been context-specific.
The challenge in tackling global and national competition is two-fold: the context and factors involved are vast, and the subject matter is subject to bias. To reduce the factors to a consistent, manageable set for this report, we chose to spend relatively little time on the US and Silicon Valley, whose strengths and weaknesses are generally well known. Instead, our focus will be overwhelmingly on China. Additionally, we will use the five principles that Sun Tzu discussed inThe Art of War to gauge the progress China has made. These five principles are:
• Purpose – that which causes others to desire to follow you without fear and to have harmony with your goal
• Climate – the economic conditions including constraints, capabilities and trade
• Landscape – the environment itself including points of technology change and positioning (either through situational awareness or good luck)
• Doctrine – the system itself, the levers of control and the structures used
• Leadership – the ability to set a direction of travel
In the final section we will examine specific scenarios for particular technologies, and suggest approaches to competing with China.
9 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Purpose Existing beliefs
US-centric view of Economic Thought
How the US thinks China operates How the US thinks it operates
Marx Keynes Smith Hayek Friedman Centrally Laissez planned faire
less effective model most effective market model (’ communist‘) (’capitalist’) European-centric view of Economic Thought
How Europeans think China How Europeans think the US appears to operate appears to operate
Marx Keynes Smith Hayek Friedman Centrally planned
less effective at most effective market model less effective at national level? (’social capitalist’) national level? Interviews with 124 people, 2015
Perception of the environment depends upon the viewer.
The US view tends to be dominated by a ‘Washington model’ of how the economy should work. This appears to create incredulity over how China, with a more authoritarian and directed model, can succeed.
There are many cherished beliefs in Western management about the market – from the role of democracy to the mantra ‘innovate or die’. Our belief in this ‘Washington model’ causes confusion about how the Chinese ‘Beijing model’ operates. For example, it’s often difficult to reconcile the sustained rise of China with our beliefs about a centrally planned and authoritarian regime.
Our inability to accept that China might in fact be operating a different and more powerful model forces us to provide counter-arguments that such success is a blip, or simply cheap labour, or state intervention, or the copying of technology. But what’s often forgotten is that the US itself (and specifically Silicon Valley) developed from a history of state sponsorship of industry and an even longer history of state-sponsored copying of other nations’ technology4.
In China there exists an increasingly consumer-based business model that is both highly entrepreneurial and led by private industry. It is state sponsored in much the same way that a venture capital firm sponsors its companies. It has and does rely on technology transfers. However, according to Bloomberg’s 2015 ranking of the world’s 50 most innovative countries, China is now ranked second in high-tech (behind US) and third in patents (ahead of the US). This does not fit comfortably with a view of a country that simply copies others and produces at scale.
This bias in Western ideals can be illustrated by the major differences between US and European economic thought and understanding regarding the role of the state and the actual thinking of some of the world’s most famous economists (see figure above). Such misunderstandings barely scratch the very distinct cultural, philosophical and strategic differences that exist between the US and China. Hence, one of the risks for America is that so many of its economic experts refuse to acknowledge that China is based on a very different conception of an economic system and of how to achieve success. For this reason, they tend to talk about Chinese policy in terms of ‘market distortion’ rather than ‘effective gameplay’. Such thinking is becoming increasingly risky. 10 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Hubris and optimism e r
Positive Negative
China US Consumer confidence for the futu
2010 2011 2012 2013 2014 2015
Whilst both nations show positive business confidence in the non-manufacturing sectors (e.g. services), when it comes to consumers then the Chinese are far more confident than their American counterparts are about the future. However, the gap is closing as confidence returns to the US.
To complicate matters further, popular media feeds these biases. We routinely hear stories about larger-than-life CEOs and genius young entrepreneurs – stories that reinforce the view that the US market is a highly competitive and Darwinian environment led by mobile warriors and global ‘chess playing’ masters. While, of course, there are indeed many fine leaders and firms, these beliefs can very easily spill over into hubris. The cult of the individual and the arrogance this can create can blind even the most thoughtful executives to the early signs of major market change. To compound this, there is also the issue of whether executives are always working in the interest of the firm or of self.
In China, executive decision-making is more influenced by social obligations, combining both collective and self interest. Like the US, China is result-oriented and highly innovative in technology, business and management models (such as Haier’s organization of the company through cell-based structures) but this is aligned with considerable political and social will. The impact of such collectivism can help dampen the worst effects of executive hubris.
As shown in the figure, there are also marked differences in societal optimism. In many ways, economics is a confidence game, in that only those people who truly believe in a different, better future can find the passion and energy needed to pursue it. For many decades this optimism has been a great American strength. But especially since the major recession of 2008, US self-confidence has been challenged as never before, with many Americans now believing (and repeatedly being told) that the country’s best days are behind them. While these attitudes have improved a little in recent years, the level of pessimism is still worrisome. In contrast, after many decades of fear and even humiliation, China is now a confident, forward-looking nation.
11 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Mobility and inequality
Whilst inequality exists in both the US and China at comparable levels, in the US inequality is based upon class whereas in China it is related to geography and growth.
In the US, what matters is who your parents are. In China, it’s more where you are born.
In both China and the US there are serious social mobility issues, and income inequality is seen as a major challenge by roughly half of the population in each country. While the data varies between sources, both China and the US can be seen to have the ‘1 percent problem’, where a small number of people possess a highly disproportionate share of the national wealth.
In greater China, there are now 715 dollar billionaires5 and in both nations the IT sector is a major contributor to wealth creation, whether you are talking about a Jack Ma or a Jeff Bezos. However, in China, 95 percent are self-made billionaires, with only 5 percent inheriting their wealth. China is also the global leader for women in business with 49 female self-made billionaires, out of a total 73 in the world6. The concentration of wealth (in terms of GDP) is also lower in China than in the US.
More importantly, over the last 25 years China has lifted nearly 500 million people out of extreme poverty, which is the biggest uplift in human history and constitutes 76 percent of world poverty reduction7. Nominal GDP has increased 30 times and per capita income 25 times since 19908. It is estimated that by 2025, there will be half a billion people in China who are middle class (representing 37 percent of the population and exceeding the entire US population). China is currently set to dominate the middle classes with significantly lower percentage amounts of both extreme wealth and extreme poverty compared to the US9.
The inequality in China is primarily a geographic issue, with wealth mainly concentrated in the east, where the major economic zones were first created. Whilst China’s income inequality appears to be substantially higher than government statistics suggest, its nature means policies can be aimed at improving the situation. From 2010, early signs of such a change in policy direction have been observed10.
With this in mind, inequality in China appears to be a consequence of the mechanism of rapid economic growth rather than the structural issue it has become in the US11.
12 Large aircraft Large aircraft Microcircuits Microcircuits Vehicle parts Vehicle parts Cars Cars PCs PCs Chemical productsChemical products CPUs CPUs
Medical instrumentsMedical instruments CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Computer peripheralsComputer peripherals Climate Computer parts Manufacturing capability and trade
Computer parts Large aircraft Circuit breakers and panels Microcircuits Circuit breakers and panels Vehicle parts Cars TV and radio transmitters PCs TV and radio transmitters Chemical products Telecoms parts CPUs Medical instruments Telecoms parts Computer peripherals Power tools Computer parts Circuit breakers and panels Power tools TV and radio transmitters Toys and games Telecoms parts Power tools Toys and games Knitted outerwear Toys and games Knitted outerwear Luggage Knitted outerwear Luggage Footwear % comparison 1993 % comparison 2013 Luggage Footwear US China This comparison of the percentage of the total exports of both nations in 1993 and 2013 shows China has % comparison 1993 moved up the value% chain.comparison 2013 Footwear In 1993, the US dominated export of PCs and microcircuits between the nations. By 2013, China dominated. % comparison 1993 % comparison 2013 China is the world’s largest manufacturer, producing over 90 percent of the world’s PCs, 75 percent of the world’s solar panels and 70 percent of the world’s mobile phones. Manufacturing is a highly competitive and flexible ecosystem in which there exist tremendous economies of scale. Moreover, China benefits from both its exports and its rapidly growing domestic market. For example, China is the biggest manufacturer of cars (mainly through joint ventures) but also the largest consumer of cars.
But there are two significant changes in the Chinese manufacturing landscape that need to be considered. A decade ago, the majority of Chinese exports could be considered to be basic items, but today high-tech exports dominate. Using data from the United Nations Statistics Division12, we can compare the US with China by creating the export profile (percentage of total combined exports of both nations) shown in the figure above. In 1993, China mainly provided low-end exports (footwear, luggage, toys and games) to the US whereas the US dominated high-end, high-tech exports.
The same comparison for 2013 shows a different story. Whilst China has maintained its position regarding the lower-end exports, it has now made significant inroads into higher-end, higher-order value chains. It is not therefore enough to say simply that the market in China is growing; the nature of the market is changing and expanding into higher-value systems.
The second change relates to the geographical centres of production and the shift from the coastal regions towards central China due to improving communication and infrastructure. This internal market is a key battleground where Chinese manufacturers develop scale and capability before moving out to face global competition.
13 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Human capability and R&D
Uncharted Industrialized Visible
There are two aspects of human capability that Componentization need to be considered: R&D and competition.
Both require access to alue chain alue V capital and talent. Whilst R&D is inherently more risky, competition enables future R&D whilst reducing cost of failure.
Experimentation Competition
visible
n I Genesis Custom Product Commodity Evolution built (+ rental) (+ utility)
Another issue of scale is human capability. Behind China’s recent Nobel Prize for medicine, the first driverless business bus, the development of drone delivery services and internet start-ups, there exists a highly effective colossus of an education system. Over the last two decades the Chinese government has focused on increasing human capital and the transition from a manufacturing economy to becoming ‘innovation-driven’ by 2020, with the number of college and doctoral graduates rising rapidly over the last 15 years.
For example, in 1993, China accounted for just 2.2 percent of the world’s total R&D effort; in 2014 it represented 17.5 percent and it is expected to overtake the US by 202213. Similarly it has risen as a destination for corporate global R&D efforts: between 2010 and 2014 China matched the US in terms of number and volume of investments14, but internal R&D investment has increased by 46 percent in the last year and the number of companies represented on Strategy&’s Global Innovation 1000 list with HQs in China has increased from 8 in 2005 to 114 in 2014.
Whilst manufacturing capability is shifting inwards (in terms of both demand and converting rural areas to manufacturing), the intellectual centres are focused around the former manufacturing centres. Overall, though the US has long ruled in terms of human capital and innovation, it seems likely to be replaced by China, which will dominate many forms of manufacturing and R&D.
In practice, this means we’re likely to see both rapid development of novel concepts and rapid development and industrialization of existing concepts in China. Over time this acceleration will have a compound effect, as industrialization of established activities opens up new pathways for the development of novel concepts through componentization effects (see figure above).
14 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Financial, economic and government capability
Uncharted Industrialized Visible
There are two aspects of wealth to be considered: its necessity in both R&D and competition; and the potential for directed
Competition investment. alue chain alue V In the case of China, the Government acts as a huge venture capitalist, directing investment in areas of strategic interest. Directed
investment
visible
n I Genesis Custom Product Commodity Evolution built (+ rental) (+ utility)
China has vast reserves of wealth, with over $16 trillion of bank deposits15 and a trade surplus with the US that has gone from $6 billion in 1985 to $343 billion in 2014 (including $44 billion16 in August 2015 alone). China became the leading destination of Foreign Direct Investment (FDI) in 2014 ($232 billion)17 and China’s own total outbound direct investment (ODI) has increased significantly18 from $6.9 billion in 2005 to an expected $1 trillion in 201519. Perhaps most telling is that China’s investment in the US now exceeds that of US companies into China20. Furthermore, China’s external investment focus has shifted from resources such as oil fields and manufacturers to real estate and the services industry.
As for economic output, China exceeded the output of the US in terms of purchasing power adjusted GDP in 201421. However, as noted before, it’s not just volume but the nature that counts, and the Chinese government has a deliberate focus on developing ‘major scientific research and experimental facilities, to promote the extension of the value chain’.22
For example, whilst the US dominates sales of semiconductors (in 2014 the US had 51 percent and China 4 percent of worldwide semiconductor sales), when it comes to use then China is the biggest market (50 percent of the $336 billion global market in 2014). To address the lack of domestic semiconductor design and production (a potential strategic threat), the Chinese government has introduced a $150 billion investment plan with a view to establishing a world-leading semiconductor industry by 203023.
Overall, China has manufacturing, human and financial scale and we would expect to see future expansion into higher-order, more complex value chains.
15 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Constraints
Uncharted Industrialized Visible
If your own industry is Local Global less developed than a catch-up competitor then constraints can enable your industry to catch up and overtake.
alue chain alue V + Constraint Constraints can either be preventative measures (providing a safe haven) or, more effectively, restriction of underlying components.
Take out field with last man standing
visible
n I Genesis Custom Product Commodity Evolution built (+ rental) (+ utility)
We live in a world of limited resources that can be controlled and manipulated, for example through constraints. It is not sufficient to say that a nation with a larger population will in time have a larger market and so be advantaged. We need to consider not only China’s 1.4 billion population (compared to 320 million in the US) but also its consumption and control of the world’s materials.
It was not until 1993 that China became a net oil importer and only much later did demand begin to exert a significant impact on global resource markets24. Currently China consumes 60 percent of the world’s concrete (in the last three years it has consumed more than the US did in all of the 20th century25), 54 percent of aluminium, 50 percent of nickel, 49 percent of coal, 48 percent of copper and 45 percent of all steel. The supply of such materials is not unlimited; already the world is suffering from a shortage of sand26 – an essential component of toothpaste, solar panels, silicon chips and buildings.
There are a number of different strategies that China appears to have deployed to gain strategic control and security of supply over resources and related supply chains, either directly or with major producers or the competitive fringe27. These strategies include special relationships (often equity investment or agreement for future output), financial loans repaid through output (e.g. financial loans through the China Development Bank secured by the sale of resources28), the recent building of artificial islands in the South China Sea29 and the use of tiered pricing (for example, companies operating in China can buy rare earths used in electronics from smart phones to satellites at a lower cost).
An example of this investment and trade is the way Chinese companies invest in foreign infrastructure (pipelines, roads and railways), funded by loans secured on resource payments. For example, China has made significant investments in the development of Sudan’s oil resources and has a 40 percent share in Sudanese oil projects.30
According to Professor Brahma Chellaney, testifying before the US-China Economic and Security Review Commission in 2012, “China has pursued an aggressive strategy to secure (and even lock up) supplies of strategic resources like water, energy and mineral ores. Gaining access to or control of resources has been a key driver of its foreign and domestic policies.” 31
16 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
For more than 80 minerals tracked by the US Geological Survey, China is not only the major consumer but it dominates world production – for example, it produces more than 80 percent of the world’s antimony, magnesium metal and rare earths. The control of such resources enables China to move more easily up the value chain from raw materials to finished goods by providing an advantage to its companies through access. For example, many of these materials (including rare earths) are subject to export and mining restrictions (these apply particularly to foreign companies); and in 2007, the Chinese government ordered the development of strategic reserves and the stockpiling of a wide range of resources from copper to lead.
Furthermore, China has been seeking to conserve its own mineral resources and where possible rely on imports through beneficial agreements (such as loans repaid through output). Hence, even though China has substantial reserves of iron ore, it has banned exports and encourages iron ore imports.
Despite the strategic and often critical nature of many of these materials, US policymakers have tended to overlook their technological, political and economic importance, relying more on market forces. For example, the US has become dependent on foreign suppliers for all rare earth materials and with the closing of its own mines, it is now estimated that it would take 10 to 15 years to re-establish an effective supply chain for rare earths in the US.
When considering the economic climate – whether the growth of the market, R&D, foreign investment or the use of constraints – then China looks to be gaining the upper hand and certainly demonstrates a more co-ordinated strategic approach.
17 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Landscape Points of technology change
Product-to-product substitution Product-to-commodity substitution Type of discontinuity (+rental services) (+utility services) Example Apple vs BlackBerry Amazon vs IBM/HP Characteristics Threatens past? Yes Yes
Predictability Low (what, when) Moderate (what , when) Can we anticipate? No Yes Discovery Horizon scanning Situational awareness Warning signs Only when in play Many years in advance Inertia Moderate to high High Disruptive Yes Yes Key to defence Adaptability of culture Situational awareness Chance of Punctuated equilibrium Low High Co-evolution of practice Low High Increase in higher-order systems Low High Strategic Many (first mover, use constraints, co-opt, Options Few (acquisition, copying, abandon) patent coverage, ecosystem, open play etc.) Exploitable in advance? No Yes
Economic state Peace War
In the evolution of any act, there are two main forms of disruption. The first concerns product-to-product (substitution) discontinuity – for example, BlackBerry versus iPhone. The second is product-to-commodity (+utility) discontinuity, such as the ongoing battle between Android and iOS or the almost-completed battle of cloud infrastructure versus server products. The natures of these disruptive changes are very different and a list of the general characteristics is provided in the table above.
What should be noted in particular is the predictability of the changes. Product-to-product disruption is notoriously unpredictable and it cannot be effectively anticipated as it solely depends upon individual actors’ actions and the discovery of new properties relevant to end users. In contrast, the shift from product to commodity can be anticipated well in advance. This type of predictable disruption is exploitable; it is described by an economic state of ‘war’, a subject that was covered in our earlier report on disruption32. There are a number of weak signals that can be used to determine the onset of this state. (The figure on page 8 provides likely timings for the state of war in various technology fields.)
The impact of these points of change on any industry will depend upon the value chain of that industry. In this section of the report we examine a number of these points of change and contrast how well positioned the US and China are. The points of change that we will examine are: • Change that has already happened – the internet • Change that is nearing the end of the war – cloud computing • Anticipatable points of change that are rapidly approaching – robotics, 3D printing, immersive technologies • Anticipatable points of change that are far away – emerging technologies 18 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Internet
Market cap of top 20 internet companies by country of origin, Oct 2015 ($Bn)
Whilst the US leads by a considerable margin in 26% terms of the most ($448Bn) US valuable internet companies, the Chinese China market has developed 1% Japan rapidly and now 73% 0% accounts for 26% of ($1260Bn) Russia the total. In this field, however, China is ‘playing catch-up’.
In terms of wealth potential, China represents around 26 percent of the total market capitalization of the top 20 internet companies with groups such as Alibaba, Tencent, Baidu, JD.com and NetEase. Whilst these are rapidly growing, China is still playing catch-up in the internet field.
However, China has the largest33 number of internet users (twice the US number) and, according to official figures34, the number of broadband subscribers (780 million) is even greater. The scale of China’s online retail market also exceeded that of the US in 2013 ($295 billion vs $270 billion35) and has only widened since.
In Q2 201536, China’s online shopping market was estimated to be $136 billion (+ 40 percent YoY, 12 percent of total retail) with mobile online transactions accounting for $70 billion (+133 percent YoY). This compares to a US37 online shopping market of $84 billion (+14 percent YoY, 7 percent of total retail) with mobile online transactions estimated38 as $25 billion. Thus, China is not only the largest internet economy but also the fastest growing and more mobile than the US. However, it’s also far less evenly distributed across the market. For example, only 20 to 25 percent of SMEs in China are actively involved in selling online compared to over 70 percent in the US.
Growth of internet commerce is a key focus of China. Li Keqiang announced the Internet Plus39 action plan to “integrate the mobile internet, cloud computing, Big Data, and the internet of things with modern manufacturing, to encourage the healthy development of e-commerce, industrial networks and internet banking, and to help internet-based companies increase their international presence”. This includes over $6 billion of government funding for emerging industries, along with $182 billion over three years on increasing internet speed and extending internet services to rural areas40.
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Cloud computing
Cloud computing (IaaS, PaaS, SaaS) is firmly in the state of ‘war’ with the shift of computing resources from products to utility-like services. In the US, new entrants in this space dominate the field (for example, Amazon, Microsoft and Google in IaaS) and past giants based upon product solutions (HP, Dell/EMC, IBM) are struggling.
The Chinese government through the 12th Five Year Plan (FYP) in 2010 initiated a framework to provide support for cloud-based technology and related industries. But according to CSIA (China Software Industry Association) this has had mixed results due to ‘blind’ development, inefficient organization and hastily constructed projects41. However, there are significant and growing cloud providers in China that we should not underestimate. Instead, we should seek to understand the reasons for these early failures.
There are a number of likely causes. The shift from product to utility depends upon an act becoming widespread and well defined. In computing this started to happen in the US around 2003 after some 40 years of intensive development, resulting in the launch of cloud computing services in 2006. Though computing in China has expanded rapidly and started moving up the value chain in the last decade, it lacked this background and experience, as well as higher-order value chains and companies with large global enterprise footprints. Hence whilst China observed the point of change to cloud computing and desired to achieve a strong position in the computing industry by orientating around it (with investment and focus), it lacked many of the basic elements and cultural heritage (i.e. experience) necessary to effectively exploit it. This put China at a disadvantage and in ‘catch up’ mode.
However, in the last 12 months there have been signs that this has been changing. Aliyun (Alibaba’s cloud computing platform) has been operating since 2009 and is claimed to have over 1.4 million customers42. It recorded an 82 percent YoY growth43 in Q1 2015, striking a number of prominent partnerships, and opening its first overseas data centre (in Silicon Valley) in 2015. Aliyun represents around 22 percent market share of IaaS in China. It is being invested in heavily, with a further $1 billion in 201544, and whilst it is a minnow compared to Amazon Web Services (whose cloud computing revenue is estimated to exceed $7 billion in 201545), its growth rate is on a par.
Currently the IT market in China is around $140 billion a year, with cloud business worth $18 billion and doubling in size YoY46. Though foreign companies are looking to expand into this space, the Chinese government continues to maintain restrictions on investment by requiring parties to enter into partnerships with Chinese companies to obtain relevant permits. Looking at the export profile of the two nations, and taking into account that China represented 2 percent of PC exports in 1993 and 93 percent by 2013, the focus of the government on cloud, the speed of learning, the investment, the growth of the internal market and the constraints used; it is not unreasonable to assume that Chinese cloud providers such as Aliyun will start to impact the global market by 2025.
20 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Robotics
“Robotics designers in the US have long gotten their inspiration from both science fiction and biology, and Chinese engineers are no different, most especially those working on walking combat robots.” Jeffrey Lin and P.W. Singer, 2014
With crab walkers and ‘big dog’ clones, NORINCO (China North Industries Corporation) provided the first Chinese quadruped robot, autonomous underwater unmanned vehicles47, and land- and sea-based defensive unmanned aerial vehicles48 ($10.5 billion of investment), commercial drone delivery49, self-driving electric cars ($1.2 billion of investment in a Tesla rival50), quadcopters and self-driving buses.51 China is now the fastest-growing robotics market in the world; its industrial robot industry emerged in 2003 and it overtook Japan as the world’s largest consumer market in 201352.
Sales of robotic systems in China increased by 56 percent in 2014 to over 57,000 units, 25 percent53 of the global total, with approximately 17,000 units produced in China (an increase of 60 percent YoY). There are over 1,000 robot-related 54 firms across China including Shenyang Siasun, which introduced a smart assembly line for robots in September 201455. This was the first of its kind in China and can produce 5,000 industrial robots annually.
It is estimated that by 2017 there will be 400,000 industrial robots operating in China’s production plants, more than in the EU or North America, and by 2018 the annual shipment of robots in China is estimated to exceed that of the EU and North America combined, at over 150,000 units. China is predicted to become the leading manufacturer of robotics between 202556 and 203057, and the industry is currently supported by government policies including subsidies for companies who buy local-brand robots, and a national merger and acquisition fund to help Chinese makers acquire world-advanced technologies from foreign companies. Given that we expect robotics to start becoming highly industrialized around 2020-2025, China seems extremely well positioned to exploit this technology change.
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3D printing
“[This house] was 3-D printed inside WinSun’s factory, using a machine that turns construction waste and digital designs into precisely layered walls. That’s a production model that could upend labor markets, housing markets and the entire architectural design process.” Matt Sheehan, Huffington Post, April 2015
Since the mid-nineties, the Chinese government has fostered the 3D printing market. Currently China owns 8.7 percent of all 3D printers worldwide, ranks third in the numbers of 3D printing patents held and its 3D printing market is predicted to reach $1.6 billion in 201658, representing 22 percent of the global $7.3 billion market. In comparison, the US accounts for nearly 40 percent of all industrial 3D printing systems sold to date. However, China has been playing catch-up. According to Wohlers Associates, in 2003 there were ten companies in the US and three in China making industrial additive manufacturing (3D printing) systems, but by 2013 China had overtaken the US59.
Today, there are several major producers and over 100 smaller companies involved in a diverse market including biomedicine, architecture, materials and software60. Applications range from military use for repairing warships61 to 3D printed cars62 and houses – see the illustration above63. China’s 3D printing industry is also breaking new ground – from fully functioning hip replacements64 to the largest metal parts for aerospace65. The Chinese Ministry of Industry and Information Technology (MIIT) launched a National Plan for 3D printing that includes mechanisms to ensure that Chinese businesses keep up with technological advances and accelerate from playing catch-up to a position66 at the forefront of the international market by 2016.
The government is investing $1 billion into 3D printing across academia, state-owned enterprises and private business. It intends to put a 3D printer into every one of its 400,000 elementary schools67 and outpace the US by more than 3 to1 for public investment in 3D printing68. Thus, China is well positioned and considered to be growing faster69 than other nations in this important future field.
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Immersive technologies
“From the global perspective of the market, both China and the world are still in the early development stage of the VR industry. A star product that attracts a large number of consumers hasn’t appeared in any of the markets.” Wang Jingyi, iResearch Group in an article by Liu Shang, The Telegraph, 2015
Virtual reality: Testing the Three Glasses helmet (Picture provided to chinadaily.com.cn)
Immersive technology covers both virtual (VR) and augmented (AR) reality. These technologies are still far from industrialized and there is the possibility that VR technology may be disrupted by augmented70 products that have already established a stronghold in military, training, retail and engineering. The consumer VR market is expected to grow to anywhere from $4 billion71 (devices) to $20 billion (including content) by 2020, with the entire VR field (including applications and theme parks) hitting $16 billion72 to $30 billion73 within a total immersive market of $150 billion. The uncertainty in the figures is typical of a field that is still developing.
Chinese involvement in VR started in 199574 and today there are over 100 virtual reality HMD (head-mounted display) manufacturers in China. Baofeng alone is estimated to have sold 300,000 units of its first-generation VR headset in its first year. Sales of VR consumer devices in China are predicted to exceed $300 million in 2017; this represents up to 15 percent of the global market75.
In addition, China and the US each have a $22 billion gaming market, with China dominating growth (22 percent versus 3 percent)76. Taking together the use of VR in gaming, consumerization effects, China’s strength in smartphone manufacturing (10 of the top 17 smartphone manufacturers77 are based in China, which has over 200 manufacturers78) and the use of smartphones in VR, then it seems likely that China will grow to become the dominant player at least on the manufacturing side.
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Other emerging technologies
Advanced manufacturing These projects vary in scope and can include the use of robotics, virtual reality, IoT and 3D printing. China currently has roughly 100 major efforts in progress in various scientific research institutions and enterprises with the goal of expansion in 2016 and operation in 2017.
Internet of things The IoT market is forecast by IDC to reach $1.7 trillion in 2020 with China representing 59 percent of the market opportunity. The Chinese government has focused on this change since 2010, setting up nearly 200 economic development zones and local governments as ‘smart cities’ with a view to addressing pollution and congestion. $24 billion of government investment funds have been announced and in 2013 China became the leading market for M2M (machine-to-machine) communication when its IoT market exceeded $80 billion. It is now considered to be twice the size of the US market and is currently spearheading standardization efforts. There is significant activity and consolidation in China with companies such as Xiaomi planning to acquire many tech startups to expand its IoT ecosystem79. Kevin Ashton (considered to be the father of IoT) describes this as the first tech race that the US might lose80.
Nano and materials science China has a strong focus (see, for example, the UK-China Advanced Material Research Institute and the Beijing New Material Research and Development Center) on new materials science and the potential for disruptive impacts of superconductors, nanomaterials (such as nanocomposites and nanofibres), graphene and bio-based materials (for example in soft cell tissue repair) on industries. The development of such materials is considered to be a key strategic issue for China and since 2008, China has held the pole position worldwide for the number of patent applications in materials science. However, all is not rosy. Central South University is a world leader in new materials R&D, and though it has helped nurture a large number of fast-growing companies, it faces obstacles in terms of commercialization and the patent system. Too often technology is acquired by foreign companies and the patent system then used to apply costs to Chinese manufacturers.
Intelligent agents In 2015, Andrew Ng81 (renowned AI pioneer and former head of the Google Brain project) said that China’s fast-growing internet economy has created the conditions for the best AI research opportunities in the world. He has recently joined Baidu, which is engaged in a large-scale AI project split between China and its huge Silicon Valley research lab.
China has developed the first AI system capable of beating a human in a verbal IQ test82. Aliyun is launching the first cloud-based AI service in China (similar in concept to those provided by AWS and Microsoft). Baidu has launched an AI assistant similar to Siri. Whilst five years ago it could confidently be said that the US led the field of AI, that situation is radically changing.
24 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Doctrine Understanding China with OODA Loops
“Machines don’t fight wars. People do, and they use their minds.” Col. John R. Boyd “In manoeuvre warfare, we attempt not to destroy the entire enemy force but to render most of it irrelevant.” Lt. Col. Robert R. Leonhard
The OODA loop is a model that was developed by John Boyd from his observations of how US fighter planes (principally F-86s) could outmanoeuvre faster, more nimble MiG-15s. Boyd’s argument was that the pilots in the US planes had a greater field of vision that gave them a significant advantage through enhanced situational awareness. Boyd developed this model into a general structure (shown in the figure above) to explain most competitive environments. It is an iterative structure with four stages:
• Observe – collect information on the surrounding environment • Orient – analyze the landscape based upon past experiences, cultural heritage and any new information gathered • Decide – determine a course of action (a hypothesis) based upon the landscape • Act – test the hypothesis by following through with action
It is important to understand that the ‘orient’ step includes examination of not only the landscape but also the library of past experience. Where you have no past experience then you can only gamble (based upon your cultural traditions and genetic disposition – your willingness to take risks) and experiment (using a best-guess hypothesis) in order to develop past experience.
Orientation is therefore the critical step83 not only in determining decisions but also in learning. Thus China, whilst it might have observed future points of change (the internet, the cloud), lacked the heritage of past experience and had to develop this; hence it is playing catch-up and technology transfer is critical. But in immersive and IoT technologies, China has not only observed the change but has equal footing with the US. Here, its investment is targeted towards leading, not just catch-up.
25 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Government
“You need to be careful with immediate moves you take. That is to say, we need to take targeted measures to resist downward pressure on the economy, but at the same time we need to build momentum for sustainable and healthy economic growth.” Premier Li Keqiang, comparing the Chinese economy to a game of chess, September 2015
The common Western perception of China is one of a growing economy dominated by state-run enterprises that are somewhat ineffective. While there are many such bloated enterprises, the Chinese government’s overall operation is in fact more like the world’s largest venture capitalist focused on national interest (as opposed to short-term financial gain). In this effort it uses a distinct form of gameplay:
• Observe. Identify an industry that is ‘strategic’ either in terms of future development, or a constraint that can be used to gain advantage or limit the impact of foreign intervention. • Orient. Mandate and encourage the development of the industry domestically. This is achieved by developing an export industry (where a mature market exists) using Special Economic Zones and/or the creation of a hub (a centre of gravity) using Technology and Economic Zones. It’s worth noting that China appears to have become increasingly sophisticated in both the actions it takes and its awareness of whether it is playing catch-up or leading the market. This alone implies some mechanism for understanding the landscape (e.g. enhanced situational awareness and learning). To date we have not ascertained what that body or mechanism is beyond the NDRC (National Development and Reform Commission). • Intervene (act). This can include direct investment and encouraging the formation of joint ventures with both stringent rules on ownership and technology transfer in return for market access. Most recently, this approach has been extended to cyber security requirements forcing US companies to hand over source code84. IBM’s announcement of a partnership with a Chinese ISP to bring its Bluemix platform to China includes provisions that it will allow access to the underlying technology. The government also steers R&D efforts towards increasing future capabilities and skills. Though much of this is directed, it should not be viewed as isolated from the market but instead as enabling conditions. The Chinese government encourages many firms to develop in a hub for a specific industry. For example, 10 of the top 17 mobile handset manufacturers are Chinese, but there are over 200 handset manufacturers in China. The same pattern appears throughout robotics, materials science, immersive technology and IoT. • Leverage (act). Numerous mechanisms are used, from encouraging domestic demand to government procurement, platform services and protection of a fledgling market through constraints (e.g. import restrictions, delaying tactics and regulation) or two-tiered pricing or investment. One example, according to the European Chamber of Commerce in China, is the use of certification: “Compulsory certification in excess of what is reasonable is being used to keep foreigners out of the market and business license requirements continue to exclude foreign companies from entire sectors”85. 26 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
The companies that are involved in an industry compete for local demand. In effect, a game of ‘last man standing’ often develops, driving the industry towards more efficiency and commodity forms: • Expand (act). A fledgling industry that has been helped to develop and evolve to meet internal demand under intense competition is then encouraged to expand onto the world stage. The Chinese government is actively encouraging technology firms to ‘go global’86. At this point, constraints on foreign companies are often reduced, but only when highly competitive local firms exist. Xiaomi, Huawei, Tencent and Alibaba all developed in the intense local market under conditions that restricted direct foreign competition, enabling them to develop their craft, cultural heritage and experience before embarking on expansion.
This pattern of observation, orientation and then deciding to act through intervention with directed investment or by leveraging market forces or expansion onto the global market, is a signature of the ‘Beijing model’. It differs from the ‘Washington model’ in that the Chinese state takes a more entrepreneurial stance and is both willing and able to intervene. Whilst the more laissez faire approach of the ‘Washington model’ is argued to be more effective by some economists, the rapid rise and growth of China and its leadership in certain technology fields would argue otherwise. Data does not respect dogma in this case.
Within this general pattern, there are four aspects to be considered in more detail: structure, industrial policy, breadth of strategic play and entrepreneurship. These are discussed on the following pages.
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Structure
2006 Today
White Horse Village, a study by Carrie Gracie, BBC
China has 160 cities with 1 million or more people, compared to 10 in the US. It is important to understand the speed at which these cities have developed. Thirty years ago, Shenzhen was a small fishing village with around 20,000 residents; today it is a sprawling metropolis of more than 10 million inhabitants with the related necessary infrastructure. Over 200 of the global Fortune 500 have made investments in the city. Another example of such a transformation, documented by Carrie Gracie for the BBC, is White Horse Village – a small sleepy inland rural community in 2006 that became a city within a decade.
The Chinese government manages this scale with a mix of Special Economic Zones (SEZ), free trade zones, state-level National Economic and Technological Development Zones (NETDZ) and High-Tech Industrial Development Zones in order to foster and encourage technology and economic development. There are two basic forms of these ‘Zone’ instruments: inbound and outbound. The SEZs, for example, tend to be outbound instruments with the primary focus on growing the export industry. They provide tax incentives to foreign investment, and allow for JVs and wholly owned foreign enterprises that focus on developing export business and are mainly driven by market forces. Industrial Development Zones are metropolis-level and tend to be inbound, where the primary purpose is the replacement of imports with goods and services ‘Made in China’. The purpose of these zones is to enable industry clusters supported by local value chains and to promote skills development, training and knowledge sharing.
This last issue of knowledge sharing (including technology transfer) is critical, as the close proximity of similar value chains and related skills allows for the rapid development of new concepts and is key to developing future industries. Whilst a great deal of knowledge transfer comes through formal JVs and licensing arrangements, there is also much that is unauthorized and uncompensated.
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Industrial policy
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In China, multiple government groups are involved in co-ordinating industry policy from financing to research to education.
Education, for example, is seen as the key driver for future industries. In this area, China outstrips the US at an increasing pace.
For the last decade, the Chinese government has focused on moving the economy away from traditional industries to a more advanced technology-driven environment with indigenous innovation. The national ‘Medium and Long Term Plan for the Development of Science and Technology’ (known as MLP) intends to turn the Chinese economy into a technology powerhouse by 2020 and a global leader by 2050. It covers a wide range of key sectors, priority areas and emerging technologies87.
Government policy is currently focused on seven core SEI (strategic emerging industries) – biotechnology, advanced manufacturing, environmental, energy, materials science, emerging IT (including IoT and intelligent agents) and next-generation automotive. Guiding this development are a number of different entities including:
• National Development and Reform Commission (NDRC) – sets policy development
• Ministry of Industry and Information Technology (MIIT) – develops detailed plans for emerging industries
• Ministry of Science and Technology (MOST) – directs R&D and education efforts
• Ministry of Finance (MOF) – organizes funding
Co-ordination between central and local groups uses the concept of catalogues that outline which products and technologies are permitted, restricted, encouraged or even purchased through the Chinese government’s extensive procurement market.
Unlike in the US, the actions of such groups are closely coordinated. For example, innovation incentives (including funding) that are available to both domestic and foreign entities are often conditional on IP that is developed and/or owned in China. 29 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Breadth of strategic play
Focus Gameplay Known use
Confusion (choice, Education and Lobbying/ FUD (fear, Artificial User perception perception bundling and uncertainty, competition counter artificial needs) doubt)
Accelerators Market enablement Open approaches Exploiting Co-operation Directed (data, source etc) network effects investment
Decelerators Exploitation of Creating constraints Limitation of existing constraints Patents & IPR (supply chain) competition
Dealing with Forced update Disposal of toxicity liability
Exploiting buyer/ Harvesting and Market Innovation policy Pricing policy supplier power tech transfer Standards game Signal distortion
Threat acquisition Raising barriers Procrastination Defensive Defensive or replacement to entry and timing regulation
Creating a centre of Enabling Investment in R&D of gravity Purchasing policy
Undermining Fool's mate Attacking Last man standing barriers to entry (lower orders)
Ecosystem Alliances and Platform ILC Tower and moat 2 factor markets Embrace and Co-opting and co-creation enablement (sensing engines) extend intercession
Competitor Restriction of Talent raid Ambush Fragmentation Reinforcing Sapping Misdirection movement (circling) (tech drops) play competitor inertia (multiple fronts)
Positional Land grab First mover Fast follower Information (industrialization) (innovation) asymmetry
Designed to fail Poison Licensing play Insertion (community)
There are many forms of repeatable gameplay that can be re-applied between contexts. In the case of China, there appears to be common repetition of gameplay between different industries. This suggests a mechanism for situational awareness and organizational learning.
Chinese strategies tend to be long term and the variety of policy instruments that are used is significant. They range from ‘tower and moat’ (whereby local investment in strategic areas is combined with replacing foreign technology through restrictions and delays on both export and import) to the use of utility patents to negate foreign IPR advantage, and standards to act as artificial barriers. In examining Chinese policy, we found examples across the board of known repeatable methods (i.e. techniques that can be transferred from one industrial context to another) – as shown above. This suggests a deliberate mechanism for organizational learning along with moderately high levels of the situational awareness that is required to achieve this. Examples of common strategic plays across government and into industry include:
• Education and perception. China produces more engineering bachelors’ degrees than Japan, South Korea, the US, Taiwan, France and Germany combined, and twice as many doctorates of engineering as the US. Education is a key focus of the Chinese government. The Ministry of Education (MOE) takes a long-term view of education needs, with targets of 90 percent gross enrolment in secondary education and 40 percent in higher education by 2020. This is to be achieved through a mix of direct investment, private ventures and joint ventures,88 with investment tied to the strategic goals of the government.
However, another aspect is perception. Hollywood was a fundamental driver of the worldwide perception of the US as the heart of innovation, and a major promoter of the American dream. In China, the movie market is expected to surpass that of North America in 2017 ($11.5 billion versus $9 billion). This is not just an import business; ticket sales for local films increased 144 percent in 2013 (to $1.1 billion) whilst imports of foreign films slumped 21 percent ($670 million)89. “Ten years ago China was an afterthought as a market”90 – and this was a common view, but today it is driving 30 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
the global box office and has a rapidly expanding industry. The aspiration of Chinese producers91 – “We want to learn how to make movies that appeal to a global audience” – and the government’s desire to promote the ‘Chinese dream’92 are clear. It is not enough to have the capability; the Chinese government is focused on ensuring that the world perceives it as the heart of future innovation. Movies can help.
• Market enablement. As described earlier, this includes the use of special economic zones fostering the development of local, JV and foreign entities by providing tax incentives and loans.
• Centres of gravity. China is actively creating hubs such as its technology and economic development zones.
• Directed investment. Investment is directed at multiple components. For example, China will spend nearly $150 billion on subway systems in the next five years with plans for another 34,000 kilometres of network by 2020 at a cost of $730 billion.
• Standards game. China uses a mix of mandatory and voluntary standards covering national, professional, local and industry-specific needs. These standards can be used to restrict or delay the import of goods to force technology transfer – recent cybersecurity regulations require technology vendors to hand over secret source code and adopt Chinese encryption algorithms. China is also leading the development of standards in some areas, for example establishing an IoT standards association and promoting Chinese-developed standards internationally93. Standards games can often be used to create an advantage and impose costs on competitors.
• Investment in R&D. China is the world’s second biggest spender on industrial R&D with an exceptional growth rate of 18 percent annually94 and it is expected to overtake the US by the early 2020s95. Its high-tech exports (enabled by intensive R&D) exceeded the US in both value ($560 billion versus $147 billion) and growth rates in 201396. China has already moved ahead of the United States in various technological capabilities. For example, Chinese R&D demonstrates a specialization pattern that is different from global research patterns97. In China, the strongest and fastest-growing fields are engineering, physics, materials science, chemistry and biomedics, providing potential competitive advantage in these fields. By 2017, China’s government will spend98 twice as much on core biomedical research (a future indicator of industry growth99) as the US government. However, in other fields (such as the arts and humanities), China has not progressed to the same extent. China’s R&D is very specifically directed to end goals. In contrast, in the US, despite recent efforts to link federal funding to particular targets, the university- and market-driven nature of R&D means investment is less directed.
• Last man standing. Winning in the Chinese market requires efficient product costs including significant economies of scale, strong distribution channels throughout China and a good relationship with government. The market itself often develops internally, with a ‘last man standing’ effect as costs are driven down until losses put competitors out of business, before the winner expands into the global arena. This pattern has been repeated many times, internally and externally, for example in solar panels, rare earths and steel100.
• Information asymmetry. The cloud market in China could be worth anything between $2 billion in 2018101 and $20 billion in 2020102. It is often extremely difficult to get a realistic picture of the market in China – but this is not to say that the Chinese government doesn’t have a realistic view. This asymmetry of information means it is difficult for Western companies to effectively assess the markets they are entering. In contrast, in the US a more accurate picture is readily available across most markets.
• Purchasing policy. This strategy uses the government’s policy of purchasing through catalogues to promote specific industries and players.
• Talent raid. This includes the encouragement by the Chinese government of the creation of incubation and development facilities within Silicon Valley and direct competition for talent by Chinese firms.
31 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Entrepreneurship and entitlement
The US economy has become less entrepreneurial over time Firm Entry and Exit Rates in the United States, 1978-2011
16%
14% Firm entry
12%
10%
Firm exit 8%
6% 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011
Source: US Census Bureau, BDS; authors’ calculations
“Business dynamism is the process by which firms continually are born, fail, expand, and contract. Research has established that this dynamic process is vital to sustained economic growth. The national decline in business dynamism has been a widely shared experience.” Ian Hathaway and Robert E Litan, Declining Business Dynamism in the United States, The Brookings Institution, May 2014
Despite all that China is doing to compete in and win the innovation game, the West tends to see China as posing no real threat and simply being a large labour market that is good at copying. The US appears to have developed an attitude of entitlement and assumption that it will always lead – despite evidence across multiple R&D fields and high-technology industries suggesting this is not the case. This entitlement is a dangerous path. We should never forget that Spain dominated the world in the 16th century, Holland in the 17th, France in the 18th and Great Britain in the 19th. Whilst the US dominated most of the 20th century, it shows clear signs of economic bias, viewing its own economic model as the right model for innovation and investment, and dismissing an interventionist approach despite evidence of China’s rising dominance in multiple industries.
The signs of such entitlement can be seen for example in the August 2014 Wall Street Journal article proclaiming that Silicon Valley will continue to rule the tech economy103. The argument was that success breeds success, the Valley has the infrastructure and the people, that companies have shifted their research and development labs there, and that concerns about housing, lack of government spending on basic R&D and issues of social cohesion were no big deal. But alas, more foreign investment is going into China, it has greater education and manufacturing scale, and the US is increasingly dependent upon foreign talent. Many are concerned that Silicon Valley is hollowing out to a dangerous degree.
Excessive self-belief is not new. In June 2002, the Economist published a special report on China with the title ‘A dragon out of puff’ that concluded: “In the coming decade, therefore, China seems set to become more unstable.” In reality, China enjoyed record levels of growth and consistently outperformed even its own ambitious targets, resulting in the fastest growth of any nation in recorded history.
32 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Counter plays
“We do not like to compete against Chinese manufacturers.” Charlie Munger, Berkshire Hathaway, 2005 “The supreme art of war is to subdue the enemy without fighting.” Sun Tzu, c500 BC Counter play: An offensive position which counters an opponent’s advantage in another part of the battle.
The natural reaction to a change that goes against one’s beliefs is to deny that the change is happening. Alas, China is a large, growing and fiercely competitive market with global ambitions that cannot be ignored. But there are potential counter plays:
Adapt (commercial): Whether you are already working in China or not, the threat of technology transfer exists. The only way to counter this is to out-innovate. While you should also use patent protection, as Chinese companies are as aggressive as US firms in acquiring patents overseas, do not rely on it. Focus on working in co-operation with the Chinese way (e.g. through joint ventures or Chinese members on the executive board), becoming an enabler of change, encouraging rapid development within your organization, and adapting to a game of ‘last man standing’.
Adapt (national): In one sense this means adapting to the new reality of China and encouraging trade; in another it means learning from the approaches of the Chinese government and its breadth of strategic play. This means a more interventionist approach (including directed investment in research and identifying and focusing on core strategic assets) along with longer-term play is required. Past examples include ‘Freedom’s Forge’ and the ‘Space Race’, but the question remains whether the current bias towards the ‘Washington model’ can be sufficiently overcome.
Containment (national): The book The Red Queen among Organizations104 describes the process whereby a member of an ecosystem is forced to adopt changes that bring an advantage to other members of an ecosystem. However, there is a secondary effect in that the potential growth of any single member is limited by the adoption of changes by others. Hence, any balancing strategy should not be aimed at keeping China down, but at encouraging growth of other nations around China through financial investment, beneficial trade agreements and technology transfer. The Trans-Pacific Partnership (TPP) could be seen in this light, except that it seems more focused on reinforcing the IP approach of the ‘Washington model’ than encouraging complementary and sequential innovation.
33 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Analysis of Structural Factors
Factor Class Sub-class Today 2025
Existing belief Purpose Hubris and optimism Mobility and inequality
Manufacturing capability Human capital R&D scale Climate Financial capability Economic capability Government capability Constraints
Internet Cloud Robotics Points of technology Landscape change 3D printing Factor Class ImmersiveSub-class Today 2025 Existing belief IoT Purpose Hubris and optimism Factor Class Sub-class Today 2025 Mobility and inequality Other Existing belief Purpose Hubris and optimism Manufacturing capability FactorMobility and inequalityClass Sub-classGovernmentToday Human play capital 2025 Structure R&D scale ManufacturingExisting capability belief Climate Financial capability Purpose HumanHubrisDoctrine capital and optimism Industrial Economicpolicy capability R&DMobility scale and inequality Government capability Climate Financial capability Breadth of strategicConstraints play EconomicManufacturing capability capability Entrepreneurship GovernmentHuman capability capital Internet ConstraintsR&D scale Cloud Climate Financial capability Robotics Internet Points of technology Economic capability LandscapeAdvantage to US Advantage3D printing to China Neutral Government capabilityCloud change Immersive Constraints Robotics Points of technology IoT Landscape 3D printing change Internet Other Immersive Cloud IoT Our analysis of theseRobotics factors of purpose,Government playclimate, landscape and doctrine indicates that China will Points of technologyOther Structure Landscape 3D printing have changemany advantagesDoctrine in most of Industrialthese policyareas by 2025, when multiple points of change and periods Immersive Governmentof ‘war’ play will occur in IT. The figureBreadth ofabove strategic provides play our best estimate of who has the advantage from Structure IoT Entrepreneurship Doctrine Industrialnow policy to 2025. However,Other this does not necessarily translate into industry success. Rather, it points to Breadth ofChina strategic beingplay in relative ascendency. EntrepreneurshipGovernment play Structure Doctrine ToIndustrial understand policy the potential impact of this relative advantage in a particular industry, we would Breadth of strategic play needEntrepreneurship to examine its value chain and then plan different scenarios that consider the competitors, the landscape (i.e. the value chain itself), impacts of anticipatable points of technology change (the points of war), leadership and strategic play.
To provide clients with the mechanisms to do this for themselves, the next few pages of this report take the automotive industry as an example, using both the points of technology change graph (page 4) and the above analysis of potential advantage as guides.
34 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Leadership Automotive
Uncharted Industrialized Status Route A to B
Visible management
Comfort Affordable
Car
Infotainment Entertainment
HUD Screen IS Intelligent agents IoT
Maintenance
alue chain alue LBS V OEM Power supply Assembly Automotive, 2015 Design Sensors Simulation Pipeline Manufacturers CPU Known gameplay Fabrication Material
Point of war (product to commodity/utility)
visible
n I Genesis Custom-built Product (+ rental) Commodity (+ utility) Evolution
The figure above provides a simplified map of the automotive industry as it is now, starting from its two basic user needs – the desire to move from A to B, and status.
Fulfilling the desire to move from A to B has three sub-components: affordability, efficient transportation (route management) and comfort (including safety). All of these factors depend upon the car. This is shown as the pipeline at the top of the figure, from privately-owned cars through rental services to more commodity vehicles and utility-like services (such as Zipcar). One aspect of comfort is the desire to be occupied during the journey, either through the driving experience (not shown) or through infotainment or entertainment. All are dependent upon the information system (IS) available.
Interaction with the IS in today’s vehicles is through standard controls, usually a screen display or – much less common – a heads-up display (HUD). The IS itself will most likely provide access to location-based services (route planning/GPS) and maintenance information (power and performance instrumentation, fault detection). It may be derived from an intelligent software agent (though this is as yet uncommon) and/or include some IoT element. To keep things simple, this map does not examine the power supply system (fuel based, electric and hybrid).
The entire system is built by the car manufacturer (OEM) requiring assembly, sensors, design (including simulation of designs), manufacturers of components and processing capability (CPU). These in turn require fabrication methods and access to raw materials, some of which (such as steel and plastic) are commodities.
35 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Automotive: state of the industry
China overtook the US and became the single largest car market in the world in 2010. It now accounts for 35% of the global market.
Whilst the market is currently dominated by foreign JVs providing localized car production and design, China’s own car makers (e.g. Beijing Automotive Group) are rapidly growing.
In 1994, the Chinese government designated automotive as a ‘pillar industry’ and used a wide variety of techniques including JVs, industry clusters (hubs), import tariffs and subsidies to encourage the development of a local industry. An automobile is composed of more than 10,000 components and so the industry depends on many other industries from metallurgy to electronics105. In 2005, the Chinese market represented around 10 percent of global consumption (6 million cars). In 2010, it became the largest single-country new car market. In 2014, 23 million vehicles were sold in China (representing 35 percent of the global market) compared to 16.5 million in the US. In 2015 there has been a slowdown, decline106 and rebound in the domestic market (overall, the market is expecting 3 percent YoY growth), and alongside this has been the rapid development of a second-hand car market.
The automotive market in China has been largely dominated by international companies107 through the use of JVs108. However, by 2014, Chinese automakers won an estimated 40 percent109 of domestic car sales. Despite the slowing market, they are expecting to see 13 percent growth this year. Whilst the US exports more of both cars and auto parts to China than the reverse, in a recent milestone GM has announced110 it plans to become the first major automaker to sell Chinese-made cars in the US.
Both countries are heavily investing and developing self-driving vehicles and the use of intelligent software agents, with Baidu and BMW together planning to launch self-driving cars this year111. Both markets also have home-grown taxi hailing services – Uber and Didi Kuaidi, both of which have raised multi-billion-dollar investments and have global ambitions.
Didi Kuaidi dominates China112 with over 3 million rides per day (about three times the size of Uber) and is using a mix of strategic plays from ‘last man standing’ (heavy discount) to sapping (supporting Lyft with a $100 million investment to encourage competition in Uber’s home market113).
36 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Automotive: a possible future scenario
Uncharted A to B Industrialized Status Route
management Visible Comfort Affordable
Car
Infotainment Entertainment Immersive
IS
IoT Intelligent agents
LBS Maintenance alue chain alue V OEM Power supply
Automotive, 2025 Design Assembly Sensors
Pipeline Simulation Manufacturers CPU Known gameplay Fabrication Material
Point of war (product to commodity/utility)
visible
n I Genesis Custom-built Product (+ rental) Commodity (+ utility) Evolution
By 2025, a number of discrete ‘wars’ (points of industrialization from product to commodity) will have started or be well advanced, including IoT, immersive technology, 3D printing and robotics. Intelligent agents will have become a well-developed product closing in on the point of industrialization. This will have a number of discrete impacts on the automotive industry.
Self-driving cars will have become commonplace. In some areas, the benefits of such vehicles (principally collision avoidance) will have led to legislation banning the use of human-driven cars, with all the knock-on effects in ancillary transportation mechanisms (car parks, traffic systems, insurance) that this entails. Our relationship with cars will be changing and travel by car will be seen increasingly as a utility provided through services such as Didi Kuaidi, perhaps with the exception of very high-end status vehicles.
The car will have become more immersive – for example, windows will also serve as screens providing entertainment and information. OEMs will have adapted to providing this immersive experience, perhaps maintaining status differentials through subscription services that provide preferential route management (low status passenger cars moving out of the way) and access to premium design and content.
Vehicles will be highly instrumented and most communication will be M2M (machine-to-machine), whether co-ordinating movement with other vehicles, informing maintenance shops of existing or predicted faults, or providing routing information. The supply chain will have also altered, with assembly and maintenance becoming increasingly automated through robotic systems and construction mechanisms using digital fabrication techniques such as 3D printing. Whilst many of these changes will be in play, they will not yet have come to dominate the market.
37 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Automotive: gameplay
Uncharted A to B Industrialized Status Route management Visible Comfort Affordable Domestic demand Car
Last man standing Infotainment Entertainment
Immersive Strategic investment IS Strategic investment Dominant IoT Intelligent Robotics (Strategic investment) agents
LBS Maintenance alue chain alue V OEM Pillar industry Power supply
Robotics (Strategic investment) Design Assembly Automotive, 2025 Sensors Manufacturing scale Pipeline Simulation Manufacturers CPU Tower and moat Known gameplay Fabrication 3D printing (Strategic investment) Material
Point of war (product to commodity/utility) Constraint
visible
n I Genesis Custom-built Product (+ rental) Commodity (+ utility) Evolution
With the future scenario of the previous figure in mind, we can start to analyze how well China may or may not be positioned to take advantage. From the top of the figure above: • China is already the largest market for cars
• Didi Kuaidi is already the largest utility-like player in the market (exceeding Uber by a factor of three) and should be expected to play a game of ‘last man standing’ when expanding onto the global scene
• Immersive technology is already a strategic focus of the Chinese government with a rapidly growing market in both VR and AR techniques
• Intelligent agents are another strategic focus of the Chinese government, through talent and technology acquisition
• China is the largest market in IoT and leads the world with 193 development zones (hubs)
• China is the largest market in robotics and expected to become a leading manufacturer in 2025
• OEMs (automakers) are a key pillar industry that is rapidly growing
• China dominates microcircuits with manufacturing scale
• China is engaged in a ‘tower and moat’ exercise, with a $150 billion investment to replace existing dependence on semiconductors and become a leading player by 2030
• China has a vibrant 3D printing market and is outpacing US investment by 3 to 1 in a game of catch-up
• China dominates the main supply chains for key materials (including rare earths used in display technology, and steel, since automotive steel accounts for 12 percent of global steel consumption114 and China produces 49 percent of the world total) and can use constraints to advantage local development
In short, China appears to be well positioned for the future automotive industry.
38 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Trains
“China is in discussions with more than 20 nations including the United States, Russia, Brazil and Thailand on the export of high-speed railway technology and products.” Zhao Lei, ‘China’s high-speed rail network is on the global fast track’, The Telegraph, 21 April 2015
The price of entry into many lucrative Chinese markets is co-creation, which translates into production by local companies. This technology transfer is a normal operating mechanism of the Chinese economy and foreign firms cannot rely on existing IPR, as patent recognition between the US and China is a complex and reciprocal issue115. You must out-innovate rather than rely on IPR, and failure to do so can be costly.
For example, China is currently investing $730 billion ($128 billion in 2015116) in development of its railway systems including 16,000 km of high-speed rail track by 2020 and a high speed rail link from China to Iran117. In 2005, Siemens entered into an agreement to build 60 high-speed passenger trains for Chinese National Rail (CNR) including the training of technicians in Germany. The first three trains were built in Germany, the remaining 57 at CNR’s plant in Tangshan118. The following award for 100 trains ($5.7 billion) went directly to CNR whilst Siemens was provided with a $1 billion contract to supply components.
High-speed rail transportation equipment is one of ten key sectors that the Chinese government is prioritizing to improve manufacturing and export119. Total Chinese exports of railway equipment hit $4 billion in 2014 (10 percent of the global market120) and Chinese rail companies are involved in contracts in emerging markets worth $25 billion. CNR has now merged with others into the behemoth China Railway Construction Corporation (market cap $193 billion). It is larger than Siemens ($75 billion market cap) and has a history of developing high-speed rail at two-thirds the cost of its competitors121.
In short, within a decade, Siemens enabled a global competitor and is now facing a game of ‘last man standing’ against a larger and potentially cheaper foe that has the advantage of a rapidly growing domestic market and cutting-edge technology including a permanent magnet synchronous traction system122.
39 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Cloud computing
Uncharted Industrialized Visible
Domestic demand Application
Strategic investment
Strategic investment Internet Platform
Infrastructure Strategic investment management
alue chain alue Compute V Constraint
Data centres Storage Cloud, 2015 Tower and moat Network CPU Last man standing Pipeline Air Constraint conditioning Known gameplay Power
Point of war (product to commodity/utility)
visible
n I Genesis Custom-built Product (+ rental) Commodity (+ utility) Evolution
The figure above shows a simplified map of the cloud industry as it is today. The basic user need is for the delivery of applications as SaaS or built on PaaS (e.g. Cloud Foundry) or IaaS (e.g. utility compute). There is a constant pipeline of new applications that over time become more utility-like. PaaS has entered the utility domain (initiation of a war) whereas the war in IaaS is basically over – Amazon won, Microsoft came second and Google third. There is still debate over transitional structures (e.g. hybrid clouds using home-grown private structures) but the traffic is one-way. Open source efforts (e.g. OpenStack) have failed to dent the public space due to poor strategic play and the formation of a collective prisoner dilemma. Public cloud offerings by US groups (such as HP Helion) have shut their doors. However, does Amazon’s current leadership ensure future dominance?
Here we have a classic game of catch-up. The Chinese government has focused on cloud as a strategic industry. Large investments are being made in Tencent ($1.5+ billion), Alibaba ($1+ billion), Huawei ($1+ billion) and others. Local demand is rapidly growing and all these companies are now starting to expand outside China. Though there exist many JVs (including Mirantis and UCloud123) in China for cloud services, this again should be assumed to be a process of technology transfer (as with IBM Bluemix) and whilst OpenStack shows signs of decline in the US public arena, it is growing in China both in the public cloud and in the area of network equipment (expect future challenges to Cisco).
When examining the map above, with consideration of constraints and support of the government with a focus on expansion, and the fuel of local demand, then it appears reasonable to conclude that a highly competitive market grown out of China will start to challenge Amazon’s leadership by 2025. In this case, the beneficiaries of OpenStack will not be the US giants that once hoped to compete against Amazon, but a market led by Chinese firms.
40 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Aerospace
China is focusing on ten key sectors: • New information technology • Robotics • Aerospace • Ocean engineering • High-speed rail • Energy-efficient cars • Electrical equipment • Farming machines • New materials • Biomedicine
It is estimated that China’s current fleet of over 2,000 in-service aircraft will increase to more than 3,500 aircraft in the narrow body 150-seat segment alone and in total between 7,000124 and 8,000125 aircraft by 2030. China’s aviation market passed 100 million passengers in Q1 2015 and current IATA estimates are that China will exceed the US as the world’s largest passenger market in 2030126. China plans to build 73 new airports (a total of 244) by 2020127.
Aerospace is one of the ten key sectors targeted in the Chinese government’s ‘Made in China’ plan. This includes the design, manufacture and commercial operation of large aircraft that can compete with Boeing. The first flight of the narrow body Comac C919 is expected in 2016, with commercial flights scheduled for 2018. With an order book of over 500, industrial analysts are questioning whether the threat to Boeing is being underestimated128. As with high-speed rail, many of the key components are foreign-made in this early stage and the strategic play of the Chinese government is following an established pattern: an intervention phase encouraging growth in the domestic market before global expansion through exports by substantially undercutting rivals in a game of last man standing.
In this intervention phase, we’ve seen foreign players trade technology for market access in the aviation space despite the risks of being bypassed in the future129. China will invest $3 billion130 in an aviation hub focused on manufacturing and research, covering 30 square kms in China’s Hubei Province. It intends to build 50 more such hubs and there are signs of potential consolidation in the market (as happened in the train industry)131 along with early exports to emerging markets. Despite the complexity in aviation, given past examples (trains, solar energy and others) it does not appear unreasonable to believe that China will become a major competitor in this space by 2025.
41 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Biomedicine
“Many scientists believe that genetically modifying human embryos crosses an ethical line and should remain taboo.” The Guardian, 23 April 2015 “A team of scientists in China dropped a bombshell earlier this month, and almost nobody noticed.” qz.com, 23 April 2015
Progress here follows the consistent pattern of intervention, including opening China’s vast market to greater foreign investment through JVs (e.g. Amoy Diagnostics and Illumina132); biotech parks in Beijing, Shanghai and Shenzhen; and a direct investment programme including rapid increases in R&D spending (30 percent YoY133) at a time when US spending (though higher) has slumped and in cases been cut134. US government expenditure is currently estimated to be less than half that of the Chinese government135.
In 2009, China announced a major new drug innovation programme with $4.5 billion of funding. It has now produced over 3,000 patents and is targeting 100 new drugs (80 percent of the Chinese market is generics136) by 2020 from 15 national drug development hubs. China has also created funding programmes for commercialization and its industry shows growth rates of 25 to 30 percent with the goal of becoming a global power by 2050. Hutchison China MediTech (Chi-Med) expects that the first modern drugs developed in China will be submitted for approval in 2016, a sign of its growing potential137.
In the area of genetic engineering (anticipated industrialization in 2025-2030), China is often in the lead. China’s BGI-Shenzhen has the world’s biggest capacity for genome sequencing138, producing 25 percent of the world’s genomic data; in 2013 it acquired the US company Complete Genomics139. Chinese manufacturers are developing advanced DNA sequencing machines140 – Direct Genomics introduced the world’s first single molecule genome sequencer141. And Chinese companies are pioneering modified ‘micro pigs’, the world’s first genetically engineered dogs142, and even genetically engineered human embryos143.
More recently, the world’s largest cloning factory has been announced in China focused on cloning cattle in order to feed China’s ‘rocketing demand for beef’144.
42 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Energy – renewable and nuclear
“China is building the largest solar power plant on Earth, and it’s going to be nearly the size of Bath, [it] will cover 25 square kilometres.” metro.co.uk, 4 August 2015
China is not only the largest producer of solar panels (70% of world total) but also the largest and fastest growing consumer.
The world’s demand for energy is expected to rise 37 percent by 2035, and much of this is related to the continued growth of China’s economy. Not surprisingly, China is heavily investing in energy (in 2014, the State Grid invested $67 billion in electricity transmission systems) but even so is predicted to become the world’s largest energy importer by 2035145.
China has 30 nuclear power reactors in operation, 21 under construction, 43 planned and 170 in various stages of proposal146. China’s National Nuclear Corporation plans to invest $120 billion by 2020 and nuclear is seen as a key energy source over the next 15 years. China is self-sufficient in reactor design and construction and the current policy is to export nuclear technology including to the UK. China’s R&D in nuclear technologies is considered to be ‘second to none’147 and it is currently leading world research on thorium reactors. While the US accounts for more than 30 percent of operational nuclear power worldwide with 99 reactors, it has just 5 more under construction148.
China is also the world’s largest producer of solar panels (70 percent of capacity). It used ‘last man standing’ (through subsidized government loans) to expand solar production, causing prices to hit historic lows and pushing many competitors out of business. In 2015, China became the largest market for consumption, accounting for 25 percent of new solar energy (approx. 14 GW)149 compared to 8 percent in the US. Around 80 percent of China’s solar power is provided through large solar farms.
China is also the world’s largest producer of wind power with nearly half the world’s total production (four times the US)150. Chinese turbine OEMs account for 80 percent of the domestic market, and eight are in MAKE’s top 15 global rankings151. Chinese industry is also the leading employer in renewables with 3.4 million people152 (the US has over 720,000).
43 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Leadership: A Future View
Factor Class Sub-class Today 2025 Factor Class Existing belief Sub-class Today 2025 Purpose Hubris and optimism Factor Class Sub-class Today 2025 TechnologyMobility and inequality Cloud Existing belief Transportation Auto Purpose Hubris and optimism Manufacturing capability Train FactorMobility and inequalityClass Sub-class Today Human capital 2025 R&D scale Aero ManufacturingLeadershipExisting capability belief Climate Financial capability Purpose HumanHubris capital and optimism RenewableEconomic capability Nuclear R&DMobility scale and inequality Government capability Solar Climate Financial capability Constraints EconomicManufacturing capability capability Wind GovernmentHuman capability capital Biomedical Internet ConstraintsR&D scale Cloud Climate Financial capability Robotics Internet Points of technology Economic capability LandscapeAdvantage to US Advantage3D printing to China Neutral Government capabilityCloud change Immersive Constraints Robotics Points of technology IoT Landscape 3D printing change Internet Other Immersive “The victorious strategistCloud only seeks battle after the victory has been won.” IoT Robotics Government play Sun Tzu Points of technologyOther Structure Landscape 3D printing change Doctrine Industrial policy Immersive Government play Breadth of strategic play Structure IoT Entrepreneurship Doctrine Industrial policy Other Breadth ofAccording strategic play to James Bullard, President, Federal Reserve Bank of St Louis,153 “The US would be playing EntrepreneurshipGovernment play a roleStructure to China similar to the role the UK plays to the US today” and “it’s probably only 25 or Doctrine 20Industrial years policy away”. From our analysis so far, we conclude that by 2025 China will continue its expansion Breadth of strategic play upEntrepreneurship the value chain, becoming a leading manufacturer in the auto and technology industries, and a major player in nuclear, aerospace and biomedicine, though it’s unlikely to have reached the dominant state in the last three. China’s policy of focusing on key strategic areas, intervention into the market, and encouraging domestic growth before expansion onto a global stage, appears to be working and the figure above provides our best estimates for the change.
For most LEF clients, China is not a market that can be ignored and it must be considered as a partner. Technology transfer and the growth of domestic manufacturers with indigenous innovation should be considered a normal part of operating in this market. It can be countered through not just increasing the pace of innovation, but effectively industrializing existing components and developing a deep understanding of your own value chains including context and forms of strategic play.
There are also actions that nation states can take – including directed investment, specialized patterns within R&D and containment mechanisms. However, this requires more of an interventionist approach and adoption of a ‘Beijing’ rather than a ‘Washington model’. Such an approach requires skill and finesse beyond the blunt and protectionist instruments of the TPP or Donald Trump’s proposed tariff on China.
As to the question of whether China can dethrone Silicon Valley, it’s important to recall that the Valley’s history also depended on government spending – from the original contract with the Federal Telegraph Company to the formation of the ‘Wireless’154 valley, the investment in the growth of HP and the formation of Fairchild Semiconductor by the ‘Traitorous Eight’. Its managers later created various companies (known as the Fairchildren) from AMD to Intel, another organization that benefited in its early days from government funding155. Over 2,000 firms including Google and Apple can trace their origins back to those eight co-founders156. Washington has used the ‘Beijing model’ more effectively than is generally acknowledged today – from the Manhattan Project, to space, and most recently, Sematech.
Today, there are more than 100 Silicon Valley ‘unicorns’ (privately held start-ups with $1 billion valuations) but there are also increasing concerns that many are over-valued, and widespread speculation about a second dot.com bubble. Whilst no one can know the future, this precarious situation is occurring at a time when many traditional IT leaders are struggling, and China is launching a challenge that exploits future points of technology change.
44 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
We’re clearly in unknown territory, and while on their own many parts of Silicon Valley do not look well positioned, no doubt some counter-moves will emerge. Many of these are likely to involve alliances with other nations, as everyone seeks to adjust to a changing landscape. Korea and Japan certainly hope to compete effectively with China in many hardware markets, while India does not want to be limited to its traditional strengths in software and services. The role of other nations, particularly the technology industry in India, will be an important area of future LEF research.
45 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY? Competing with China Purpose and action
Purpose The Game
To compete, we need to Landscape combine elements of Sun Observe Tzu and OODA. Climate We need to understand the game, to observe the landscape and climate, Act orientate ourselves with appropriate doctrine, and play the game. This we Doctrine Orient must do in an iterative fashion.
Leadership The Play (Decide)
Purpose is that which causes others to follow you and provides a moral imperative for your action. But purpose is ultimately an idea, and in the world of business it is transient, the result of past strategic play. Nokia didn’t start out as a telecoms company; it was first a paper mill then a rubber company. Its purpose has changed because of its actions. There is no ‘why?’ to purpose in this sense other than ‘we arrived here for various reasons, where next?’ and ‘we wish to survive’.
It’s important to understand this distinction because we often describe purpose as our ‘core values’, but in order to survive you have to adapt, or in the parlance of Silicon Valley, pivot. Take Odeo, which started as an MP3 sharing service before eventually becoming Twitter. Similarly, Ludicorp, an online game company, created a new purpose for itself when it launched Flickr. For both companies there was a point in time at which a choice changed both their purpose and the game they were playing.
Strategy is fundamentally about deciding between choices in the prevailing environment. This requires us to understand our environment, the landscape and our heritage and to choose between here and there. Strategy is about answering the question ‘why here over there?’ and the decision you make will impact your cultural heritage and so your purpose.
Hence, before embarking on a venture into China you must accept that you will need to adapt in a hyper-competitive environment, and that you will face new forms of gameplay, new styles of management and different rules. Competing in China may very well change the nature and purpose of your company. You should not look at China as an emerging market in which you can simply re-apply old business models because you have some weakness in existing markets; China will not save your firm from the ravages of commoditization in US/European markets. You cannot ignore China; you must adapt to it.
46 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Preparation via value chain mapping
Customer Uncharted Industrialized
Aggregator Leisure time Visible
Content Branded
Commissioned Acquired Content pipeline
Artistic Internet Traditional media direction broadcast WHERE? Website (DVDs etc) + Constraint
Creative studios Streaming + Constraint alue chain alue Recommendation Service V engine Why? Production talent (strategy) Market Analysis + Constraint Web server + Constraint CRM WHERE?
Production Compute systems
Open Power
visible
n I Genesis Custom- Product Commodity Evolution built (+ rental) (+ utility)
A map showing a form of gameplay known as ‘Fool’s mate’ applied in the media industry. The desire is to drive a component (creative studios) towards more commoditization, but a direct attack will face resistance. Attacking an underlying component (production systems) achieves the same end.
Whether you are competing in China, against China, or both, you will likely face some of the most complex and high-stake strategic decisions in business today – joint ventures, technology transfers, intellectual property sharing, government oversight and more. Making good decisions in this environment requires more than seeking to expand your current business model, or following strategies that seem to have worked for others. New decision-making approaches will often be required. We think our value chain mapping processes can be of significant help.
Maps can help your firm both better understand its situation and become sufficiently fit for the fierce and dynamic competition ahead. In regard to the former, maps enable companies to better anticipate how their overall value chains are likely to evolve – from changing user needs to the key underlying components. Accelerating the industrialization of key components is a particularly important aspect of many Chinese technology strategies.
In terms of fitness, maps help by making it much easier for companies to build consensus in identifying needless duplication and potentially dangerous sources of bias. Additionally, once value chains have been broken down into their discrete components, new ways to address discrete challenges with smaller, more agile teams often emerge. Where possible, these components should be reused by adopting a platform strategy based on microservices.
Once firms gain sufficient hands-on mapping experience, they will naturally start to think more directly in terms of the strategic challenges addressed in this report. These include: seeing the competitive chessboard, anticipating major future changes (points of war), exploiting anticipatable disruption, and using (and responding to) the many forms of proven strategic gameplays. These are the best ways we know to prepare for the many challenges and opportunities that China presents.
As Sun Tzu observed some 2,500 years ago, “The general who wins the battle makes many calculations in his temple before the battle is fought.” 47 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
Bibliography
This report provides a small window into the world of Chinese technology competition. There are clearly many additional market aspects and sources of background information, and so a bibliography of useful (if often contradictory) texts is provided for those works that have been influential in writing this report.
History Kenneth Pomeranz, The Great Divergence: China, Europe and the Making of the Modern World Economy, Princeton University Press, 2000 Peter Frankopan, The Silk Roads: A New History of the World, Bloomsbury, 2015 Richard Baum, The Fall and Rise of China, The Great Courses, 2010
Strategy and Philosophy Sun Tzu, The Art of War, various translations Roger Ames, Sun Tzu: The Art of Warfare, Ballantine Books, 1993 Ezra Vogel, Deng Xiaoping and the Transformation of China, Harvard University Press, 2011 Francois Jullien, A Treatise on Efficacy: Between Western and Chinese Thinking, University of Hawaii Press, 2004
Economics, Technology and Political Thought The Wit and Wisdom of Lee Kuan Yew, Editions Didier Millet, 2013 Alex Josey, Lee Kuan Yew: The Crucial Years, Times Books International, 1968 Jonathan Fenby, Will China Dominate the 21st Century?, Polity Press, 2014 Daniel Bell, The China Model: Political Meritocracy and the Limits of Democracy, Princeton University Press, 2015 Martin Jacques, When China Rules the World: The End of the Western World and the Birth of a New Global Order, Penguin, 2009 Robert Kaplan, Asia’s Cauldron: The South China Sea and the End of a Stable Pacific, Random House, 2014 Ben Chu, Chinese Whispers: Why Everything You’ve Heard About China is Wrong, Weidenfeld & Nicolson, 2013 Jeffrey Towson and Jonathan Woetzel, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories, Towson Group, 2014 Edward Tse, China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies are Changing the Rules of Business, Portfolio Penguin, 2015 David Moschella, Waves of Power: The Dynamics of Global Technology Leadership, 1964-2010, AMACOM, 1997
General Economic Thought Mariana Mazzucato, The Entrepreneurial State: Debunking Public vs Private Sector Myths, Anthem, 2013 William Barnett, The Red Queen among Organizations: How Competitiveness Evolves, Princeton University Press, 2008 Peter Drucker, The Age of Discontinuity: Guidelines to Our Changing Society, Heinemann, 1969
48 CLASH OF THE TITANS: CAN CHINA DETHRONE SILICON VALLEY?
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153 Michael S Arnold, Americans Must Adjust to a World Dominated by China – Fed’s Bullard, The Wall Street Journal, 28 March 2014 154 Steve Blank, The Secret History of Silicon Valley, Core Magazine, Computer History Museum, 2009 155 Stephen B Adams, Silicon Valley’s Long History of Government Codependence, Bloomberg View, 11 June 2013 156 Rhett Morris, The First Trillion-Dollar Startup, TechCrunch, 26 July 2014
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