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China's Venture Capital Industry and Technology-Based

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China's Venture Capital Industry and Technology-Based Working Papers R & D CHINA’S VENTURE CAPITAL INDUSTRY: INSTITUTIONAL TRAJECTORIES AND SYSTEM STRUCTURE by S. WHITE* J. GAO** and W. ZHANG† 2002/122/ABA * Assistant Professor of Asian Business, INSEAD, Boulevard de Constance, 77305, Fontainebleau Cedex, France. ** School of Economics and Management, Tsinghua University, Beijing, China. † School of Economics and Management, Tsinghua University, Beijing, China. A working paper in the INSEAD Working Paper Series is intended as a means whereby a faculty researcher's thoughts and findings may be communicated to interested readers. The paper should be considered preliminary in nature and may require revision. Printed at INSEAD, Fontainebleau, France. Kindly do not reproduce or circulate without permission. China’s venture capital industry: Institutional trajectories and system structure Steven WHITE* INSEAD [email protected] and Jian GAO and Wei ZHANG School of Economics and Management Tsinghua University Beijing [email protected] [email protected] *corresponding author ABSTRACT The current structure of China’s venture capital industry is a recent phenomenon emerging from decades of government-led technology policy and a still-transitioning business system. This paper first traces the institutional and policy trajectories that have led to the current complex system in which technology-based new venture firms are being created and financed. It then compares the types of venture capital firms—government, corporate, university and foreign- backed—that have emerged in recent years as the primary agents financing new ventures in China. Case studies of venture capital firms and ventures that have been funded by them are used to identify general trends and important challenges to China’s current system for establishing and nurturing new technology-based firms. This research was supported in part by a grant from INTECH of the United Nations University, and this paper was prepared for the International Conference on Financial Systems, Corporate Investment in Innovation and Venture Capital held in Brussels, 7-8 November, 2002. 1 INTRODUCTION The Chinese government has always seen science and technology as a critical part of its search for economic development and national security. Venture capital in the Chinese context, therefore, has been promoted not as a means to private gain, but as a critical mechanism for linking scientific and technological capabilities and outputs on one hand, with national and regional economic and social development on the other. No longer, however, do policymakers or analysts ask the naïve question of whether China’s venture capital industry will follow the “Silicon Valley model”, that of some other country or region, or develop into a distinctive “Chinese” model. Although still developing, China’s venture capital industry is clearly an outcome if its particular combination of political, economic and social institutions1 and the nature of the broader changes it has been undergoing during its transition from central planning to a more market-based business system. China’s venture capital industry, including the total set of related actors and institutions, has undergone a dramatic transformation over the last two decades. Because of it starting conditions—in particular, its legacy of inefficient central planning and socialist ideology—the results of this transformation seem particularly striking. The system that has emerged so far is highly complex in terms of variety and number of organizational actors, as well the multiple dimensions on which these actors are linked (Figure 1). This complexity is increased because all of the organizational and institutional elements are themselves changing in response to policy, technological and other developments. Although still in flux, the system has already generated impressive results in terms of sheer scale (see Table 1). It now includes 86,000 new technology-based ventures employing 5.6 million and generating revenues of RMB 1.5 trillion. Supporting them are over 200 venture capital firms, at least 130 publicly listed firms, 465 technology business incubators, and 53 high- tech zones, as well as the central bureaucracies and provincial and municipal governments. This paper examines the development, structure and key issues facing China’s venture capital industry and its impact on new technology ventures. Although by no means stable in terms of structure or dynamics, we are able to discern certain trends and trajectories. We are also able to understand the nature of the outcomes of this system to date regarding the development of new technology ventures, various forms of venture capital firms and 1 In this paper, we use the term “institutions” in the sense of North (1990), as “rules of the game” and including disembodied systems of practices, norms, and regulations; the legal system and financial system are in this sense institutions; in contrast to Nelson (1992) and others who use the term to indicate actors (such as universities) or a cluster of actors (educational system). 2 organizational structures supporting them. We relate these features of the system to indicators of its performance, as well as the current and emerging issues affecting its further development. POLICY AND STRUCTURAL LEGACY Venture capital represents a set of major institutional and organizational changes in China, especially compared to the central planning system operating into the 1980s. The timeline in Table 2 presents the major policy and business developments related to China’s VC industry since 1984. Although the result has been dramatic, the series of changes are best seen as evolutionary and primarily driven by China’s larger objective of national technological and economic development. As such, key changes in China’s science and technology policy and business system structure during the transition era can be linked to the emergence and nature of China’s venture capital industry. In this context, venture capital is simultaneously an extension of prior policy trajectories, as well as a potential answer to problems that other policy initiatives have not been able to solve. Three changes during the transition from central planning to the (still evolving) market- oriented business system2 represent the principle policy and structural antecedents for China’s venture capital industry. First, a growing number of policymakers and ministries have developed an increasingly sophisticated perception of cause-and-effect relationships linking technological and economic development. By the late 1970s, pragmatic leaders had recognized the inefficiencies and lower effectiveness of a centrally planned economy in practice. The R&D system in China under central planning and lasting until the early 1980s comprised a large number of organizations specialized in particular industries and in specific stages in the value chain (i.e., research, development, manufacturing, distribution, etc.), each answerable to one or several parts of the central and often local government, but with little or no horizontal linkages and information flows between these functionally specialized actors. Innovation was primarily initiated by central government ministries and bureaus, within the guidelines of the State Planning Commission’s (SPC) national plans. These bureaucracies claimed both authority and responsibility for initiatives such as technological development, adoption, upgrade or transfer, as well as for definition of production output and distribution. Accordingly, science and technology development efforts were driven by policy objectives, and from 1956 the priority was on developing research and production capabilities in atomic energy, electronics, semiconductors, automation, computers and rocket technology 2 For a fuller account of this transition in China’s national innovation system, see Gu (1999), Liu and White (2001). 3 (McDonald, 1990), and it also injected massive resources into ultimately successful mission projects, developing atomic and hydrogen bombs (1964, 1967 respectively) and launching satellites (1967). This system structure and innovation dynamics stands in stark contrast to that of most developed countries, in which large firms play a central role in R&D, undertake activities across the value chain (although certainly not completely independently), and make their own decisions regarding science and technology initiatives, funding and outputs. The complete dependence on the central government for targeting and providing resources for innovation, however, created an environment in which there were no incentives for organizational actors in the innovation system—research institutes and manufacturers, in particular—to introduce, adopt or diffuse innovations proactively. There was no market competition, profit, nor other operational efficiency-based criterion for their performance. In this context, many of the reforms introduced in the 1980s can be interpreted as the central government’s willingness to experiment with a new institutional structure that would be more effective at introducing, transferring and exploiting new technology. The emergence of a few successful entrepreneurs—for example, Stone Electronics—also spurred the central and local government to re-examine its S&T policies and related institutions. The first wave of reforms in the 1980s had two objectives. The first was to increase science and technology outputs, reflecting the assumption that a greater supply of technology would lead to greater diffusion and implementation,
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