Perspective Edward Tse Kevin Ma Yu Huang Shan Zhai A Chinese Phenomenon Contact Information Beijing Yu Huang Senior Associate +86-10-6563-8300 [email protected] Greater China Dr. Edward Tse Senior Partner +86-10-6563-8300 +852-3650-6100 +86-21-2327-9800 [email protected] Hong Kong/Shanghai Kevin Ma Principal +852-3650-6100 +86-21-2327-9800 [email protected] Kate Li, a Booz & Company associate, also contributed to this Perspective. Booz & Company EXECUTIVE Shan Zhai is becoming a widespread phenomenon in China. SUMMARY Originally used to describe a bandit stronghold outside government control, the term “Shan Zhai” today refers to businesses based on fake or pirated products. However, it does not stop there. Many businesses with humble Shan Zhai origins are now becoming formidable market disrupters and, in many cases, market leaders. The innovative nature of Chinese culture and the huge potential in the Chinese market create vast opportunities for Shan Zhai companies. The best of them are fast, flexible, innovative, and willing to take risks. As they achieve certain scale, they quickly move up the value chain and develop core competencies to differentiate themselves from the also-rans. The Shan Zhai phenomenon is not about low-cost fake products anymore; it is about how one type of Chinese company achieves success without following conventional wisdom and develops competitive advantage through innovation. Booz & Company 1 WHat is SHAN Ms Yang, a Beijing office worker, Perhaps the most impressive aspect shows off her new mobile phone of the phenomenon is the rise of ZHAI? to her co-workers. It boasts all the a number of successful Shan Zhai features of a “typical” handset: companies. Often starting from touchscreen, camera, MP3 and video scratch, Shan Zhai businesses can players—but it offers a lot more evolve with astonishing speed to besides. Shake it, and its wallpaper challenge incumbent players in changes automatically. Dial in, and mature industries. Understanding lights on the sides flash in sync with how they function is important for the most popular ringtones. But foreign managers for two reasons: this is not a Nokia, a Motorola, or First, because they leave no room a Samsung. In fact, it has no brand for complacency—today’s backyard name at all and costs just 480 yuan imitator might tomorrow be eating (US$70), about a fifth the price of your lunch. Second, because the similar “branded” products. This is success or failure of Shan Zhai what is called a Shan Zhai model in businesses is predicated almost China. uniquely on their ability to disrupt the status quo by inventing new and The term Shan Zhai (山寨) is often ingenious business strategies widespread in China. Originally used tailored specifically to the local to refer to a bandit stronghold outside market. These can be illuminating for government control, it has today foreign managers looking for ways to become shorthand for fake or pirated improve their own business models. products, though it can also refer to anything improvised or homemade. Mobile phone maker Tianyu, for From mobile phones to digital example, whose knockoff handsets cameras, wine to medicine, New Year target trendy but value-conscious galas to movies, Chinese consumers buyers, has emerged from nowhere encounter Shan Zhai in almost every to become a major player in China. corner of their daily lives. Nokir and Not only did it take Tianyu just two Samsing Anycat mobiles, Pahetohic years to overtake top domestic player TVs, and Wetherm skin cream are Lenovo, but the company is now just a few examples. Shan Zhai was closing the gap on foreign giants such even the subject of a heated debate at as Nokia, Samsung, and Motorola this year’s National People’s Congress and moving aggressively into overseas held in Beijing in March, with some markets. BYD, a local battery and members deriding the vast number automotive manufacturer, is another of Shan Zhai goods as low-quality standout. After starting out making counterfeits, while others advocated half-price imitations of best-selling more tolerance given the benefits of Toyotas, the company has grown Shan Zhai to Chinese society. into one of China’s most successful automotive manufacturers and today Often starting from scratch, Shan Zhai businesses can evolve with astonishing speed to challenge incumbent players. 2 Booz & Company also ranks as a global leader in car- battery technology and dual-mode drive-train systems. Future Cola, once labeled a cheap copycat of Coca- Cola, has grown to become the third- largest player in the local carbonated soft drinks market, right after Pepsi. Finally, QQ, originally a Shan Zhai version of ICQ, has now become China’s largest and most successful online instant-messaging platform, with nearly 380 million active users and more than 80 percent market share. These companies and others all form part of China’s so-called Shan Zhai economy. Although each Shan Zhai company WHY DOes SHAN is different, they often have common Nonetheless, understanding how the characteristics, such as tendencies to ZHAI Matter? Shan Zhai culture works is important do the following: for companies operating in China, especially foreign companies. While • Focus on the domestic market (at cheap copycat-type operators are least initially) generally short-lived, some of the best Shan Zhai companies have quickly Proponents of Shan Zhai companies evolved to become disruptors in their • Target mostly mass consumers believe they bring both social and respective industries. economic benefits. By boosting the • Strive for very short cycle time on range of available products, Shan Three key questions are worth product introduction Zhai companies offer consumers probing: more choice at lower price points—an • Focus on cost (but often offer important advantage in the current • What environments would lower quality too) economic climate. In addition, encourage the emergence of Shan supporters say Shan Zhai products Zhai companies? • Tailor product features and can help break monopolies held by functions specifically to local makers of more expensive products • How can we identify those Shan requirements while simultaneously encouraging Zhai companies that will emerge grassroots innovation at home. as disruptors with sustainable Successful Shan Zhai companies Opponents, however, say Shan businesses, as opposed to the vast may begin as counterfeiters or pirates Zhai companies generate a flood majority that will fade away? but often evolve into legitimate of substandard products that often businesses with their own intellectual openly flout other companies’ IP • What are the implications for property (IP) portfolios. rights. Others argue that the Shan companies that compete with Shan Zhai culture fosters laziness and Zhai businesses, especially those ignorance and impairs creativity and from abroad? competitiveness. Booz & Company 3 HOW did SHAN The Shan Zhai phenomenon did not survive, they were forced to adopt evolve spontaneously—it emerged as a creative and pragmatic solutions, often ZHAI cuLture result of both “soft” factors (Chinese by emulating the strategies of foreign emerGE? culture, history, and the policymaking/ companies. Shan Zhai was part of regulatory context) and “hard” the answer. factors (market supply and demand) (see Exhibit 1). Chinese culture therefore provides a context for flexibility and creativity. Culture, History and Regulation: In fact, the salient quality of modern- Setting the Context day Chinese entrepreneurs, including Shan Zhai practitioners, is not their In terms of culture, Chinese people “me-tooism” but their willingness have a long history as “fearless to take chances and learn from experimenters”. Going back to the their experiences. “Let’s try it,” days of China’s ancient civilizations, they say. If an idea doesn’t work, evidence of Shan Zhai culture can they abandon it and try something be traced to Chinese classics such as else. Speed is critical. The ability to Journey to the West（《西游记》） experiment, replicate success and and The Story of Shui Hu（《水浒 move rapidly up the learning curve 传》）, stories that have influenced has given many Chinese companies the Chinese people for centuries. In an advantage over some slower- Journey to the West, for example, Sun moving foreign competitors. (See Wu Kong (孙悟空), the “Monkey China’s Five Surprises by Edward King”, demonstrates his fearlessness Tse, strategy+business, Winter 2005, and creativity in confronting provides more on challenges and fighting evil as he “fearless experimenters”). strives for justice against traditionally powerful authorities. In Shui Hu, the In terms of policy, the Chinese base where the heroes lived is called government has for years gradually Liang Shan Bo, a literal Shan relaxed the regulatory environment Zhai itself. in one industry after another. In the automotive sector, for instance, The mentality is also reflected in while authorities have tried to Chinese sayings such as “crossing the support growth at large stated- river by feeling the stones,” and in owned enterprises such as First recent times has been quickly adopted Auto Works (FAW) and Shanghai in Chinese business circles and even Automobile Industrial Corporation its major policymaking processes. (SAIC), nimble companies such as For example, when economic reform BYD and Chery have quickly grown was initiated on the Mainland into strong players. In the mobile about three decades ago, most local handset-manufacturing sector, enterprises started at a very low level, competition was for years stifled by with experience and resources far licensing requirements imposed by the inferior to those of the global majors. Ministry of Industry and Information Many, especially in the private sector, Technology (MII). However, the lifting lacked both the institutional support of this licensing barrier in October enjoyed by state-owned rivals and the 2007 allowed the newly legitimized economies of scale of large foreign Shan Zhai enterprises to bring new companies. Hard-pressed even to vitality to the industry.