China's New New Economy

Back to Contents of Issue: October 2002

China has a new breed of investors and wireless startups. The good news is, they've avoided the dot-com hangover.

by Richard Meyer

THE DEVELOPER'S CONFERENCE IN Beijing was unremarkable in many ways. There were the usual suspects: the programmers, the corporate executives and the overseas VIPs. There was the buffet table, of course. And there was the conversation peppered with acronyms that few beyond the Grand Ballroom really cared about.

But in the crowd going almost unnoticed was a presence totally out of place in 2002. They tried hard to disguise themselves. They wore suits instead of T-shirts. They no longer sported buzz cuts. They spoke at a reasonable pace and their ideas and sentences held together fairly well. Their level of arrogance remained on the charts. But they could not completely hide what they were. Every once in a while, you could sense that strange combination of excitement and fear that comes when starting a new company. They would sometimes slip up and use phrases like "killer application" and words like "team" and "content." They would sometimes talk about their businesses like they were converting souls. But one thing they would never do, having been sternly warned by PR, is call themselves "dot-coms."

And strictly speaking, they are not. They have all the fundamental elements of that near extinct species. They are startups; they work with new technologies, are either dependent upon venture capital money or dispensing it and their executives are compensated with stock options. But for the most part, they are not working on the Internet in the traditional sense. They are working with the wireless equivalent. This is more than just a difference in delivery systems. The fact that these companies are dealing with handsets rather than Web sites is why they are still standing.

"It is a totally different business model, a totally different interface and a totally different way of doing business," says Richard Robinson, CEO of Mobile Interactive Games, a Beijing-based company.

On the Internet, executives in China say, people generally do not pay for what they see and use. Partially that is a function of habit. So much was given away on the Internet, in hopes of gaining viewers, that people rarely want to pay. Partially, it is a structural flaw. An easy and cheap way of making small payments was never popularized. But mobile phones do not suffer from the historical problems of the Internet and have a built in payment system: the phone bill. This has led to a very different sort of economics.

"With the Internet, eyeballs were supposed to translate into advertising," says Mark Atkeson, a partner at Mint, the investment company supporting Mobile Interactive Games. "There is no reliance on ad revenue here. That allows us to create businesses that come to profitability in eight to 12 months simply on messaging volume or software licensing."

Wireless "is a more solid model because it's based on real and projected revenues," says David Sheff, the author of China Dawn, a book about the Chinese Internet economy.

Brave new world
China missed out on much of the Internet boom. While the country did experience its own mania, it was nothing like that in the West. Regulations and legal issues delayed the emergence of the dot-coms in China, so the Internet economy neither rose as high nor fell as far as those in the US, Japan and Hong Kong. As a result, the dot-com hangover is not as pronounced and the psychological baggage is not as heavy in China. The country is entering the wireless age with less of the cynicism and caution, indeed fear, that is now plaguing the West. Wireless entrepreneurs are coming to a market filled with optimism rather than one struggling with its past.

Indeed, they are coming to a place that is ready for just about anything. The Chinese know that their entire economy is now in the process of being overhauled as the country chucks out its old and virtually worthless industrial base and replaces it. The people must, by definition, be entrepreneurial. They have to get involved in companies, industries and businesses that just didn't exist in China a few years ago.

"The entire country is a new economy, whether it is a technology company or a factory making backpacks," says Derek Sulger, managing director of Lunar Group, a technology investment company.

China's wireless market is also helped by the fact that the country's economy is growing fast. In the first half of this year, its gross national product expanded at a 7.8 percent annualized rate. And China's new economy has been growing faster than the overall economy. The number of people using the Internet rose about 50 percent last year, according to the Computers Network Information Center of the Chinese Academy of Science. More than 34 million people are online in the country and more than 175 million people use mobile phones, with 5 million subscribers being added a month, according to statistics from the Ministry of Information Industry. About 8.5 billion short text messages were sent in June by China Mobile customers and more than 28 billion by them in the first half of the year, up from 15.8 billion in the same period last year. While entrepreneurs and financiers in the wireless economies elsewhere are trying to build a market in the context of stagnation and even decline, those in China have the wind at their backs.

And while China's mobile economy is dominated by two state-owned behemoths, Unicom and China Mobile, these companies have structured the industry in a manner that affords a lot of opportunity to small companies. The carriers themselves have largely stayed out of the business of creating and selling content or applications, leaving that to others. They have acted primarily as delivery systems and payment networks for them.

"You have revenue sharing schemes that are roughly similar to what the Japanese are doing with i-mode and what the Koreans are doing," says Mint's Atkeson. "They have left a reasonable opportunity for third-party value-added service providers to make money." 

Where's the cash?
Given the numbers, the environment and the expectations it would not be surprising if China's wireless world went the way of the Internet. But while the young and eager wireless companies have a lot of similarities with their predecessors, they are fundamentally very different. Their executives may come across as the reincarnation of the dot-com animals, but they are not the same.

What separates them is simple: money, or the lack of it. These people are not a part of an industry that is driven by the weight of money. Indeed, they are part of an industry that is defined more by the absence of it. Before, during the Internet days, it was almost impossible not to raise cash. Now it is almost impossible to get it. Before, the initial public offering was around the corner. Now, a stock sale of a high-tech startup is little more than a dream. This has had a great impact on the way the companies operate and the way their executives act. They are engaged in less of a financial exercise and marketing event and far more focused on actually doing business and making money.

"The difference between the wireless days today and the Internet days of before is that there is a lot less funding but more revenues," says Robinson.

"More down to earth, nuts and bolts business building," says Sulger. "People are doing things here almost purely for the bottom line. You won't hear how much money they are going to burn or months to go and all that kind of crap. They are much more focused on when is the first month in which they are going to break even, where they have broken even, more on what their margins are.

"There is a great disconnect between equity valuations and the health of a business," says Sulger. "In 1999, equity valuations where too high compared to base financials. In 2002, equity valuations have gotten too low. I tend to believe that the only constant you can really focus on is the bottom line."

If it smells like a dot-com...
Sulger's group is a good case study of the new New Economy in China. Dot-comish elements are still present. The offices are 'funky.' Sulger dresses casual. One of the subsidiaries is a bar. And some of the products are tough to take seriously. For example, the Lunar Group's Linktone subsidiary offers a 'pet park,' whereby subscribers can take care of virtual tigers, koalas and pigs, feeding them, sending them to bed and reassuring them.

But the former Goldman Sachs banker (who says he prefers suits anyhow) makes sure that people understand that he is running a real business. He'd rather talk about the minutia of his operations than the big picture. He prefers to discuss the sale of products, not the sale of stock. The conversation gets, at times, refreshingly boring.

Eric Rosenblum, CEO of Sumit, one of Lunar's subsidiaries, says he is quite happy that the go-go days are over. "I did the '99 boom thing too," he says. "You could raise money, but you had to spend the money on marketing. You could not concentrate on the business. You had to buy the market."

Dot-com ghosts still linger. No matter how competent these companies may be, or how well they are doing, they have to face skepticism. They have too much in common with Internet startups not to be mistaken for them. And in the post-Enron world, where whole numbers have lost their absolute qualities, even a profitable company has to contend with doubts. Indeed, the apparent success of these companies can be a hurdle: They have a good story, strong management and lots of customers. It all sounds too familiar. Some people are defensive: "If this is another dot-com rising from the ashes story, I want nothing to do with it," says a wireless entrepreneur in China.

But in the spirit of the new age, most just soldier on. Faith is not the key element of these companies. They live for a giant and very real market. So these companies go about building their systems and selling their services. It is the kind of world where IPO as exit strategy is at the bottom of the list. At the top, or at least near the top, for anyone who is honest, is profit: making money from the business.

Humility is the new currency; hyperbole avoided. "I am surprised at myself for saying this," says Thomas D. Kirkwood, managing partner at Mint. "We are comfortable."

Regular trips to Tokyo
Japanese companies are showing a good deal of interest in China's wireless world and in the small companies taking a shot in it. Since China is largely working off the DoCoMo model, a lot of companies involved in i-mode see China as a natural place for their businesses to grow, an economy where they can leverage what they have already built. Investors in Japan meanwhile understand the market and have already seen the success of the model in Japan.

Index, for example, has put some cash into Linktone, the Lunar Group subsidiary. At the same time, the wireless entrepreneurs in China say that Japan is one of their focuses. They make regular trips to Tokyo, seeking a broad range of relationships and opportunities. "We look out into the rest of the world for leading edge concepts and business models that have been successful," says Atkeson. "Obviously Japan is one of the primary places we look."

"Our interest with the Japanese is across several fronts. Japan has a fairly good selection of Java-related content as well as sophisticated ringtones," he adds. "In terms of content, that relationship can go both ways," he says. "China can be a low cost source for development of content for Japan, Korea and Taiwan. So we are interested in meeting with and working with Japanese content developers and aggregators."

"At an investor level, the Japanese are interesting strategic investors," he says. "They understand this space very well." @

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