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China's tech trajectory - Perspectives from a European VC

Exclusive Interview with Hussein Kanji - partner at Hoxton Ventures

· venture capital

{{{Max Schubert}}}

Hussein Kanji is a founding partner at Hoxton Ventures, a London-based early-stage European venture capital firm which invested in the unicorns Darktrace and Deliveroo. Before founding Hoxton Ventures, he worked in Silicon Valley for over 10 years before joining Accel in London. He has an undergraduate degree from Stanford University in Symbolic Systems and an MBA from London Business School.

Given his experience in both the US and the European technology eco-system, we interviewed Hussein Kanji on his perspective of China's entrepreneurial trajectory, implications of the rapid growth for the West and how he envisions the future of the Chinese technology eco-system to take shape.

Max: How do you perceive the importance of Chinese technology companies for Western markets?

 

Hussein: We see Chinese players moving into geographies that have not been in the main focus of American technology companies in order to get a foothold in the European market. A prominent example is Alibaba moving into Eastern Europe. Entering in low-competition geographies and avoid head-to-head competition with Western heavyweights is a smart move as Chinese companies still face skepticism when it comes to privacy and security. Building a track record in Europe before taking on the leading competitors can help reduce this disadvantage.  

 

On a different note, China’s capability to run hugely successful B2C products in the West is impressive. The most common example is TikTok. It has seen immense growth in many Western countries. This social media app is a product of Bytedance, one of China’s largest privately held tech companies. Becoming one of the most popular social media apps in the US market requires precise cultural knowledge and customer centricity. This move proves that Chinese tech can operate successfully in new markets and is ripe for expansion into the West. I expect to see more Chinese companies taking on Europe and the US within the next years. At the same time, this development is troubling as Western technology companies such as Amazon, Ebay and Uber have failed to compete in the Chinese market successfully or are being kept out by government censorship (e.g., Facebook, Google, Snapchat). Western tech giants will have to expand to the Chinese market to stay globally competitive in the long term.

Background:

TikTok has seen massive success in many Western countries as can be observed in the following graph on top Android downloads in the US

Further reading on Bytedance and TikTok by a Bytedance employee

 

出海 - Chu Hai – The label for a recent trend of Chinese technology companies to increase their involvement abroad. A recent PwC report interviewed 101 Chinese unicorn CEOs of which 70% stated to have a strategy for international expansion. Further reading on this trend.

 

Max: Where do you see differences between the Chinese and European VC industry?

 

Hussein: Most notably, China’s political organization allows for a market-economy-like approach to venture capital on different government levels. The support of startups is encouraged by the central government, and thus local decision makers compete to get involved with the most promising startups to move up the ranks of the communist party. The resulting overfunding is strategic, and policy-makers are very-well aware that much capital will go to waste. Nevertheless, the inflationary capital injection allows China to supercharge the growth of its technology eco-system and enabled the dizzying growth we have seen in recent years. As this funding spree continues, I am confident that China will easily outpace Europe in terms of innovation potential in the next 10 years and go on to rival the US.  In Europe on the other hand, the European Investment Fund (EIF) is a single entity and has a monopoly on supranational government-led venture investment efforts. The bureaucratic giant moves slowly in comparison to competing Chinese players. Europe would benefit from implementing China’s strategy to eco-system building and innovation.

Background:

The advent of China as a global VC heavyweight in the last five years can be observed in the graph above. Government involvement in venture funding exploded in 2015 after the government made it a priority in 2014. China's party system is meritocratic, and moving up the ranks requires to hit quantitative targets decided by senior government levels. Therefore, encouragement by the central government will have immediate effects for local government decision-making on all levels. 

 

A closer look at government-led funding shows the explosive growth in 2015 in the graph below:

This fundamentally different approach to government involvement has given birth to $856 bn government-led guidance funds represented by a web of 1,171 entities according to a report by China Venture. This number dwarfs Softbank’s Vision Fund, with a size of $100 bn. The mechanics of guidance funds are similar to public-private partnerships. The Chinese government contributes a minority stake in the fund and has private enterprises provide the majority and make the investment decisions. Several players in these funds are listed below:

Max: Are Western startups and VCs ready to compete in China?

Hussein: The reason that people are relatively unaware of Chinese technology companies is that, until recently, China has pursued growth predominantly nationally. Didi (ride-hailing similar to Uber), WeChat (chat platform), MeiTuan (food delivery), household names in China, are unknown to Western consumers. Despite recent efforts, China remains a closed market and difficult to penetrate for foreign companies. The failed attempts of Amazon, Ebay and Uber in the past highlight the difficulties companies face when entering the Chinese market. User preferences differ considerably from the Western market, and unlike in pan-European expansion efforts, the knowledge of the local language is paramount. Expanding to the Chinese market historically required and still requires a strong partner on the ground which further complicates market-entry beyond language, cultural difference, and strong competition. This makes expanding to China a gargantuan task for young technology companies. Another critical factor is the government. Its rigorous censorship policies have thwarted the efforts of Facebook, Google, and Snapchat, among others, to compete in the Chinese market.

In the VC industry, big players like Sequoia Capital and Matrix Partners have successfully managed to fare in this environment, and the amount of deals and growth makes the market increasingly attractive. Entering the Chinese market, nevertheless, would require substantial investments in legal, partnerships and the establishment of a local network. Hence, small VC firms will have a difficult time to handle the work and cost associated with actively investing in the Chinese market.

Background:

Amazon recently announced to shut down its Chinese local market place, citing a focus on cross-border transactions from the West to China as the reason. E-commerce in China is dominated by Alibaba and JD.com and it is likely that Amazon was unable to establish a significant market position amidst the two giants with long-standing local experience. In a precedent case, Alibaba pushed Ebay out of the market by localizing the e-commerce experience to fit Chinese user preferences.

 

Similarly, Uber lost the competition for market dominance to its Chinese competitor Didi. The latter acquired Uber’s China business and dominated the Chinese market with a share of over 80%. The following graph emphasizes the dominance of Didi in comparison to Uber worldwide.

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