By Professor Edison Tse, Department of Management Science & Engineering, Director of Asia Center of Management Science and Engineering, Stanford University
(Assisted by Dr. Zhang Lijun, a Research Scholar at Stanford University and the Chairman of the Board of V1 Group Limited)
1. New strategy of China’s Disruptive Innovation
Ancient Greek historian Thucydides holds that when a newly rising country threatens to replace the established leading country, the likely outcome is war. In this age of nuclear weapon, a worldwide war is not possible to happen. However, when leading country feels that the rising country is threatening its dominant position, it will try to use all kinds of tactics to prevent the growing of the rising country. How should the rising country handle the situation smoothly without engaging in a head on confrontation? As a latecomer the rising country should not confront and challenge the leading country’s ecosystem directly, but to use reverse thinking process to develop a powerful and different ecosystem.
1.1 China’s technology innovation development is facing the risk of being vigilant and suppressed
Through a series of disruptive innovations in the information industry since 1982, the US had developed a strong and hard to replicate information technology ecosystem. Logic chip and operating system are two main components for all information technology products. The production of the advanced logic chips highly depends on advanced semiconductor equipment. These are all in the hands of US technology companies. These companies sell the most advanced core components to information technology products companies, who design the most advanced information technology products that are sold in the global market. This gives US the leading position in the global development of information technology. When the US felt the “Made in China 2025” could threaten its leading position, it looked for ways to stifle China’s development. This has been demonstrated by the recent US-China Trade War and technical barriers. So, how should China continue its technological innovation development?
1.2 My suggestion is that China should develop a different ecosystem the synergistic effect to US’s information technology ecosystem to achieve a win-win situation
Maslow’s hierarchy of needs depicted human needs as hierarchical tiers, that individuals do not think of the higher level needs when the lower level needs is not satisfied; but when the lower needs is meet, people will aspire to higher level needs. Maslow divides human needs into five levels. Lower-level needs are the “basic needs”, such as food, solving crisis, stable life, and health. Higher-level needs are the pursuit of a good living environment that is “nice-to-have”, such as wireless communication, smart phones, driverless vehicles, wireless payments, etc. There are also several levels among nice-to-have and basic needs respectively. Incremental innovation is to improve value in a particular need level, while disruptive innovation is to fulfill a higher need level. The most important distinction between basic and nice-to-have is that, basic needs is objective and is widely known, while nice-to-have is more subjective and only perceivable with personal experience. The fact that unsatisfied basic needs exist in a region is because that free market economy in that region does not work efficiently under the existing political, social, economic and technological conditions to solve the problem. To solve the basic needs problem, one needs to engage in disruptive innovation by combining technology, social resources, infrastructure development, change of institution and market structure. Therefore, most of the basic needs disruptive innovation cannot solely rely on free market economy, but needs a government-led market economy. In comparison, the nice-to-have disruptive innovation mainly comes from new possibilities brought about by new technology and young people’s pursuit of new ideals in life. Therefore, the successof nice-to-have disruptive innovation must happen in a free-market economy environment.
United State of America is a developed country with free-market economy, and the majority of its people pursue better life. Therefore, it is an ideal place to promote nice-to-have disruptive innovation. Through a series of nice-to-have disruptive innovations in the information industry, US had built up the competitive advantage in nice-to-have disruptive innovation driven by new information technology. The main market for advanced information technology products is people with middle and high income. Selling to the global market with middle and high income gives its economy of scale. To sustain its leadership position in global information technology development, US needs to assure that information technology products based on its advanced information technology can be sold in the global market with middle and high income, and this market is growing steadily.
Conclusion 1: Chinese should adopt a reverse thinking process. Instead of competing with the US in nice-to-have disruptive innovation driven by new IT technology, China should focus on basic needs disruptive innovation to help people meeting basic needs of life, which will lead to developing a completely different ecosystem. This is also in line with China’s development direction.
1.3 The development of China has experienced two consecutive disruptive innovations. The first was basic needs driven, while the second was nice-to-have driven.
China’s rapid economic development is the result of two consecutive disruptive innovations.Deng Xiaoping initiated the first disruptive innovation in China in 1978 with Reform and Openness policy.China established platform at the national level that combined domestic and foreign resources, through infrastructure development, change in institution and market structure, which successfully got majority of Chinese out of poverty. This basic needs disruptive innovation improved the living standard of Chinese people. The key to success lies in the practice of “seeking truth from facts”. Deng encouraged small-scale experimentation of disruptive innovation at a local level, especially in farms and urban area, and if successful and promising rolled out to national level with policy support. A new business culture slowly formed in China: cross-region creative imitation. In 2001, China joined the WTO and created synergies with other members of WTO, benefiting all WTO members. Joining the WTO platform helped China’s first disruptive innovation and made China the major manufacturing country with the reputation of “Made in China”. International companies outsourcing to China benefited its low labor costs, and people in developed countries benefited from low-priced good quality products. From 1980 to 2005, China’s economic development has lifted many people out of poverty, and per capita income has continued to increase. Many Western economists think it is a miracle. In 1998, private enterprises practiced creative imitation of successful US Internet B2C business model in China, initiating China’s second disruptive innovation. The success of the Chinese creative imitators hinges on their ability to execute and deliver value of Internet services in China’s unique cultural, social and business environment. In the process, each developed skills to overcome the institutional void and develop a new ecosystem that each leveraged to pivot into a new related businesses that have positive network effect with the original business. This is nice-to-have disruptive innovation to satisfy Chinese people’s pursuit of better life quality. Even though they started as creative imitator, each of them created its own unique ecosystem to transform itself and established a new identity as a major player in multi-related sectors.
Conclusion 2: China has established a unique nice-to-have disruptive innovation ecosystem: Creative imitation of successful US nice-to-have disruptive innovation to China by overcoming its institutional void and deliver new value to China’s unique cultural, social and economic environment.
China’s second disruptive innovation built on China’s first disruptive innovation. The first basic needs disruptive innovation brought the majority of Chinese people out of poverty and increased most people’s per capita income, which provided market demand for the second nice-to-have disruptive innovation. Network effects between basic needs disruptive innovation and nice-to-have disruptive innovation will result in future economic growth. China’s rapid development over the past 40 years has also brought about many basic needs problems, such as income disparity, polluted environmental, food safety, health and so on. Also many traditional enterprises are facing a crisis with urgent need of transformation, breakthrough and upgrading. Focusing in solving these basic needs will expand the market demand for nice-to-have.
Conclusion 3: Through a series of successful basic needs disruptive innovations, China will steadily build up a different and hard to replicate basic needs disruptive innovation ecosystem that combines technology and resources, infrastructure development, change in institution and market structure to solve basic needs problem and expand market demand for nice-to-have.
1.4 The grand vision of China’s Belt and Road Initiative is to meet the basic needs of the countries along the route, and thus cultivate new market for nice-to-have
The Belt and Road Initiative is similar to China’s first disruptive innovation where it drew global resources to help China in developing its economy. This time China takes the initiative to leverage and extend its experience to draw global resources (including its own), combine proper technology, and infrastructure development to help other developing countries out of poverty and boost regional in economic development. The Belt and Road will expand and enhance China’s basic needs disruptive innovation ecosystem, and develop new demand for nice-to-have. Many traditional, environmental and infrastructure development projects can be regarded as a platform to promote basic needs disruptive innovation by changing its value proposition.
Let us look at a real case example. In 2014, PetroChina engaged in a natural gas processing plant and pipeline project in Tanzania. Tanzania’s Mtwara, Lindi and the arduous Songgosongo Island are the source of pipeline processing plants. At the beginning, there people in Mtwara and Lindi were against the project, and the project implementation was not going well. The project manager decided to allocate resources to provide drinking water for the villagers, education to local children, boost employment rate, and other public diplomacy activities. The project team created nearly 2,000 jobs in the local area, with local workers exceeded 50%. As a result, all local people supported the project, which enabled it to complete smoothly. The project also trained local employees for the gas pipeline and processing plant management and operation technology. In one year, it trained over 1,000 people of various skills that will support Tanzania’s future development in natural gas industry. The completion of the project in 2016 enabled power generation through natural gas, which greatly alleviated the power shortage in Tanzania, and promoted the development of Tanzania’s electric power and related downstream industries. Meanwhile, by replacing imported heavy oil fuel with natural gas to generate electricity, environmental pollution was reduced and energy cost saving is at least US$800 million per year. With stable electricity supply, more investors were attracted to set up factory that boost regional economic development. At present, six power plants have signed gas purchase agreements, and two power plants are ready to sign gas purchase agreements.The Tanzanian project has to 1.59 billion yuan export of Chinese equipment. With the development of domestic economy and increase of per capita income, a new consumer market is developing. The implementation of this natural gas processing plant and pipeline project has established a basic needs disruptive innovation platform. The value of this project is not the completion of high quality construction project with low cost; but through this project, to improve local employment, improve the technical level of local employees, promote local economic development, open up new consumer markets, provide business opportunities, and build customer stickiness. This fulfills the value of basic needs disruptive innovation.
1.5 Develop basic needs disruptive innovation platform
The concept of the platform is that it is an entity, but its main value is not in itself, but the benefits it can bring to the members joining, which is a change in the concept of an entity’s value. Whether it is product, service, or engineering project, we can see perceive it as a platform by changing its value concept. PetroChina does not regard the Tanzania natural gas processing plant and pipeline project as a purely engineering project that only cares about the value of the project itself. It took this project as a starting point and combining multiple resources to make the success of this project drive regional economic development. This project is a basic needs disruptive innovation platform. Many traditional industries, environmental protection industries, infrastructure industries, and public utilities can become a basic needs disruptive innovation platform by a change in its value concept. For example, in a relatively backward rural area, take a sewage treatment project as a starting point to combine appropriate new technologies and various resources, coordinate with rural reform to solve rural environmental problem, while at the same time help to establish local industries with development potential to foster local economic development. In doing so, the sewage treatment project becomes a basic needs disruptive innovation platform.
2. China needs to initiate a third disruptive innovation to continue its development
2.1 I believe China is ready to implement a 3-pronged disruptive innovation: the first prong is the disruptive innovation driven by China’s basic needs, the second is the disruptive innovation driven by Belt and Road, and the third is that China continues to apply creative imitation of the US’s nice-to-have disruptive innovation in China.
Consecutively implementing basic needs disruptive innovation in China and in Belt and Road Initiative will enable China’s economy continue to grow. It will expand the nice-to-have demand market that will increase China’s success in applying creative imitation of the US’s nice-to-have disruptive innovation. This 3-pronged disruptive innovation will accelerate the development of Chinese economy, and China can avoid the middle-income trap. In the process, China will establish two unique and synergistic disruptive innovation ecosystems – basic needs and nice-to-have. The two ecosystems will have positive network effects that will sustain economic growth. If we focus implementing basic needs disruptive innovation in China’s economy backward regions, it will reduce the income gap between rural and urban areas, increase the number of people with middle to high income, and improve the income inequality problem. It will also increase the market demand for new technology products and services for nice-to-have, making China the world’s largest economy.
2.2 New technology brings us new possibilities
The progress and improvement of a new technology depends on the scale of the application market of its new technology products. Therefore, the competition of new technology is not who gets more patents, who has more and better functions, better, who is technologically more advanced, but who has the larger application market. From a technical point of view, as long as one is willing to invest, no matter what technology, one can reverse engineer and develop a different but with similar characteristics and capabilities technology in a period. Therefore, the entry barrier of a technology is the application market that the technology has occupied rather than technology itself. Whoever takes the largest application market first is the winner. The technology that first occupies the largest application market share is the winner.
The reason that US is able to dominate the global information industry is that through more than 30 years of disruptive innovation and development in the information industry, it has built a strong information technology ecosystem, but not just some core technologies. We can say that no country can compete with US in information technology field, because it has already captured the largest global application market share. However, if the US wants to maintain its leadership in information technology, it needs to maintain its dominance in the global application market share; otherwise it cannot support its huge R&D costs for improvement. Therefore, the more China can capture information technology application market share in the world, the less likely that the US will “ban” on the core information technology from China, because this may lead to weakening its information technology ecosystem and may lose its leading position. Most IT companies in China are now relying on the latest advanced IT technology to develop the best products to build their competitive advantage via incremental innovation, but this will expose them to the risk of diminishing returns and being blocked. I suggest that the IT product enterprises in China should not build their competitive advantage on the products with the most advanced IT technology; instead, they should use the most advanced IT technology as the fulcrum and promote disruptive innovation to develop a strong market-driven ecosystem to build its competitive advantage. Derive most of the profit comes from serving ecosystem members, rather than relying on products with the most advanced IT technology. This will reduce its diminishing returns and the risk of being blocked. They should allocate appropriate portion of the profit to the research and development to develop the core components for special applications that can further reduce dependence and build their own brand. As for some new technologies, such as 5G, AI, new energy, etc., everyone has yet to build a strong ecosystem of the technology, and everyone is at the same level of competition, depending on how one applies them and builds different ecosystems.
Conclusion 4: China should apply the relatively new technologies in basic needs disruptive innovation to foster global economic development; and as a latecomer, it should creatively imitate the US’s nice-to-have disruptive innovation to China
3. Sustainable economic growth needs successive disruption innovation compatible with innovative thinking
3.1 Depending on its education, family, society and political environment,each country has a different culture of innovation that leads to different innovative thinking
We usually think within our own familiar scope, which, like a box, limits our thinking. A type of creative thinking called “Think outside the box”. This way of thinking is not subject to any restrictions, think of the unthinkable, and challenge yourself to think outside your familiar scope. Steve Jobs and Elon Musk possess this way of thinking. There is another type of creative thinking called “Think in a bigger box”. This way of thinking is when a person who is worthy of your trust gives you guidance or certain events that inspires you with a bigger scope. You will jump out of your familiar scope and think in the context of the bigger scope. Jack Ma and Pony Ma possess this way of thinking. In scientific innovation and nice-to-have disruptive innovation, the first type of creative thinking has more advantage, while in incremental innovation, basic needs disruptive innovation, and creative imitation of nice-to-have disruptive innovation, the second type of creative thinking has more advantage. The historical background of the United States, its educational, family, social and political environment make US relatively more compatible with the first type of innovative thinking. The historical background of China, its educational, family, social and political environment make China relatively more compatible with the second type of innovative thinking is more compatible. In China’s first disruptive innovation, Deng Xiaoping gave Chinese people a bigger box – reform and opening up. It promoted the emancipation of the mind, encouraged people to develop their potential, found successful regional disruptive innovation in this bigger box, and then encouraged creative imitation to apply this innovation to the rest of China. In China’s second disruptive innovation, the successful US Internet B2C business model and China’s social and political environment gave Chinese entrepreneurs a bigger box. Several successful cases triggered a grass root movement in “Internet thinking” wave in China.
3.2 Successful disruptive innovation must be compatible with innovative thinking
We see that China’s first and second disruptive innovations are compatible with China’s innovative thinking. While US nice-to-have disruptive innovation in IT is compatible to US innovative thinking. The sustainable economic growth of a country needs to a successive wave of successful disruptive innovation. The key is that each disruptive innovation is compatible with the country’s innovative thinking. In the suggested 3-pronged disruptive innovation, President Xi Jinping has given a bigger box to Chinese enterprises for the first and second pronged, while the third pronged continues the second disruptive innovation where successful US Internet B2C business model and China’s social and political environment gave Chinese entrepreneurs a bigger box. Therefore, I believe the 3-pronged disruptive innovation would have a good chance to succeed, as it is compatible with China’s innovative thinking.
3.3 Using external force to consolidate the basic strategy of disruptive innovation
During the process of promoting disruptive innovation, one may encounter some external forces that exert pressure to you to change your strategy plan. If this external force is difficult to avoid, it is better to tackle it from a different perspective. We may make use of this external pressure to help consolidate the disruptive innovation strategy.
During China’s first disruptive innovation, joining the WTO would enable China to deepen its integration with the world economy, and strengthen the ecosystem of the first disruptive innovation. At that time, the decision of joining WTO was a difficult one for China. The benefit for China in joining the WTO is that it would enable China to expand its export, acquire advanced technology and foreign capital that would help its economic development. However, China would have to accept considerably harsher conditions than other developing countries and additional conditions imposed by US. An addition, Chinese enterprises would face global competition pressure, which they had no prior experience. These would exert pressure to China to make significant changes in China economy that conflict with its prior economic strategy. After a lengthy process of negotiation, China joined the WTO on December 11, 2001.
After China’s accession into the WTO, the government responded to the pressure by setting up environment for industrial reform, encourage technology exchange and corporation, and foster foreign direct investment. Its state-owned enterprises engaged in restructuring and upgrading in response to global competitive pressures. State-owned and private enterprises learned and used their creativity to develop system and improve production efficiency and management, which enable them to compete competitively in the global market. This attracted more foreign investors to invest and set up factories in China to engage in OEM production and low cost products to the world market. Resource and infrastructure development projects further boosted domestic economic activities.All these expanded local employment and its domestic market. China used the pressure of joining the WTO to help in consolidating its first disruptive innovation strategy.
Now that China has risen to become the second largest economy in the world, the US feels that the purpose of “Made in China 2025” is to surpass its dominant position in high-tech field, so it uses trade wars, blockades of technology, etc. to stop the growing of “Made in China”. This would stifle China’s innovation activities. Especially with many innovation activities follow the “cool” tech boom in Silicon Valley and directly compete with those innovation projects in Silicon Valley, will cause more pressure from the US. However, China can also take advantage of this pressure to explain in detail the general direction of the 3-pronged disruptive innovation: Instead of competing with the US in nice-to-have disruptive innovation driven by new technologies, China focuses on basic needs disruptive innovation that help people meet the basic needs of life. It aims to create a completely different ecosystem. It uses new technology in basic needs disruptive innovation to foster global economic development, and as a latecomer, creatively imitates the US’s nice-to-have disruptive innovation to meet China’s growing nice-to-have market.
About V1 Group Limited
V1 Group was established in 2005, listed on the Main Board of Hong Kong Stock Exchange in 2006, became the first Chinese video media enterprise listed in Hong Kong. V1 Group Limited was named the “China’s Top 100 Internet Companies” three years in a row from year 2014 to 2016. After eleven years of rapid development, V1 Group’s main businesses have fully covered the Internet and mobile terminals. In 2016, V1 Group successfully transformed from the new media industry group into a new economy in the internet industry, forming a strategic layout with media as the lead, financial investment as the driving force, and “digital + new culture and entertainment” as its core businesses.
V1 Group IR website: http://ir.v1.cn
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