China 2010: Innovation, Copycats, Cheap Labor, Staffing Challenges

Part 1 of 2 posts.  Part 2 is here.

Is China a copycat nation, or capable of true innovation? Is cheap labor a myth?  How do you retain staff in China?  These were just some of the topics addressed in an event called “China 2.0: New Rules, New Opportunities” in Silicon Valley, hosted by the Churchill Club and sponsored by Symbio.  (Disclosure: I was invited to the event by Symbio and they paid for my $70 ticket.) Speakers included Linda Chen (Partner, KPMG), Jacob Hsu (CEO, Symbio), Harry Shum (Corporate VP, Search Development; Microsoft), and Lip-Bu Tan (President & CEO, Cadence Design Systems, Inc.) (Note: post is draft, I will add links to this post later today)

The event was moderated by Robin Chan (Founder/CEO of XPD Media, a social gaming company) and Robin asked the panelists to comment on several commonly held views about China, and whether these views were “myth or reality”.  Some of these questions include:

• Is China capable of innovation, or is it a copycat business and technology culture?
• Is China’s proposition the easy availability of cheap labor?
• Is China going to take over the world?
• Does China seek more Foreign Direct Investment?

I’ll cover some of what I heard in 2 parts.  Part 1 is below, and Part 2 is here.

Copycat Nation or True Innovation?

The common Western narrative of China is of  a country whose businesses unfairly compete by stealing intellectual property from others and making money off of copycat technology.  While undoubtedly a large amount of IP theft does happen in China, its hard to believe that anyone can look at China and not see innovation everywhere.  I’ve noticed that this question of innovation in China comes up often among Western observers of China.  Why?  Do we feel that the playing field is unfair?  Are we in the U.S. desperately looking for signs of an enduring competitive advantage even as we’ve shipped our entire manufacturing base overseas?  I’m not sure, but the topic sure comes up a lot.

Yes, China can innovate, but what kind of innovation? Jacob Hsu (Symbio) remarked that in Silicon Valley, investors and entrepreneurs are looking for “business model” innovation, which I interpreted to mean a new product that creates new markets.  He characterized  Chinese innovation as mostly incremental “technology” innovation in the past, but that increasing we were seeing highly innovative companies emerge, such as Tencent.  He also highlighted the phenomenon of “shanzhai” as an example of innovation on a much smaller scale.  The “shanzhai” consumer electronics economy in China is rapidly creating next generation connected devices out of laptop and mobile phone components, and that in most cases the minimum scale required to produce these units can be as small as a few hundred units to make money.

Conventional wisdom equates intellectual property protection with innovation.  But the “shanzhai” phenomenon challenges this idea.  Could the lack of intellectual property protection create opportunities to remix, modify and mashup existing technology that creates an “innovation capability” for China’s entrepreneurs even as the lack of IP protection prevents them from fully capitalizing on their successes (because the next guy will just rip them off)?

In this environment, is Open Source and Creative Commons a logical next step in creating a framework for rights that rewards creators by creating an orderly way for derivative works to be created, since they will be anyway?

Cheap labor is a myth (at least in software development)

The panelists generally agreed that the perception of China as a cheap labor destination is wrong, at least in the fields of software, semiconductor, and professional services.  According to Jacob Hsu, “if you are going to China for labor cost arbitrage, you are missing the point.”  I found it surprising that the CEO of a software outsourcing company would say this, because if cost is not a relevant factor, then why put up with the built-in inefficiencies of offshoring at all?  And yet Indian IT firms are also rapidly entering China to set-up their own China operations, to serve both the domestic China market and the global software outsourcing market.

Symbio shared that they are increasingly staffing in Chengdu and Hangzhou, cities with great universities, much lower staff turnover and lower labor costs than Beijing and Shanghai.  Earlier this year, while sipping coffee at the Beijing Wanda Starbucks, my friend and China business consultant Paul Denlinger put it even more strongly to me: “If you [a technology company] plan on coming to China, for heavens sake don’t ever come to Beijing or Shanghai!”  He then proceeded to regale us with tales of how aggressive Wuxi municipal authorities were about attracting software outsourcing.  Of course, the punchline on the joke is you have to live and work in Wuxi, a far cry from life within 5 km of that very same Wanda Starbucks (or life within 5 km of Wudaokou and Tsinghua, for that matter).  Here again, the conventional wisdom of 5-10 years ago (Beijing is the IT center; Shanghai is the business center) is being challenged by upstart second-tier cities with elite universities and hungry government leaders.  Looking forward 5-10 years, it appears that unless you have a special reason for locating in Shanghai or Beijing, you need to look seriously at other options where staff retention is easier and labor costs lower.

Cost advantages further eroded by high cost of senior people and “always having a Plan B”

Harry Shum (Microsoft) was one of the founding members of Microsoft Research China and spent 9 years there as a research before moving back to the US.  He shared that while junior talent was abundant, senior managers can command international level of pay.  His strategy for retention of staff in China (or at least in Beijing) was refreshingly simple: overpay people!  What initially appears to be low labor costs in China can carry many hidden costs that erode your cost advantage.

Lip-Bu Tan touched on an interesting point during this discussion: you “always have to have a Plan B.”  What if your General Manager leaves?  What if your HR Director leaves?  What if the entire leadership team leaves?  What if all your servers walk off?  Because of unpredictable legal recourse, wage inflation, shortage of middle managers, and unsophisticated employees willing to jump ship for an incremental RMB500/month, your plan requires a greater degree of redundancy than you might have in a more stable, developed Western country.  I see this as a *huge* area of hidden cost for operating in China.

Retaining key staff through rewards on the one hand, and guilt on the other hand

How do you keep key staff?  Harry Shum said that Microsoft simply tries to “overpay people” but that often, this compensation is not purely monetary.  It can be in the form of the work challenges, the career opportunities, and other non-monetary factors.  Lip-Bu Tan characterized his strategy as more guilt-based!  Let top people recruit their own lieutenants, help cultivate a “family-like” team dynamic among their staff, and use guilt to prevent them from leaving this team behind if they jump ship.  This strategy makes sense, as long as the whole family doesn’t jump ship when the leader does!

Be prepared to invest in training and development

Robin Chan pressed the panelists to come up with mistakes they made and what they would do differently the second time around.  Harry Shum spoke very positively of his experience as a founding team member of Microsoft Research China (now Microsoft Research Asia).  What is most encouraging about China is the education and talent coming out of elite universities like Tsinghua, who is a partner with Microsoft.  The challenge is providing the training and development to morph that raw talent into world-class researchers and mid-level managers of researchers.  Harry said he underestimated the time required for local researchers to “grow up” into the mid-level and high-level research leaders that he expected.  Microsoft has had to import more foreign-trained (particularly US trained) research talent to work within the organization.   KPMG’s Linda Chen also reiterated the need to invest in training and development in local staff as a key factor to their growth.

So Why Staff in China?  Because for most global enterprises, China cannot be ignored

Lip-Bu Tan stated several times, China is so important, it is impossible to ignore.  Jacob Hsu highlighted the increasing cost of entry, and the need for a long term commitment to the China market in order to be successful in China.  My takeaway is that companies that have global aspirations and either seek to ultimately have a presense in China, or hope to be a global innovation leader, must factor China into their plans.  The advice from the panel is:  prepare to put your best people, your best technologies, and your best products against the opportunity in China or else you will fail.

I’m interested in hearing reader’s comments on these points.  I’m sure many of them can be debated and are highly situational to the challenges that Symbio, Microsoft, KPMC, and Cadence face.  Where is their advice and perspective simply not true in today’s China?

More to come in Part 2.

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