In a special post, we discuss the startup and entrepreneurial landscape in China. Columbia Business School has been making a great push towards becoming a premier school for future entrepreneurs and has over the last few years truly become an MBA program focused on and devoted to helping students become business owners and founders. Proof of this was the interest three students (all InSITE Fellows) had on discovering the startup and entrepreneurial ecosystem in China, separate from the scheduled meetings. They met with two startups and discovered the similarities as well as the uniqueness of the startup world in China.
The group met with the COO of FClub, a fashion flash sales site, and with the CEO of 800TeleServices, a business process and call center outsourcing provider.
FClub’s target customers are women in their late 20s-30s, predominantly urban, and typically public sector employees (nurses, school teachers, etc.). They sell fashion that is ” main stream fashionable” but a bit more “risky”. They mostly sell domestic brands (90% of their sales) but also sell international brands such as Puma. The company, at 500 employees, is on its way to becoming a $1bn company while still considering itself small . The unique thing about China is that “scale” is an entirely different concept from what we are used to. The retail industry is so fragmented (and the ecommerce landscape still so nascent) that there is room for several $1bn companies to emerge and successfully compete against one another (and grow beyond $1bn). FClub caters to a very specific market segment and income segment. Income gaps are very disparate in China meaning that several flash sales sites can emerge and be large and successful just catering towards a carefully selected market (such as “sightly more risky mainstream fashion”).
Ecommerce in generall presents an open playing field in China. The reach of the classic brick & mortar retail store is limited due to the sheer size of China. Only about 13% have penetrated the ecommerce market due to the high costs and barriers in shipping across a huge country like China. There is a large and steep tradeoff between managing warehouses / inventory and transportation in terms of costs. Ecommerce is also at an inflection point as online payments develop further and domestic brands are demanded across areas of China with low penetration of brick and mortar retail stores. Further, the development of the consumer economy and the growing middle class present tailwinds for Chinese ecommerce.
Founded in 1997, 800 TeleServices provides a comprehensive range of outsourcing call-center and ecommerce solutions to some of the world’s top fortune 500 and famous enterprises in China (such as UPS, SONY). 800Tele’s customers are very big corporations, and they’re sticky (some have been with the company for over ten years). The company’s customer portfolio is comprised of companies who aren’t price-sensitive and appreciate the quality and reliability 800Tele offers.
Broader lessons learned from both companies:
As we heard in many of our visits, the issue of high employee attrition rates, especially after the Chinese New Year, is a challenge for both companies. In both startups, we heard about the different approaches towards labor, key employees, and core management: labor will have high turnover rates and that’s part of the business (at 800Tele the average employee (a call center specialist) age is 24, and the average time with the company is less than 1 year); key employees usually receive ESOP (employee stock option plan) to incentivize them to stay longer but most employees are only incentivized by benefits and intangibles such as a good working environment; the most important thing is to keep the core management team together through the ever-changing dynamics of the competitive market in China.
800Tele specifically is looking to recruit key employees with previous international, or multinational corporation experience.
“It’s a good time to be a startup!”
Apparently there’s over-supply of capital to invest in higher-risk ventures. Initially we were surprised to learn that, given that VC funding in China was down 40% in 2012[i]. This decline can be explained by several factors, including the global financial crisis, accounting scandals making the IPO market less attractive, and more specifically – as we heard during the PwC visit – the anticipation for the Chinese government change.
(Source: ZhenFund, http://www.slideshare.net/ZhenFund/chinas-startup-ecosystemand Source: 17Startups, http://technode.com/2013/01/13/chinese-startups-in-2012/)
Nevertheless, as we heard during multiple company visits, there are very few investment vehicles available to Chinese people who have accumulated wealth. This has led to concerns about a real-estate bubble and similarly an oversupply of risk capital. It’s important to note that debt financing isn’t practical, so our discussion here is focused on equity financing.
Interestingly, we found out in both meetings that the executives didn’t believe that institutional investors have that much value-add; the best resource investors can provide is strategic partnerships – and this is relevant usually at a later stage. These partnerships can help lower customer acquisition costs, overhead and IT infrastructure, position the startups as legitimate / IPO ready, etc. This perspective is clearly different than what we’re used to seeing in western VC funds (which sell their ability to mentor and provide management advice), so the question of how successful investing in China will be becomes even more intriguing. Institutional investors can also, in certain cases where it makes sense, provide a different outlook on the world and management styles different from those inherent to China. However, this is again is limited to certain circumstances and certain companies, meaning that most institutional money flowing to China might be no more than “dumb” capital.
Regarding their exit strategy – IPO vs. M&A – both startups referred either as means to an end; in other words, they don’t have a specific preference and both companies are trying to play in a way that would prepare them for both alternatives in the dynamic market. FClub, for example, might theoretically prefer an IPO since they “see no limits to growth” currently. However, their biggest competitor has recently issued stock for $90M so there might be an attractive M&A takeover opportunity.
“China is a free market, it’s just that the government is one of the competitors”
One of the main issues that were brought up in all of our company visits is the rule of law. Both startups we’ve met with are listed outside China: FClub is a Cayman Islands holdings company, and 800Tele is listed in Hong Kong. US Dollars and RMB management, employee corruption, corporate governance controls, etc. are issues the executives must handle constantly.
800Tele navigates between being an off-shore company and receiving government support quite easily, as it’s not an asset- or manufacturing-intensive company that requires regulations, and at the same time it provides many jobs for local Chinese people.
On the other hand, the government is becoming better at dealing with hi-tech companies and encouraging innovation (see graph of incubators above): the knowledge accumulated overtime and overseas, the foreign investments, and pure market need have led to more efficient processes, incubators and accelerators, mentorship programs, etc. The CEO of 800Tele himself mentors MBA students in Shanghai who aspire to become entrepreneurs. These concepts, however, are quite new to the Chinese entrepreneurial landscape.