China’s Innovation Quotient

Long saddled with the stigma of being the country that has perfected the art of copying, China now has its sights set on joining the ranks of the globe’s most innovative nations by 2020. Five years ago, the Chinese government outlined an ambitious plan to achieve this goal: push R&D spending up to 2.5% of GDP, boost China’s total patents and research volume into the ranks of the global Top 5, and ensure that Chinese science and technology contribute to more than 60% of the nation’s economic development.

With an annual R&D injection from public and private business sources of 1.5 % of GDP over the last decade, the results have begun to pay off.

Having already surpassed Japan as the world’s second leading producer of research publications (one major source of the fuel that drives innovation), China is moving up quickly, although still a distant second from the US which had 28% of global research publications in 2008.  Meanwhile Chinese companies such as BYD, in the field of alternative energy, Li Ning in sportswear, Huawei in IT, and e-commerce powerhouses such as Taobao and 360 Buy have, arguably, established themselves internationally for competing through innovation. As these companies illustrate, innovation exists in many forms in China (as it does in the rest of the world): from BYD’s radical and disruptive creations – which turned the auto industry on its head – to the more common incremental improvements made in terms of cost, products, processes or business models.

In this cover story, TheLINK surveys a team of knowledgeable professors and alumni entrepreneurs to share their views on China’s innovation quotient. Is China ahead of the game or – despite the gains made – does the nation still lag woefully behind the world’s top players? Just how conducive is the Chinese environment today to fostering creativity and risk taking? Is ‘copying’ always wrong, or is it a necessary step along the learning curve toward innovation?

Founder and former CEO of Ku6.com,
Executive Director of the CEIBS Centre for Entrepreneurship and Investment,
Adjunct Professor of Entrepreneurship Kevin Li

The LINK: Around the world, there is the perception that Chinese companies operate as copycats, incapable of generating new ideas of their own. What’s your view on the role that copying plays along the learning curve of a country’s development?

Adjunct Professor Kevin Li (KL): The first stage of innovation comes from adaption, or copying. If you’re at the early stages of development, you don’t have the foundation for innovation. You just need to learn from those who are more advanced. But after the foundation is laid, you will have the ability to innovate.

For example, because of my long history with the sector, I know that China’s internet industry has learned a lot from the West. So Sohu has now beaten Yahoo in the China market; another example is Google and Baidu, and MSN versus QQ. If I were to rate the innovation level of China’s [top] internet companies today, I’d give them a 7 or 8 out of a high of 10. They’re doing well.

But other industries [in China], the more traditional ones, rate much lower on the innovation scale. They need to learn. Adaption is not necessarily bad or ugly. It’s acceptable for a child to learn this way, and this is the same concept.

The LINK: As an entrepreneur with a successful start-up under his belt, how do you assess China’s overall attitude towards innovation? Is China ‘innovation friendly’?
KL: Generally speaking, the Chinese environment is not very conducive to innovation. This is because of several factors: regulation, culture and – most importantly – economic motivation.

The regulations need to be strengthened to protect copyrights. Also, we have to change the cultural and traditional emphasis on results – measured in terms of profits or a company’s overall success – to a measure that also encourages people to be creative, to do something different.  Because of [China’s] weak regulations, the cost of copying is low. On the other hand, innovation comes at a high cost; and even if someone is innovative, the government and society in general are often not impressed. So the ROI on innovation in China is not as high as it should be.

Small or private companies are typically much more innovative than the large ones. SOEs have access to resources, so they don’t have much motivation to innovate. Privately-owned companies, however, have a greater need to maximize returns; they need to be more innovative in order to do this.

TheLINK: In China, who or what drives innovation? Is it promoted from the government downwards, or is it from the grassroots up?
KL: The real motivation for innovation is economic return: somebody wants to make a profit, so they innovate. The government has taken several important steps, but there is a long way to go. For example, a lot of patents are being registered locally, thanks to the government’s list of incentives, but most of them remain unused. Compare that to what happens in the US. At Google and Apple, for example, they provide an environment that encourages innovation. There is an economic incentive (a profit-sharing scheme) and, even more importantly, you know that your innovation will be used in a practical way.

Co-Director of CEIBS Centre on China Innovation, Professor of International Business Bruce McKern

TheLINK: Are MNCs worldwide learning from innovations made in the China market, or is knowledge only flowing in one direction?
Prof Bruce McKern (BM): There is a progression, among MNCs, from seeing China as just a market outlet to seeing it as a place where firms have to adapt their technologies, their processes, their business models in order to survive. And then, finally -- and this is the stage some companies are now reaching -- they see China as a market where they will develop technologies and business models they can use in other parts of the world.

A great example of that is the GE cardiac monitor which was developed by the company in India for markets which couldn't pay US$10,000 per device. GE brought the cost down from US$10,000 to US$1,000. That's a huge change! And it was done by understanding very clearly what the customer -- the doctor and the hospital -- really needed and providing only what they really needed [without sacrificing quality or functionality of the product].  While this example is from India, there are similar innovations being done in China.

TheLINK: It is widely believed that China now largely relies on incremental innovation -- racking up successes by simply making changes to already existing products, processes or even business models. You have said that incremental improvement is appropriate for China at this time. When will China move towards more radical innovation?
BM: The time is approaching. … There is already some movement in this direction: there are now hundreds of Chinese R&D centres outside China, set up by Chinese companies overseas -- some by acquisition, some by joint venture, some as green fields.  Why is China doing this? First, these firms want to tap the expertise and technological capabilities of researchers overseas. Second, they want to be located in innovative centres where new ideas, technologies and business models are being generated. Third, they want to be close to advanced markets, where the demand for more sophisticated products appears first. Being in foreign markets stimulates innovation and heightens appreciation for it.  So I think that's the right strategy for Chinese companies. 

TheLINK: Do you agree with the widely-held perception that the Chinese do not use disruptive or radical innovation?
BM: It’s broadly true, but it’s exaggerated. The reason people feel that way is because we don't see radical innovations, as consumers, until they’re developed into products and services that we use. There’s no Chinese company that’s had such an impact on consumers as Apple has, so that creates the perception that there’s not much happening.

Below the surface there’s a lot happening. One way of gauging that is by looking at the Chinese efforts in patenting, and also in publications of research in scientific journals. It is very interesting how quickly China has grown. Back in 1998, China’s share of business R&D spending was just 1.9% of the total business R&D spending amongst the OECD countries plus China. Today, this has increased 5 fold to about 11%.

Chinese companies and SOEs are doing a lot of patenting now, but the majority of it – 95% – is actually patenting within China. As other researchers have pointed out, domestic patents are often small improvements on existing technologies, or attempts to patent in China something that exists in another country, before the foreign owner can use it in China. So there’s a big challenge for Chinese companies and SOEs to increase the percentage of patents which have international quality and applicability. Once China becomes a major developer of international patents, it will have reached the point of radical innovation.

The important issue, though, is the trend; and the trend is definitely upward. China is increasing rapidly its share of patenting.  Likewise, it is also rapidly increasing its share of articles published in scientific journals, having recently overtaken Japan.  Its growth has been particularly strong in chemistry, physics, engineering and computer science, fields which underpin its industrial growth.  

The LINK: What industries should China emphasize most, in terms of pushing innovation?  
BM: Governments should not make big bets about sectors. The US, for example, which has the most successful innovation system, has achieved this by using much of its government R&D funding to support fundamental research in universities and research institutions, but without directing which industries should be supported. It’s understandable that China has identified key sectors and emerging industries for technology development, such as alternative energy, aerospace and high-speed railways, and these big investments add to the research and technological capacity.  But it would be better to put more effort into developing world-class research institutions. Make sure the incentives are there – incentives for researchers to do long-term, high quality research.  Second, put more effort into the commercialisation units within universities and research institutions – the people who can take a newly discovered scientific or engineering idea and find a commercial application for it in the marketplace.

The LINK: What are the obstacles to radical innovation in China?
BM: The obstacles are, first, experience: lack of a sophisticated, deep innovative capacity within companies – but that’s changing. Second, the lack of a market that places a premium on radical products. If much of the market is still developing, and looking for lower-priced, less complicated products, then there’s not a great need to be radical.  And as long as the Chinese market is sufficient for companies, then the impetus to be radical is not there.

When the market becomes richer and more satisfied, as in the US or Western Europe, then consumers start looking for something different, becoming more open to challenging current perceptions. As the upper segments of Chinese market become more important, and Chinese firms increasingly operate abroad, the demand for radical innovation will become more powerful. That’s when you get more radical innovations. It is not uniquely supplier-driven, it’s considerably demand-driven.

Professor of Marketing, Wang Gao

The LINK: How do China’s old and new economies stack up against each other, in terms of being innovative?
Prof Wang Gao (WG): For the new economies, particularly for those that are in e-business – such as Ctrip, Baidu, 360 Buy, QQ – I don't think they really lag far behind the West. The founders of these companies keep abreast of what’s current. So in the new economy, I don't think we see a big gap. Many of the e-commerce businesses have become very successful. They may have started out by basing their product or business model on an existing Western idea but they have found creative and innovative ways to modify those methods to conquer the China market. Look at Taobao’s T Mall, for example. It was an overnight success.

But for China’s “old economy”, the story is quite different. These companies are, in general, using incremental innovation. Electronic products such as home appliances are a good example. If you look at TVs, refrigerators, air conditioners, Chinese firms are okay because there is no dramatic change in that industry. The core technology is pretty much the same, so there is really no differentiation. So on the incremental side, private firms in the traditional economy are doing an okay job. The big challenge is to become a radical innovator.

There are some good examples: Huawei used to be a cheap supplier for the telecom industry; now they are not cheap in certain areas – they are the technology leaders. Sany Heavy Equipment is another example – they were the only company that had the equipment needed to cool down the reactors after the Japanese earthquake and tsunami. And in Chile, they supplied equipment for the rescue of the trapped miners. These are great accomplishments, even though these industries are still dominated by MNCs. Now, Chinese companies have not only started challenging the big international players like Ericson or Caterpillar, they are winning in certain areas. This shows that Chinese firms can become competitive through innovation.

The LINK: What drives innovation in China?
WG: There are two key driving forces for innovation. One is competition. If you really feel the pain, either you are forced out of the business or you have to be innovative if you want to stay. It’s about that time now for many Chinese companies. From the demand side, your product may have been fine at first and there was no great pressure, but now the consumer has become more and more demanding. It’s innovate or die.

The LINK: What are the obstacles to innovation in China?
WG: China’s private companies don't have the experience, skill, or the talent to do R&D. They may have started from a small plant, so how would they know how to do R&D? They lack talent, and financial resources. And even if they feel the pressure from the demand side, they are very short sighted. If they think their business can only survive for three years, why would they bother to invest in R&D?  For many, many firms, that’s the situation. They cannot see the long-term picture.

In addition to internal factors, externally, at the macro level, a lack of IP protection is still a big problem – although the government has tried to address the issue. If you don’t benefit from what you create and people can simply copy you, that’s a big, big obstacle for companies to innovate.

Another important factor is having a stable economic environment that will give confidence to SMEs. The real challenge, if China wants to become a global competitor, is to create new things. That’s radical innovation.  And we know the biggest enemy of radical innovation is uncertainty. Nobody knows whether your R&D product will bear fruit or not. It requires huge investment, it’s long-term and maybe all that effort and investment creates nothing. So all this makes firms reluctant.  There’s a lot of risk. So there needs to be some party there to play the role, and I think that’s the government.

The obstacle for SOEs is their governance structure. The heads of the large SOEs have term contracts. If you are only measured for three or five years, you focus on short term goals and not on innovation. The ROI from an innovation cycle in a pharmaceutical firm, for example, can be 10 years or even longer.   But if you know you’re only on the job for three years, and you won’t enjoy the fruits after you leave, why try? So the governance structure and the institutional arrangements in these SOEs are not in favour of innovation for SOEs either.

[Reprinted with permission from The China Europe International Business School.]