The McKinsey Quarterly has a newly published package of pieces on innovation in China. As the authors of the overview, Gordon Orr, a director of McKinsey’s Shanghai office, and his colleague Erik Roth, note:
Considerable innovation is occurring in China in both the business- to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy.
Chinese companies’ increasingly outdated global reputation for being imitative not innovative is because much product innovation in China stays there, and so escapes the notice of those not on the ground. That is as true of advances by local companies in domestically oriented consumer electronics as it is in tech media such as instant messaging and online gaming.
Orr and Roth acknowledge the importance of government support, clearly already evident in the development of industries, from high-speed rail to pharmaceuticals to green energy technologies, that Beijing considers strategically important. There will be more of that to come. The current five-year plan calls for a large increase in R&D spending. Up to 10 trillion yuan ($1.5 trillion) is a figure being bandied about. The anointed industries are biotech, post-fossil-fuels energy, energy conservation and environmental protection, clean-energy vehicles, new materials, and next-generation information technology and high-end equipment manufacturing.
But government support for R&D is far from the only reason for China’s increasing innovation. The quantity and quality of the country’s scientific and technical talent is growing. China’s universities graduate more than 10,000 science PhDs each year. That is enabling a potent blend of technology transfers from multinationals and indigenous R&D.
The formula isn’t infallible. Again, as Orr and Roth note:
Some notable examples [of flops] include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.
As we noted yesterday about some Harvard Business School research on the management of Chinese companies, the heavy preponderance of state-owned companies acts as a counterweight to developing the internal corporate cultures of risk taking, learning and collaboration that are necessary to nurture innovation. Chinese companies have traditionally preferred what Orr and Roth call “innovation through commercialization”—putting a new product or service into the market quickly, however rough its initial quality might be, but improving its performance rapidly through subsequent generations.
What also needs not to be lost sight of is that this is a different stripe of innovation, not so much yet leading-edge technological innovation, as process innovation; the use of China’s labor quality, including its intellectual capital, supply chain integrity and infrastructure to reduce cost. As S.D. Shibulal, chief operating officer of Infosys Technologies, noted in an INSEAD article on innovation in emerging markets, Chinese companies “are redesigning products to reduce costs; they are redesigning entire business processes to do things better and faster than their rivals.” He dubs this “frugal innovation”.
This lets Chinese companies pick off niches where consumers are prepared to accept a small drop in quality in return for a large cut in price. The real challenge for foreign firms is going to be not so much at the top end of the market in many given industries, but in the middle market. No doubt China will eventually be making breakthrough innovations; Orr and Roth say it will only be a matter of time before China evolves “from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common”. But before that happens, Western multinationals are going to have to learn to compete in the middle market as well as the top-end one, as that is where the next battles for world market share will be fought.