In Just a Few Years, Chinese Internet Companies Have Pulled Ahead of Silicon Valley in 5 Areas. How Did It Happen?

Mobile payments, e-commerce, internet finance, on-demand home services, online video... and definitely not artificial intelligence

Twenty years ago, when the Beijing municipal government announced its plan to turn Zhongguancun into "China's Silicon Valley," it sounded suspiciously like another round of "overtaking Britain and catching up with America." For a long time, the area was just a street of shops that assembled and repaired computers.

Walk down its famous "Entrepreneurship Street" today and you will see the signboards of all kinds of startups, founders in coffee shops eager to tell every passerby about their dreams, and visiting officials and dignitaries, or their admirers.

Still, Liu Qiangdong, who once sold CD burners in a Zhongguancun computer mall, really did take JD.com to Nasdaq, and its share price rose 30% in the year after listing.

Look away from that overcrowded street and you will find that in some areas, technology is spreading through China faster than through Silicon Valley, the place China once copied.

Mobile payments, e-commerce, internet finance, home services, online video... In these areas, Chinese tech companies have left the West Coast giants behind

In the US, a year after Apple Pay launched with the iPhone 6, only 12% of iPhone users had used it, and it accounted for just 1% of all US retail transactions. Google Wallet, which Google has renamed three times, has still not become a habit for anyone.

In China, by contrast, you can now leave home with neither cash nor a bank card, as long as your phone has Alipay Wallet or WeChat installed.

Not long ago, QDaily tried traveling for 12 days without a phone, and pulled it off. Even in a remote tourist area like Wuyi Mountain, shopkeepers took Alipay. And WeChat Pay, which arrived on the back of digital red envelopes, works even for a tricycle ride in a third- or fourth-tier city or a snack at a night market.

In the second quarter of this year, mobile payments in China reached 3.4 trillion yuan, and 85% of those transactions went through Alipay and WeChat Pay, two apps that demand almost nothing of a phone's hardware.

Even before mobile payments took off, China had become the world's largest e-commerce market. For last year's "Double 11" shopping festival, tens of thousands of Alibaba employees spent half a year preparing, then stayed up all night updating sales figures, surrounded by cases of Red Bull and portraits of Jack Ma.

In the first hour or so after the "festival" began, Taobao and Tmall alone took in US$2 billion, as much as all merchants together sell in a full day during America's biggest online shopping event.

Alibaba has driven internet finance too. Yu'e Bao, the money market fund run by Ant Group, held 613.3 billion yuan in the second quarter of this year, and that was after it had shrunk by 100 billion yuan.

PayPal's equivalent product, meanwhile, shut down in 2011, having never grown beyond US$1 billion. Today, the top two finance apps in the US App Store belong to two traditional banks, Chase and Citi.

Then there is the vast range of at-home services: food delivery, fresh groceries, private chefs, medicine, manicurists, hairdressers, drivers, even people who come to put screen protectors on your phone... Almost every home service you can think of has become a startup. The US has similar startup ideas, but they are mostly concentrated in San Francisco, and at most New York. Here, companies like Helijia and Gongfuxiong, less than five years old, already serve 7 to 10 cities with populations in the millions.

We even get plenty of cheap or free video. New films that take anywhere from 6 months to 2 years to reach viewers at home in the US can be watched on China's major video sites within 2 months.

Apart from the Hunger Games series, none of the top 50 US box-office films of the past two years is available on Netflix, America's largest paid streaming service. To watch them you have to buy a digital copy from Amazon or Apple for US$15-20 (HD costs more). Piracy is an important factor, but the tens of billions of yuan that internet companies have spent on licensing have also brought online video into the mainstream.

So what explains the gap between the tech industries of China and the US?

A large, dense population, a huge market, and cheap labor

The most obvious explanation is that China's population is large and dense, which gives domestic tech companies a huge market. In Beijing, the Dongcheng and Xicheng districts alone had 23,000 people per square kilometer in 2011. San Francisco, the second most densely populated city in the US, has less than a tenth of that: 1,900 people per square kilometer.

It is not just the number of people. Cheap labor also makes cheap, fast logistics possible. Free shipping within Jiangsu, Zhejiang and Shanghai is now standard on Taobao. In the US, that kind of speed is still a perk reserved for Amazon Prime members, who pay US$79 a year.

And while Uber spent more than a year cautiously testing a same-city bicycle courier service in Manhattan, in Beijing, Shanghai and Guangzhou it has long been standard for restaurant and same-city deliveries: crowdsourced couriers from services like Shansong and Dada ride electric scooters and get a parcel or a takeout order to you within an hour.

The gaps in the last generation's infrastructure became an opportunity

Mobile payments are booming in China because the previous generation's cash killer, the credit card, and the credit-reporting system that goes with it never fully developed here.

Two-thirds of Americans have a credit card, and the average cardholder carries 4.4 of them. Card companies compete hard to get people using their cards, and over the years the credit card has become a form of electronic money that replaces cash, as well as the yardstick of an American's creditworthiness.

In China, banks control both the issuing and the running of credit cards, which was always going to make progress slower. By the end of the first quarter of 2011, China had issued 2.553 billion bank cards in total, of which only 242 million were credit cards, less than 10%.

One detail shows the difference. In China, almost everywhere except McDonald's, you hand your card to a clerk to swipe, and many cards still require a PIN. In the US, paying by card in stores is already a habit; even subway ticket machines take cards, and almost every card payment is made by customers themselves without a PIN, faster than any mobile payment.

Alipay and WeChat each had a head start: one had e-commerce and a credit system already in place, the other a powerful network of personal relationships. Between them, they took over the role of banks and other businesses and built a credit system for the mobile internet. The result was Alipay Wallet and WeChat Pay, both launched in 2013, which now have 270 million and 200 million users respectively, already catching up with the number of credit card users in China.

Video shows a similar gap in infrastructure. In the US, discs and pay-TV channels are how films keep earning money after their theatrical run ends. In the internet era, film studios would rather back pay-per-title video than Netflix.

Neither channel really exists in China; there is only the pirate market. From the start, internet companies have called the shots in online video.

In China, video sites such as Youku, Tencent Video or iQiyi have a new film no more than two months after it opens, and most films are free. Within six months, even the CCTV movie channel is showing it. Distributors still depend on the box office for their money, but they have to get the film onto licensed video sites as fast as possible, because pirated copies are so plentiful and appear so quickly. Once a film has spread across the internet, distributors, and even the video sites, earn even less.

In the US, the process is four times slower. For 3 to 6 months after release, a film can only be seen in theaters, even though most theatrical runs are shorter than three months. Only after six months do the DVD and Blu-ray versions come out and the film becomes available to pay for on video sites.

A different investment climate: startups can still raise tens of millions with a slide deck

Since the dot-com bubble of 2000, raising millions of dollars in the US with nothing but a PowerPoint deck and a domain name has become very difficult. Startup investment in Silicon Valley now falls clearly into two stages: angel and VC. Incubators such as YC, together with hundreds of thousands of angel investors who have founded companies themselves, mainly serve to "screen people." They give startups anywhere from tens of thousands to hundreds of thousands of dollars to get going. The companies refine their products, and only once they find the market really can grow do they seek million-dollar rounds from VC firms.

Ben Thompson once described American investors this way: the media should often see them not as moneymen who throw cash around but as intermediaries, who connect the people supplying capital with promising companies and help them earn high returns. Investing is, of course, still a high-risk business.

On TechCrunch, America's largest startup news site, stories about a startup working out its business model often come with funding rounds of a few hundred thousand dollars, or even just tens of thousands.

In China, though (at least until July this year), raising several million or even tens of millions of yuan on a slide deck alone was not unthinkable. Even so-called "angels" prefer to "co-invest." According to one report, more than 70% of angel-funded projects in China in 2014 were co-investments. As a result, more than 28% of co-investment deals were worth 10-20 million yuan or more, and 25% were worth 3-5 million yuan. By comparison, YC, Silicon Valley's best incubator, gives startups just US$120,000 (about 760,000 yuan) to build a product and assemble a team.

The difference is even greater among those who come in at the middle and later stages. In Silicon Valley they are mostly investment firms; in China they are the three tech giants: Tencent, Alibaba and Baidu. All three took part directly in this year's many mergers, including Didi and Kuaidi, 58.com and Ganji.com, and most recently Meituan and Dianping.

You won't see Apple, Google, Amazon or Microsoft do this, even though they have more money. The tech giants of Silicon Valley and Seattle generally invest in one of two things: businesses that will have high technological barriers in the future, such as driverless cars and artificial intelligence, or companies closely tied to their own businesses, such as Apple's purchase of a fingerprint-recognition company.

Transforming traditional industries vs. exploring new technology

The difference in investment comes down to the different goals the two places pursue. Compare the most highly valued startups in each country and it is clear that technology-driven companies are still mostly an American phenomenon:

Comparison of the biggest startups in China and the US

Uber began as a mathematical model for dispatching cars efficiently, Palantir uses big data to fight online fraud, SpaceX has taken on NASA's space missions...

Even now you can see companies like Slack, whose valuation shot up a hundredfold in a year or two on the strength of an original idea and its technical architecture, even though it is just a new tool for making office communication more effective.

As for China's dozen or so internet startup giants valued in the tens or hundreds of billions, apart from DJI, Megvii (Face++) and Toutiao, they all use the internet and the phone to make traditional businesses more efficient. They move offline transactions online, show what is available more transparently and sell goods more cheaply, whether they are selling phones, fresh groceries or clothes.

When technology is not the barrier, what decides the outcome in transforming a traditional business is usually money and traffic. That is where Baidu, Tencent and Alibaba have the edge: whoever gets a button inside WeChat, whoever gets onto Alipay's home screen, whoever shows up more often in Baidu search stands a much better chance of leaving competitors behind.

That is also why almost every market for local services (so-called O2O, or online-to-offline), once competitors reach a tacit understanding, ends up relying on investment from these few companies and then moving into WeChat and Alipay to find users. Look at the Didi-Kuaidi ride-hailing war, or the group-buying battle between Meituan and Dianping.

When the fight is down to the last two or three competitors, they merge and form monopolies. The few Chinese companies that already controlled the internet 10 years ago are using investment to extend their monopoly.

Until technological breakthroughs once again become the main force behind new startups, that monopoly is unlikely to change.