China’s Allies And Why It Matters (Part I)
The current trade war between the US and China is having a substantial impact worldwide. It’s not only affecting manufacturers but startups and investors too. The conflict, though, is also opening strategic opportunities, especially in the innovation space.
In the short-term, cutting off China from US innovation is hurting the country. Even though China was the target, most Asian countries are also feeling the effects. Like any regional economy, all states have deep economic dependencies, and Asia isn’t different.
The current situation is forcing China to diversify and accelerate their innovation pace. These past few years, we’ve seen how they closed the gap of Artificial Intelligence research and even surpassed the US on specific metrics. Still, America has retained control of several critical industries like the Semiconductor one. China is desperately trying to close the gap, and so far, it’s succeeding on certain fronts.
Why it matters: China has always been conscious of its foreign innovation dependence. While they’ve been investing heavily in their weak spots for years, they lacked a sense of urgency. Losing access to US innovation is propelling the country to close those gaps faster. These investments will, in the long-term, give China independence and erode any technological advantage the US had.
The Asian Interplay
Asia, though, isn’t only China. The local market operates in the same way other regions do. In Europe, for example, most countries, despite their past, have deep ties with each other. International trade between them is tightly coupled, and there is a critical interdependency.
Asia is no different. While China seems significant, it still relies on its surrounding economies. The Asian country has extensive investments in South Korea, Southeast Asia, and Australia, to name a few. Investments not only flow from China outwards but between these economies too.
The trade wars, both between the US and China and among Japan and South Korea, are shaking the whole region. The complicated geopolitical situation is strengthening the ties between Asian countries, filling the vacuum left by the US.
The big picture: While isolationism is trendy now, it’s entirely unrealistic. Most economies, big and small, have deep interwoven links. This situation makes them very sensitive to global issues but also gives them resilience, as there isn’t a single trade partner. As the US cuts off China, the country is deepening its relationships with partners like South Korea, Singapore, or Malaysia.
Key Asian Players
Most discussions of Asia revolve around China, and with good reason. With a massive economy and large population, they’re the dominant force in the region. However, as I said before, several other countries around it are beginning to play a significant role in the innovation stage.
Despite what most foreigners think, Asia is very diverse, and Japan is an excellent example of this. The innovation and startup scene in the country is like no other. Not long ago, startups where but a blip in the country. Most innovation happened inside the big corporations (Keiretsu). These companies would then use this innovation to gain an edge in the market, in most cases, domestically.
The scene is changing fast, and several factors are accelerating the growth of the Japanese startup community. The first one is an increased investment in early-stage ventures. The reason for this is increased investment by Venture Capital, both foreign and domestic. Prime Minister Shinzō Abe’s agenda was always to open up Japan. However, it wasn’t until a few years ago that he got serious about it, and it shows.
Being an entrepreneur in Japan always had negative connotations. The country produces few and far apart. There are two significant exceptions, Masayoshi Son, founder of Softbank, and Hiroshi Mikitani, founder of Rakuten. Both have become inspiring figures for young people, showing that there are alternatives to working in a big corporation. The combination of inspiring examples and access to early-stage capital is fueling a change in the youth.
Universities in the country are seeing an increasing number of students becoming entrepreneurs. This phenomenon is creating a big wave of startups, but not just any startups. Most of the companies are spinoffs of advance research, giving birth to a robust Deep Technology sector in Japan.
Despite this, Japanese startups still confront two big problems. The first one is their sizeable domestic market. With 126 million people and a 4.9 trillion dollar GDP, most Japanese entrepreneurs tend to focus on their market. Few startups have international ambitions. Those that do struggle to find traction in other markets.
One reason for that is their extreme product adaptation to Japanese tastes. Most products are so culturally targeted that other cultures don’t find them appealing. A good example is Japan’s food obsession. I’ve never seen more Foodtech companies than in Japan. Nonetheless, very few of them would ever work outside of the country.
A second big problem is the lack of communication still apparent in Japanese society. Most startup challenges in the country derive from inadequate communication between stakeholders. As Japan opens to the outside, local entrepreneurs will start connecting with other peers. I’m sure such an exchange will enrich and help with better communication in future years.
The bottom line: As Japan opens up, we’ll see an increased presence of Deep Technology coming out of the country. One of the current natural markets is in Singapore. There is an increasing number of Japanese startups, either expanding or setting joint ventures there. Furthermore, I wouldn’t rule out an active collaboration between China and Japan in the future. China can absorb some of the Japanese exports while Japan shares deep technology with the Chinese. As they say, business comes first, history later.
South Korea, which is one of the strongest economies in Asia, is the perfect blend between Japan and China. It exposes some of Japan’s most conservative traits while retaining certain Chinese laxness. Like Japan, family-own corporations have been behind the country’s last decade incredible growth.
The overpowering presence of large corporations like Samsung, Hyundai, or LG, makes it hard for talent to divert to entrepreneurship. To offset this, the country has been investing in startups heavily since 2013, approximately four to six billion dollars during the past six years.
Despite the incredible investment, the impact has had mixed results. On one side, the growth of startup unicorns in South Korea is impressive. With nine unicorns to date, it’s one of the top Asian countries only second to China and bigger than Germany or Israel.
Insiders, though, criticize the inefficiency of many of these government-funded initiatives. For many, there is too much easy money. On top of that, the ecosystem is very fragmented and doesn’t foster collaboration.
“There were about 467 accelerators, venture capital funds, and government organisations supporting startups in Seoul and its surrounding province in 2018, some backed by bigger companies such as Samsung and Naver. There are 85 accelerators in Seoul, and the amount of angel investment increased from about US$170m ($250m) in 2015 to US$250m in 2017.”South Korean startups gather momentum. The Guardian. Oct 2019.
Too much money, though, isn’t necessarily the challenge for South Korean startups. Most of them are, like in Japan, very local by nature. They cater most of their products to their domestic market. Although having a smaller country, startups tend to have a slightly more international view than in Japan.
The lack of collaboration between startups and corporations is also a challenge. Open Innovation is a small fragment of the corporate strategy. Most organizations still derive their improvements from their employees, keeping the acquisitions of external startups on the lower side. The same is true for Corporate Venture Capital (CVC), which is quite limited in the country.
“Under the Monopoly Regulation and Fair Trade Act, startups are banned from receiving additional investments from CVC firms once the startups became a CVC affiliate after receiving an investment. This means CVC firms cannot really keep track of startups’ growth.”Seoul keeps CVC at arm’s length despite ‘Venture Boom’ pledge. The Investor. Mar 2019.
While government funds are great, the cooperation between the corporate world and startups is critical. Change is happening, but with one of the world’s lowest CEO tenure in the world (2.5 years on average vs. 5.1 years in the US), it’s hard to deploy long-term plans.
It’s not surprising then that most startups are clustered around the entertainment industry. Gaming and more, in particular, eSports, which started there, are massive in the country. Hand in hand with eSports, the rise of cryptocurrencies is significant. This trend is common to all of Asia, but South Korea’s gaming culture acted as an accelerator. The trading of cryptocurrencies was so prevalent that in 2018, the government began restricting them. The effect has been dramatic. The country has dropped from the world’s third-biggest cryptocurrency plaza to the sixth one, in one year.
Another bright spot is the prevalence of eCommerce startups, and the disruption that some of the newest Fintech companies are generating. Despite the good news, big corporations still control the local market. It’s hard for startups to crack the local market. Nevertheless, there is a prevailing mandate to build businesses for the local market. This widespread attitude is quite damaging for startups, which then have a hard time going international.
That said, there is a growing connection between the country and Singapore. Both countries have been actively investing in startups from both sides. This collaboration is fostering an increasing exodus of South Korean startups to Southeast Asia. It’s interesting to see that this trend is especially acute with Artificial Intelligence (AI) companies. The local market, still being very conservative, isn’t conducive to sophisticated solutions. Singapore, however, is becoming the world’s epicenter of both AI, Fintech, and cryptocurrencies.
Why it matters: South Korea is very well positioned to rise as one of the most potent startup hubs in the region. They have talent, money, and technology. Still, the country’s conservative society and the prominent grip corporations have on the market, makes it hard for startups to prosper. Singapore has money and access to the Southeast Asia market. South Korea holds outstanding talent that is critical for the survival of Singapore. A healthy startup alliance will benefit both. On top of that, there is China. As it stands, it already has extensive interests in South Korea. Their hunger for semiconductors, AI, and other advanced technologies, plus the ongoing trade war with Japan, will make them collaborate closer than before.
To Be Continued…
In the next article, I’ll cover the trends shaping Southeast Asia and its different players (Singapore, Malaysia) and the rise of newcomers like Indonesia, the Philippines, and Vietnam.