In addition to our quotes in the column, you will find below the extended version of our views on this topic.

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While the first wave of Chinese web companies were making fire of all wood and entering new fields a bit recklessly, I think their perspective has changed a lot and that now companies enter fields in which they feel that:

1. There is a valid business case
2. This new field is somewhat connected to their service universe / ecosystem
3. They have a headstart thanks to their media power

Tencent entered only businesses that have proven revenue models. Search, payment, blogging with virtual goods (not blogging with ads), social gaming – all accessible from their IM service. Their focus remains “mainstream entertainment and communication”.

Shanda operates a huge number of servers and correctly identified that Amazon’s cloud computing was bringing close to 1/3 of Amazon’s profits by leveraging existing infrastructure with a service layer.

Taobao is doing the same, for the same reasons. Taobao also launched an e-commerce focused SNS, to encourage interactions between buyers, sellers and among them, to build up trust and “social commerce” – it is like Facebook Beacon done right.

Baidu is entering video now that Tudou and Youku paved the way by spending millions in bandwidth and clarified the IPR issues and the business case.

Sina, Sohu and Netease entered gaming after the mobile content market crashed. They recognized that the business of online ads wasn’t scaling greatly nor being as profitable as online gaming, and that a portal’s media power could be leveraged to promote games. If you are a major portal or email provider, you can promote pretty much whatever you want, event better if it’s your own property – a very profitable and semi-commoditized service like online games!

Eventually, while it might seem that they are doing a bit of everything, I think they are making quite pragmatic business decisions, finding ways to enter proven business fields by leveraging their existing reach and service universe.

It is also interesting to see how another underlying battle is going on as some players try to be the “access layer” of others. Especially, Taobao blocks Baidu from accessing its product pages directly as it would destroy its ad-based business model. Baidu accessing video sites also undercuts those sites’ ability to drive users through their homepage, and forces them to have revenue models that work in a standalone page – in a similar way to Google killing online newspapers by providing direct access. We see today pay walls being erected in the US Internet – as the battle is still on in China, it is likely search engines will pick up the remains unless services providers find sustainable business models.

The Map is Not the Territory

In a previous column, I have talked about “the myths of innovation”, including the “lone inventor”, the “wiz kid” and the fact that the successes we see today have often evolved and changed since the initial idea. In another, I talked about the “5C’s of innovation”: Copy, Combination, Competition, Constraints and Country, which influence how services and products evolve and diverge from an initial idea due to the influence of their environment.

You might have heard this expression “the map is not the territory” – certainly valid when the Chinese explorer Zheng He possibly sailed up to America in the 15th Century. The meaning is that the name of an object, the word for an idea or the opinion about someone is not the same as the object, the idea or the person itself.

I found that deciding to call something “innovation” or someone “entrepreneur” has a lot to do with:
(1) who is talking (the speaker’s personal knowledge and bias)
(2) who else is saying that (this is also called “social proof”)

Now the questions to tackle are: When can you call something an “innovation”? When can you call someone an “entrepreneur”?

What is innovation?

1. First issue: Finding signal

I am in the business of selling ideas from Asia and I keep hearing that “China is not innovating”. Am I in the wrong business? In fact, we continually identify interesting service concepts, business models, marketing strategies in China, and explain them to our clients. We consider them to be “innovations”, so why is China’s image still so much about “copy”? The short answer is that the “signal” is hard to find when there is a lot of “noise”.

2. Second issue: unknown prior art and dual citizenship

Innovation does not have a nationality, and it is very possible for something to be invented more than once. I was told at school that Gutenberg invented the printing press in the 15th century, but I found out later that it had been around in China since the 11th. Didn’t Gutemberg invent it? I think he did, but he did not know somebody else did it too, earlier. Is the printing press “Chinese”? I am not sure about the nationality but I do hope that possible patents – there was none at the time – have expired!

3. Third issue: incremental innovations

Another issue with innovation is that if you make a tiny change to something, most people would not call it an innovation. But if you make one tiny change every day, then over a few years the result will be radically different from where you started. When did “innovation” happen then? The answer is probably: every day.

I believe this incremental aspect of innovation is what makes it difficult to understand what is innovative in China. If you use Western references to describe local services you will simply miss out on what is different, original and really important.

Call Taobao “China’s eBay” and you will fail to recognize that Taobao implemented many services that eBay doesn’t have (IM, ad exchange, service platform, micro-retail service) and a business model that destroyed eBay in China.

Call Tencent “China’s Facebook” and you will not see that not only Tencent is making about 3 times more revenue than Facebook, but that it is far more profitable and has a very different service offering. Also, Tencent’s customers are its users, while Facebook’s customers are still for 90% its advertisers. If Tencent started as a “ICQ of China” and Taobao as “eBay of China”, they are certainly very different now.

Did they innovate? They would probably not be where they are if they did not.

4. Fourth issue: innovation does not always turn into a business

Of course, not all innovations end up becoming billion dollar companies. Most innovations never turn into profitable businesses. Even great ideas can take years to find a suitable environment to prosper: group buying is becoming hot in the US with a site named Groupon. “Tuangou” group buying in China has been very popular for years, combining online gathering and online/offline purchases, even for large things like cars!

So if you want to find innovation: put aside what you think innovation “should be” and focus on understanding the differences and paying attention to emerging signs. Innovation is right there, every time something is done a bit differently that it used to.

What is an entrepreneur?

Earlier this month I came across another instance of s never-ending debate about entrepreneurs: do you have to be born an entrepreneur to become one? I will try and show that first, this question has a massive logic flaw and second, that just like innovation, entrepreneurs are everywhere. It is all a point of view.

So are you born an entrepreneur? Well the problem with this idea is it is too easy to self-prove: his/her grandfather was an entrepreneur / he has friends who are / he had the drive because he was bored with his previous job, etc. Basically, there is always something I can find to justify this. Convenient, isn’t it?

If even the most socially awkward can be trained…

To show how this idea makes little sense let me make a parallel with a TV show I watched recently. It is a reality TV series named “The Pickup Artist” where a group of men who have extreme difficulties finding a girlfriend – they can be shy, unfashionable, awkward – enroll on a training that will equip them with the skills to approach women confidently.

Some people are “naturals” – born with high social skills, while others are not and might want to do something about it. The instructors in the show are experts who, for some, make a living teaching those skills, and were initially awkward and shy themselves. Along the episodes, participants receiving instruction and techniques and are faced with increasingly difficult challenges (the winner walks away with the title of “Master Pickup Artist” and 50,000 USD).

…then why not entrepreneurs?

The show demonstrates quite effectively that you can take pretty much anyone who is willing to change and help him do that. I would say that the same applies to entrepreneurs. The media only remembers big successes and dramatic failures (see “people love heroes” in my previous column), but most entrepreneurs are not there for the big media splash.

They are in it because they want something to change.

They are not satisfied with the present; they see an opportunity (they often overestimate it) and decide to do something about it. There is something glamorous about being called an entrepreneur – maybe something like being an adventurer of the 21st century. Would “Social Entrepreneurs” be the equivalent of “enlightened philosophers” of the 18th century? Being called an entrepreneur is also a convenient “license to fail” – and at least it was romantic to try. This actually leads us to another important point: what is failure? And what is success?

Failure and Success

Again it is largely a matter of perception. Each culture has its “models” and each person has its own set of values. While success is often described with a dollar value, many creators are more interested in creation and change than in fame and wealth, which come as pleasant side effects, at least while they last.

In a sense, Western companies have both succeeded and failed in China: Facebook has no presence but local evolutions are doing well. MSN and eBay failed but Tencent and Alibaba took their concept and changed it to succeed. I know of numerous small startups with creative approaches, concepts and sometimes technologies, but most of them lack the market-building capabilities, and almost all have little interest in getting known outside of China. Some are doing very well and keeping under the radar intentionally. Some have failed but have had the ride of their life. All have earned experience.

So which ones think of themselves as successes, which ones think of themselves as failures? Their peers and society at large might have an opinion, but eventually, it’s up to them to decide what they make of it. And as the song goes “You come from nothing – you’re going back to nothing. What have you lost? Nothing!”

Note: This is a guest column written for the Chinese business magazine “China Electronic Business”, invested by Jack Ma of Alibaba, and IT news site Interfax. Syndication inquiries are welcome!

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+8* | Plus Eight Star explains to its friends and lucky clients why so many good ideas from Asia are overlooked, and how to leverage them. We’re also on Twitter @plus8star

Content

We had 1 hour to explain everything we could about social media in China. Fortunately, our friend Kaiser Kuo had a keynote a couple of days earlier about the specific case of Google in China and censorship at large, which allowed us to redirect any such question to him :-)

Our target was to challenge the common assumptions around social media in China: it’s all copy, it’s censored, it’s so Chinese and it won’t work here.

Sam’s focus was on giving an overview of social media properties as well as illustrate how people and brands use them. My focus was on highlighting innovative divergence and local innovations that could be exported. In addition to my now classic “5C’s of Innovation” (Copy/Combination/Competition/Constrains/Country), I emphasized that “Innovation does not have a nationality” and “Things are often invented more than once“.

Among interesting things in the session – itself a rather classic panel – was the feedback provided by Twitter. Tweets about our session are all here in PDF.

I made a selection of my favorites below – enjoy:

# a Chinese girl based in Austin interviewing 2 white guys based in China.
# these lengthy hashtags SUCK. #socialmediaandchina seriously? 20 characters?
# everything’s that happening in the West is happening in China – on steroids
# Groupon-like group discount biz model has existed for yrs in China
# Basketball shoe named after consumer net slang…very cool
# #socialmediaandchina has paid the price in admission for attending #sxsw -learned more in 30 min
than I did the past 2 days. [Thanks, Mike!]
# this is a fun talk [Thanks, Chang!]
# China learnt from Korea and Japan in terms of building profitable social networks via web + mobile
# China’s virtual goods market estimate for 2009 – $5 billion, 5x US! (although in 2008 it was 25x, so US is catching up)
# Social Media and China – Knee How!
# Hearing this panel, I feel like we have a lot of catching up to China in terms of monatizing the web.
# Tencent more profitable than drug dealing, with a 40% margin.
# Tencent, 3rd biggest internet company in world, could buy one MySpace per year
# First online farm game was actually made in China by company called ’5 Minutes’
# boys buy girls virtual clothes in a social dance game like they’d buy her a drink in a bar.
# 5 C’s of Chinese innovation: Copy, Combination, Compete, Constraints, China
# U.S. models that relied on ads weren’t viable in China so they invented new ones.
# 5 D’s of American innovation: Dodge, Duck, Dip, Dive, Dodge! – Patches O’Houlian
# So refreshing to hear the successes of companies that are not US based
# Great idea:Zhenai online dating calls each party after the date, then reports back. No more wondering if he’s into you
# Innovation doesn’t have a nationality and things are invented more than once.
# My favorite panel so far, great overview of chinese social media
# Online conv in China just like dinner with my folks: any topic but politics and pornography
# Was in #socialmediaandchina, following #perfectlyirrational and #zerowaste Decided to move to the green thing. Good move. [Eh?!]

A good summary was also done by John Tobin @ Ignite Social Media.

Another good presentation by Mindy Zhang on social media in China, with some shared sources:

@benjaminjoffe – in the Bay Area for a month to recover from #SXSW.

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+8* | Plus Eight Star jeopardizes its health going to #SXSW to tell about Asia so you don’t have to go to Asia do the same. If you’re not following us on Twitter, you’re missing out!

[A] Why is that not a surprise?

1. This result adds only the 4th quarter, and Tencent was already healthily above US$1B in the first three.
2. Net margin has been consistent over several quarters

[B] Now what is interesting to notice this time again?

1. Tencent’s revenue is over 3 times Facebook’s. Tencent made US$540M in the 4th quarter, more than Facebook for the whole year. While Tencent’s service is centered on IM, it extends into SNS and games, carrying over the same digital identity and can easily be counted as a “social networking service”.
2. Net profit is an order of magnitude superior
3. Tencent could buy one “MySpace” based on net profit (if acquisition price is same as News Corp.). And no, they won’t do it.
4. Ad revenue were only 7.7% of total. An Internet company making over a billion without ads?! Thanks to virtual goods, in a variety of forms (avatars, games, page decorations, background music, etc.)
5. Tencent’s IM PCU passed 100 million in March 2010. There are 20 million on Skype at peak time. MSN has 330 million active accounts (called “users”) a month. Tencent had 523 million active user accounts in 2009.
6. China’s Internet users are not as rich as their Western counterparts, which makes Tencent’s achievements all the more impressive! (average income of Chinese Internet users is around US$400 per month)

[C] Some more comments

1. Tencent is not China’s Facebook. Based on the above figures, we would rather recommend to someone in the US to become America’s Tencent.
2. Tencent has over US$1B in the bank as retained earnings. If only there was something good to buy! (maybe there is?)
3. Tencent is the third largest Internet company in the world by market cap. At the time of writing we had:
- Google | $179.8B (links and keywords advertiser)
- Amazon | $58.4B (selling low-margin commodities along with digital goods and services)
- Tencent | $36.8B (local Chinese hero)
- Time-Warner | $35.9B (the total group, owns AOL)
- eBay | $35.1B (sadly, without Skype)
- AOL | $2.8B (mentioned as AOL owns ICQ, the initial inspiration for Tencent’s QQ IM)

Tencent’s stock price quadrupled from a year ago. Recession is tough!

[C] Tencent shares are falling! Google is leaving! The ship is going to sink!

Right. Maybe. 3% temporary decrease on a Google China scare or lower expectation is not much impact for a stock that quadrupled in 12 month.
On the sunny side, the Chinese Internet is just entering the “acceleration phase” of the “S curve” in terms of adoption. Still about 25% of Chinese are connected and Internet entertainment is cheaper than 1984′s Victory Gin. How could revenue god down when adding another 100 million or so Internet users in the next 12 to 18 months?

In addition, Tencent provides extreme social value as it is not just “a social network” but real “communication infrastructure”. More people use IM than email in China. And with Tencent, everything is right there! Access search, news, SNS, games right from the IM. Upgrade your online persona, be efficient or entertain yourself. With such power, Tencent does not even have to be the most innovative, just picking the right things and making it suitable for mass-market usage.

In addition, mobile is not played out yet. Three SNS in Japan make hundreds of millions from it, this is yet to come in China (and the US).

Oh, and Tencent is unlikely to leave China this year.

How do they do it?!

We won’t explain here what Tencent does – from IM to SNS, MMO, social games, mobile services, portal – if you wish to know more, our “Inside Tencent” report is waiting for you! | http://www.plus8star.com/reports/ (Previous clients include Microsoft, Harvard Business School, Nokia Growth Partners and more!)

Disclosure: MIH, Tencent’s largest shareholder, is a client of ours on the media side (MIH is a top media company in South Africa). We are not involved with Tencent in any business manner.

Enjoy the read!
@benjaminjoffe – in the Bay Area for a month to recover from #SXSW.

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+8* | Plus Eight Star helps Asian top companies get the recognition they deserve, and foreign companies leverage their best practices. What?! You’re not following us on Twitter yet?

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In the early 19th Century, Charles Darwin embarked on a five-year journey as a field naturalist. On a visit to the Galapagos Islands he observed animals that were closely related but had some distinctive features. That triggered his thinking about possible common ancestors and the formulation of the theory of evolution. The story of this discovery teaches us that a lot can be learned from small differences. This applies to China’s digital scene as well. Here is how.

Diverging Species

China was a latecomer to the internet, and it is natural that the first ideas that were introduced, such as web portals Sina and Sohu and search engine Baidu, were from more advanced markets, notably the US. However, just like a group of animals on an island evolves in a certain way within its specific environment, so too did Chinese web companies. Mainly financed by foreign venture capital, they started off as the “common ancestor” recently stranded on an island. From then on, they had to survive in the local environment.

Domestic organizations have since evolved and diverged significantly to the point that, aside from the outward general looks, most of the “organs”, “instincts”, and even their “diet” have been affected. What exactly are the factors that influenced such evolution? They can be called the “Five C’s of Chinese Innovation” (note: jump ahead if you have already read about this in a previous column :-) ).

• Copy. This is the starting point. With experience, capital, and low costs, several entrepreneurs – including a number of foreign-educated Chinese – tried their luck at becoming the “XXX” of China.
• Competition. Competition forced companies to differentiate – how can you make a difference when a handful of competitors pick the same US model as you did? You’ll have to be creative in some way: marketing, product, business model, you name it!
• Constraints. Revenue models had to be adapted to low incomes and the limited online advertising market. While advertising alone could sustain many web properties overseas, the lower income and younger demographics of Chinese internet users slowed down the shift of advertising budget and the retail of various products to digital. This drove business model innovation.
• Combination. One solution to overcome constraints and competition was to combine ideas in new ways. Instant messaging with avatars (graphical representations of a user’s identity, e.g. at Tencent’s QQ service); social networking with e-commerce (communities for young parents, e.g. at RedBaby and BabyTree); and user-generated content with a virtual currency system (basketball-focused community, e.g. by HoopChina) are all examples of this.
• China. The unique market scale has enabled alternative business models to become viable, which Tencent and online gaming companies have cleverly exploited by charging only cents for certain services, but multiplying them by many millions. Travel agencies cTrip and eLong could not rely on the inefficient IT systems of airlines and have made use of low-cost call centres to process customer orders despite being based online; Taobao is an online platform with escrow and product delivery succeeding in a low-trust online environment.

Copy, Paste, Create

The best way to conceptualize the driving force of the “Five C’s” is through examples. Web entrepreneurs of the first wave, in the late 1990s, quickly realized as they were depleting their personal or venture capital that advertising-based models were not working well in China. They had to find other ways to generate revenue. Some got inspired by non-US models, from places where conditions were more similar to China’s, such as South Korea; others tried out brand new models.

Today, the two most successful internet companies in China are probably Tencent and Taobao, both distant descendants of Western models – ICQ and eBay, respectively. Tencent’s revenue passed USD 1 billion in 2008 with 40 per cent net profit. Its market capitalization is over USD 30 billion. Meanwhile, who really remembers ICQ? Time-Warner’s, who never did much of ICQ after its acquisition and Tencent market capitalization is likely to pass Time-Warner’s (at 36 billion USD) soon. Taobao has formed an e-commerce empire that announced on its 10th anniversary its intention to “create 100 million jobs” by empowering individuals and companies.

Like its local competitors in the instant messaging (IM) space, Tencent could not cover its costs with advertising only and decided to offer personalised avatars – likely based on their success at various companies in South Korea. Later on, Tencent added casual games and more services. Today, about 90 per cent of its revenue comes from its virtual currency (a prepaid account that allows easy transactions within a closed system to buy designs for personal pages, power-ups, etc.), and barely ten per cent from advertising.

Taobao started off like eBay, but really stepped up its game when it stopped charging commissions on transactions between users. Instead, it focused on adverting and its Business-to-Business (B2B) offering of various hosting services and tools for merchants. In doing so, it surpassed Eachnet, the market leader at the time, which had been acquired by eBay. Taobao also introduced many interesting service innovations, from reputation systems to the recent Alimama advertising platform that allows any website owner to retail its ad space in a market place. It also brought in the Taoker retail system, which enables retailers to offer commissions to website owners selling its products on their site.

These are just two examples of companies that have managed to survive and grow in an environment where the initial business models did not work. They did so by evolving towards viable forms that are superficially similar but conceptually poles apart. Unfortunately, the present obsession by outside observers with uncovering and labelling promising services the “ICQ of China” or “eBay of China” will prevent them from identifying other real Chinese success stories.

Aside from the internet, domestic firms have also been able to develop unique business models in mobile telecoms. One such example is Huicard, which charges users for coupons and vouchers redeemable at retail and dining outlets. It works because the “old way” of the West – is impossible in China. This involves distributors trying to charge the retailer for advertising, but the combined difficulty of B2B ad selling and tracking coupon usage have proved rigid obstacles. The CEO of a European mobile content provider was so impressed after a meeting with the company that he fired off three emails right away to his team to explore whether they were able to develop a similar service.
Such cases show that the peculiar conditions of the internet in China have led “web creatures” to evolve differently from those in the West. China could be brushed aside as a separate microcosm, but as we can see with virtual goods, e-commerce, or mobile coupons, some of these species are not only thriving but are also resilient and adaptable to other environments. It is quite possible that these new products and services could undermine the existing online order – as the gaming industry is realising with the rising popularity of virtual goods. For instance, could a company become the “Tencent of the West”? And will some of the 10 highly profitable Chinese online gaming companies listed on NASDAQ enter Western markets successfully?

Learning from Past Mistakes

Now that the “survival of the fittest” idea has been put forward to describe the Chinese internet market, it is quite simple to explain why most foreign companies failed in this market. Some acquired local firms that looked similar to those back home, only to realise later that their source of income was from an entirely different business, which was often neither stable, scalable, nor replicable overseas. Others tried to run their business like back home, but failed to recognize the local market structure and differences in income, usage, and business practices.

The casualties suffered by foreign firms are numerous, though they have generally tried to hide the corpses. Mobile content providers such as Index from Japan and MonsterMob from the UK, social networks like Xing from Germany, or matchmaking sites like Meetic from France have all been victims. In most cases, the market entry was hastily done, the market poorly understood, and many – quite appropriately named – red flags ignored. When selling a China story to investors, simplification helps. When running the business, simplification hurts.

Yet there is still hope for companies who are willing to be innovative and adaptable, or at least willing to embrace the evolutionary process through partnerships. In their own way, among the most successful entries into China have been:

• Google. Though the profitability of its Chinese operations is doubtful, it has grabbed some market share thanks to its gradual adaptation to local conditions while maintaining its global standards. China is now the laboratory of new business models for its operations, such as its experiments with ad-supported music downloads. Nevertheless, the recent resignation of its China CEO sends an uncertain signal about its future.
• Yahoo. By exchanging its local sites and cash for shares in Alibaba Group, which owns Taobao, Yahoo might just have entered a better operation than it could ever have run by itself.
• Online Gaming. Several gaming companies are writing a strategy for success by establishing studios to develop games in China for the rest of the world and taking the time to adapt to the domestic market before releasing any game locally.

A Darwinian Effort

Fueled by the hope of receiving venture capital, the majority of local entrepreneurs still try first to replicate Western services – discovering rapidly that revenue does not come. Like their predecessors, some explore different directions while they can, while others simply disappear.

It is commonly pronounced that “China innovates”, but many advocates are at a loss when trying to pinpoint a specific case. Tencent is convenient as it is highly visible, but the reality is that its business has been mostly the same for over five years. To put it bluntly: the exact same ideas were at work five years ago but most observers are only just finding out now, suggesting that the “attention threshold” would be the 1 billion USD figure. This will continue to be the case unless the mindset of foreign companies changes.

Aside from Tencent and Taobao, however, there are quite a few interesting service concepts and business models being explored. Some are successful, others are not. A few would be very well adapted to foreign markets; a sizeable proportion is resolutely local. But in order to understand better the business chances in China, non-domestic IT organizations need to embrace the field naturalist spirit of Darwin.

Below is the presentation on “Techno Darwinism” given at Ignite in Amsterdam.

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+8* | Plus Eight Star lives in the future in Asia and can get you there too. We are also on Twitter!