Innovation Lessons From China

Despite Chinas long and established demand for high-technology products,

many leading global companies have become increasingly wary about
operating in the Chinese market. They see unfair competitive practices,
discriminatory regulation and intellectual property theft all ostensibly
condoned by the government as part and parcel of the Chinese
experience.1 Foreign businesspeople today routinely complain that in
exchange for market access, they are required to transfer technology to
favored Chinese competitors. And once such entities have the technology,
they in collusion with the government will endeavor to seize market
share not just in China but also in other markets.

We dont deny that some of these claims are valid. After all, the Chinese
government openly acknowledges its desire to establish companies that are
market leaders and to do so, at least in part, through technology transfer.
However, we see a different side of China, one that requires foreign
companies to remain actively engaged.

Our research describes unique forms of China-based technology innovation,

mastery of which is becoming increasingly indispensible for any company
aiming to succeed in the global market. (See About the Research.)
Anybody involved in international business needs to treat China not just as a

place to sell, but also as a place to learn. In our view, companies need to
lean in rather than pull back.

Innovation China Style

China today may not yet be the place to go for path-breaking R&D or radical
new invention. But its becoming the best place to go if you want to learn
how to make ideas commercially viable. Such knowledge whether it
involves product design for low-cost manufacturing, novel approaches to
component sourcing or ways to accelerate speed to market frequently
lies at the heart of commercial innovation. We see innovation as linking
invention the origination of new ideas with commercialization, the
translation of new ideas into actual products or services that can command
value.2 Each element requires creativity and distinct types of knowledge.
That many inventors never realize returns from their creations, and that
inventions are often licensed at low prices to companies that know how to
bring them to market, suggests that the new idea itself can be a relatively
small part of the equation. Indeed, you need to have the knowledge and
ability to transform the new into the profitable. This is where the Chinese
business ecosystem excels.

About the Research

When we began this study, we were aware of the highly divergent views
about the innovativeness of Chinese companies. Some observers said they
were extremely innovative; others, including many people in China, said
they were not innovative at all. Rather than debate this issue at the

aggregate level and in the abstract, we chose instead to examine companies

themselves. Over the course of three years, we along with two MIT
doctoral students, Jonas Nahm and Florian Metzler conducted more than
150 semi-structured interviews with senior managers, design engineers and
product developers in China-based companies. The interviews spanned a
range of manufacturing-focused sectors, including wind turbine production,
solar photovoltaics fabrication, heavy equipment manufacturing,
semiconductor production and power generation subsystem manufacturing
(for both nuclear and nonnuclear thermal plants). Efforts were made to
cover both electromechanical and chemical processes, as well as companies
operating across a range of scales and production volumes. Both foreignowned and indigenous Chinese companies were included in the sample.

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As we will describe below, such China-based knowledge can be grouped in
four categories: capabilities for rapid tempo operations and speed to market;
accommodation of unique customer preferences; world-leading capabilities
for reducing waste and costs in the production process; and capabilities for
new forms of networked production.

1. Capabilities for rapid tempo operations and speed to market

For several reasons policy uncertainty, the vast number of competitors

populating most sectors in China, legacies of traditional Chinese approaches
to business, etc. commercial success in China is often intimately linked
with tempo. Innovation in this sense involves not the development of brand

new technology, but rather the introduction of incrementally upgraded

products with unprecedented rapidity. The new product may provide
slightly new functionality, or it may simply offer an existing product at a
slightly lower price point. Either way, its introduction permits the producer,
at least for a brief period of time, to realize a slightly higher margin. The
proprietary knowledge needed to deliver this product is understood to be
fleeting; it will soon be learned or copied by competitors. The imperative,
then, is to get the product to market as quickly as possible, capture
increased margins during a narrow time frame, and then, as soon as the
inevitable imitators jump in, scramble forward into a new round of
incremental product innovation. In virtually all cases, winners in this system
develop enhanced capabilities for speed in design, speed to market and
speed in debugging.

2. Accommodation of unique customer preferences

The emphasis on speed can be seen in part as a response to a particular kind

of customer routinely found in China. This customer, whether household or
industrial, is at once impatient, frugal and sophisticated. For any given
product, such customers demand new functionality, unprecedentedly low
price and rapid delivery. Unwilling to wait for a fully mature product, they
instead want it now (even if now means the product wont perform
perfectly), they want it cheap and they want immediate service when bugs
arise. Meanwhile, they exhibit little brand loyalty, ready to jump at a
moments notice to competing providers products when new functionality,
better reliability or lower prices are offered. The pattern can be seen in
products ranging from mobile phone handsets (where the purchaser is a
household consumer and the product life cycle can be counted in months)

all the way to wind turbines (where the purchaser is a commercial power
generator and the product life cycle is counted in decades).

3. World-leading capabilities for cost out

In response to the pressures described above, Chinese producers have

become masters of what we call cost out identifying and removing all
forms of waste that hurt the bottom line. At one level, cost out involves
redesigning existing products to make them easier to manufacture or more
compatible with cheaper componentry. Detractors often dismiss these
efforts as mimicry, even piracy. But the truth is that redesign for cost
competitiveness is knowledge-intensive, creative and critical for business
success across a wide variety of global markets.3

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Cost out often involves supply chain reorganization. Chinese businesses

dont just redesign products, they also source them differently, often relying
on densely populated and intensively competitive supplier networks found
within China. The goal throughout is to eliminate waste that elevates
consumer prices and eats into corporate profits.

Foreign companies can learn from these approaches. To do so, though, they
have to be willing to let go of existing (and from the Chinese consumers
perspective, overengineered) offerings and reengineer their products to
meet local customer needs. Moreover, they must be prepared to
significantly rearrange their traditional business models, altering the way
they source materials and components and how they handle make-versusbuy decisions. They must be willing to make these changes not just on their
low-end offerings but even at the high end. By doing so, foreign companies
can substantially improve their opportunities to succeed both in highgrowth emerging markets and mature industrial settings.

4. Capabilities for new forms of networked production

Domestic companies in China, particularly those least tied to the state and
least exposed to subsidization, tend to survive by carving out niche
specializations in the production process and then partnering with other
businesses that can perform the remaining functions needed to bring a
product to market. These new entrants create opportunities for themselves
by creatively reconfiguring the production process, often in unprecedented
ways. The more experienced incumbents often have fully integrated
operations, which were developed over many years of investment and
learning. The best and most nimble Chinese entrants, however, quickly
assess what they are able to do in-house and then immediately go
outside to fill gaps. As a result, a wide swath of Chinese industry has become
extremely adept at operating in complex production networks, often
involving very sophisticated technologies and intensely collaborative
product development efforts.

What these networks offer global companies goes beyond just opportunities
for outsourcing. Rather, the networks provide foreigners opportunities to
learn from local partners who have proprietary knowledge about cost out,
accelerated product development and new product definition. Some
foreigners may be reluctant to expose themselves to such learning lest they
give up proprietary know-how. Yet even the most wary foreign corporations
those least inclined to engage with Chinese production networks must
recognize that some of their global competitors will have no such reluctance.
Thus, learning from China is not really an option its an imperative.

Chinese Innovation in Action: Examples From the Field

Across widely divergent industries, Chinese competitors arent simply

climbing learning curves defined by Western competitors years or even
decades earlier. Instead, as well see with the examples of wind turbine
manufacturing and semiconductor design, the Chinese are creating their
own paths and often in ways that can be extremely instructive to global
companies.

Wind Turbine Manufacturing

Given widespread concerns about climate change and resource scarcity,

numerous governments and companies have become interested in

renewable energy technology. Until the mid-2000s, the center of activity for
both the supply and demand of wind turbines was Europe and North
America. But China has recently become the worlds largest market for wind
power technology, accounting for 35% to 45% of annual installed capacity
globally. Moreover, Chinese manufacturers such as Goldwind, Sinovel,
Guodian United Power, Ming Yang, Dongfang Electric and Shanghai Electric
have become major players in the global equipment industry. Goldwind, for
example, is now a leading supplier of wind turbines.

What explains this dramatic shift? Although the role of Chinese government
policy provides part of the answer, there are other important factors at
work, including decisions by Chinese companies to develop products for the
low end of the market, to form partnerships with other companies rather
than developing a full range of capabilities on their own, to localize their
supply chains and to treat time to market and cost out as essential.

Create products for the low end.

When Chinese demand for wind turbines began to boom, the most lucrative
markets in North America and Europe were still red hot. As a manager for
one multinational supplier recalled, Our sales guys didnt even have to
leave their desks to sell all the products our production facilities could
produce and still achieve a decent margin.4 Major players such as Vestas
and Gamesa, which had built large production facilities in China, were
tentative in their responses to local demand from Chinese customers and
Chinese indigenous competition. Chinese customers seemed to want low-

end, low-quality and low-margin products, and local suppliers were eager to
comply to get a foot in the door of a growing market, in a market segment
that Western suppliers werent pursuing.

Chinese producers developed wind turbines that were 30% cheaper but only
10% less reliable. Not only were the products attractive to buyers in China,
but they also met the demand criteria for customers in other emerging
markets.
Early on, Chinese companies leveraged their engineering expertise to
redefine the entry-level product the mid-size, onshore turbine for
customers looking for something simpler and less expensive than what
multinational players were offering.5 Indeed, by using lower-end
components, Chinese producers developed turbines that were 30% cheaper
but only about 10% less reliable. Not only were these products attractive to
buyers in China, but they also met the demand criteria for customers in
other emerging markets.

Team up with partners.

Chinese suppliers have generally approached the market differently from

global incumbents. Rather than taking many years to develop in-house
capabilities, they elect to work with outside partners to piece together
production capabilities. Beijing-based Goldwind, for example, acquired
turbine designs by partnering with, and later acquiring, Vensys, a wind
turbine company based in Neunkirchen, Germany. This approach allowed

Goldwind and other companies to gain a meaningful foothold in the market

quickly.

Image courtesy of Goldwind

China is the worlds largest market for wind turbines and home to major
wind turbine suppliers such as Goldwind.

Image courtesy of Goldwind

Ironically, working closely with partners, which had at one point been
dismissed by the established turbine manufacturers as amateurish, has
become a relatively standard strategy for leading companies hoping to
remain on the cutting edge of product innovation. For example, Samsung,
which produces some of the largest offshore turbine models, works closely
with SSP Technology A/S, a company based in Strensup, Denmark, on blade
design and development.

Localize the supply chain.

Chinese turbine producers have differentiated themselves in other ways as

well. They have been aggressive about localizing supply chains to China as a

way to reduce cost. While competitors at multinational companies have

attempted to play catch-up in this area, typically their efforts have been
slower and more incremental. By the time foreign players understood what
their Chinese competitors were doing and how they could respond, they had
already lost substantial market share.

Emphasize speed to market and cost out.

Chinese turbine makers have embraced speed to market and cost reduction
as managerial imperatives that take precedence over everything, including
quality. Thus, some companies have intentionally released products before
they were fully developed and tested, on the understanding that few
customers were willing to pay for perfection and glitches could generally be
addressed on the back end. Such companies have relentlessly pursued highvolume production, often capturing substantial market share in the worlds
fastest-growing markets.

Its difficult to see how established turbine producers might have been able
to maintain their market share in China. Given the fact that the Chinese
government had officially deemed the wind industry to be of strategic
national concern (unlike solar, which, for the most part, was ignored), it is
conceivable that there were no circumstances under which European and
North American companies could have preserved dominant market
positions. Looking forward, its equally difficult to anticipate the extent to
which Chinese newcomers such as Goldwind will be able to realize success in
markets where customers demand state-of-the-art technology products.

Yet, in many industries, it seems that market leadership is becoming

increasingly contingent on the ability to absorb and master the type of
innovation-related capabilities found in the Chinese business ecosystem.
This is certainly true in emerging markets and lower-end products, where
cost competitiveness is critical. But even in markets for high-end products,
companies that turn a blind eye toward excessive costs or avoidable product
development delays do so at their peril. If Chinese upstarts dont identify
ways to beat them, their global counterparts surely will.

Semiconductor Design

Similarly disruptive forces are at work in the Chinese semiconductor industry,

which is loading increasing amounts of functionality onto mobile handsets
and other devices. The number and range of devices available for plug-andplay operation, especially no brand smartphones, is proliferating on a
monthly basis. But many of the suppliers of these no brand devices (the
Chinese call them Shanzhai) have few or no engineering capabilities of
their own. Rather, they are working closely with IC (integrated circuit) design
houses, which themselves depend on third-party semiconductor foundries
to fabricate the chips.

Emblematic of the phenomenon is a 12-year-old Silicon Valley company that

has become one of the largest chipset providers to Chinese smartphone
manufacturers. The company we cant use its name is also developing

a customer base among multinationals. When the company was founded, its
peers were focused on chipset designs for the nascent 3G market. But the
3G market was slow to materialize, thus wiping out many design houses
unprepared to wait so long without cash flow. Whats more, global phone
manufacturers and large U.S. and European mobile carriers werent inclined
to place big orders with an unknown design house, preferring to buy from
more established suppliers.

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So this company targeted a different kind of customer in a different kind of
market: the Shanzhai handset manufacturers serving the burgeoning
Chinese customer base at the markets low end. These players were limited
in what they could do technically; basically, they used 2G technology and
only produced phone cases and the software for the welcome screen. Any
further functionality had to come from outside vendors, which is where the
Silicon Valley chipset designer came in, with full solutions on a chip.
Although the solutions lagged well behind the technological frontier, there
were tens of millions of customers seeking low-end tech-related innovation.

Shanzhai phone producers sought to make money by operating on narrow

margins and winning quick sales by introducing cheap phones with basic
functionality. Their aim wasnt to produce something high quality or long
lasting the expectation was that end users would upgrade every few
months. The idea was to produce cheap, attractive phones with features
users liked or at least felt constituted something new (for example, analog
TV or dual SIM card capability). It was up to chipset providers to suggest
such functionality and make it possible.

Handset manufacturers needed new functionality quickly, given the short

life cycles of their products. They expected low-cost upgrades from chipset
providers every few months. And they expected rapid debugging. To meet
such demands, the Silicon Valley startup moved its headquarters to
Shanghai, believing it had to be located closer to its customer base. And it
collapsed its product development cycles into a new kind of China time.
Among other things, it learned to compress debugging processes that took
normal chipset providers three months to complete into a mere three days.

Operating on a new kind of China time, the Silicon Valley startup collapsed
its product development cycles. It learned to compress debugging processes
that took other companies three months into a mere three days.
With so many phone models and levels of functionality being released into
the market often with minimal lead time the traditional relationship
between technology providers and manufacturers had to be reconfigured. In
addition to being able to design chips quickly, design houses, for example,

had to be close to their customers to stay abreast of evolving functionality

requirements, which in turn were being driven by rapidly evolving end-user
tastes.

As the Silicon Valley design house found success in China, its overall
competitiveness and standing in the global marketplace soared. Having
proven itself with no brand customers, it was able to attract orders from
major Chinese branded handset manufacturers such as Huawei and ZTE.
Currently, at least one major mobile carrier in Europe is pushing a major
handset maker to use the design houses chipset for one of its European
product offerings, indicating that it may be on the cusp of becoming a
recognized global technology supplier. Whether the design house can
solidify that position is impossible to say, given the intensity of the
competition and the accompanying managerial challenges. But whichever
companies prevail in this market will surely draw on the lessons and
capabilities companies are learning in China.

Translating Ideas Into Commercial Products

Many people in China fear that their societys focus on manufacturing has
come at the expense of innovation. Conversely, many in the West fear that
allowing manufacturing to migrate offshore over the past two decades has
impeded their innovative capacity. We think both views miss the mark,
particularly insofar as both treat innovation primarily as new-to-the-world
invention. Clearly, invention is an important aspect of both commercial
competitiveness and human progress. But even the most groundbreaking

ideas are devoid of commercial value unless they can be delivered as

products in a manner, at a price point and within a period of time that suits
the preferences of an existing customer base. Whether were talking about
specialized industrial equipment or mass-manufactured consumer products,
knowing how to translate an idea into a viable product is in many ways at
the heart of innovation, the fulcrum upon which value creation rests.

China today has become the leading global center for precisely this kind of
knowledge. By operating in China, overseas businesses expose their
intellectual property to risk. But deciding to stay away entails the even
greater risk of missing opportunities to acquire knowledge that is critical for
competitiveness across a wide range of global markets.

Once in China, senior managers must confront strategic questions on three

distinct levels. First, they need to assess the extent to which they are in
China to serve the Chinese market and how well they understand its
competitive dynamics and its particular types of customer preferences. Does
their overall business model or the product line that previously brought
them success in other markets apply to China? If not, does the in-country
management team have the capabilities needed to succeed there, and will
headquarters provide the experimental space to develop those capabilities?
How ready is the company to learn and change its practices to meet
the demands of this market?

Second, managers must assess how prepared they are to leverage their
knowledge from China to build competitiveness in other emerging markets.

Can mid-range products developed for China be marketed in other

developing or middle-income nations? Can supply chains or R&D operations
localized for China be redirected to serve global production efforts, including
efforts based in other emerging markets?

Third, managers must ask how prepared they are to apply the capabilities
developed in China to become more competitive at home. Is the company
ready to use this knowledge in the most advanced markets? Do employees
involved with the R&D and product development functions back home
believe they can learn from how things work in China? Do executives and
strategists at corporate headquarters think competitors intend to leverage
knowledge from China to build competitiveness in advanced industrial
markets? And do those executives and strategists think that resourceful
companies from China are making plans to attack those very same advanced
markets?

We think theres a real problem when technology-focused companies in the

West shy away from China, whether out of fear or indifference. The
contemporary Chinese innovation ecosystem is a force to be reckoned with.
The real issue today for overseas companies is not what they have to give up
to enter China but what kind of know-how they can acquire from being
there. The decision to operate in China cannot be undertaken lightly.
However, it often must be undertaken to ensure sustained competitiveness
both at home and abroad.

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REFERENCES (5)

1. GE CEO Jeffrey Immelts comments in 2010 typified this view. See G.

Dinmore and G. Dyer, GE Chief Accuses China of Hostility, Financial
Times, July 2, 2010, sec. 1, p. 1.

2. For comparable views of innovation, see R. Henderson and K. Clark,

Architectural Innovation: The Reconfiguration of Existing Product
Technologies and the Failure of Established Firms, Administrative Science
Quarterly 35, no. 1 (March 1990): 9-30; and W. Aulet, Disciplined
Entrepreneurship (New York: Wiley, 2013).

3. Comparable phenomena have been observed in earlier cases of East Asian

development. For example, in the case of South Korea, see A. Amsden,
Asias Next Giant: South Korea and Late Industrialization (Oxford, U.K.:
Oxford University Press, 1989); and L. Kim, Imitation to Innovation: The
Dynamics of Koreas Technological Learning (Boston, Massachusetts:
Harvard University Press, 1997).

4. Interview, Beijing, June 2013.

5. Scholars have observed comparable patterns in the Chinese automobile

and construction equipment sectors. See L. Brandt and E. Thun, The Fight
for the Middle: Upgrading, Competition, and Industrial Development in
China, World Development 38, no. 11 (November 2010): 1555-1574.

Hide References
ABOUT THE AUTHORS

Edward S. Steinfeld is a professor of political science and the Deans

Professor of China Studies at Brown University in Providence, Rhode Island.
Troels Beltoft is CEO and managing partner of Beltoft & Company in Aarhus,
Denmark.

TAGS: China, Corporate Culture, Emerging Markets, R&D

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