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Upwardly Mobile: Chinese Mobile Technology Start-ups face an Uphill Battle

by Matthew Fulco

August 12, 2013

Startups, Start Ups, Mobile Technology, Apps, Mobile Apps
Mobile technology start-ups in China are discovering that it isn’t all that easy to strike gold

Swarms of start-ups in mobile technology are feeling the effects of hyper-competition, illusive investment and fickle consumers.

Fu Cong was a stubborn smartphone convert. For years, the 28-year-old Shanghainese communications consultant carried a bare-bones Philips mobile that he favored for its simplicity and immense battery power—it could easily go 72 hours without being charged. Fu used it for calls, text messages and not much else.

All that changed in February when he celebrated the Lunar New Year by buying himself an HTC handset powered by Google’s Android. Fu loaded his new device with free applications designed for the burgeoning Chinese mobile market, like Dianping, China’s top restaurant review site, a Baidu map for navigation and Tencent’s wildly popular WeChat for voice and text messaging. “It has most of the functionality of an iPhone at half the price,” he says. “If I had to use a phone without all these functions again, I would feel disconnected from the world.”

Connectivity is a priority for the world’s largest and fastest-growing mobile communications market, whose 1.1 billion subscribers include 200 million to 330 million smartphone users, analysts say. Last year, smartphone purchases by Chinese consumers rose by 112% from 2011, according to a report by the market research firm IDC.

China’s hunger for mobile connectivity and preference for the Android iOS have sparked a boom in the production of free apps by start-up firms keen to quickly build a large user base, which they can later charge for products or services.

In 2012, 3,585 start-ups were founded in China, of which 25% were in the mobile communications sector, according to research by China tech-industry analyst Charles Custer.

“There is astounding growth in the industry,” says Kai Lukoff, a Beijing-based product manager for the international division of Wandoujia, a content management app for Android phones. “We had predicted there would be 20 million Android smartphones at the end of last year and instead there are 200 million.”

With Apple its only major competitor controlling just 10% of the Chinese market, Android will drive a highly competitive smartphone and app market for the foreseeable future, Lukoff says, prompting tech companies big and small to race for a share of the pie.

“To some extent, it is cyclical,” he says. “E-commerce was hot two years ago and then social was a huge deal. Now, mobile is it.”

The size of the target market remains captivating, especially as vast swaths of it have yet to be tapped, says Custer.

In Custer’s view, China’s mobile web is not only bigger than the broadband PC web, but also enjoys greater growth potential because hundreds of millions of its people access the internet mainly through their mobile phones, not computers. That phenomenon, coupled with the availability of cheap but powerful smartphones—Chinese brands like Xiaomi or Meizu can be purchased starting at RMB 1,000—will ensure an ever-greater share of the Chinese population goes online via mobile devices, translating into increased app downloads.

For example, photo-sharing app PaPa, which allows users to send voice recordings with their pictures, has attracted 10 million downloads from Android and iPhone users since its late-2012 launch. Consequently it has become one of the most successful Chinese start-ups of the past year. PaPa has attracted attention from the tech industry and beyond, with Innovation Works founder Kai-Fu Lee and actors Zhao Yuheng and Li Bingbing among its high-profile boosters.

Xu Chaojun created the PaPa app with a team of four in just one month in an office at a converted factory in Beijing’s 798 Art District, where a number of start-ups have set up shop, although the majority remain based in the Zhongguancun technology hub in western Beijing.

“It helps that a killer smartphone app can be something that’s very simple, cheap, and fast to develop. That’s certainly not true of, say, a hardware start-up or a company trying to make PC games for hardcore gamers,” Custer says.

Cheap but original is the key. John Tian, an analyst at 36 KR, a Beijing-based consultancy that helps start-ups increase their user numbers and find investors. “PaPa is original. It is the first mobile app in the world to integrate voice recording and photo sharing in a way that allows the user to create a spoken narrative to accompany a picture.”

Get Out of Town

Apps that are genuinely original have more than just the China market to consider. Several ambitious firms have instead found success overseas with a B2B business model.

One start-up, named Cootek, signed a contract with overseas telecom companies to provide a language input app called TouchPad for Android phones which simplifies typing on a small mobile screen, says Gang Lu, a long-time Shanghai based industry watcher and founder of the TechNode news site. Touchpad’s learning based-predictions can foresee what users plan to type based on their previous typing input. It also has a ‘blind typing’ function that corrects typing errors based on the keys a person has pressed and the context of the words, allowing users to type without constantly looking at their touchscreens.

Thanks to those smart functions, 20% of Android phones outside of China have TouchPad installed, Gang says.

Mobile gaming is another area in which Chinese start-ups have found a niche overseas either selling the games outright in apps stores, or an in-app purchase, in which the game itself is free but the user must pay for virtual goods such as weapons or food, which can improve the user’s prospects in a game considerably.

In Apple’s app store, 70% of revenue goes to the game manufacturer and 30% to Apple.

According to Gang, a Hangzhou-based start-up called Droidhen has produced a number of games that have sold well internationally, notably a game called Defender in which players need to defend a castle against monster attacks. Such was the success of Droidhen’s products overseas that the company’s founders visited the US last year on a promotional tour, their first time to travel abroad, Gang adds.

Still, gaming has its limits for mobile start-ups, says Kevin Der Arslanian, an analyst at the Shanghai-based consultancy China Market Research Group. “Since the games tend to have a short shelf life, you need a real supply chain to launch one after another,” he says.

Even with a well-developed supply chain, piracy and copy-catting present even more intrinsic challenges to mobile tech startups.

Weakness in Numbers

Despite the popularity of mobile apps in China, the longstanding habit of pirating internet products and an increasing availability of free services, few consumers value the products enough to pay for them. That leaves start-ups largely deprived of revenue streams. “Ninety percent of mobile start-ups, maybe more, can’t make money because of copycatting and piracy,” says Gang. “After one good product comes out, there could be tens of copycats, or there could be hundreds.” Data from the Chinese-language 17Startup website shows that mobile firms also had the greatest rate of failure of any start-up sub-sector in 2012, with 26% folding.

In Gang’s view, companies producing mobile apps tend to focus first on building a large user base, the way PaPa has. Founder Xu Chaojun believes his app could register 50 million users this year and 200 million by 2016, helped by its integration with the Sina Weibo microblogging service, which itself boasts 500 million users.

Start-ups believe attracting enough users, can eventually lead to money-making. A large user base helps start-ups to attract the attention of venture capitalists, says John Tian, a Beijing-based tech industry researcher. “The mobile internet in China has few business models at this point,” he says. “Venture capitalists will often decide whether or not to invest in a start-up based on the number of users it has.”

Indeed, Papa’s soaring numbers helped it secure $10 million in seed money from Innovation Works and California based Sequoia Capital.

Zeroing In

Gang advises start-ups to target niche markets smartly, citing the success of the mobile app Edaijia for Android and the iPhone, a national 24-hour on-demand chauffeur service that relies on a team of freelance drivers to help intoxicated people get home safely from social functions. Founded in Beijing a year ago, the app has become increasingly popular over the past three months.

“In China, when you meet for business, it is usually over a huge meal followed by karaoke, and you have to drink a lot,” Gang says. “Since businesspeople usually drive themselves to these functions, there is a need for this kind of service.” The Edaijia app has a navigation function that is able to pinpoint the location of users and inform them of the drivers closest to them on duty along with their mobile numbers. Edaijia pays its drivers a fixed rate—which is higher after 10pm— to serve as stand-by chauffeurs who drive the intoxicated clients home in their own cars. For each client a driver brings home, the company takes a commission.

“They’ve really gotten bigger in the last three months,” says Gang, without giving specific figures.

Another start-up app that has found a niche market is the virtual karaoke service, Changba, which starting in March, charges users to ‘gift’ singers they like with virtual flowers, but only if they want to gift more than three performers a day. The principle is identical to that used in mobile gaming: provide an entertaining initial experience for free, but require users to pay for continued stimulation.

(Click to Enlarge)
(Click to Enlarge)

No Exit?

For all the promise of China’s mobile communications start-ups, a deeply ingrained copycat culture crimps their potential to grow, as companies see little reason to pay for a good idea when they can simply copy it.

“It’s cheaper to copy here,” says Steven Millward, a Suzhou-based researcher for the TechInAsia site focused on startups. And it is not just big internet companies devouring their smaller competitors as with Tencent and WeChat—start-ups are both victims and perpetrators, he says.

But copycatting does not necessarily mean creating a carbon copy of an app, says Beijing-based analayst Tian. “In the mobile market, companies will often copy just the key functions from an app,” he says. That phenomenon causes the startup ecosystem to be full of apps with different names that perform the same tasks, reducing their competitiveness, making high user numbers all the more important, Tian says.

Millward says mobile communications start-ups face an additional hurdle because Chinese investors are reluctant to pay for something virtual. “E-commerce firms may attract investor money because they have a network of warehouses stocked with goods. You’ve got to have something physical,” he says. Without investment capital, copying becomes a much more appealing option.

Those attitudes make IPO exits, an essential pathway to expansion for start-ups in the West, elusive in China. With the exception of the RenRen social media site, no Chinese internet company has gone public (See ‘The Freeze’, page 30).

China’s restrictive stock exchange regulations, which require companies to demonstrate three years of profitability in order to go public, also prevent cash-starved start-ups from tapping the IPO exit option.

In this dog-eat-dog environment, startups need to be comprehensively strong to prevail, says Chen Hua, co-founder of Changba, which, despite its popularity in China, has yet to be duplicated.

“Your app needs more than smart technology and intelligent design,” he says. “It needs to have strong selling power, to have a genuine brand identity.”

Those attributes will help attract investor money, since the best products do not have trouble getting financing, Chen says.

Still, TechNode founder Gang Lu believes mainstream Chinese consumers lack loyalty for internet products, no matter how good they might be. “Most people just don’t care,” he says.

Such was the case with Hong Kong based start-up TalkBox. TalkBox faced dozens of copycats from its release in the fall of 2011, but it was Miliao, the voicemessaging app created by serial entrepreneur Lei Jun for the Xiaomi phone, that emerged the most successful.

But what goes around comes around, says Gang, as WeChat one-upped Miliao once Tencent realized the demand for voice-messaging apps in the China market.

Ironically, Lei Jun praised Tencent for WeChat’s success at the Global Mobile Internet Conference held in Beijing in early May, but he also said he hoped China’s smartphone users would give Miliao a chance. He declined to thank TalkBox for giving him the idea to create Miliao, however.

There is no way to stop copycats, says Changba’s Chen. “You just have to create something stronger and more resilient than everyone else,” he says.

Forget about Facebook

Looking ahead, China’s mobile start-ups have cause for cautious optimism. Soaring smartphone usage means the number of potential users is growing fast. At the same time, the popularity of gaming will buoy the in-app purchasing model, says Lukoff of Wandoujia, offering mobile start-ups different ways to earn revenue and Chinese consumers more variety in gaming.

“As it becomes easier to buy good, authorized products, that’s the direction in which mobile will move and it will be driven by gaming,” says Lukoff.

Outside of gaming, the savviest firms will devise products not easily reproduced, making them resilient against potential copycats, says Millward of TechInAsia, citing the Jiayuan dating website. Jiayuan is China’s largest online dating platform and a Nasdaq-listed company. It has an extensive network of resources, including access to some of China’s wealthiest individuals. Jiayuan has resultingly launched specialized services difficult to replicate.

And for those who would replicate instead of innovate, tech industry analyst Custer offers sanguine counsel. “While copy-to-China still works, everyone knows that the chances of your being one of the winning copycats at the end of that race is extremely slim,” he said. “I’d say start-ups are better off aiming smaller, even if that means not setting out to become the next Facebook.”

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