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Erhai Liu: Finding the Right Corporate Niche

Jun 12-2014   



201405271515755

Erhai Liu is an EMBA alumnus of National School of Development at Peking University and senior partner and management director at Legend Capital.

Innovation in China is different from innovation in the U.S. My speech will cover three topics: the driving force of Chinese economy, innovation in China, and entrepreneurs as leaders of innovation.

The Driving Force of Chinese Economy

First of all, people tend to analyze economic situation using components of GDP, which includes consumption, investment, and export. When export goes down, we begin talking about stimulating export. When investment drops, we rush to increase investment. When consumption slows down, we aim to boost consumption.

As a matter of fact, this is not the way that economy works. Using the example of a large corporation, let’s talk about Apple Inc. We all know about Apple Inc. Apple promotes consumption when it pushes products into the market. When a lot of people decide to buy iPhone, Apple Inc. gets the investment and uses it to develop cloud computing.

Therefore, similar to a successful company, we can study GDP from its components and discover interesting things in investment, consumption and other aspects. However, many companies in real life represent a combination of investment, export, and consumption. Based on this idea, let’s return to our analysis of GDP one more time, which calls for more investment and consumption. In fact, to realize such increase of investment and consumption can be very difficult. The current situation of export is relatively clear and stable.  However, it also means that there is not really a way to rapidly increase export. We have created a lot of free trade areas and ODI. Does ODI drive export or impact export? Perhaps one answer was that it drives export.

We all know the situation in real estate market – a sustained drop is currently in the play. We all saw that the people who bought new homes in Hangzhou were not happy about the drop in real estate price. This is what I called Crowded Bus Effect – people who are on a bus would tell the people who are trying come aboard that “the bus is full so be patient and wait,” and urge them to take the next bus; however, people who are trying to get aboard would say that “Let’s step up and help each other so we can all get aboard.” For the same reason, people who recently bought new homes would not like to see the drop of real estate price. Besides, the government receipt was over $4,000 billion last year. Nobody wants to be responsible for the fall of such a large government receipt. Therefore, the drop has to be sustained, and the government benefits from it. Now let’s talk about urbanization. There is no clear solution to actually solve this problem. Antitrust legislations require courage because the government needs to reallocate some people’s profit. If we include infrastructure investment such as 4G and railroad into the discussion, it is clear that the boost of consumption is more of a result than a dependent variable. Therefore, I think innovation is the only factor that can sustain continuous development of Chinese economy. Many people do not have clear understanding about the innovation that I am talking about. They think that innovation is always on the fundamental level, such as innovation in essential technology. However, this understanding is not appropriate. I will now talk about my understanding of Chinese innovation.

Chinese Innovation

Chinese innovation is different from American innovation. In the U.S., the development of high-tech industries is based on the development of its traditional industries. As high-tech industries become mature, they transform into a part of the traditional industries. Following this pattern, the development of new technology is sustained. However, this is not the case in China. The traditional industries in China are not mature, and high-tech industries will not stop their development and wait for traditional industries to become mature. As a result, the two types of industry develop together, and the development creates a new pattern. Therefore, in China, there are several ways to look at innovation – technology, development of traditional industries, and the new pattern of industrial development.

From the perspective of technology, most of us are familiar with the development of cell phone. – Android took over 80% of market share; Internet usage on cell phone in the U.S. has surpassed Internet usage on PC, and the same thing will happen in China as well, sooner or later. Today, no entrepreneur can overlook the significance of mobile service. Failure to provide mobile service will almost definitely put the company in a difficult situation in today’s market. I think Alibaba is very successful in the service it provides on PC. However, it faces huge challenge on mobile service sector despite of its consistent development, which includes a series of acquisitions. I think the dominance of Alibaba in PC service is no longer the same in mobile service. Challenges from services like WeChat payment has been increasing the level of competition for Alibaba.

We can also talk about innovation from the perspective of social development. As a country that is going through rapid growth, China is experiencing constant changes in consumption level and branding of its many industries. Companies like China Auto Rental and Pod Inn were never thought of before. The establishment and growth of these companies, of the industries, and of the society follows a pattern. This is also a pattern of social and technological development. Based on this pattern, I identified five categories of companies. I have been managing investment in many of these companies. The first category includes high-tech companies. These companies are similar to the ones from Silicon Valley. Some of the companies run social network like Renren Inc.; some are exports in electronic commerce; companies like MT develop games on mobile devices; we have also worked with social network marketing companies. The second category also includes high-tech companies. However, these companies have solid background in their respective industries. For example, Amazon.cn was initially a retail company; Zhaopin.com was a company specialized in human resources; Yiche.com was from the automobile and used car industry. The third category represents companies that have technology playing central role and their entire marketing plans based on the Internet. These companies have significantly different corporate structure from the others. The fourth category includes service companies. These companies are from traditional industries but have large proportions of internal management system and marketing system built on IT and the Internet. For example, China Auto Rental receives 70% - 80% of their orders from the Internet. Tuhu.cn also receives almost of all of its orders from the Internet. The fifth category is new business model, which includes Pod Inn. Pod Inn is popular but different from Home Inn. Pod Inn is fashion; it has its own culture, which results from its innovation. I consider these five categories of companies to represent five different opportunities and future of China.

Horizontal and Vertical Strike in Starting a Business (Finding the Right Niche in Starting a Business)

What is the purpose of innovation? Every innovation is created for a reason. Entrepreneurs innovate to make profit. I think innovation is about finding the right niche for your business. The movie The Grandmaster starts with a Kongfu fight. Then, the grandmaster said: “Kongfu is simple. You strike at your opponent, and the defeated kneels while the winner stands.” The strikes that I am talking about are clearly different from what the grandmaster talks about. By horizontal strike, I mean that enterprise needs to find the right niche in its industrial chain, to know whether their business model exists elsewhere, to understand your relationship with supplier and retailer, and to identify potential threat and competition. For example, today everybody is making VCD. You may think that making DVD is a good niche in the market. However, there is actually not enough living space. VCD suppliers can easily destroy the niche that you see. Now what is vertical strike? Vertical strike is your competitive position against others in the industry. For example, in the auto rental market, if you want to succeed, you need to look for the right niche in the market.

There are several models that we can use to analyze the right market niche. For example, the model of driving force, which analyzes driving force within an industry from market environment. The model looks for opportunity in industrial driving force. Some of the opportunities are not real; some are real but do not belong to you.

I will use the auto market as an example. We have invested in many companies including Bitauto, which we invested years ago; China Auto Rental, which is now going public; used car auction companies; used car dealers; navigation providers; and tire makers. I will talk about China Auto Rental. Many people wonder about the quality that makes this company special. They recognized that auto rental is everywhere in the U.S. and thought there is nothing innovative in opening a company like China Auto Rental. However, years ago, a lot of people thought that Chinese people would never pay for rental cars. They used to think that Chinese people who didn’t own cars would simply go for taxis. However, after analyzing many factors including navigation systems, credit card, ID card, population with driver’s license, auto/manual shift, financial support, consumption pattern and others, we reached at a conclusion and invested in China Auto Rental. The lesson is that when doing industrial analysis and looking for innovation, you need to find the right horizontal strike, or the right niche in the market.

Entrepreneurs Lead Innovation

Now I will enter the next topic. I just talked about the innovation in China, which is different from innovation in the U.S. I analyzed from the perspectives of technology, the five opportunities of industrial development, and the specific methods of analysis. Who is leading innovation in China? Scientists create technological inventions. However, entrepreneurs and their entrepreneurship are indispensable parts of innovation.

We have several models, one of which is the VALUE model. The VALUE model is about finding core value. I will explain using three examples. The first example is about our investment in mobile phone gaming, which includes SNS, IOS, and iDREASKY Games. When we invested in Locojoy, former CEO of Kirin Game founded the company. At first, Locojoy was not doing very well, especially with graphics. The CEO is an expert in gaming design. He wrote a book called Sphira and made a game out of it. I looked at the prototype and told him that even as an amateur, I could see that the graphics was terrible. I offered to hire a Korean art designer to improve the quality. During the fifth prototype, he lost control of temper. Despite of that, we made progress very rapidly, and the future seemed promising. The lesson from this example is that innovation is not always easy. There are often lots of failure. The master game designer from Locojoy wanted to achieve perfection. However, sometimes failure is an indispensable part of the path to success. Without the persistence of an entrepreneur, you will face a lot of pressure from others’ comments and critique, belittling your achievement and progress.

The second example is Renren Inc., which suffered a lot of setbacks at the beginning of its development. However, the growth of Renren is amazing. I used to work with Ning Yang, and I saw him again in 2002. At that time, I told him that his stay in the U.S. had at least cost him $200 million because of the high living expense in the U.S. After he came back, he started doing some business in SMS. He tried many different projects in the already mature market. I’m not saying those struggles are good; but many entrepreneurs went through them and learned a lot during the process. Later, Ning Yang acquired Xiaonei and changed its name to Renren Inc. Many of you may still remember Kaixin001, which enjoyed its success and imposed great competition against Renren Inc. early on. That company is still around today, but nowhere near Renren Inc. After all, corporate innovation comes with huge risks to entrepreneurs. Math and Management can hardly explain the entire process, which includes the factor of luck and spirit of persistence.

Lastly, I will tell you about one more example, which is also one of the companies that I invested in. The story comes from our managerial decision report. What makes up the major revenue of China Auto Rental? The company used to be like an auto club, which relied on membership fee, insurance commission, advertising fee, and corporate service. However, these sections do not provide any revenue anymore, and we have transformed into a totally different company. Before this transformation, we had over $100 million of revenue. Then, the new policy of the China Insurance Regulatory Committee came, and our revenue dropped dramatically. The future was grim, and the company discussed about changing business model. We tried car wash, rapid repair service, and parts sale. Afterward, we decided on the direction that we wanted to pursue and increased investment. The CEO is also an alumnus of BiMBA, and he spent a lot of his own money to get the business running. We faced a lot of challenges, but we are doing well now.

The lesson from the three examples above is that today’s innovation in China is really difficult to achieve during the process of corporate development. Like I have analyzed, innovation exists in technological and social aspects. Innovation also exists in different patterns. However, my job is not to realize such innovation, but to provide investment for entrepreneurs. With their entrepreneurship, entrepreneurs build their teams and work their way up. Certainly, nine out of ten times, the process may lead to failure. However, the one time of success is everything that matters. That one time of success is what we all work for. Here, I would like to wish all my fellow entrepreneurs to achieve that one time of success despite of all the losses. Thank you very much.

Comment from Professor John Yang:

We appreciate the speech from Mr. Erhai Liu. Many topics that Liu mentioned should be very familiar to our business students. Liu talked about that in many industries, innovation does not only exist in technology. Business students often ask me, “I don’t have a science background, and I am not an engineer. I can’t start a company in Silicon Valley, but can I still innovate?” This question is answered by the examples of Liu’s five categories of industry – Innovation can be realized in all five categories.

Liu’s discussion about corporate niche is closely related to the “business strategy” that we learned in our business school. Understanding strategic position of a company in a market is important. Without this understanding, you will not understand your relationship with suppliers and retailers in the industry; you can’t identify the special features of your industry; you can’t see the value that is created during each process of the industry. As a result, you will not survive in the heavy competition. Therefore, learning the industrial environment is critical for a company to excel.

Liu made a clear illustation about the quality and virtue of entrepreneurs. Under the Chinese market environment, especially with all the uncertainties, innovation cannot succeed without firm persistence, confidence, and discretion about future. Among ten people, nine may very likely drop out.

I know Liu pretty well. He was among our early graduates. During the last decades, we had dinner together almost every year. I am a witness to all the foreseeable and unexpected development of his career. Today, he has become an expert in the field. However, this expertise came from all the hard work he had done. Liu is a rational man. He learned from experience and was able to consistently make progress. Now, his opinions on some issues have become totally different from his opinions a decade ago. Some people question the practicality of things that we teach in school. Many think that the degree is suited for MBA students but not EMBA students. I do not agree with this idea.

Steve Jobs once said: “You can hardly know whether the things that you learned will help you in the future and whether the course you take will benefit your career upon its completion.” However, after you have learned so much, you will be able to connect all the dots and make sense of the bigger picture. Innovation in this society is built on consistent learning. Maybe a decade, or two decades ago, we could start a business without much consideration. This will not work now. All of the three people (Hui Zhu, Bin Yang, and Erhai Liu) know about the importance of learning.

Based on the shorthand of speech on “20th Anniversary of National School of Development at Peking University.” Article is not proved by speaker.

 

 

.

Erhai Liu: Finding the Right Corporate Niche

Jun 12-2014   



201405271515755

Erhai Liu is an EMBA alumnus of National School of Development at Peking University and senior partner and management director at Legend Capital.

Innovation in China is different from innovation in the U.S. My speech will cover three topics: the driving force of Chinese economy, innovation in China, and entrepreneurs as leaders of innovation.

The Driving Force of Chinese Economy

First of all, people tend to analyze economic situation using components of GDP, which includes consumption, investment, and export. When export goes down, we begin talking about stimulating export. When investment drops, we rush to increase investment. When consumption slows down, we aim to boost consumption.

As a matter of fact, this is not the way that economy works. Using the example of a large corporation, let’s talk about Apple Inc. We all know about Apple Inc. Apple promotes consumption when it pushes products into the market. When a lot of people decide to buy iPhone, Apple Inc. gets the investment and uses it to develop cloud computing.

Therefore, similar to a successful company, we can study GDP from its components and discover interesting things in investment, consumption and other aspects. However, many companies in real life represent a combination of investment, export, and consumption. Based on this idea, let’s return to our analysis of GDP one more time, which calls for more investment and consumption. In fact, to realize such increase of investment and consumption can be very difficult. The current situation of export is relatively clear and stable.  However, it also means that there is not really a way to rapidly increase export. We have created a lot of free trade areas and ODI. Does ODI drive export or impact export? Perhaps one answer was that it drives export.

We all know the situation in real estate market – a sustained drop is currently in the play. We all saw that the people who bought new homes in Hangzhou were not happy about the drop in real estate price. This is what I called Crowded Bus Effect – people who are on a bus would tell the people who are trying come aboard that “the bus is full so be patient and wait,” and urge them to take the next bus; however, people who are trying to get aboard would say that “Let’s step up and help each other so we can all get aboard.” For the same reason, people who recently bought new homes would not like to see the drop of real estate price. Besides, the government receipt was over $4,000 billion last year. Nobody wants to be responsible for the fall of such a large government receipt. Therefore, the drop has to be sustained, and the government benefits from it. Now let’s talk about urbanization. There is no clear solution to actually solve this problem. Antitrust legislations require courage because the government needs to reallocate some people’s profit. If we include infrastructure investment such as 4G and railroad into the discussion, it is clear that the boost of consumption is more of a result than a dependent variable. Therefore, I think innovation is the only factor that can sustain continuous development of Chinese economy. Many people do not have clear understanding about the innovation that I am talking about. They think that innovation is always on the fundamental level, such as innovation in essential technology. However, this understanding is not appropriate. I will now talk about my understanding of Chinese innovation.

Chinese Innovation

Chinese innovation is different from American innovation. In the U.S., the development of high-tech industries is based on the development of its traditional industries. As high-tech industries become mature, they transform into a part of the traditional industries. Following this pattern, the development of new technology is sustained. However, this is not the case in China. The traditional industries in China are not mature, and high-tech industries will not stop their development and wait for traditional industries to become mature. As a result, the two types of industry develop together, and the development creates a new pattern. Therefore, in China, there are several ways to look at innovation – technology, development of traditional industries, and the new pattern of industrial development.

From the perspective of technology, most of us are familiar with the development of cell phone. – Android took over 80% of market share; Internet usage on cell phone in the U.S. has surpassed Internet usage on PC, and the same thing will happen in China as well, sooner or later. Today, no entrepreneur can overlook the significance of mobile service. Failure to provide mobile service will almost definitely put the company in a difficult situation in today’s market. I think Alibaba is very successful in the service it provides on PC. However, it faces huge challenge on mobile service sector despite of its consistent development, which includes a series of acquisitions. I think the dominance of Alibaba in PC service is no longer the same in mobile service. Challenges from services like WeChat payment has been increasing the level of competition for Alibaba.

We can also talk about innovation from the perspective of social development. As a country that is going through rapid growth, China is experiencing constant changes in consumption level and branding of its many industries. Companies like China Auto Rental and Pod Inn were never thought of before. The establishment and growth of these companies, of the industries, and of the society follows a pattern. This is also a pattern of social and technological development. Based on this pattern, I identified five categories of companies. I have been managing investment in many of these companies. The first category includes high-tech companies. These companies are similar to the ones from Silicon Valley. Some of the companies run social network like Renren Inc.; some are exports in electronic commerce; companies like MT develop games on mobile devices; we have also worked with social network marketing companies. The second category also includes high-tech companies. However, these companies have solid background in their respective industries. For example, Amazon.cn was initially a retail company; Zhaopin.com was a company specialized in human resources; Yiche.com was from the automobile and used car industry. The third category represents companies that have technology playing central role and their entire marketing plans based on the Internet. These companies have significantly different corporate structure from the others. The fourth category includes service companies. These companies are from traditional industries but have large proportions of internal management system and marketing system built on IT and the Internet. For example, China Auto Rental receives 70% - 80% of their orders from the Internet. Tuhu.cn also receives almost of all of its orders from the Internet. The fifth category is new business model, which includes Pod Inn. Pod Inn is popular but different from Home Inn. Pod Inn is fashion; it has its own culture, which results from its innovation. I consider these five categories of companies to represent five different opportunities and future of China.

Horizontal and Vertical Strike in Starting a Business (Finding the Right Niche in Starting a Business)

What is the purpose of innovation? Every innovation is created for a reason. Entrepreneurs innovate to make profit. I think innovation is about finding the right niche for your business. The movie The Grandmaster starts with a Kongfu fight. Then, the grandmaster said: “Kongfu is simple. You strike at your opponent, and the defeated kneels while the winner stands.” The strikes that I am talking about are clearly different from what the grandmaster talks about. By horizontal strike, I mean that enterprise needs to find the right niche in its industrial chain, to know whether their business model exists elsewhere, to understand your relationship with supplier and retailer, and to identify potential threat and competition. For example, today everybody is making VCD. You may think that making DVD is a good niche in the market. However, there is actually not enough living space. VCD suppliers can easily destroy the niche that you see. Now what is vertical strike? Vertical strike is your competitive position against others in the industry. For example, in the auto rental market, if you want to succeed, you need to look for the right niche in the market.

There are several models that we can use to analyze the right market niche. For example, the model of driving force, which analyzes driving force within an industry from market environment. The model looks for opportunity in industrial driving force. Some of the opportunities are not real; some are real but do not belong to you.

I will use the auto market as an example. We have invested in many companies including Bitauto, which we invested years ago; China Auto Rental, which is now going public; used car auction companies; used car dealers; navigation providers; and tire makers. I will talk about China Auto Rental. Many people wonder about the quality that makes this company special. They recognized that auto rental is everywhere in the U.S. and thought there is nothing innovative in opening a company like China Auto Rental. However, years ago, a lot of people thought that Chinese people would never pay for rental cars. They used to think that Chinese people who didn’t own cars would simply go for taxis. However, after analyzing many factors including navigation systems, credit card, ID card, population with driver’s license, auto/manual shift, financial support, consumption pattern and others, we reached at a conclusion and invested in China Auto Rental. The lesson is that when doing industrial analysis and looking for innovation, you need to find the right horizontal strike, or the right niche in the market.

Entrepreneurs Lead Innovation

Now I will enter the next topic. I just talked about the innovation in China, which is different from innovation in the U.S. I analyzed from the perspectives of technology, the five opportunities of industrial development, and the specific methods of analysis. Who is leading innovation in China? Scientists create technological inventions. However, entrepreneurs and their entrepreneurship are indispensable parts of innovation.

We have several models, one of which is the VALUE model. The VALUE model is about finding core value. I will explain using three examples. The first example is about our investment in mobile phone gaming, which includes SNS, IOS, and iDREASKY Games. When we invested in Locojoy, former CEO of Kirin Game founded the company. At first, Locojoy was not doing very well, especially with graphics. The CEO is an expert in gaming design. He wrote a book called Sphira and made a game out of it. I looked at the prototype and told him that even as an amateur, I could see that the graphics was terrible. I offered to hire a Korean art designer to improve the quality. During the fifth prototype, he lost control of temper. Despite of that, we made progress very rapidly, and the future seemed promising. The lesson from this example is that innovation is not always easy. There are often lots of failure. The master game designer from Locojoy wanted to achieve perfection. However, sometimes failure is an indispensable part of the path to success. Without the persistence of an entrepreneur, you will face a lot of pressure from others’ comments and critique, belittling your achievement and progress.

The second example is Renren Inc., which suffered a lot of setbacks at the beginning of its development. However, the growth of Renren is amazing. I used to work with Ning Yang, and I saw him again in 2002. At that time, I told him that his stay in the U.S. had at least cost him $200 million because of the high living expense in the U.S. After he came back, he started doing some business in SMS. He tried many different projects in the already mature market. I’m not saying those struggles are good; but many entrepreneurs went through them and learned a lot during the process. Later, Ning Yang acquired Xiaonei and changed its name to Renren Inc. Many of you may still remember Kaixin001, which enjoyed its success and imposed great competition against Renren Inc. early on. That company is still around today, but nowhere near Renren Inc. After all, corporate innovation comes with huge risks to entrepreneurs. Math and Management can hardly explain the entire process, which includes the factor of luck and spirit of persistence.

Lastly, I will tell you about one more example, which is also one of the companies that I invested in. The story comes from our managerial decision report. What makes up the major revenue of China Auto Rental? The company used to be like an auto club, which relied on membership fee, insurance commission, advertising fee, and corporate service. However, these sections do not provide any revenue anymore, and we have transformed into a totally different company. Before this transformation, we had over $100 million of revenue. Then, the new policy of the China Insurance Regulatory Committee came, and our revenue dropped dramatically. The future was grim, and the company discussed about changing business model. We tried car wash, rapid repair service, and parts sale. Afterward, we decided on the direction that we wanted to pursue and increased investment. The CEO is also an alumnus of BiMBA, and he spent a lot of his own money to get the business running. We faced a lot of challenges, but we are doing well now.

The lesson from the three examples above is that today’s innovation in China is really difficult to achieve during the process of corporate development. Like I have analyzed, innovation exists in technological and social aspects. Innovation also exists in different patterns. However, my job is not to realize such innovation, but to provide investment for entrepreneurs. With their entrepreneurship, entrepreneurs build their teams and work their way up. Certainly, nine out of ten times, the process may lead to failure. However, the one time of success is everything that matters. That one time of success is what we all work for. Here, I would like to wish all my fellow entrepreneurs to achieve that one time of success despite of all the losses. Thank you very much.

Comment from Professor John Yang:

We appreciate the speech from Mr. Erhai Liu. Many topics that Liu mentioned should be very familiar to our business students. Liu talked about that in many industries, innovation does not only exist in technology. Business students often ask me, “I don’t have a science background, and I am not an engineer. I can’t start a company in Silicon Valley, but can I still innovate?” This question is answered by the examples of Liu’s five categories of industry – Innovation can be realized in all five categories.

Liu’s discussion about corporate niche is closely related to the “business strategy” that we learned in our business school. Understanding strategic position of a company in a market is important. Without this understanding, you will not understand your relationship with suppliers and retailers in the industry; you can’t identify the special features of your industry; you can’t see the value that is created during each process of the industry. As a result, you will not survive in the heavy competition. Therefore, learning the industrial environment is critical for a company to excel.

Liu made a clear illustation about the quality and virtue of entrepreneurs. Under the Chinese market environment, especially with all the uncertainties, innovation cannot succeed without firm persistence, confidence, and discretion about future. Among ten people, nine may very likely drop out.

I know Liu pretty well. He was among our early graduates. During the last decades, we had dinner together almost every year. I am a witness to all the foreseeable and unexpected development of his career. Today, he has become an expert in the field. However, this expertise came from all the hard work he had done. Liu is a rational man. He learned from experience and was able to consistently make progress. Now, his opinions on some issues have become totally different from his opinions a decade ago. Some people question the practicality of things that we teach in school. Many think that the degree is suited for MBA students but not EMBA students. I do not agree with this idea.

Steve Jobs once said: “You can hardly know whether the things that you learned will help you in the future and whether the course you take will benefit your career upon its completion.” However, after you have learned so much, you will be able to connect all the dots and make sense of the bigger picture. Innovation in this society is built on consistent learning. Maybe a decade, or two decades ago, we could start a business without much consideration. This will not work now. All of the three people (Hui Zhu, Bin Yang, and Erhai Liu) know about the importance of learning.

Based on the shorthand of speech on “20th Anniversary of National School of Development at Peking University.” Article is not proved by speaker.

 

 

.