a16z Podcast - a16z Podcast: 'In the Eye of a Tornado' -- Views on Innovation from China

Episode Date: February 18, 2016

No matter how one views Xiaomi -- and there are many ways to view it, for better or worse -- one thing is clear: It, and other such companies (like WeChat and Alibaba), indicate a broader trend around innovation coming from China. Companies and countries that were once positioned as copycats or followers are becoming leaders, and in unexpected, non-obvious ways. For example, through scale, distribution, logistics, infrastructure, O2O, a different kind of ecommerce, mobile marketing, even design... But of a very different kind than iconic examples like, say, SpaceX. Or Apple, which arguably could damage the U.S. if single-mindedly regarded as "our official most innovative company". Or so argue the guests on this podcast, which include a16z partner Connie Chan and author/long-time observer of internet and social media culture Clay Shirky, who is currently based at NYU Shanghai, wrote the popular book Here Comes Everybody, and most recently authored Little Rice on "smartphones, Xiaomi, and the Chinese Dream".

Hi everyone, welcome to the A6 and Z podcast. I'm Sonal, and I'm really excited because we have a podcast today with two guests, and we're talking about smartphones, Xiaomi, and the Chinese Dream. That's actually the subtitle of the book Little Rice by Clay Shirky, who's one of the guests on this podcast. Clay has been a longtime observer and commenter of internet culture, social media. He's written a really popular book called Here Comes Everybody, and he's currently the global network professor at NYU Shanghai. We also have on the podcast, Connie Chan, who's a partner in the deal and investing team here at Andreessen Horowitz, and she's an expert in all things China. Among many of her other pieces, she wrote a piece earlier this year on WeChat. And in both of these cases, we're just mentioning WeChat and Xiaomi. What we're really talking about more broadly is this broader theme of innovation and how it's now happening in a different way than before where we're starting to see companies that maybe previously might have been, quote, so-called copycats actually lead the march forward. I want to just start on that note and hear from both of you, Connie and Clay on what's happening?

I think the important note here is to understand that there are various ways of defining the word innovation. Some people might say and take a very strict view that innovation is the first person that comes up with the new piece of technology or the first person to figure out some formula. If you argue, though, that innovation can mean the first person to scale a company, scale a product, the first person who can figure out a distribution model or a business model that allows the product to be given to millions of consumers, then I would say there's a ton of innovation happening in China, and there has been for the last several years.

I think that's absolutely right. And one of the things I think people often miss is the Americans have been brought into the cult of Steve Jobs and have regarded innovation as being basically covalent with industrial design. And so when they hold an iPhone in their hands, they think the hardware and the user experience that they're having is what innovation is. When you look at a company like Xiaomi, what you see is innovation in process. You see innovation in customer service. You see innovation in manufacturing. The hardware itself is the least important part of this incredible chain of supply and creativity. I think Connie's right that when we think about innovation, we have to realize that there can be innovation in operating system design. There can be

innovation in packaging and shipping. There can be innovation in customer service. And that in many cases, the innovation that's outside the direct thing the consumer holds in their hands or interacts with is a bigger part of the business landscape right now. When you said supply and creativity, I don't ever put those two words together. How does that actually play out? ShowMe has created this sweet spot, which no one previously thought existed in the market, where it is a well-designed product for cheap enough to be competitive with luxury products in its domain. What it lets Xiaomi do is do these flash sales, where they say, look, we've got 100,000 of the Hong Meir.

We've got 100,000 of the Me Too. We're going to sell those now. You have to sign up for the right to get a ticket to have a chance. to buy the phone, which means Xiaomi has now used e-commerce as a way of signaling massive unmet demand. They can then take that down to Shenzhen and say, we know

how many people want this phone, and we want you to give us these components at the million unit price. So they can actually squeeze costs out of the manufacturing system even before they make the phone, and they can use that money to invest in design without driving costs to the roof. What I love that you're

touching upon is that you're Using flash sales as one of the mechanisms, as well as the design process and how they come up with changes to the software, they're able to create a brand that users actually adore. And so it's not about just consuming a product that is interchangeable with something else. The brand actually stands for something. People love their Xiaomi bunnies. They love promoting the fact that they own Xiaomi devices. Companies have been manufacturing products like smartphones in China for years. What's changed?

Why now? they bet on open source software they bet on e-commerce they said you know we're not even going to bother with the supply chain thing we're going to ship from the warehouse anybody who buys a phone from us whether it's a you know mom and pop vendor or an end user we get the money they get the phone we don't deal with returns and they bet enormously on social media every time you upgrade your operating system you're given the ability to advertise to your friends hey i just upgraded me you i right so they have they've got their users and as connie said these these spans, the sort of really passionate, engaged users have become their marketing base. They provide feedback. They suggest new features. And I'd say they also just caught the right timing, to be frank. Lay Jing is famous for that saying where, you know, in the eye of a tornado, even pigs can fly. And it's really indicative of the rapid adoption of technology in China. Just users in China adopt new forms of technology at a very, very fast pace. It's not just about the technology, it's also about the business model and the distribution and the whole company that

goes around it. It kind of comes full circle to the point that there's different types of innovation. I resist this a little bit simply because I'm so used to thinking of innovation as something new. And even though you're describing new mechanisms and new processes and new logistics and new marketing techniques, when I think of new, I think of Elon Musk, like launching a shuttle into space. And so the other thing I want to kind of hear your thoughts on is how this plays out in the broader context of other trends around innovation. Because, you know, there's a phrase jugat innovation, which is described of an Indian word jug, which is sort of like using sort of the constraints that you have around you to come up with new innovative ways. You have

reverse innovation, which is this philosophy that innovations that are happening in other places are now coming back to the U.S. What are we talking about here more broadly? I don't mean to keep hammering on this, but I want you guys to convince me a little harder about what the innovation is that's happening. When I think about China, innovation to me means survival. And I say that because there are so many people in China, 1.3 billion people. There's a huge population of entrepreneurs in China right now. And you match that with a huge abundance of capital that's available to these entrepreneurs. And you have an environment that's extremely fierce. And so for me, innovation is a lot about survival. Because in China, a lot of

these startups, they're thinking of it as an all or nothing game. Everything is built because it has to scale, because if it doesn't scale, you're going to go to zero. And therefore, innovation is very tied to business model, path to profitability for a lot of companies and distribution. Yeah, and the size question, it really, particularly for a Lai, like myself, for a foreigner, just getting used to being in a country that operates at this scale every day is itself a kind of disorienting process. I moved with my family to Shanghai, about a year and a half ago, and it took a while to realize what it means to live in a city whose population is larger than Australia, right?

It's just, it's a different set of scale here. So here is where that ties into innovation. Because anything that works well here works under crushing load, and because you have to control costs everywhere in the chain if you're going to reach the mass market, the question about an innovation is, will shall me now be better prepared to compete in those global markets than U.S. companies that have all of the infrastructure they can afford to operate at small scale, everyone has a credit card, the kind of innovations around e-commerce where people are paying using their mobile phones as with M-PACE and Kenya or have entirely alternate payment systems,

as with AliPay here, that's a kind of what innovation Americans don't even recognize, right? Our innovations around the financial system right now look like. mint. Whereas in China, it really is an entire alternate electronic currency. And I think because we expect innovation to look like the space race, we're very often missing the kind of innovation that, as Connie says, is coming out of these countries where the question for the entrepreneur is not, do I get a 15% margin or a 45% margin? The question for the entrepreneur is, do I stay in business or not? Chinese companies have global aspirations. They're chomping at the bit to go global to be international, and they're thinking that way very, very

early on. But another point is that they're going to face struggles when they try and go international. And the same is true for Silicon Valley companies when they try and enter China, the same kind of struggles that the U.S. companies face. Chinese companies are facing that as they enter new markets as well. They regard the hardware as a way of getting their platform into the hands of the users and then selling services. And that's working well in China. The real question, is, and it's a question not just for Xiaomee, but for Baidu, Alibaba, Tencent, seen as a big Chinese internet companies, is the ability to offer an internet service in China an advantage or a disadvantage when trying to move to the rest of the world?

Because unlike hardware, an internet service company doesn't just have to operate at scale. It also has to implement an enormous number of controls that Beijing demands over certain kinds of public speech, whether it's monitoring or censorship or propaganda. And we are good at doing what Beijing asks us to do. It's a competitive advantage in only one country in the world. It remains to be seen whether or not China, as it moves locally to a more services-based economy, can export that as well as it's exported hardware. For some companies, it's not necessarily appropriate to enter that market.

And they might not have good chances of survival there. And the question that I usually ask our portfolio companies is, does your product or service get better if you have Chinese consumers? on your on your platform so then on the flip side of that what is the advantage that a chinese company would have internationally because to your point there's this advantage in the scale but then there's this tradeoff in the fact that they are optimizing for this scenario like so what what what are the things that they can sort of bring to the world in a way that's actually translatable outside of boundaries well first of all janky infrastructure is no surprise right

the chinese custom to operating in a world where you have to have backup systems, you have to assume that things are going to go wrong. They're not used to walking into a country where everything from the interstate highway to the phone grid has been laid out decades before and everybody understands how it worked. And this is something I think people often don't understand about China. Because technological change comes late and fast, the interstate highway system is something that's happened in recent memory, right? The connecting of the western cities and the building of new buildings is going on at such a feverish pace that the Chinese businesses just operate with an outlook that's more like

what's going on in Lagos now than someone trying to move from Cupertino or Mountain View. You know, when I talk to a lot of U.S. companies thinking about entering the Chinese market, that decision can take one or two years. When I talk to a Chinese entrepreneur who wants to enter the U.S. market, he can have a team out here in a quarter. So Chinese companies move very, very quickly, and they have access to large amounts of capital now. But can they compete? So, you know, one of the arguments that you guys have both made is like, and Benedict has made as well, is that, and just to use a case of Xiaomi here, we're seeing for the first time the design, as well as this innovation coming out of China, like originating in China. I understand all the things happening underneath.

How does a consumer know, and do they even care that they're benefiting from these innovative products? The question I'm trying to get a handle on is, like, does the origination of that really matter? The first thing the consumer cares about, and the first place the innovation shows up is in price. And that ability to just inflect the cost quality curve in the direction of people who have a moderate amount of money and are willing to pay something of a design premium. The consumer cares about that, even if they just experience it as this thing works well. I got it for cheap. The more complex a product is, the more the user interface is the user experience, right? That, in fact, any given smartphone is just a slab of black glass with three or four hardware buttons. Everything is on the screen. And Xiaomi has invested enormously in what's

called MeUI, their version of Android. And the user experiences that all the time. Blaise June has said that a third of the features in MeUI have come from suggestions from users from users. So they are really investing in the kind of open source model of, look, it's just, it's just Android. We can't prevent these features from being, from being copied. But if we're closer to our users and do a better job of understanding and integrating, we still have a competitive advantage. So they built their own, they built their own scam database. They look at incoming phone calls. They look at incoming text and they tell you, you know, this, this is a scam call. There is no do not call registry in China, but they built that feature for their users because

their users wanted it. So both of you guys are talking about this concept that Eric von Hippel laid out a few years ago around innovation coming from the users. So just to be clear, this isn't crowdsourcing the innovation technically. What is it exactly that we're talking about? It's being really clear about what customers want and what customers don't, but not just broad market study, actual customers. It's being really focused on customer service. Richard Liu, who's one of the earliest investors, has said we never talk in terms of handsets sold. We always talk in terms of customers converted. Every time they ship a new version of the operating system, which is every Friday, they do it every week and they've done it every week for

years, they go out with a set of exactly the same four questions they ask the user. What was your favorite feature? What do you not like? What are you missing and so forth? And they collate this feedback week by week. So it's not crowdsourcing in the sense of Wikipedia where it is, it is assembled by a self-nominating group. But it's about what actual users think, not field test, not market research, not focus groups. One of the most striking is that they, in almost any manufacturing company, they would regard customer service as a cost to be reduced by outsourcing it. Right. And to tie that specific example back to Sonal, your original question of what are

advantages that Chinese companies might have coming here or U.S. companies going out there, I think you can think of that analogy across countries as well. And so for a U.S. company to enter the Chinese market, that means they're also now going to be able to get the feedback and the product suggestions of a whole new crop of people, a billion plus people, right? And the same thing is true for Chinese companies when they expand elsewhere. They're able to make their product not a Chinese product, but a global product. But tying back again to this original notion of this cult of Steve Jobs, I can't help but wonder, like, Apple would never do this. Or maybe they do secretly, we don't know about it.

So how do we sort of reconcile what's happening, what's say like the leader, Apple? And we are talking about this larger question of who's leading innovation. What are your thoughts on that? So I'd like to question the premise that Apple's the leader. the company that Xiaomi is most like is Amazon. And when you think about the kinds of things Amazon has done to innovate, you see, again, this obsession with supply chain management, you see this obsession with aggregating and then creating value from customer feedback.

You see an obsession with customer experience at every part of the chain. It's interesting to be now in China for long enough that a little bit of my ability to understand the context of the U.S. is fading. And when I look back at the U.S., I think that the U.S. has been somewhat damaged by regarding Apple as our official most innovative company. Because, in fact, Apple does what it does brilliantly, no question. And it's obviously its commercial success as a result of, you know, is the result. But in terms of practical surprises in how a company does things, you would look at other companies before you would look at Apple. The competitive battle is not going to be engaged in North America.

It's going to be engaged in Kenya and Mexico. There's so much American centricity in the way we think about technology that we're often just unprepared for the coming global market. I think I agree. And in general, I don't like, I always never feel like it's perfectly accurate when I say this is the X of China or the X of whatever. if I really had to pick two other brands that have some kind of connection to how I think about Shami, one I would say is Dell in the sense that they're able to offer good products at low prices

and have different new ideas of distribution and a good understanding of supply chain. And another one that I know people don't think about, but in some ways it captures that brand loyalty is IKEA. because IKEA is able to give a lot of people access to beautiful design furniture at a very, very reachable price. The one thing that I think is a nuance here is that there is this interesting tension between the notion of the smartphone as both a commodity device and a premium object. Is that something we resolve in a single device or is that something that we resolve with the range of whatever objects are offered as aligned by a particular company? What are your guys' views on that? I think on the Android side, that answers your questions and all, which is there is not going to be one premium product. There is, in fact, already in China, a range of phones that people can choose from.

But it's the Android market is fragmenting now, not just in terms of what the manufacturers do with the operating system. It's fragmenting in terms of how they reach customers. And the interesting, you know, sort of macro question is, does that make the Android market more competitive or less competitive with the iPhone? And certainly the view from China suggests more competitive. What I love about what you're saying is maybe that's another way to think about innovation. Like what kind of company pushes an entire industry forward? I think that's one way to think about innovation, who is pushing everyone forward and who is challenging everyone to be more efficient, come up with better product, create more customer loyalty. I like that we're expanding the definitions of innovation and how and where the innovation comes from.

I accidentally did a little Freudian slip earlier and said American dream, not to be ethnocentric about it by any means, but like how, what is the Chinese dream? What does that even mean? I make a distinction between lowercase D and uppercase D. So the lowercase D Chinese dream is the casual connection that many Chinese citizens feel with a kind of national greatness and a sense that their country after a long period of. what's sometimes called the century of humiliations and then more recent suffering in the great lead forward in the cultural revolution. Their country has reasserted itself in its natural place on the world stage, and the importance of China in global affairs is on the rise in all kinds of ways, economic and political and so forth. And there is just a pride in Chinese achievement that feels to an American like America used to feel. There is a sense here still of incredible optimism, despite having obvious problems that the country has to overcome.

On top of that, there is the uppercase D-Chinese Dream, which is a motto promulgated by Beijing under Xi Jinping under the current administration, which wants to harness that sense of pride and entrepreneurial activity into a kind of nationalist sentiment that is, basically comfortable with the status quo and also comfortable with slowing economic growth. So the Chinese dream in its, you know, billboard-driven version where Beijing creates these slogans and distributes them from morning to evening, living the dream is one of the things it says in the subways, you know, signs by the subways as you go in here. It's trying to create a sense among the citizens that everything, you know, that the current, current model of Chinese

governance, particularly political governance, is to be supported, and that we have a kind of national identity which will enable us to, which will enable Beijing, basically, to weather the economic slowdown.

And one of the really interesting questions for me living in China is, are those two dreams going to diverge? Are the things that the population wants for themselves? going to become different enough from the things that Beijing wants for them that the government will have a harder time managing its, essentially, will the government in Beijing have a hard time

legitimating itself in the eyes of its now newly successful people? Well, why I like the phrase the Chinese dream so much is how it captures the idea that hard work means that it can pay off and you can create lots of opportunity and create a better financial outcome for you and your family. That's how people describe the American dream, too. Right, right. And I do also agree with Clay that you have people from all kinds of backgrounds who really believe that if they work really hard, they can make something huge. And when you pair millions of people with that mindset, and then you pair that with access to a lot of capital, you get the ingredients for these mega companies. When I first started coming here in 2011,

the Shanghai Tower, which is the second tallest building in the world, was a hole in the ground, and we walked around it, and the kids looked at it, like, oh, yeah, they're building a building here. And then when we got back in 2013, the steel was up. And it was really striking to see that speed of construction. I look at, where I live in New York, I look out my south window at One World Trade, which took 14 years, I think, from the idea that we should build something here to topping out the steel. So the speed with which, once a decision is made, the speed with which it is enacted here is astonishing. At the same time, one thing I love about Chinese companies is they'll launch products and features before it's fully QA tested and before it's fully ready. And so sometimes you will try products and you'll hit some dead ends here and there or some features will be buggy. But it's because things are launched very quickly.

What does that mean for the shape of the firm, the nature of the company itself and the organizational structure? Like, does that change to adapt? Back to Connie's earlier point about perhaps one way to think about innovation is what company changes the shape of the market they operate in. Xiaomi has absolutely done that for the idea of focused experimental management and for being able to decide sort of an employee at a time or a division at a time what you're going to invest in. Yeah, I'd say the question around headcount, probably case specific when I think about China, there are companies that have enormous headcount that I think their Silicon Valley counterpart probably would bulk at.

But in my mind, that's just a different usage of resources. The question around org structure, I think, is a really interesting one. And it's one that often goes overlooked. For U.S. companies, when they are entering China in the software space, it's a question they really have to think about. Are they willing to make changes to their org structure? Are they willing to have product and engineering either be a global? or do they want product and engineering to have a small team in China? And what are the ramifications for how quickly they can get new features out there? That's stuff that management teams really need to think hardly hard about before they decide whether or not they want to go to China. One theme that's kind of fascinating to me is that you guys keep coming back to this notion of density, density in population, in proximity. In this notion, Clay, you mentioned in your book, Teladensity, which is a really awkward phrase. I've never even heard that word. How do we sort of wrap our head? around the impact of that and how this all sort of plays out.

To me, density means more competition, and more competition means it's harder to survive. But at the same time, that means those that do survive are stronger, smarter, wiser, just someone we can learn from and respect. And the other thing, density means these not just volume of people, it's the fact that the Tier 1 cities here, the Tianjin, Beijing, Shenzhen, Shanghai, are, they are the size of countries. The city I live in is larger than the continent of Australia. Getting that scale in something that works like a city rather than a country

means that the kinds of applications that rely on density, any app that has to do, anything that has to do with delivery, anything that has to do with transportation, anything that has to do with local, with ratings and recommendations for things you would actually physically go to simply work to the scale here that dwarfs anything in the United States. One of the challenges for the U.S. is we have no testbed

for operating in very high-density, moderate income environments. Our high-density environments, New York, San Francisco, and so on, also tend to be where the luxury markets are. And so people get lulled into a sense that New York is a big city. I used to think I lived in New York for 30 years and it felt like a big city. And now I go home and New York feels medium size. The U.S. has no native testbed for building out services that have tens of millions of potential users on moderate income living in a small area. And yet that is where many of the next battles over innovation and market share are going to be waged.

What that density means it's complexity, I think, is what you're saying, right? It's so much more difficult to solve a problem in terms of scaling to that many customers. It's a beautiful thing, this density that we're talking about, this amazing test bed. But another physical manifestation of that is the pollution problem that's happening and the red alerts. There are definitely consequences of fast growth. The banking system simply works differently. Credit cards are not widely accepted. Many of the things you take for granted being plugged into,

are just not readily available. And so living here is hard, doing business is hard. But yeah, it's good to not sort of overbraw the picture of this environment. Because in many cases, innovation is an answer to problem solving. And to be an environment where you want to solve hard problems, you have to be in an environment where you have hard problems. Who knows? From that, there might be innovation coming through electric cars or alternate uses of energy, right?

It's already happening. So Shanghai has moved to largely. electric scooters, in part by simply raising licensing costs to the point where a market for electric scooters and charging stations emerged as a result to the market signals. To just something that I think doesn't often make it to the United States about pollution innovation here is there's Plan A, which is clean all of the smoke coming out of the smokestack industries. And importantly, that's not in the big cities. That is in the heartland where, because the electrical grid was not good enough when the industrialization happened. Every factory started

generating its own electricity burning dirty coal rather than having a single plant that you could clean. But the solution to the pollution problem here is going along two tracks. There's plan A, which is clean the air, but there's also plan B, which is to clean indoor air in particular. So the market here for air purifiers, air masks, et cetera, has taken off. It is a response to local needs and it is a local innovation. But when you look at the Shanghai Tower, which is just down the block for me, it is the tallest skyscraper in Shanghai, which is saying something. And when you're looking at it, you're not actually looking at the skyscraper. The skyscraper is enveloped in a glass sheath that stands about two and a half meters away from the actual skyscraper.

So they built a skyscraper. Then they built an environmental containment shelf for the skyscraper. Wow. And so that's plan B, which is to say, stake out some kind of turf or whatever the atmospheric equivalent of turf is and defend that. And that solution is going to. going to have all kinds of ramifications for environmental control and for for indoor and architectural construction. It's in part just a response to pollution in HVAC, but it is going to

spread from here to elsewhere. Yeah, so maybe in that sense that kind of innovation is problem solving. No, I think it's a very compelling thing. The harder the environment, the more the innovation can happen. And you need to happen. Needs to happen. Right. One last final question to wrap it up, which is just basically this interesting notion of you being an American living in China and what it was like to write the book? One of the things when I was writing Little Rice, one of the things I wanted to be sure to emphasize is I am a foreigner. One of the things I often say about Shanghai is it's the most different place I've ever been that isn't at all exotic. You know, if you go to Vietnam and

you see someone plowing a rice patty with a water buffalo, that's very different from New York City. Shanghai, what I see in Shanghai is just an alternate way to be a full. industrialized society. So the surprises that I feel as an American who thinks about internet technologies in particular on both sides of the Great Firewall have been the thing I tried to put into Little Rice because that sense of this system works, you know, parts of it work well, parts of it work badly, just like in the United States, but different parts are working well. And that's really the thing that I find most fascinating. This idea that China is an alternate universe, it's similar but different. I like that mindset as a way to think about China, that you will see companies that look like the Facebook of China, look like the Google of China, look like the YouTube of China, but they're different. And that's why it's not just Chinese Twitter.

Right, right, right, right. This idea of distinct, distinct companies, similar but different. I really like that. That's great. Okay, you guys, well, thank you again for taking the time. And for those of those of our listeners, thanks for being patient with our technical sound difference. It was actually quite complicated getting this podcast going, believe it or not. But thank you, everyone.