US tech firms in China: Out of the comfort zone

Uber's boldness seems boundless. The US-headquartered mobile ride-hailing app has thrown down the gauntlet to its Chinese rivals, confirming that $1.2 billion has been raised for a dedicated China unit. The move comes after local incumbent Didi Kuaidi received $2 billion.

Search giant Baidu, already a stakeholder in Uber globally, is one of several "national brands" supporting the China unit, according to CEO Travis Kalanick. This capital will support an industry arms race as Uber and Didi Kuaidi offer subsidized trips in order to build up market share.

The US company has said it is willing to spend $1 billion in China this year. "Simply stated, China is the No.1 priority for Uber's global team," Kalanick told investors in an email in June.

You can't just do it half in, half out, or some kind of experimental expansion. That doesn't work in China - Chris Evdemon

Uber is not the only US-based internet company targeting China. Vacation-rentals platform Airbnb, for example, has entered into a partnership with local VC firms China Broadband Capital (CBC) and Sequoia Capital and is looking for a China CEO. Fresh from a $1.5 billion funding round, the company is also relying on investors such as Hillhouse Capital, Horizon Ventures and GGV Capital to support its expansion.

However, Airbnb faces stiff local competition in the form of three-year-old Tujia.com, which has established a strong local presence. CBC and GGV are also investors in the Chinese company.

China has long been a challenging market for foreign internet giants. In the early 2000s, eBay and Amazon acquired local players as a shortcut to market share but lost out to Alibaba Group. The ambitions of Google, Facebook and Twitter were thwarted by the Chinese government blocking their services, while Groupon's business model failed to get traction.

The new wave of US-based tech companies appreciate the need for proper localization in China, setting up local joint ventures, employing domestic management teams, and seeking out strategic partners among the corporate and VC ranks. Will they find the going any easier than their predecessors?

"The general rule for US companies that want to expand in China is it's a binary option strategy - either you do it or you don't. If you aren't interested in the market, that's fine, stay out of the way. But if you want to enter China, then you have to do it all-in," says Chris Evdemon, a Silicon Valley-based partner at Innovation Works. "You can't just do it half in, half out, or some kind of experimental expansion. That doesn't work in China."

Beware the locals

China's internet economy has changed markedly over the last 10 years. There were only 110 million internet users in 2005, with an internet penetration rate of 8.5%, according to the China Internet Network Information Center (CNNIC). As of last year, internet penetration had risen to 50% and 557 million of the 649 million internet users were going online via mobile devices.

Business models have also evolved, often in a similar fashion to the US. Didi Kuaidi is an example of how local entrepreneurs have seized on opportunities in the online-to-offline (O2O) space, while venture capital investors are only too willing to support them in the race to scale.

Didi Dache and Kuaidi Dache started out in direct competition to one another, receiving support from Tencent and Alibaba, respectively, as the internet giants sought to expand their businesses into new areas. Didi had raised $700 million and Kuaidi $600 million when Qing Liu, daughter of Legend Holdings chairman Chuanzhi Liu, joined Didi. She initiated merger talks that, on Valentine's Day this year, created one of the largest ride-hailing apps in the world.

It was in some respects a merger of necessity. Uber embarked on an aggressive expansion plan in China in July of last year and subsequently formed alliances with Baidu and China-based Hillhouse Capital.

Primarily a digital intermediary for taxi companies, Didi Kuaidi has expanded into car-pooling, vehicle rental, designated driver services, and private car booking that includes rides in Audi and Mercedes-Benz vehicles to high-end customers. The company is increasingly in direct competition with Uber, which also now offers a variety of services in China. It has also hired Zhen Liu, a niece of the aforementioned Legend chairman, as strategy manager for the country.

However, there is some skepticism among VC investors at Uber's continued aggression in China and willingness to burn cash. They also question whether Hillhouse and Baidu can provide practical local support to the company in China, noting that Baidu has made investments in several local Uber-like start-ups.

"I think timing is a very important consideration for foreign companies to decide when to enter China. I introduced Uber to Didi in the summer of 2012. Imagine what might have been if Uber was open to a Yahoo-Alibaba investment-partner model then? Coming in strong in 2015 is a bit late for Uber; Didi-Kuaidi already has an 80-90% market share," says Hans Tung, managing partner at GGV, who co-led investments in Didi Dache and Airbnb.

Airbnb, meanwhile, is entering China at an even later stage than Uber, given that Tujia is already well set. The firm recently closed a $300 million funding round led by All-Stars Investment and including The Ascott, a serviced residence business unit of Singapore's CapitaLand.

Much like Homeaway and Airbnb, Tujia allows home owners to post properties that are available as vacation or business rentals. However, it differs from its US-based counterparts in that there is a property management business bolted on to the platform. It helps maintain and rent out properties, setting the rental prices and splitting the revenue with the landlord.

"Tujia intended to create the same platform as Airbnb, but they realized that the Western model doesn't fit the China market," says J.P. Gan, managing partner at Qiming Venture Partners, an investor in the company. "We support the management team led by Melissa Yang and Jun Luo, who can provide much more localized services to consumers."

Given their different value propositions, some see the possibility for cooperation between Tujia and Airbnb as opposed to the Uber strategy of taking the fight to local competitors. While Tujia offers concierge services in serviced apartments and vacation homes in China, Airbnb's footprint is more global and community-based.

"I do not think it makes as much sense for Airbnb to set up a separate local entity in China. The company should and has been leveraging its global networks and inventories to attract Chinese outbound travelers," says GGV's Tung.

China is one of the biggest and fastest growing outbound travel markets in the world, with travelers taking 109 million trips in 2014, up 11% year-on-year. Chinese have also been the top spenders in international tourism since 2012, according to the World Tourism Organization.

Innovation Works' Evdemon agrees that Airbnb should have built a local team and focused on the outbound market. It should be the job of the local team to "tell the story of Airbnb to all the Chinese people now traveling abroad," he adds. "When these people are satisfied with Airbnb's outbound offerings, then they probably will be the first movers to consider listing their extra rooms or flats."

The differentiation factor

Airbnb's property sharing culture is an education process in China. Its US counterpart LinkedIn faced a similar problem: the company had no strong local competitors when it arrived in China. Most of the local LinkedIn copycats had failed because the country doesn't have an established professional online networking culture.

Last year, LinkedIn launched a simplified Chinese version to provide a more localized services after over a decade of operating in English only. It also created a joint venture with Sequoia and CBC, the VC firms paying $5 million for a 7% stake with the rest held by the US parent. Derek Shen, previously vice president of Chinese social networking site Renren.com and CEO of group-buying site Nuomi.com, was appointed president of LinkedIn China soon after.

LinkedIn had 1.5-2 million users in China before it launched local JV and is now looking to target a larger share of a market estimated to number more than 140 million white-collar professionals. As part of these efforts, Shen created an instant messaging service called Chitu in order to draw more people to the platform.

The common factor in LinkedIn and Airbnb's China plans is CBC and Sequoia. While Sequoia's US unit is an investor in both companies, so collaboration made logical sense, CBC has a long-term strategy to help US companies expand in China. It has previously invested in MySpace China and Evernote China, and Edward Tian, founder and CEO of CBC, is perceived among US tech players to have strong government connections. Tian was CEO of China Netcom, which is now part of China Unicom.

"The partnership with CBC and Sequoia helps. But I think the most important part is whether the US global management can set up a strong local team, and empower the China team by allowing them to make local decision and develop local services and products. China is a very big and competitive market, and local players tend to understand the market better and move fast," says James Mi, co-founder of Lightspeed China Partners.

Groupon China is a good example of a business that is highly local in nature and thus harder for foreign companies to master. This same applies to the O2O space in that expansion is likely to be much harder for those that seek to compete on the basis of offline services. Rather, companies will get traction if they offer differentiated online products in areas such as education and cross-border e-commerce where the international angle can be brought to bear.

GGV's Tung adds that labor is another key consideration, citing eBay as a company that failed to take advantage of China's lower labor costs and offer more value-added services. "It refused to offer customer services by telephone and online chat, insisting on only emails," he says. "Many US companies prefer no-touch models to minimize costs, and DYI is the norm in the US. But that kind of service level is not be enough to satisfy Chinese consumers."

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• Topics
• Technology
• Greater China
• North America
• Consumer
• Expansion
• Consumer
• TMT
• China
• USA
• GGV Capital
• Qiming Venture Partners
• CBC Partners / CBC Capital
• Sequoia Capital
• Innovation Works