China cloud computing: Billowing forth

Alibaba Group may be a minor cloud computing player from a global perspective, but its stirrings make noticeable waves in China, where it is by far the biggest operator. The latest news from the company’s small but promising cloud division highlights a doubling of data storage and processing power in Hong Kong as well as a 115% year-on-year revenue surge during the December quarter.

The industry has digested this eruption in two ways. On one level, it is seen as a sign of increasing regional demand for the big data number crunching capacity that underpins cloud business models. More incisively, it implies China’s internet heavyweights are bound to dominate the emerging local market in much the same way that the likes of Amazon and Google have in the US.

VC firms in China, however, point to a parallel momentum among smaller local companies as evidence that a more inclusive investment landscape is possible. This potential is rooted in a number of variables unique to the Chinese market, including an awkward combination of reliable national internet infrastructure and widespread shortcomings in corporate IT competence.

A lot of companies in China have started very actively thinking about using cloud services because labor costs are really growing – James Mi

“As venture capitalists, we’re never afraid of the giants because an elephant walks and turns slowly, but we can run and turn fast,” says Chris Pu, head of Greater China at Telstra Ventures. “This is a turning point for enterprises in China to leverage the higher penetration of smart phones at the front end while upgrading their IT capabilities on the back end.”

Transition time

The essential play for venture investors in China is to service the migration of small and medium-sized enterprises (SME) from traditional IT infrastructure platforms to cloud-based systems. China is better positioned than the US to seize this opportunity in part because the lack of in-house IT support compels local companies to outsource expensive technical operations to relatively cheap clouds. 

Government imperatives to secure sensitive cloud-processed data and the prevalence of state-owned enterprises present another potential advantage for start-ups. Although Alibaba has made a few forays into private cloud infrastructure services, it remains largely associated with public platforms and therefore considered off limits to many banks, insurance companies and government agencies. This was part of the rationale for Lightspeed China Partners’ investment in private storage company QingCloud. 

“The China market will eventually be just as big if not bigger than the US market,” says James Mi, co-founder and managing director at Lightspeed. “In the past year, a lot of companies in China have started very actively thinking about using cloud services because labor costs are really growing and they need to invest in IT to improve productivity.”

China’s immaturity in the cloud space, however, also presents an important limitation. The massive collections of unstructured data that drive much of the cloud computing business opportunity are still relatively rare assets in the country, controlled by large players with little incentive to share. VCs will always find cracks in a conglomerate-dominated cloud market because small software developers tend to avoid major infrastructure platforms in order to protect proprietary source code. But at this point in China’s development curve, it is still not advised to rely too heavily on doing business with the minnows. 

“It’s definitely a good time to start investing, but in China, you’ve got to talk to the big customers instead of the small enterprises because even though a lot of Chinese SMEs don’t have an IT staff, they don’t have the budget to pay for a move to the cloud either,” says Michael Zhu, managing partner at Gobi Partners. “Eventually, I truly believe that SMEs in China will be big enough to pay for cloud but who knows how long that is going to take.” 

Gobi has made more than 10 cloud company investments in China across the past six years using this evaluation approach in combination with a strong focus on making sure portfolio teams have sales experience in whatever specific niche of the value chain is being targeted. The idea is to bypass a common cloud company imbalance between technical knowhow and customer service ability.

“If you’re targeting the security industry, your best practice will be completely different than if you’re targeting the telecom industry because the terms and the people and the needs are all different,” Zhu adds. “Cloud is not as light as people assume, and customers are not going to be able to use your API [application programing interface] without any education or outside service. Not every team in China really understands that.”

Open source

The importance of providing adequate technical support in cloud computing is compounded by the fact that many of the industry’s basic components are based on open source code. Enterprise-grade software-as-a-service (SaaS) offerings are therefore under added pressure to demonstrate that a differentiated product will be provided on top of the readily available infrastructure.

Marketing plays a big role in this effort but it can also represent a pitfall for interested investors. As the hype curve runs its course in the Chinese cloud space, VCs will need to be able to recognize when companies with no competitive edge are posturing themselves as something innovative. 

“In cloud computing, there are a lot of technology buzzwords like ‘containers’ and ‘open stacks’. The key for start-ups is not just becoming one of the providers in those areas but developing differentiated products and services based on those topics,” says Telstra’s Pu. “At the end of the day, SaaS is a subscription model, so if there’s no differentiation, it becomes sort of like a utility – and that would be bad because it’s getting very competitive.” 

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• Topics
• Greater China
• Technology
• Early-stage
• China
• Venture
• Gobi Partners
• Lightspeed Venture Partners
• Telstra Ventures