August 24, 2017
As a FinTech and startup aficionado, we already know the three Chinese giants, most commonly referred to as BAT: Baidu, Alibaba, and Tencent. All of us have read about the success story of Robin Li of Baidu, Jack Ma of Alibaba, and Ma Huateng of Tencent. But only a few of us are aware that they reached this level of success because of other macro-economic and political factors, which paved the way for them to scale rapidly. Moreover, the People’s Republic of China (PRC) had its special role in the growth of these companies.
China/US Foreign Exchange Rate. Source: FT Alphaville
Between 1978 and 1992, China devalued its currency from $1.5 to $8.5. The level of inflation during that period rose because of this. More worrying was that the wage rate of Chinese workers was not growing at the same speed with the inflation rate. The Chinese currency was capped at subsistence levels because governments provided everything for free. Any foreign claims, like dollars earned by state enterprises, were forcefully fed to state coffers because state officials supposedly knew the best ways to deploy or reinvest (read: embezzle) those funds.
Deng Xiaoping, of course, realised that market-focused economic reform and partial privatisation was inevitable if China was to avoid the economic problems of the Soviet Union. But overturning a system used to subsidising loss-making state-owned factories and hiking food prices to placate struggling farmers, with vested interests of the old regime, was not an overnight task. The system needed capital badly and privatisation was inevitable. Nevertheless, the government selected isolationism and hostility to western market practices. In the early 1990s, China began introducing export and investment-oriented reforms. Concessions included the opening of the capital account to foreign direct investment, the adoption of foreign industrial processes and management systems, the establishment of special economic zones, and the opportunity to gear up its manufacturing base to serve foreign investors who brought all the resources needed by China.
Foreign direct inflows in China 1982-2016. Source: World Bank
This revolutionary period was in the 1990s when BAT started their business operation and in the 2000s when they came into power. Other factors that contributed to the rise of the three Dragons to rise to power are explained below.
In economics, capital can be classified as human capital and physical capital. In the case of China, both types of capital were available in abundance and at a cheaper cost. With wage rates capped at sustainable levels and yuan exchange rate extensively managed, there was a huge stock of US dollars in China. This boon facilitated Chinese companies to borrow at cheaper costs; along with cheap labor, they were able to work on high margins.
With the Chinese economy following an isolated, export-oriented approach, there was no international competition in its huge domestic market. People who have tried to trade with Chinese companies in the 1990s knew how difficult it was to move across complex layers of rules and regulations to conduct business in the Chinese market.
Unlike in 2000 when the Chinese population was 1.26 billion, in 2017 its population is about 1.3 billion (Source: World Bank). Apart from that, with its internet penetration showing an upward trend, China is arguably the largest market for internet and e-commerce services.
Internet penetration in China 2000-2016. Source: Internet Live Stats
In order to promote exports in the country, the PRC granted export subsidies to almost every other manufactured commodities. This led to domestic firms jostling to export as many items as they could. And while there is no data available for subsidies for export of services, the assumption is that those benefits assisted BAT directly or indirectly.
East Asian countries like Japan, South Korea, and China followed a similar route – unofficially helping domestic firms which had the potential to scale internationally. The government authorities pushed the domestic companies to export more products as well as subsidizing their export productions and providing cheaper land and labor for them.
Even though GAFA (Google, Apple, Facebook, and Amazon) and BAT are equally outstanding, history shows that companies can achieve such historic success by employing different business strategies. Moreover, having gone through different paths of growth of development in heavily varying economies and cultures, even large companies with abundant resources may find it difficult to conquer each other's markets.
Some notable examples include Apple and Uber. In 2016, Uber China merged with Didi in China as it was facing a lot of profitability issues. It was practically not able to compete with the domestic company Didi Chuxing. Similarly, Apple is facing profitability issues while dealing with labor issues. Another challenge for Apple is that its iOS is not supporting WeChat. Among other factors which assisted these Chinese firms, it is safe to conclude that the government policy and regulatory environment played significant roles in making what GAFA and BAT what they are today.