China's tech slowdown
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So over the past five years, China's internet industry has seen dizzying growth with record amounts of funding each year.

In the second quarter of last year, Chinese startups raised more venture capital than startups in North America for the first time. But starting at the end of 2018, the industry started winding down and rumors started about mass layoffs at different tech firms like Ofo and even JD.

So what's happening? Is China's startup scene finally facing the music? Is this just a market correction or a sign of worse things to come? When it comes to the employee side, you certainly don't want to be part of the part that's get corrected. Customers are more rational and they are more care for about spending their money. Welcome to Digitally China, a podcast about the fascinating Chinese tech industry created together with Radii. I'm Eva. I'm Jacob. And I'm Tong.

So, according to various studies, China's gaming industry is now, in fact, the largest in the world. You may know their messaging app called WeChat. Chinese outbound M&A. Chinese corporates are buying international companies at record pays. The hottest phone you've probably never heard of. China's Xiaomi. Yes, it's staked its claim to Apple's crown. Major deal over in China. You have Chinese tech giant Tencent.

I don't know about you, but I remember a few years ago when I just started writing about tech in China. I was like,

It was always mind blowing to me about how much money was just being thrown around in the industry. I mean, people would talk about how like VCs are just throwing money at random projects and they would never do any due diligence.

And valuations were crazy. So the fact that things are winding down, well, it's very different from, let's say, 2015, 2016, 2017. Yeah, I mean, it might sound a little bit weird that one episode we're talking about the great opportunities of China and then a couple of episodes later we're talking about the slowdown of China, right? And I agree, like, my impression is the same from China. When I came here...

you know, everything was crazy. Everyone got money all over the place. And it was like there was no other way than upwards. And now finally, we're kind of seeing, you know, signs of slowdown. And actually, we've been seeing that for a while. After you spend a few years in China's tech industry, at least, you know, a year ago or prior to that, it felt like, I think it was very contagious as well, right? Like this kind of optimism or even...

I guess more negatively blindness to risk because I remember writing these stories where it's like, "Oh, all these power bank sharing companies are raising millions of dollars." We would laugh because it's such a crazy concept, like why are they getting so much money? But then Tencent would fund one and then like, "Oh, maybe the business model makes sense because it plugs into WeChat and there might be advertising."

And then you like accept all these very bizarre or implausible sounding business models, right? Yeah. No, I mean, like, I think definitely it's been an overhyping of certain concepts and projects over here. But on the other hand, like the larger picture of that is that everyone's been obsessed about, you know, getting the eyeballs, getting the users involved.

Sometimes that probably have made a lot of companies too obsessed with that and too focused on that and not even thinking about if that is a sustainable business model, which for the first time I would say in the internet economy of China,

the question is raised. Yeah, and I think there's a lot of different perspectives on this and people are getting hit in different ways. So to understand more about how the slowdown is affecting developers, investors, other people in the industry, and maybe understand why it's happening, we spoke to a few people for this episode.

Hi, I'm Gushi, a marketing partner of Higgs Technology, which is an AI education company focusing on using adaptive technology to really improve people's, primarily high school students' learning capabilities and learning efficiency.

They have this saying that 20 years ago, when you walk on the street and you'll be stopped by a passerby and they'll ask you, do you need a CD? Because that's what Zhongguancun was for originally. And then 20 years later, and if you walk on the same street, there's just full of cafes and investors sitting in there and like looking for people to invest in money. So it's highly likely that you'll be stopped by an investor and ask you, do you need money to start your own business?

So what's interesting about the thing that Gusi just mentioned is that she runs a women in tech nonprofit called Techie Cat, which encourages more women into the tech industry and teaches them how to code. So at the time, a few years ago, there were a lot of investors approaching her to invest in her nonprofit.

which was really bizarre because it's a nonprofit. But still, like a lot of people were trying to encourage her to build into a business, which she never did. But she did say that because 10 investors or at least, you know, many investors were coming up to her. She was starting to consider it like maybe I should consider trying to turn this into a business somehow, which I think just illustrates this very irrational investment mentality that was common at the time.

Goussier also said that if she had asked those same people now if they wish they invested in her, they probably would have a very different answer.

I remember probably the first year when I came to China, which was about five years ago, I heard these crazy stories about friends of mine that literally, you know, went into a VC with a PowerPoint asking for 4 million RMB, which is a pretty small amount, but still based on the PowerPoint and no team and no nothing. And they just got the money during the meeting.

And I specifically remember one thing one of those friends mentioned is that when he got out of the meeting, he got a message like WeChat message 30 minutes after saying, where should we wire the money?

And he responded like, I don't have a company. I don't have a company account yet. I just want one thing for a pitch. And they said, no, it's okay. We can wire them to a personal account. We just need to sign this off right now so we can move on to the next deal. And literally within one day, he got 4 million RMB onto his personal account. And they were like, just send the paperwork later when you started the company. But he just could have taken the money and gone out of there. He literally just got 4 million for free on his bank account.

I mean, I feel like a lot of FOMO, like fear of missing out, motivated a lot of investors, right? You want to spot the next Tencent or the next big fish before everyone else does and at a cheap valuation. I don't think that's unique to China, but I feel like there's a lot of emphasis on this. Like, I remember there being a lot of PR for Bob Xu, like one of the founding partners, I believe, of GenFund, which is the seed fund in China.

And I'm not knocking GenFund because they're a pretty reputable venture capital firm. But I know there's a lot of stories about him investing based on like gut feeling or him like liking the person or being able to somehow like evaluate people really well. And that's a big part of early stage funding is like,

investors being able to judge the success of a company mainly based on the quality of the founder and the founding team. That also encourages a lot of this risky behavior, which is just like,

I don't even care about your business model, but I like you and I feel like you could be a successful person. So I'm going to give you like a million dollars, right? Yeah. And, you know, obviously, depending on the total fund size, that is a pretty imported kind of model from Silicon Valley, where a lot of very top tier firms, especially when it comes to early stage, are only betting on founders. I mean, Sequoia Capital in the United States, they have this thing, right, where all the founders they have invested in,

can, no questions asked, refer, I think, a few hundred thousand US dollar deal to one of their friends. No questions asked. I mean, it's a very small amount compared to the total fund size. And for Sequoia, that makes sense because, you know, we've done a lot of due diligence on this founder investing in his company. And if he's got a really good friend, he's got only one shot to refer those money and he's going to choose his friend. Well, it's probably a pretty good

I mean, like if we're going to be critical about how the Chinese VC market was a few years ago, I mean, I think it's very clear that thanks to the successes of Tencent and Alibaba and equivalents, we saw a huge surge.

in the domestic VC market. At least my analysis of when I entered the market a few years back, when I met a lot of the investment managers and the fund managers over here in China, you know, a lot of them came from other industries that hadn't done really high risk VC investments. And if you compare those profiles versus the ones I've met before in Europe, I

where everyone are former entrepreneurs. So they kind of know what type of entrepreneur that is required to build a company of size X. Make sense? And the people here at that stage were slightly less experienced in this type of investments, which makes sense because suddenly the market went from having $1 to $1.

And then, of course, it's hard to catch up with all the talent. And from that perspective, I think, you know, obviously, you know, a lot of miscalculations were made in terms of finding the right founders. And then, as you say, FOMO. Everyone is going heavy into this space right now. We need as well because our limited partners, our investors as a fund...

they're asking us why we're not getting in here, you know, and they're our bosses. So we just need to get in there and invest as much as possible as soon as possible before someone else steals the deal. Yeah, and I think also in China, corporate investors have been super active. So Alibaba, Tencent and Baidu in a lot of ways have funded tons of startups.

and maybe even encroaching on the space of VCs. And I just think that, you know, in addition to seeing a lot of people getting funded, which I think the positive thing is that it meant a lot of people were trying to start their own startups or businesses in China. But I remember just writing up some funding news sometimes when I was just focusing on tech.

And you would see things like, you know, Ant Financial raises a $4.5 billion Series B. And it's like, okay, is it a Series B? Because it's $4.5 billion. Like, how is that a Series B, you know, funding amount? And it's just, and there's tons of examples like that, right? Where people raise billions of dollars at a very early stage, and you kind of wonder if,

if that amount of money can be managed well when it's injected at such an early stage. I mean, maybe not for Ant Financial in that case, but for other companies, right?

Yeah, and I think part of that is driven by a really toxic environment that spread over from the West to China. And as with anything that enters the Chinese system, it goes crazy because of the scale in China. And the toxic environment, I mean, was the craziness around valuations. They chase after high valuation. But if you actually look at the term sheets,

You know, even though the investor went in and bought shares in your company at a valuation of $200 million, they had so many clauses protecting them, i.e. guaranteeing them a payback, even though if you would exit the company at $50 million.

But that's not calculated in the PR message, right? When you say, oh, we're valued at $200 million. And that just drove the craziness. And I've seen a lot of the term sheets around here in China. And they're basically the same thing, but in many cases, even worse. So it's very common, of course, when early stage investors come and invest in your company saying, you know, we're okay to just value a company at $10 million the first round.

But here's the thing that I need 8% return year on year. So whenever you exit, I'm going to get my initial investment back plus 8%. I don't care how many shares I have. And only after that, you as a founder get paid. So in reality, it is not the valuation of $10 million. It is a valuation of whatever that calculation is.

Yeah, and I think also besides the FOMO of investment, I think maybe because there's such a buoyant, optimistic atmosphere, companies themselves maybe weren't spending their money the right way. Like, for example, maybe bonuses being too high. Or Gu Xi was telling me this, I thought, pretty funny story because at the time, during the startup, when I was in Shanghai, so I wouldn't have known about this. There's a place in Beijing called Wangjing.

And there's a lot of startups there as well. And she said that at the height of the startup bubble in China, you would just go there and there would be so many people handing out swag, right, like USBs or whatever to advertise their companies that you could just bring a basket with you. And by the time you left, Wang Jing will be full of the stuff. So, yeah.

I think that really shows like, yeah, a lot of people were kind of swept up by this craze. I mean, it's hard to speculate about why this slowdown comes, right? Global economy, right?

Trade wars. China's GDP. China's GDP, exactly. But I think one of the key reasons here right now is that there is a huge uncertainty among investors and entrepreneurs right now. The question is, can a startup actually disrupt Alibaba, Tencent, Meituan Dianping, etc.? Or is that battle already won? ♪

So, yeah, something else that I was really curious to hear about from different people that I've spoken to is just about the impact, because there's a lot of reports in English and Chinese media about bonuses being cut, pretty major or well-known Chinese tech companies laying off staff and young people, white collar workers struggling to find the next job.

So earlier we also mentioned this. We kind of framed this slowdown in the startup industry as a market correction, right? And that it's really healthy and companies shouldn't overspend, which is not something that I disagree with. But I had a conversation with Chan-Shi Zhang, who's a freelance tech writer based in Canada, but he used to work in China. Actually ByteDance, one of the companies, social media companies that we've spoken about in the past.

Yeah, and in talking to Chauncey, who, you know, a lot of his friends and former colleagues are in their late 20s and early 30s, which in China means, you know, they're buying houses, they're getting married, or they're searching for someone to marry. It's kind of like a vulnerable age, I would say, because there's a lot of costs that you're preparing for. And I think he made a really good point about the impact of the slowdown.

The argument about market correction is that I feel like that argument is kind of credible, but when it comes to the employee side, you certainly don't want to be part of the part that's get corrected. The problem here is that

They assumed that they can expand to a larger scale. That's the reason why they were hiring people. I mean, just take ByteDance, for example. That's the reason why they were massively hiring people in the time I was there. But I mean, at the end of the day, I realized that expectation is not right. It's not about optimizing their operational costs. It's about having one wrong strategy and they're trying to fix it back.

Bonus is actually a very critical part of how you make money. And if you're not having that part of the money, essentially you're losing perhaps 30 to 40% of your income. And to many people out there, that's going to be a critical hit because if we're talking about engineers, we're talking about computer programmers that are working for the company state, they essentially rely on that income to pay back their housing loans and to pay back their marketers.

I mean, in the startup industry and the tech company industry over here in China, it's very common, even for the very big players, to offer below market rate type of salaries with the promise of learnings and career advancements. But I didn't actually know that the bonuses were so huge and such a big part of it.

And obviously, like when you hear it like this, from his perspective, this becomes way more human in a way, you know, like before when we talk about market correction and when we talk about slowdown, it's just they are just almost economic terms. But, you

you know, when you actually hear about how this impacts young people that put their faith into one company to build their future, it feels kind of horrible in a way. Yeah, I mean, I think that, you know, John Seigey makes a good point, which is that a lot of these companies, if they didn't manage their money well, well, the people who pay that cost in the end, it's not like the founding group or the top level people, but they're probably the bottom level workers. And

And I think another side effect to this is also the customers themselves. So with Ofo, which was one of the top two bike sharing companies in China, you know, they've been such a catastrophe. Like,

Like they've had a huge cash crunch as well. And a lot of people have not been able to get their refund because they're just there's so many people that want them that there's just a huge queue. And so obviously you have a lot of angry people or people that are waiting to get the money that they put into this app. And even darker stories with peer to peer lending. So you had all these scammy or inexperienced peer to peer lending platforms that

that basically took away a lot of people's money. And it got to the point where people would come to Beijing to protest, right? And that's kind of like the last stand for a lot of issues, including a lot of human rights issues, right? Like people will come to Beijing to voice their concerns or grievances to the central government. I guess my point in summary is that when these tech companies raise a lot of funds or take

expand too quickly, hire too quickly, and then they have to cut back because they're too optimistic or overestimate their capabilities. Their staff face the price and then also sometimes their consumers. One thing that worries me quite a lot is that I think that the public perception, especially among the young people, the people early in their careers,

That has changed quite a lot. I mean, a few years back, a lot of the young people, new grads from universities, the only thing they could talk about was joining a tech company. And nowadays, we're seeing more and more articles and voices around, like, why should I join a tech company?

company. I'm going to work 996, get a shit pay, and probably get laid off. And for me, obviously, that's a worry because it feels like a few really high-profile cases have given the industry kind of a

a bad reputation and of course me as a startup founder wants people to get into this space because I think it's a great life experience for people as well to be part of something fast growing or not challenging or not but you know be part of the innovation of the world instead of just going to a normal office job that's going to exist here forever and it's a little bit depressing to be honest

I think the reactions vary across different demographics. Like, I think what's interesting is that we see a lot of the candidates that interview for the AI company that she works at, a lot of them are quite young, let's say part of the post-95 generation. So let's say early 20s up to 25. And

are not as concerned about maybe not making as much money as they could have a few years ago. And they're really focusing on finding a company where they can develop their career and develop their abilities. So from talking to her, she made it sound more like

A lot of young people are still interested in gaining work experience, life experience, even at startups. But it is true that like both sides have to be more picky. You know, is this really the company that I want to dedicate years of my life to? And then for the company side, like,

cannot hire five or ten more people like I just have enough funds for one headcount and is this going to be the person even if we might sound negative and especially me about this slowdown and how it impacts people I really think actually this market correction is a positive thing

Because of the hype, because of the huge overflow of money in the industry, I think that has given a lot of startups that shouldn't be there on the market. It's made the ROIs much lower in the tech industry than it should be, especially in quite good industries. It

it kind of ruined any industries because there was like too much money in it. So instead of 10 competitors about something, it was 10,000 competitors doing something. I think bike sharing is a good example of that. I generally still believe bike sharing could be a good business,

But it just got totally screwed up due to thousands of startups doing exactly the same thing. And everyone just racing to the bottom to hit as close as zero as possible with their price point. And in a corrected market, in a more mature market, your investors would tell you that this is not acceptable for you to just use my money to give discounts because it is not sustainable.

Yeah, and I think something else that struck me from my conversation with Gu Wuxi is that, you know, she brought up the government's support of innovation, right? So the Chinese government has been really enthusiastic and financially very supportive of entrepreneurs, even local governments, governments in smaller cities, not necessarily Beijing, Shanghai, Shenzhen. I think it's good for the government to encourage people to get into startups, to encourage entrepreneurship.

And I remember at the time when, let's say, I believe Lee Koe-chang, so the premier, he was really pushing for maker spaces and some makers, like people who tinker, people who, let's say, 3D print or just make things on their own. And

And I think like if you have high level support, even just verbal support, let's say of something, it encourages people. You know, at the time, people were like, you know, the fact that the government's so vocal and its support means that maybe more people in China will be willing to like stray from a traditional path and be in a startup, which I think is positive. But on the flip side, and Gusi brought this up, it doesn't.

puts money and the money's not used very well. Like people, and you've probably seen this yourself, like governments will set up these innovation or tech parks

And they'll invite startups to fill the office. And it's kind of like a real estate play. And then they don't even really care about the quality of the startup, per se, that moves into this, quote, tech park. They just want the startup to hire and fill the space, basically. And they might even get funding for this tech park, right? So something I've heard, you know, this struck me just now about...

the rush of funding and also activity in the startup industry a few years ago, and why maybe it's a good thing that it's calming down a bit. Yeah, my opinion is that the market is slowing down. It's definitely not dying because there's a lot of opportunities in China, a lot of money to be made.

But finally, everything's getting a little bit more sensible. Finally, entrepreneurs are starting to ask themselves the question, do I really need to raise $10 million or do I actually only need one?

And suddenly investors are starting to ask the question on a broad basis, of course, what is your business model? Are you going to make money? Like it's not only about you getting 2 million active users per day. I want to see that you have at least an idea how you're going to monetize on that so you can pay me back the money.

And if we didn't think about China or the West or anything, if we were just to try to be investors and, you know, didn't think about the craziness in China, that would actually be very realistic questions to ask. And I also want to share this quote that Gu Si told me, because I think it really captures the sentiment in China's tech industry, which is like a mixture of, I think,

well, people bracing for what's ahead, but also trying to view everything in a positive light. Founder of Meituan, Wang Xin, he said, well, I got two news. One news is 2019 will be a really bad year regarding like investment-wise or company growth-wise and the whole economic environment. And the good news is 2019 will be the best of the following 10 years. Well, I kind of agree with that.

We could definitely feel the economy is not that prosperous. And it's pretty hard for us to acquire customers because customers are more rational and they are more careful about spending their money. But I also think it's a good thing to put

everyone into a stable and rational mind. And also it forces us to think, constantly think about this question. Do I really need a big team? Or do I really need two people to do this type of work? So, so far at least, when we're talking about the slowdown of Chinese tech investments and slowdown of the economy, at least my translation is just still, it is maturing.

And that's why it becomes a correction. And then, of course, we have macro trends impacting this. But overall, the main difference between what's happening in China right now versus, let's say, the dot-com bubble, which is probably before a lot of our listeners started working with tech, but that's still a very valid comparison to be made because during that time, basically, VCs funded a bunch of start-ups

that started to pay each other money to make it look like the economy grew, but actually no real consumer were in the ecosystem paying them money. Like one startup just made advertising money from another one that had VC funding. But what's happening in China and worldwide in tech right now, obviously, is that people are actually using Taobao or Pingduoduo to buy real stuff from real factories. Yeah, I mean, I...

still remember the days just a few years ago, actually, when you could hail a taxi or a car for free because VC money was basically subsidizing your ride. And that's obviously a sign that money's not being used very well or that these cash subsidies are a bit out of control. So I do think it's like a healthier direction now. But I think something to keep in mind is that

It'll really depend with all these macro trends as well, like the slowing economy. So if all these people get laid off, are they really prepared to find other jobs? And are people, let's say, if they graduate doing one thing now because of the new market environment, it's hard to, they have to switch. Like, is the system set up where people can adjust accordingly without, you know, being jobless or struggling with pay?

So back to the original question, is China's startup scene finally facing music? Is this just a market correction or a sign of something worse to come? So I do not think that the Chinese startup scene is going to return to the way it was a few years ago, you know, with sky-high valuations,

crazy cash-burning subsidies to the point where people are getting freebies left and right. Because I think, I really think that was just a product of its time. So, you know, unreasonable levels of optimism in the market and also at the government level.

So I think what we see now with the slowdown in the startup industry and the internet industry, I think that's just the new normal. Yeah. And with that, thank you so much for listening to this episode of Digital in China. As always, feel free to reach out to us on Twitter, LinkedIn, whatever channel. Thanks for listening.