Feted as the founder of Alibaba.com and doyen of Chinese internet entrepreneurs, Jack Ma wouldn’t be where he is today without a talent for predicting the future. Back in July 2008, Ma wrote an email to staff warning of hard times to come.
"This winter will be longer, colder and more complicated than any have predicted!" he said of the economic crisis then just unfolding. "We need to prepare for this winter!"
Even Ma may have been surprised at how brutal the business climate has become. Alibaba is an undisputed survivor, and it will be here after the slowdown. So will other proven Chinese internet companies with established brands.
But the past three years have seen an explosion of new Chinese Web 2.0 companies such as video sharing sites, micro-blogging engines and social networks, backed by vigorous venture investment. A few may become China’s next generation of online champions, but many lesser-lights that traded on the glamour of Web 2.0 are suddenly gazing at a bare larder.
Already there are signs of contraction. In November Dow Jones VentureSource reported that 2008 would be China’s biggest year for venture capital investment since 2001. But they also reported that technology deals were down 17% year-on-year in the third quarter, and the fourth quarter was expected to be difficult. "Exits" are a critically endangered species.
This is trouble for a market heavy with dreary copycats. One online industry veteran said that he expected to see lots of zombie 2.0 firms in China in 2009.
However, what is coming is less an indiscriminate massacre than a brutal but healthy thinning of a herd that has outgrown its pasture. The hardiest will prosper as weaker competitors stumble. China’s entrepreneurs are not the green crop they were a few years ago. Many have cut their teeth in successful startups or international IT firms. The smart ones are already reducing costs and preparing for a financing drought that could last two years.
Deals will continue, but more selectively than in years past. For those seeking financing, ownership of intellectual property with intrinsic value will be a big advantage. Cash flow will be solid gold.
Likely winners include micropayment-driven entertainment and e-commerce sites that derive revenue directly from consumers, and companies like restaurant directory Dianping that combine social aspects with services that have little competition from traditional media. Video sharing will be a survivor, thanks in part to the dire broadcast offerings. Video leaders Youku and Tudou are already monetizing visitors through brand promotions and advertising. Online games are well established in China and will also prosper. One game company CEO observed that in bad times, people want to escape reality.
Companies depending solely on display advertising face a hard time. The pie is still growing, but much of it is devoured by the established portals, leaving even promising newcomers scrambling for meager crumbs. This may explain why investment group Oak Pacific’s popular social networking site Xiaonei is busy deploying a micropayment system that can be an alternate source of revenue.
But even when deals are happening, dreams of soaring valuations are being dashed. Power has shifted back to investors, sucking the air from frothy valuations like the US$1 billion that Oak Pacific engineered for Xiaonei last April. At the time, JLM Pacific Epoch estimated Xiaonei to have just US$9-10 million in annual revenues. Some early investors took the opportunity to cash out.
The long game
Tech will bounce back in China. The internet is still a growth market, as are advertising and mobile data. There are plenty of opportunities yet to be explored and, despite the prevalence of copycats, a lively and creative entrepreneurial community.
A good idea always has a chance of finding funding if it is backed by a strong team. But the era of stupid deals and highly speculative investments in half-baked and unprofitable companies is over.
Ultimately, a spell of straitened times will be a good for the industry, enabling the strongest firms to consolidate audiences and advertising and restoring the primacy of good teams and good ideas over me-too hype. The winter will be long and cold. But it will cull the herd of the sickly and leave it stronger when, as it finally must, spring arrives.