Building China's Information
Technology Industry

IBM. Fujitsu. Microsoft. NEC. Legend.

Legend? If you haven't heard of it already, get ready. This firm may well be the first big success story in the country's attempt to become a major player in global IT. And it may be only the first of several.

How do you build a world-class information technology industry? For late starters like China, the power of a handful of gigantic American and Japanese companies looms as both a challenge and a threat. China nevertheless intends to break into the big leagues early in the 21^st century, and has been making great strides towards that goal.

Lately, the country's booming Internet and its spunky young entrepreneurs have captured the headlines. This growth spurt may well accelerate the country's race into the information age, but it is far from sufficient to make China a global contender. World-class players need hardware and software capabilities to underpin the information economy. The roots of recent progress and potential future problems may be found in these more traditional arenas.

Since China's big push for computer industry development began in the mid-1980s, the production and sales of computers, monitors, printers, and other peripherals have grown extremely fast. From 1989 to 1999, domestic PC output rose from approx. 57 thousand units to just shy of 4 million (see Fig. 1). Printer and monitor production grew to far higher levels. Escalating output has made China into a new exporting powerhouse. In 1998 it sold abroad over 11 million printers and 17 million monitors. By 1999, its computer hardware trade surplus with the U.S. had grown to over $3.6 billion.

But China's domestic market, too, has grown increasingly hungry for computer products -- witness the April 2000 promotion by the Shanghai VW joint venture, offering a free (Chinese brand) PC with auto purchases. Last year Chinese buyers snapped up US$15.8 billion worth of computer hardware. Domestic brands have captured increasing market shares from their foreign rivals. By 1999, three of the China's top five PC suppliers were Chinese companies. The highest selling, Legend Group, outsold second-place IBM by over 200%; two other Chinese companies placed in the top five.[1] Legend rose to third place as a PC supplier in the Asia-Pacific region,[2] and aims for first place this year.

So get ready to learn the names of some new players. If Legend, Founder, Start, HiSense, Great Wall, and Langchao mean nothing to you yet, you may find them on your desktop within the next five to ten years.

How did any of these become so successful? Each has a unique history, but some common threads may be found in the following sketches of two of the top ten firms.
 

Legend Group[3]

Alongside the company's "Chinese card," Legend also made handsome profits reselling foreign-made computers. Profits went into R&D and capacity. When the first domestically produced 486s and Pentiums came out, they sailed out under the Legend flag. Legend by 1995 was the hottest selling domestic brand of PC. By 1997, it claimed the largest share of any company in the Chinese market. It has held onto that lead, with the Legend brand winning nearly 22% of the domestic market by 1999.[4] By 1998 the company was ranked as the number one electronics firm in China.

In getting to that point, it went through several metamorphoses. In 1988-89, the company set up the joint venture Hong Kong Legend (HKL), and then reconstituted itself as Legend Computer Group Company (in Beijing) to control Beijing Legend Company and the Legend share of HKL. The Group Company then expanded operations under several sub-companies, specialized in producing own-brand computers, reselling imported computers and peripherals, designing and producing motherboards (mostly for export) and printed circuit boards, and doing systems integration.

In 1994 some Hong Kong Legend shares started selling on the Hong Kong stock market. Three years later, the Group Company transferred titular ownership of most of the manufacturing operations to Hong Kong Legend, with the Beijing-based Legend Group Holding Company still controlling the majority of shares. In 1998, a further reorganization in Beijing dissolved the old Computer Institute, putting part of its personnel into R&D within Legend and the rest into a new research institute with some top Legend managers on its board of directors.

Those reorganizations made it possible to raise capital on the Hong Kong stock market and created a framework allowing Legend employees, especially key managers, to receive ownership shares in the Beijing holding company -- approximately 35% of the total share value. The state, however, in the form of the Chinese Academy of Sciences, maintained the majority ownership.

Legend attributes much of its success to the leadership role played by its president, Liu Chuanzhi, and especially to his strategic choices. He is credited with insistence on using market demand as the main determinant of development -- an approach that helps to explain the company's success in riding, and possibly in amplifying, one after another wave of new types of demand. The company fared extremely well with a line of PCs with a user-friendly interface, capturing much of the surge of household computer demand that began around 1997-98. By 1999 Legend began emphasizing the Internet as a new development track, and in early April 2000 announced a new reorganization of the company structure built around an Internet strategy.

Legend has built a reputation as an extraordinarily well organized company. Managers can readily summarize the elements of a company culture that has been explicitly formulated as a method for getting things done: forming teams, setting strategy, and leading the "troops." Employees attend frequent training sessions. Some managerial methods have been borrowed from companies like IBM and Hewlett-Packard. The rhetorical flavor, though, is sometime reminiscent of the writings of the more organization-minded leaders of the Chinese Communist Party in the glory days of the revolution.

The company has selected foreign partners with an eye to acquiring the know-how necessary for each new phase of development. With its close partnerships with the likes of Intel and Hewlett-Packard, and its more ad hoc but no less strategic partnerships with others like Microsoft, Toshiba and Hitachi, Legend has dramatically sped its progress up the learning curve.

The company has achieved a symbiotic relationship with the government. Legend provides a handy model and continuing public relations copy for the government's strategies in the high-tech sector. At crucial junctures, Legend has won huge state contracts that helped it develop new business lines. In the mid-1990s, it benefited from two crucial new opportunities. The first was the government's massive investment in the Golden Projects (see below). The second was the strategy announced in 1994 to cultivate China's potential global contenders. Legend was one of a handful of companies selected for special nurturing, including huge bank loans.

Some of the U.S. and Japanese IT giants received similar boosts from state spending or preferential policies at early stages in their development, but still had to win out over other, similarly favored companies by dint of better strategic choices or better management. Legend may claim similar credit for fighting its way to a leading market position not only against foreign competitors but also against new domestic competitors who have charged into the market with their own distinct advantages. One such new competitor is Start Group.

Start Group[5]

The Start PC in only a little over a year was among the five leading domestic brands, and held the number-two slot for household computers. From 86^th place among China's electronics firms in 1993, the company rose to the number 26 spot in 1998. Despite intensified competition in the PC market in 1999 with the entry of some of China's largest household appliance manufacturers, Start still came in seventh among domestic PC makers, and third among domestic printer manufacturers. It aims for fifth place or better among information technology companies by 2001.

Unlike many high tech startups of the late 1980s, Start began as a shareholding company. Of the initial capital of RMB 250,000, state-owned entities held 70% but the sixteen "founders" held 30%. Managers and employees are encouraged to purchase shares in the company. Start Group shares have been traded on the Shanghai Stock Exchange since 1996, and the company has ranked among the high performers there.

Like Legend, Start Group has benefited from both state assistance and foreign partnerships. The company's relationship with Epson goes back to the dot-matrix printer years; in July 1998 Start and Epson formed a new joint venture to manufacture bubblejet printers, which will give Start employees new technical know-how. The SSI subsidiary, within a year of its foundation, could already boast a long list of "cooperations" with foreign companies including IBM, Informix, and Cisco. Not all of those are close partnerships, but all hold the potential for ramping up the company's technical capacities.

Initially, Start Group could expect state assistance only at the provincial level. (Several companies owned by the provincial government are still major shareholders in Start Group, including an investment corporation that holds nearly 24% of the total.) But Start has proven adept at seizing the opportunities afforded by national policies and projects. A manager of the SSI subsidiary explained the decision to locate that firm in Beijing partly in terms of its qualities as a "policy center" close to ministries and offices making the decisions that could spell the difference between success and failure in landing large contracts.

The Group's growth strategy has emphasized expanding capacity by first buying, merging with, or investing in other companies. The company's merger with another Fujian peripherals factory in 1995 was pivotal in ramping up output. SSI Company's key function has been to identify successful small companies (some of them privately owned) in which to invest, with Start the majority shareholder in most.

SSI's investments paid off with the acquisition of several companies that made Start a major contender in systems integration virtually overnight. The company's clients by early 1999 included a long list of banks, insurance companies, share exchanges and investment companies, telecommunications agencies, and government departments at central, provincial and city levels.
 

Software Woes

The root of the problem, many argue, is the high rate of software piracy. In value terms, China is far from the worst offender on this score. Business Software Alliance estimates put the dollar value of 1998 piracy losses in China at only 42% of those in the U.S. However, piracy rates in China remained among the highest in the world: 97%. Some foreign software companies question the adequacy of Chinese government efforts to publicize and police the problem, but it must be acknowledged that enforcement is impeded by the prevailing attitudes among Chinese users.

Ultimately, Chinese software manufacturers are probably the biggest losers. Chinese users preferred to go for the (perceived) best in pirated software, and foreign brands captured the share long before they got the market. In the late 1980s and early 1990s, often there was no legal Chinese version of these brands available in the mainland, and users had to use pirated versions or none at all. Later, when Chinese users did start buying software, they were inclined to upgrade to legal versions of the foreign applications they already had, and at least one major foreign software manufacturer based part of its marketing strategy on this tendency.

Although foreign software prices are high for Chinese budgets, Chinese software companies' prices sometimes ran higher still. Chinese companies often tried to recoup development costs by pricing their packages quite high, under the assumption that any new software would be quickly pirated and that they could sell very few packages before that happened. The high prices of course made this a self-fulfilling prophecy. More recently, many companies have adopted a new pricing strategy.

There are some software industry successes. Founder Group, a company started as a spin-off from Beijing University, became one of the biggest IT companies in China by the early 1990s largely on the strength of its desktop publishing system, which captured most of China's market for such products, and then began selling abroad. On the whole, though, success stories like Founder's have been more the exception than the rule.

The bright spot on the horizon is that the software and services sector has begun growing even faster than hardware. Rapid Internet and intranet growth in the past several years has sparked much higher demand for systems integration and server software. The recent nudges towards adoption of the Linux operating system may augment demand for indigenously developed software using that system, while relieving some of the nationalistic fears about foreign dominance. But there is still a long way to go, and the domestic software industry's development will be curtailed until sufficient intellectual property protections are in place.
 

The Government's Role

Defining direction. At certain key junctures, decisions made by the central government have opened the road to rapid development for the whole sector. The first key point of departure came in 1984, when the government chose to shift towards microcomputer development, and the PC architecture beckoned new aspirants with its standardized components and low startup capital requirements. Since the Ninth Five-Year Plan period began in 1995, the government has stressed "informatizing" the whole country, with attendant commitments to massive investments in infrastructure.

High-tech zones. In these designated areas, high-tech startups could enjoy five years of significant tax breaks.

Seed money. Notable seed money has come, for example, from the "863 Project," funding a number of IT-related projects like a Chinese operating system and a number of computer-integrated manufacturing systems applications.

Tariffs, foreign investment and foreign sales regulations. Initially, foreign companies seeking to sell their products or to manufacture in China faced requirements that they seek Chinese "channel partners" or create joint-venture partnerships. Coupled with tariffs, these requirements encouraged in-country production and transfer of technology to Chinese firms. In recent years, China has reduced such barriers in hopes of joining the World Trade Organization.

Standard-setting. The Ministry Information Industry and other relevant agencies enjoy the power to set technical standards. The standard-setting process can and has been used to ensure that Chinese firms get a large piece of the action.

Market expansion. Paradoxically, the government has greatly enhanced the market for IT purchases and information services even as its own share in these has declined. Until the early 1990s, private and household purchases were negligible, and most large customers were government agencies and state-owned companies. In the 1990s, the state sponsored three "Golden Projects" aimed at creating a networked infrastructure and applications in several sectors.[6] In 1999 a highly publicized campaign got nearly all central government departments and many lower ones online. The publicity and the availability of useful content have helped fuel the Internet boom (see Fig. 3), which in turn has fueled the growth of the domestic PC market.

Conclusions

Information technology is a complex and fast-changing industry, and today's winners can be easily upset, or surpassed, because of a sudden shift in markets or technologies. The Chinese government has shown wisdom in providing fertile soil for growing the industry, and watering it judiciously. It has many tasks ahead of it, including further improvements in intellectual property rights. Internet use might grow even more rapidly, benefiting many sectors of the economy, if the government could more quickly reduce connection fees and allay anxieties over the rules governing online content.

Chinese IT companies face new challenges in the coming era, when WTO membership may spell more intense competition from foreign companies -- but may also mean more opportunities for Chinese companies in foreign markets. The Internet boom shows no sign of abating, and will both fuel, and be fueled by, content production. E-commerce is bound to take hold, and offers myriad new opportunities. Chinese companies enjoy cultural advantages in capturing the Chinese market in this new era, and may find foreign companies eagerly soliciting them for partnerships in order to share at the feast.

But who could resist ending with the bigger questions? How will Info-China mesh with a slowly changing political system, or with a society in which many are poorly educated and too poor to gain access to the leading-edge technology? Will all of China march into the Information Age, or will most of it stand on the other side of a digital divide watching a fortunate minority? Stay tuned.

Notes

2. IDC's "Asia-Pacific region" does not include Japan.

3. The information here has been compiled from interviews at Legend (Beijing) in 1995, 1998 and 1999; from Legend's in-house magazine, and from the company's web site at www.legend.com.cn.

4. Wang Chuandong, "PC market wins 25% gain," China Daily Business Weekly, 28 Feb. 2000, p. 5.

5. The information here has been compiled from interviews at Start Software and Systems Integration Industry Corporation (Beijing) in 1999; from Start's in-house magazine, from the Start Group's web site at www.start.com.cn, and from Liu Yong, Blue Channel: from 16 People to 1.6 Billion [RMB] (Beijing: China Economics Publishers, 1998.

6. For detailed discussion of the Golden Projects, see Manuel Fries, "The Golden Projects: The Chinese National Information Infrastructure," Diplom-Wirtschaftssinologe thesis, Bremen Polytechnique, 1997, available online at www.gip.int/offshore/html/en/thesis/manuel/fries2.pdf. A book revising and updating the thesis is forthcoming soon.