End of an era: China moves into a slower growth phase driven by B2B entrepreneurship

Amid the China-US trade war and calls to curb reliance on Chinese imports in a post-pandemic world, it has become even more critical to understand the domestic economy in China. This article illustrates the significant shift from a high-growth period fuelled by B2C internet startups to a more moderate growth phase led by B2B businesses.
The shift marks an end to explosive growth in China where technology adoption and demographics favoured a boom in the tech industry, giving rise to several tech monopolies that changed the playing field. What does this mean for Chinese entrepreneurship? This article looks at the future outlook, challenges, and opportunities.

Over the past year, the number of business-to-business (B2B) companies Jinshajiang Venture Capital has invested in has exceeded those of business-to-consumer (B2C) companies. Zhu Xiaohu, who manages the firm, believes that this is not a fluke and over the next 10 years, growth in China will be in its B2B businesses.

But when people who know Zhu Xiaohu think of him, they think of his investments in some of China’s most successful B2C internet companies. These include DiDi, which ate up Uber to become China’s top ride-hailing app, ofo, China’s largest bike-sharing company, and Ele.me, one of the country’s top food delivery services.

The common thread between these businesses has been explosive growth, tens or hundreds of millions of users, and fierce long-term competition with at least one competitor. It is these characteristics that made these B2C internet companies hit the headlines; even their investors became stars overnight. So why are Zhu Xiaohu and many investors like him changing course?

The internet has boomed over the past two decades in China. 15 years ago, 111 million people (just 8.5% of the population) had access to the internet; now that number is 904 million (62% of the population).

During this time, China’s internet giants slowly ate up their competition, gaining market share and taking up more of people’s time online. Now Baidu, ByteDance, Alibaba, and Tencent control around 70% of internet traffic in China, a larger share than what the biggest American internet companies have in the US. The Chinese internet giants also achieved monopoly faster than their Western counterparts. This is reflected in their funding. In 2018, just 1% of companies received 48% of investments.

B2C companies are reaching a zero-sum game

These internet giants have begun to run out of steam, though. McKinsey stats show that by 2019, screen time had reached around 41 hours per week in China, a number which has stabilised in recent years. There are only so many hours in a day, and China’s low birth rate means that demographics do not offer much assurance for internet companies either. 

Chinese netizens already spend on average six hours a day online. Credit: McKinsey

Companies once rushed to develop apps and produce smartphones for chunks of China’s population that were not yet online. With this, apps became an integral part of everyday life in China, and app developers began to monetise their users. However, the opportunity for explosive growth is no longer there, and it has left an even greater problem for startups. 

Internet user growth in China has slowed down now that most of China’s population is online. Credit: QuestMobile

A symptom of these changes is the increasing costs of customer acquisition. Here are some reported figures that illustrate how the costs for acquiring each customer have boomed:

  • from US$1.4 in 2013 to US$14 in 2017 for mobile games;
  • from US$42-$70 in 2013 to US$140-$422 in 2016 for financial services;
  • now more than US$14 for each customer in online-to-offline services (including food delivery);
  • now more than US$1,400 for each customer in the travel industry.

The numbers show that for many industries, the cost of acquiring customers has increased by 500-1,000% over the past few years. Together with a fall in the growth rate of online sales, the end of the high growth phase for China’s internet companies is over. 

These changes do not only mean that there is little opportunity left for new startups; it also means the giants have had to adapt their business models too. Long gone are the days where you could operate at a loss, raise money through several investment rounds, go to IPO, then raise prices to start earning a profit from your hooked users. Most industries have begun to reach a zero-sum game.

Competition has got tough for many of China’s internet startups. Credit: QuestMobile

Now that China’s internet giants have transformed life in China with their killer apps, they are shifting course to B2B markets. The changes ensuing include overturning business models and designing new products that help digitise offline business. Tencent CEO Pony Ma described these changes as “the start of the next two decades.” For China, it is an exciting restructuring and new beginning for the economy.

Why are B2B companies the one to watch?

When it comes to the markets, the shortcoming of strictly B2B companies is that they are less flashy than their B2C counterparts. SAP and Salesforce, both business software companies, each have a market cap of over US$100 billion. That makes them up there with the likes of Netflix, but as B2B service providers, they do not get as much public attention as their B2C counterparts. B2B is not sexy enough.

It is not just their modest public image that keeps them off the radar of many Chinese investors. Another factor is that the vast majority of B2B companies do not achieve the explosive growth that many internet giants have enjoyed over the past few years. Nor can they deploy the same marketing strategies B2C companies use to acquire customers. In China, there are also fewer large B2B companies. In a 2019 list of China and the US’s top 50 internet companies by market cap, only one purely B2B business from Mainland China, Hikvision, is listed.

However, some traditionally B2C companies are now significant B2B service providers; Alibaba provides cloud services, and WeChat has an enterprise version, to take two prominent examples. WeChat Enterprise’s clientele has reported saving millions thanks to the platform. There are several features which support a wide range of business needs, everything from sending customers push notifications to providing round the clock consultations.

There is vast potential here. There are over 40 million SMEs in China, contributing around 50% of all tax collections and accounting for about 60% of GDP and 80% of urban employment. Yet, Zhang Rui, Director of Frees Fund, estimates that Chinese enterprises only spend 10% of what American companies do on technology, of which 85% is on hardware and only 15% on software and other services.

China’s consumer internet is driving the industrial internet. Credit: BGC

The gap leaves enormous growth potential for B2B companies in China. China’s SMEs face multiple challenges to digitising, among them squeezed profits and problems accessing credit. In the face of the challenges, many companies consider digitising their businesses a low priority. For that reason, accessible B2B services could be a big win for China’s SMEs in the coming years to improve efficiency, reduce costs, and raise profits.

Nurturing B2B businesses will require extra patience from investors

Xiong Fei, Partner at Jingwei China, has been watching B2B companies for eight years. He says he has never experienced the excitement people get out of the B2C market. Instead, Xiong feels his job is more like that of a farmer. He needs to sow seeds and wait rather than chase the market.

But then the B2C investors came in. The newcomers first aggressively invested in several robotic process automation (RPA) companies, some of which tripled in size last spring. Then the newcomers lunged on several middleware (software that links front- and back-end systems) companies.

Xiong Fei has reservations about the investments in RPA and middleware. Many of these previously B2C investors still like “big things.” He believes their investment logic has not adapted to B2B investing, which requires more research and less following social trends. Zhai Jia of Sequoia China agrees, he says that companies heavily invested in will not by default succeed.

There are several distinctions B2C investors have not made. In PwC’s words, the B2B-oriented giants pay more attention to valuation, whereas the B2C-oriented enterprises emphasise business traffic and the brand value brought by investors. B2C enterprises also attach more importance to growing the value of their brand, whereas B2B ones focus more on establishing influential precedents.

Xiong Fei predicts that many funds will end up using B2B investments to guarantee returns and still invest in B2C companies to place bets. To be successful in B2B investments, the newcomers will need to realise that pumping a company will not directly accelerate their business. Instead, their investments will likely be spent on research and development.

China SaaS market growth and forecast 2013-2021. Credit: QuestMobile

Some patience will be needed too – experts say that the B2B market may take until 2025 to outgrow the B2C market, with China expected to take the lead worldwide. Other numbers predict a 40% growth each year over the next three years. COVID-19 has helped accelerate some businesses such as online education and video streaming, but looking at all B2B business, we can expect a slowing down of the trajectory the industry was on.

Nonetheless, in March this year, the Chinese government announced vital measures to speed up their “new infrastructure construction” (software infrastructure including cloud services) to offset the economic slowdown caused by the pandemic. This includes a pledge to give US$529 billion to local governments with priority for “new infrastructure” projects. It is the beginning of a new era for China, and investors should note that B2B is not just a fad; it is the future trajectory of the entire economy.

Investor interviews from 36Kr.

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