The Chinese New Economy: Alibaba as Sauron and why the old economy will be the winners

Sauron eye

Anyone familiar with the Chinese new economy will be aware of the rise of the internet giants of Alibaba and Tencent, along with their satellite businesses. Most will also be aware of the largely exclusive ecosystems within which Chinese online life is led – platforms that encompass everything from messaging to shopping to transport to payments and beyond.

It seems astonishing to remember that barely five years ago many commentators fretted over whether China could ever achieve real innovation. The Harvard Business Review for instance posed the question “Why Can’t China Innovate?”, baldly stating:

Can China lead? Will the Chinese state have the wisdom to lighten up and the patience to allow the full emergence of what Schumpeter called the true spirit of entrepreneurship? On this we have our doubts.

This of course is all rather a fading memory now. Innovation can broadly be divided into three areas: upstream (essentially, “how it works”), midstream (“how it’s made”) and downstream (“how it’s used”). For years, China as a manufacturing hub had made quite noteworthy progress on midstream innovation but most uneducated observers – including many in government – have an unhealthy obsession with upstream blue-sky invention. Yet as we can see with the likes of Berners-Lee, inventors are rarely rewarded and rightly so, since the real creativity and invention from the likes of Steve Jobs, Mark Zuckerberg and Jeff Bezos is in the downstream. Jobs was an arch innovator in how technology is actually used and therefore spread through an economy, with a vision of how lives are actually impacted and changed. Chinese companies, particularly through the big online giants, are clearly doing the same: modern life in China is now lived in quite an advanced but different manner to modern life in OECD countries. Alibaba and Tencent have contributed towards the creation of a real and organic Chinese modernity and technological innovation within China arguably outpaces even the US even leaving aside issues of theft.

So it is worth spending a moment to look at these two major ecosystems and how they really behave – who they are, as it were. First, there is a question of why ecosystems exist in China in the first place in a way which outside of China they do not. Amazon comes the closest of the American tech players to demand a closed ecosystem but even they seem to find limits. Western shareholders have always rewarded single-capacity specialization, and often find the idea of any conglomerate absurd, let alone a tech company offering bicycles and banking.

In China though, this has been natural, for two reasons. First, there is the historical socio-anthropological tendency within Chinese society to build a “closed loop universe” within one’s own family or clan, which has extended to the national level through the Communist Party and SOEs. My own preference for explaining this remains Karl Wittfogel’s hydraulic empire theory, which tells us that most ancient civilisations relied on centralized power to deliver water to its people, enshrining the principles of autocracy and top-down governance at the government and family level. This in turn typically leads to closed-loop systemic thinking since everything has to work together or else nothing works – diversity of thought is only bad news. Secondly though, and somewhat ironically, these ecosystems have become so broad precisely because they are making up for assurances which the Chinese government cannot offer. When you make a purchase on TMall, you have more faith in the Alibaba-backed guarantee that your products will be delivered and that your payment is safe, than one does with the disparate parts of the national banking, postal or legal system offered by the government. The tech giants had to offer a total universe, or else consumers would have been reluctant to actually engage with the new business model in the first place.

Chinese ecosystems (2)

Source: SCMP

So much for why they exist – the bigger issue is how to understand who they are, what their personalities and identities are and how they should be understood from the outside. One possibly analogy, given their conflict, is that of the Cold War. In this world, Alibaba are the Soviet Union – a sprawling empire with a strong centralized view on how things are supposed to be done. Tencent on the other hand are the United States, a beacon of freedom and inspiration but which has its own agenda focused on generating and owning consumption. are Britain: commercially-minded, focused on trade and fully acquiescent into the American (Tencent) world. Lastly you have Meituan – which owes its existence to Tencent, but like France to the US is entirely ungrateful and maintains the pretence of wanting an ecosystem of its own.

Upon reflection however, a new analogy came to me which may be a touch more accurate, which is Middle Earth. In this version of events, Alibaba are indisputably Sauron, the lurking, evil presence which looks across the lands of men with an unrelenting will to dominion. They provide you the tools to “help” only so that they can own them and you. They invest in you because they need to control your system from the inside. Resistance is futile; eventual subjugation can be the only outcome. The interesting one is Tencent, who I liken to the High Elves of Rivendell. The things about the Elves is this: they are generally on the side of good, and can facilitate it; but they are not themselves a force for good since they sit far away from the battle, detached from it all. They too provide tools, but they may not tell you how to use them; their attention is ultimately elsewhere. The forces of Men ranged against Sauron – let us assume these are essentially a proxy for traditional retail and consumer business in the region – ultimately have to find the solution for themselves, aided at times by the Elves but not reliant on them. If I were to stretch this analogy ad absurdum, perhaps this makes the Dwarves with their grubby focus on gold and commerce; whilst Meituan the slightly nobler Rohirrim, since they, er, move around a lot on delivery scooters like the horses of the Riddermark. Which start-up will be the valiant hobbit which destroys Alibaba, God only knows.

The serious point to all this is that for old economy companies, it feels like making a choice is inevitable. But the more one looks at the giants of the new economy, the more apparent it is that in the conflict of “internet+” vs “+internet”, it will likely be the latter – especially established asset owners – that win out. In particular, it is difficult to imagine that in this inflated global asset price environment, that the business which need, as Alibaba and especially are doing, to build out a network of physical infrastructure can be the eventual winner. Well, maybe one early mover can, but the world is not about to be flooded with online victors – by and large, the winners will be whoever of the old economy players adapts best to the new, rather than a new economy player.

And this then comes down to the vision thing. I have another analogy: I call it the “Physics & Philosphy” dilemma™. P&P is a little known but highly intellectual degree at Oxford (arguably the most esoteric of all) which combines two subjects that are not immediately connected. Yes, it is true that in the first term, courses such as Logic may play a part in both areas but then it would appear the two diverge. Yet we should see this like the rings of Saturn: you start off at one point travelling in two opposite directions on the ring, and whilst they move far apart to begin with in the end they meet again. In P&P, the questions at the other end of the circle see the two disparate subjects poetically rejoin on questions such as: what lies beyond the Universe? What happens if time stops? What if light bends? What is not obvious when you start the degree, become enormously obvious by the time you end it.

And seeing what is on the other end of this ring – what exists on the “dark side of the planet” as it were – is the very thing that marks out business geniuses from mere mortals. It took Amazon 14 years to become profitable, but there seems little doubt that Bezos had an idea of what lurked out of his sight in the distance. Likewise Jobs as he labored through various versions of Apple. But the point is, old economy companies can equally achieve this. We know the famous examples of IBM and Intel reinventing themselves based on their competencies; Apple itself did so. Further back in history are companies like Berkshire Hathaway and General Electric, and even Nokia who started life in rubber products. Reinvention is hard, but the world has not ended just because a series of new giants seem to own everything in sight. If the old economy is to learn anything, it is that with courage and vision, and a will to innovate internally if imperfectly, the future is still going to be theirs. For every Amazon which succeeds, there will still be a dozen Walmarts and Targets which make it, stronger than before.

The technology giants will go down in history mostly as the midwives of change, delivering the new baby to their old economy counterparts. We are already seeing them do this, below the surface as Alibaba and start to crystalise value in real businesses where they can (finance, technology etc rather than the core e-commerce platforms which have rarely made money for anyone). In many ways they are merely pioneering the examples of what the future looks like, so that old economy companies can learn from it but probably implement it better – the Chinese O2O supermarket businesses are a case in point. Indeed the cheerleading nature of the new economy player’s roles in businesses like retail, ahead of its time, loss-leading and ultimately doomed as a standalone business, begs another more controversial comparison. The tech giants are St John the Baptist, crying in the wilderness; the old economy players are Jesus.

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