Why American internet companies fail in China: a cultural perspective

Photo DONG Jielin / Associate Professor and Member of the Academic Committee, Research Center for Technological Innovation, Tsinghua University / September 5th, 2016

Different hierarchies of needs explain why, in the internet industry and other high-tech industries in China, there are both the Chinese way and the Silicon Valley way of doing business, and why some big American companies have been struggling to make headway here. High-tech sounds high-up, but for online service providers, it all boils down to understanding other people’s ways of thinking and doing things. They have to understand local governments, their employees, business partners, users and clients. Looking back, the U.S. internet giants that failed were simply out of tune with the Chinese market. They didn’t clearly see the importance of understanding Chinese culture; they talked to the wrong people in the wrong ways about the wrong things.

Dunhuang, located in the western end of the Hexi Corridor, is a city in northwestern China with a population of less than 200,000. Dunhuang was a major stop on the Silk Road and is best known for the Mogao Caves, which are world-famous Buddhist sites. Tourism is important for the local economy.

In mid-June 2016, the city welcomed some very special guests. More than 100 CEOs, entrepreneurs, and venture capital partners from all parts of China gathered during hot summer days in Dunhuang to attend a training camp organized by Hundun Club, a private entrepreneurship workshop. On the podium, Li Shanyou, founder of the club and a famous former professor at China Europe International Business School (CEIBS), gave a passionate speech not unlike a rock star.

Equally spectacular are Li’s students. They include Wang Feng, a top Chinese rock musician who now runs his own headphone company; Michael Yu, founder and CEO of New Oriental Education & Technology Group Inc., a New York Stock Exchange-listed Chinese private education company; Xu Xiaoping, another New Oriental founder and an angel investor; and Liu Chang, successor to her father as head of New Hope Group, a publicly-listed Chinese company.

The speech was about discontinuous innovation and cognitive patterns. Professor Li wants to compare disruptive innovation, technological transitions, scientific revolutions and evolution, and he finds things in common among them. Li is well-prepared to do this, having spent a whole year in Silicon Valley focusing on these things. But for his students, who run restaurants or supermarkets, sell headphones, or invest in real estate, a question they often ask during the class, perhaps repeatedly, is this: What’s it got to do with me?

In the following two or three days, participants and teachers at the camp went to the desert for physical exercise and sightseeing, as well as team building and willpower training. During the day, they hiked in the sweltering heat. After dark they had bonfire concerts. At night, they shared tent beds. Everyone was in a festive mood. And the participants in the willpower training workshop were obviously in for a treat. Each of them was assigned on average two people to look after them. The entourage included trainers, physicians, drivers, photographers, cooks and handymen.

During the workshop, the participants used every opportunity to make friends. One more friend, one more potential business partner. In a business environment where guanxi (relationships) rules, connections with influential people are clearly seen as something that boosts one’s odds of success. Indeed, throughout the program, people only talked about one thing: how to make more money. A Silicon Valley person would probably find all this a bit unnerving, as it’s contrary to their usually low-key, black-technology-rules Silicon Valley way of doing business.

Or would they? If they had gone through the “dotcom bubble” of 1999-2000, they would probably still remember the maddening crowd. Everyone was talking about stock options. Whenever there was a party, there was exciting discussion about companies going public and people getting rich overnight. Silicon Valley was like a casino in Las Vegas. Big wins were being constantly announced. Startups held meetings at seaside resorts, sometimes inviting celebrities. Young CEOs were flown by private jet to spend a wonderful weekend on an island. But it was only a short-lived dream. Following the bust, things went back to normal. Pioneering days became once again difficult, with investors reminding you, not always pleasantly, of the virtue of thrift and cash.

Normally, in Silicon Valley, content is always the key for any kind of workshop or training program. Teachers give lectures and organize discussions with an aim to introduce the latest knowledge or thoughts to the students. For their part, students often cite technology literature and leading-edge research papers to support their arguments when they ask questions, debate, or exchange information. It may not sound sexy, but the discussions often yield very impressive results. Books by Silicon Valley entrepreneurs such as Zero to One and The Lean Start-up are already must-reads for entrepreneurs across the world and textbooks for business schools and training programs in China.

Nevertheless, it is too early to use Silicon Valley standards to examine China and conclude that there is a bubble in the Chinese start-up industry.

When Nevis people meet Maslow people
Some participants in the Dunhuang workshop have also noticed the difference between the China style and the Silicon Valley style. A founding partner at an investment fund who was at Dunhuang observed: “Today I met some technology entrepreneurs from France, Israel and the United States. I saw determination and self-poise in their blue eyes. They are like cold-blooded killers. Then I look at the new friends I made in Dunhuang. They are passionate, maybe too passionate, but not cold-blooded enough. Our discussions were loud and lively. Everybody was saying something to impress. But ace players really compete to be the most collected and cool-headed, not the most boisterous.”

But the majority of the participants do prefer the Chinese way. Chen Jun, founder and board chairman of Eastide Group, is an experienced real estate developer. He said that he signed up for the workshop to meet more young people in the internet industry. Chen has his own theory regarding the hierarchy of needs. According to him, human needs can be put into three categories. “The first one is basic needs: food, etc. The second category is called strong needs, such as human interaction and social life. Everything else falls into the third category, which is called weak needs. A business that is linked to basic needs and strong needs is more likely to succeed. Education itself is only a weak need. But if education can be seen as an opportunity for social interaction, then it becomes a strong need. So the popularity of business schools and workshops is not based on the merit of their content. Rather, it is because of their social value.”

Academic research abounds in motivation theories and corresponding incentive mechanisms, with Abraham Maslow’s Hierarchy of Needs model being one of the most referenced and discussed. Maslow first published his theory in 1943 and identified six levels of human needs. At the bottom of the hierarchy is basic needs, followed by safety needs. The third level of need is “Love and Belonging.” Then the “Esteem” level, and after that the “Cognitive” level. At the top of the pyramid is the “Need for Self-actualization,” even “Self-transcendence.” According to Maslow, humans start with meeting basic needs and gradually progress to higher needs. Some argue that Maslow’s model was developed using the American middle class as the subject and it does not necessarily apply elsewhere. Nevertheless, Silicon Valley fits Maslow’s model.

But according to Prof. Edwin C. Nevis of MIT’s Sloan School of Management, Maslow’s theory has a certain cultural relativity and works best in the individualist American culture, but not in the collective Chinese culture. Nevis reshaped the pyramid into four levels, with belonging at the base, physiology and safety following, and finally, self-actualization at the top. For Nevis, belonging and guanxi are more basic needs than food in Chinese society. He also added that the Chinese approach to self-actualization is different from that in the West. A Chinese person achieves self-actualization by providing social services; for example, by becoming a government official. He gets accepted by others this way. The “Esteem” level and the “Transcendence” level in Maslow’s model have completely disappeared in Nevis’s description of the Chinese, and there are many things in common between Nevis’s theory and Chen Jun’s observations—as well as from other scholars of Chinese culture. It also helps explain why at a Chinese dinner, information-exchanging and network-building are more important than wining and dining.

Human needs are closely linked to cultures—the formation of which is long and gradual. Any attempts to “change” cultures would be as difficult as swimming upstream. Not surprisingly, when Nevis people meet Maslow people, there may be some interesting, perhaps even painful, misunderstandings.

china-cfel-2

Guanxi determines results
Different hierarchies of needs explain why, in the internet industry and other high-tech industries in China, there are both the Chinese way and the Silicon Valley way of doing business, and why some big American companies have been struggling to make headway here.

High-tech sounds high-up, but for online service providers, it all boils down to understanding other people’s ways of thinking and doing things. They have to understand local governments, their employees, business partners, users and clients. Looking back, the U.S. internet giants that failed were simply out of tune with the Chinese market. They didn’t clearly see the importance of understanding Chinese culture; they talked to the wrong people in the wrong ways about the wrong things.

Who are the customers? The American social class structure conforms to an “olive-shaped” distribution, with the middle-class making up the bulk of the U.S. market. Back home, the American companies target them. But in China, the structure is more of a pyramid than an olive. Middle class, upper-middle class and upper class people who understand and appreciate American culture only account for a fraction of the Chinese population. Yet, when the American companies entered China, they ignored the Chinese social structure and focused only on the middle class market, thus losing the majority of potential users.

The wrong business model: American internet companies in China stuck to American internet systems and business procedures and did not invest enough in developing service modules and functions that worked best in the Chinese context. Dr. Kai-Fu Lee, previously the president of Google Greater China, once observed in a blog post: “The Chinese market is so special, it deserves special attention. But American companies have put too much emphasis on maintaining a unified network platform. Such a strategy of course ensured a consistent global platform, but it came at a cost: local market share. Take eBay and its China operation Eachnet. After the acquisition, eBay took Eachnet offline and switched it to the eBay platform—a poor decision that later turned out to be a total disaster. In addition, whereas eBay depended on the credibility of the online merchants, who were not always reliable in China, Alipay offered third-party payment guarantee and thwarted eBay.”

Wrong localization strategies: American internet companies in China focused on the wrong customers and lacked the awareness to localize. Consequently, they rarely conducted enough market research or developed content to suit the Chinese taste. Their localization efforts only went as far as translating their websites and mobile phone applications into Chinese. That was perhaps enough for them to receive applause from overseas returnees who were already familiar with the American platforms, but less likely to impress hundreds of millions of regular Chinese users. In his blog post, Wenxiang Gong, founder of Shenzhen Chudian E-commerce Ltd., commented: “American websites have many assessment criteria, and they follow many rules to stay artificially ‘high-end.’ They consider it their responsibility as multinationals to uphold work ethics and professional integrity. They go about doing business only when all the boxes are checked, then they launch dozens of long- and short-term projects at the same time.” As a result, the Chinese teams of these American companies did not have much autonomy to develop market-relevant content.

Network-building: American companies keep overhead to a minimum by reducing the cost of communication. Problems are solved via emails or over phone calls. But in China, where guanxi is of paramount importance, people establish trust first before they even start talking about making money. Initial costs are high, involving much wining and dining, which requires time and money. One story goes like this: In 2004, 3721, a Chinese search engine founded by Zhou Hongyi, founder and chairman of the internet security company Qihoo 360, was acquired by Yahoo!, with Zhou heading Yahoo! China’s operation. Soon, Zhou noticed that former Yahoo! employees contacted clients and business partners by email and never bothered to have dinner with them. He decided to kick them out. Things improved soon after.

Over the past few decades, home-grown internet companies have dominated the Chinese market. They may have borrowed business ideas from American companies in their nascent stage, but by trying their best to understand customers, build connections, cultivate a unique business ecosystem, develop and improve their technology, products and business models based on the needs of the clients and through innovation, the Chinese companies have firmly established themselves as distinctly Chinese. Alibaba is no longer eBay’s Chinese equivalent, nor is JD China’s Amazon. Chinese companies such as Alibaba, JD, and Tencent made their name and stand on their own feet.

Admittedly, there are numerous other examples of foreign companies not understanding the market and the culture, not the least of which are American internet companies. The thing is, however, most of the other companies sell products with clear performance indexes. If they could understand the market better, they would make more money. But even if they don’t bother, they don’t get battered.

If we go back to the workshop in Dunhuang with Nevis’s theory in mind, things may look quite different. Professor Li draws this conclusion: “My mission is completed when I gathered you, China’s most brilliant CEOs, entrepreneurs and VCs here in Dunhuang. What I have to say to you as an instructor isn’t important at all. My knowledge could be all wrong.” He is not being modest. He is sincere. Students cheer him, and they also mean it. Both the teacher and the students know that a quality business guanxi network has just been built.

Note from the editors. This article was originally published in our Chinese edition, developed with Shanghai Jiao Tong University, SJTU ParisTech Review.

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  • Why American internet companies fail in China: a cultural perspectiveon September 5th, 2016