The Shenzhen Miracle

When we think of major cities in China, we tend to focus on Beijing, the political center and Shanghai, the commercial hub. However, Shenzhen will play just as essential of a role in China’s development, especially in the coming decades. With an impressive lineup of technology and financial services companies, Shenzhen’s rise from a sleepy fishing village to the innovation hub of China is nothing short of a miracle.

Located on the east bank of the Pearl River, immediately to the north of Hong Kong, Shenzhen started out as a small town just shy of 30,000 people. It was designated the first Special Economic Zone when Deng Xiaoping experimented with capitalist-style market reform in the late 1970s. Over the ensuing decades it would become a mega metropolis of more than 10 million people and one of China’s four Tier 1 cities alongside Beijing, Shanghai and Guangzhou. Being a Special Economic Zone, it enabled laws and regulations that were conducive to foreign direct investment and cross-border trade. Perhaps more importantly, the local government facilitated inward migration by relaxing China’s restrictive “hukou” regulations which had placed limits on people’s work rights and mobility.

Why was Shenzhen chosen? Its strategic position next to Hong Kong made policymakers believe that its affluent neighbor’s wealth and free economy would have a spillover effect on this small parochial town. This decision was quite prescient, as cheap labor in the Pearl River Delta region was a perfect fit with Hong Kong’s knowhow in manufacturing a variety of goods. Hong Kong’s long-established laissez-faire tradition, coupled with its smooth-running ports and financial market, played an important role in the emergence of Shenzhen as a bustling regional center for manufacturing and now, for innovation.

Shenzhen’s story is perhaps best told through the rise of several industry-leading enterprises: Huawei Technologies, Ping An Insurance and Da Jiang Innovation (DJI). Each of these companies represent major aspects of the culture and economy in Shenzhen, and the telecommunications, finance and innovative technology industries, respectively.

Ren Zhengfei is the founder of Huawei, one of the world’s foremost network equipment makers, had humble origins and grew up in mountainous rural area of China. His family did not have a kitchen and used the pit in the middle of the home for both cooking and heating. Ren’s poverty gripped him in a very real way; he was sometimes so hungry that he failed exams and would resort to foraging for wild plant roots for food.

In Huawei’s early days, it was reselling switches imported from Hong Kong and its sole focus was to manufacture phone switches on its own. There were several factors that contributed to the transformation towards building massive telecommunication networks. The key distinguishing factor in Huawei’s growth relative to many other Chinese companies was the fact that it did not rely on joint ventures for technological progress. Ren promoted R&D which would reverse engineer such foreign technologies. Joint ventures at that time which were wildly popular in Shenzhen actually conferred fewer benefits than initially anticipated given the reluctance of foreign companies to share technological secrets.

Support from the government also played a role in Huawei’s rise, as joint ventures with local authorities would pay dividends when many state-owned enterprises began using Huawei products in their networks. Many also believed that Ren’s background as a   military engineer in his youth was a factor in Huawei winning a critical contract to build the first nationwide telecommunications network for the army. These network effects compounded to effectuate what Huawei is today. Huawei in 2014 spent 6.6 billion USD on research and development, more than Apple and Facebook, and in 2017 surpassed Apple as the world’s second largest smartphone manufacturer.

While this narrative might seem like a testament to the stereotypical critiques of China’s copycat culture, it obscures the extraordinary work Ren has done. Apart from technological innovations, Ren’s strategic decision to expand market beyond developed countries also paid off handsomely. When you go to Zimbabwe, the first poster you will see coming out of the airport is one of Scarlett Johansson promoting a sleek smartphone—Huawei has long ago bid farewell to its old days of reverse engineering and has since become the market leader in telecommunications equipment.

Ping An is one of the world’s most valuable insurance brand; on many fronts, it outshines China Life which is a state-owned insurance behemoth. In 1988, the Shenzhen-based China Merchants Bank proposed to establish an insurance company that could provide coverage for trucks moving goods between Shenzhen and Hong Kong and thus, Ping An Insurance was born.

There are a number of reasons why the insurance industry has huge potential in China. The first vector is a demographic one: China has a huge 1.4 billion population and it is aging. Due to the one-child policy instituted from 1975 to 2015, this trend will only continue to proliferate itself soon end. The rapid rise of average income, particularly in urban areas and SEZ’s such as Shenzhen, certainly allowed the residents to be more financially literate and be able to afford insurance products.

Ping An management’s focus on delivering products and services addressing the needs of locals made it stand out even among its peers in the insurance industry. In response to this though, insurance companies such as Ping An have tailored their products to be more appealing. For many Chinese, there is a lack of sufficient social safety net and there are chronic shortages for certain public goods, e.g., hospital space and availability of medical professionals. Ping An developed an application named “Ping An Good Doctor” which establishes appointments for outpatients and increases the likelihood of admission for inpatients at medical institutions. In many cases, people who are not in immediate need of treatment would register in order to have a placeholder or connection at certain hospital networks. Ping An also offers insurance to fly patients to hospitals in neighboring countries with good medical facilities such as Singapore. This hybrid policy, bundled with the state’s social services, allowed insurers such as Ping An to penetrate deeper into China’s insurance market.

All of this was only possible with the open investment environment Shenzhen had, allowing many of these ventures to be funded by Goldman Sachs and Morgan Stanley. Again, its proximity to Hong Kong made it a prime target for such investments. Similar to Huawei, Ping An made sure to leverage rather than be exploited by foreign firms.

Finally Frank Wang, the founder of DJI which dominates the world’s commercial drones market likewise had his start in Hong Kong. He received his college degree of engineering from Hong Kong University of Science and Technology and he initially built flight controller prototypes out of his dorm room. Subsequently, with his classmates, he moved to what they believed was the best place for entrepreneurial opportunities and supply chains for tech products—Shenzhen. He started by selling his products to Chinese universities and state-owned power companies. With Shenzhen’s favorable investment regulations, Wang’s progress caught the eye of foreign investors, namely Colin Guinn who wanted to shoot stabilized aerial videos. The next big break was the innovative development of the Phantom drone which was not only popular in China, but also came to be dominant in the global commercial drones market.

Several trends have enabled the rise of the commercial drone industry. First has been the fierce competition that has brought the price down on the machines. The key strategic decision here was not to make huge profits at the beginning; in fact they wanted to sell at break-even point of the Phantom 679 retail prices. Nevertheless, DJI was able to increase revenue by fivefold due to the more advanced quality and unbeatable prices relative to its competitors. The fact that 30% of their revenues originate from the US, 30% from Europe and 30% from Asia demonstrates that this is not solely a Chinese fad selling in developing countries but something sustainable.

Frank Wang, with an interpersonal style reminiscent of Steve Jobs, did not have an easy time with his colleagues. Two years after the launch of the company, almost all other founding members had left the company. The haphazard approach to the drones, the initial want to not immediately capitalize on its success, the pure unadulterated innovation distinct from extant western technologies together epitomized the entrepreneurial potential in Shenzhen that has so frequently been dismissed as not the norm.

Stories like these only continue to proliferate.  A decade or two ago that innovation was just burgeoning in China but a combination of supportive policies, maturing of investment and supply chain environment, and individual breakthroughs have culminated in a formidable creative force to be reckoned with.

Aspen Wang is a student at Princeton University, and can be contacted at aspenw@princeton.edu.

 

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