Both Didi and Uber were taking aim at traditional taxis
Both Didi and Uber were taking aim at traditional taxis
Liang Jianzhang and Huang Wenzheng

-Analysis-

BEIJING — The Didi-Uber deal this month was huge business news around the world. It's the story of a local Chinese brand that acquired the entire assets, including the rights, the business and the data, of the American deity of digital car hiring.

The accord marks another defeat for global Internet titans, mostly American, by Chinese companies in their home market. Previous examples included Microsoft's MSN defeat by Tencent's QQ in instant messaging, Yahoo crushed from the outset by Sina, eBay beaten back by Alibaba's Taobao, and Expedia falling by the wayside to Ctrip, an online travel services provider.

So why do these Internet companies enjoy success in other regions and countries outside of America, such as in Europe or Japan, but not in China? The answer is not as simple as one might think.

The scale effect

Two basic factors ultimately determine the success of online services. First is the technology advantage, the other is size of the market that the enterprise relies on for its growth. Meanwhile, demographics and economic development levels within any one cultural, linguistic and political boundary determines the market size. As long as the local market has a sufficient scale, then the advantages possessed by a local enterprise can offset the technology advantage from a foreign competitor.

In comparison with the standardized production of industrial goods, Internet businesses have to offer personalized services and solutions. This highlights the importance of Internet business' ability to adapt to a local market. So even when a new technology or business model rises, the key for an Internet company doesn't simply depend on the level of the technology itself, but rather on whoever possesses the best market adaptation so as to be the first to achieve the scale effect.

So, suppose a new Internet business model requires a scale of 10 million users to survive. In China, as long it can penetrate 1% of its total population, a business will be able to survive. By comparison, an American enterprise in such a sector would need to reach 3% of the population, and a Japanese firm 10%, to survive.

Alibaba founder Jack Ma in Hangzhou in 2014 — Photo: Ju Huanzong/Xinhua/ZUMA

This also explains why in the past the United States has been favorably positioned in the Internet industry, since it's the most populous nation in the advanced world. With a market far bigger than any other developed country, America's high-tech firms need a relatively low penetration rate to exist. And, once they succeed in America, they can rely on first-mover advantage to launch abroad.

Change of rules

But China's rapid rise has changed the rules of the game. Taking into account both population and economic development, China has become the only market larger than the United States. For example, the number of broadband Internet and smartphone users in China easily surpasses that of America. This signifies that, given the same conditions, China's Internet firms can reach economies of scale earlier than their counterparts in the United States, and thereby succeed more easily.

In the more distant past, China's smaller middle-class population meant that American Internet giants were able to seize the initiative when entering the Chinese market. As China's middle-class population tops America's, the balance will gradually tilt toward both Chinese innovators and imitators. If the technical threshold is too high or America's innovation is too far ahead, Chinese companies will fail to effectively copy. But if not, Chinese enterprises will learn and reproduce rapidly, and eventually overtake their American rivals with the help of a bigger market.

Chen Yidan (C), one of the founders of Tencent, one of China's leading Internet companies in May 2016 — Photo: Li Peng/Xinhua/ZUMA

That great firewall of China?

Some people tend to attribute Chinese firms' local success to China's regulatory measures. For certain technological fields this is true, because foreign companies are more restricted and cannot fully compete with Chinese companies. But this is clearly not the explanation for the success of companies like Didi.

As a matter of fact, strict Internet control does more harm than good to Chinese companies' growth. China's fast rise of the last three decades is in fact largely attributed to its reform and policy of opening up to the world. A more open Internet would help China to learn advanced technology, allow Chinese enterprises to participate more deeply in global competition and raise their level in competition at home.

The value of the Internet can be measured in the exchange of information among different individuals. The larger the number of individuals connected, the larger each individual's scope of choice and the higher the average communication frequency and quality. Thus the value of the Internet has a positively accelerating relation with the network node number. Meanwhile language and culture are the Internet's main boundaries, which explains why demographics play an ever increasing role in competitive advantage. Not only does China have a huge market, but also the biggest pool of talent, and countless young people with entrepreneurial aspirations. Once the favorable elements of an innovative economy are put together, China's eventual and overall rise will be inevitable.

Breaking through

Of course, complacency can also turn Chinese companies' advantage in their domestic market into a disadvantage. A huge market at home limits Chinese companies' ambitions in exploring abroad. For instance, though WeChat (Weixin in Chinese), a cross-platform instant messaging service, is probably even more powerful in function and convenience than WhatsApp or Line, its number of users lags behind the latter two, and it remains used mainly in China. To be invincible in the long term, Chinese companies have to be more enterprising and target a larger market. This is one more reason that loosening Internet controls would benefit development.

All that said, an even more worrying factor is China's dangerously low birthrate and aging population today. Due to the one child per family policy, China's population has shrunk by 32% over the last 20 years — from 219 million people born after 1980 to 147 million born after 2000. At this rate, America and India are destined to overtake China. Yes, as much as politics and technology, economic prospects are largely determined by demographics.

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