Why China Wins

By Sarah Lacy , written on January 22, 2012

From The News Desk

I love this story in the New York Times. I know we mentioned it in the PandoTicker yesterday, but it deserves to be highlighted twice because its implications are that important to understand for America and its future for tech innovation.

It explains why Apple's gold-standard devices are made in China, not the US. It echoes a central thesis in my last book: China's manufacturing advantage is not cost. It started out that way, but China used that window of cheaper costs to innovate the entire way supply chains work. Today, it's a place other countries can beat on sheer cost, but not of speed, flexibility and know-how.

A snippet from the Times:

Apple executives say that going overseas, at this point, is their only option. One former executive described how the company relied upon a Chinese factory to revamp iPhonemanufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.

“The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.” It's not just Apple. This ecosystem has allowed companies that aren't even tech companies to jump into the game. Consider the Barnes & Noble Nook. B&N came to China without a clue how to make a tech device. In six month months, it produced something on par with what it took Sony six years to make.

China is to gadget creation what Silicon Valley is to company creation. There is an unparalleled system for taking something from idea to reality faster and easier than any place on the planet.

It's not just Apple. There's a staggering long tail of this. Go to the lobby of the Sheraton Four Points in Shenzhen -- or a dozen hotels like it. Table-after-table is a white guy from middle America trying to make his company competitive again sitting with a Chinese factory head or "fixer" who can get them into the right factories. It's not unlike wandering into Cuppa Cafe in Palo Alto and seeing table-after-table of VC sitting with hopeful entrepreneurs.

It shocks me that people always assume the Chinese can only make inferior products when Apple-- the gold standard of well-made products-- is made in China. Sure, China can make shitty products for cheap. But it can also make the world's best products. Again, like Silicon Valley can produce a bloated, uninteresting startup like Color and a nimble startup like Instagram that millions love. The startup machinery doesn't make a company great or bad. It just makes whatever is put into it, more efficiently than any other place. Ditto China and manufacturing.

This is how China is like a new Silicon Valley. Not because it's produced some Web companies-- but because it has produced a nimble ecosystem that can create things of great value faster than any other place on earth. 

There's a reason this has important ripple effects beyond just those Apple jobs that Barack Obama was asking Steve Jobs about in the Times piece. (I'm just going to keep linking to it until you go read it. It's that important.) That idea floated in business schools and business magazines in the early 2000s that America was only losing poor people's jobs to China, and that we'd always maintain the high dollar knowledge worker jobs was at best naive and at worst racist. The Chinese weren't doing America's grunt work, they were learning how to build. They know how to build better than anyone else on the planet right now. When you know how to build, you know how to create and innovate.

Foxconn has many well-documented bad qualities, but take away the emotion of workers rights and patriotism for a moment and consider the examples in the Times story of Foxconn waking up workers to start on glass screens, gearing up its workforce to meet demand, opening an entire new wing of its factory in case it got a client. Foxconn has managed to make a leviathan manufacturing company as nimble and hungry as any Silicon Valley startup. And as we know better than any other place in the world, nimble and hungry can beat nearly anything.

China is already using this expertise to climb the production pyramid. It has already climbed from basic assembly to more sophisticated manufacturing and controlling whole supply chains. Its startups are already leveraging that strong base of the pyramid to reach into product design and aspiring into brand. Pretty soon, China won't just be the place where our branded luxury items are made. They'll be making their own. And that has profound implications for a company like Apple that makes such high revenue off of both making things in China and selling to the Chinese.

I wrote about a company called CK Telecom in my last book. Located in the manufacturing wonderland of Shenzhen, they make mobile phones for other emerging markets. At the time I wrote about them, they employed 10,000 people and were on pace to do $1 billion in annual revenues. And all of that was built without a dime of venture capital.

The company had a luxury that few competitors do: It was entirely vertically integrated because it was located in a place where manufacturing was a core competency. That gives CK Telecom better margins on its products and more flexibility than competitors. The company had innovated on things like camera modules and battery life, but in truth, its devices looked like copy cats of Blackberries and iPhones.

But CK Telecom's founder, Roy Ho, had an astounding rebuttal when I brought this criticism up: "Look at HP, look at Dell. Who isn't copying Apple right now?" he said. "We're all chasing the one who has the first idea. You grow in a mature market by being the one who can run faster. That's what we can do in China."

Maybe a company like CK Telecom doesn't ever beat Apple. But why can't it beat the more bloated American companies that are also beating Apple who can't run as fast?

Now, consider Xiaomi, a company TechCrunch highlighted at Disrupt Beijing last year that is vying to be the Apple of China. It's an ambitious play by serial entrepreneur Lei Jun to make the first innovative, cool, high-quality smart phone made by and for the Chinese market, running on a proprietary Android store with an army of clever apps, and sold at cost. Xiaomi's is less than half the price of the iPhone and one of the hottest stories to watch in China's tech scene right now. All of those margin points that Apple gets by making things in China? Xiaomi is giving them away in an ambitious gamble to grab marketshare. (Go here to see my interview with Lei Jun at Disrupt last October.)

This is the next face of Chinese entrepreneurship. It's gone in reverse order from the way it developed in Silicon Valley. We rooted our culture of innovation in making the tiniest building blocks of computing-- transistors and integrated circuits. That lead to computers and then networking and then software and then the Web that runs over all of it.

The biggest Chinese tech companies started with the Web and are working backwards into hardware and devices. And because we don't innovate much on hardware anymore, the market is wide open for entrepreneurs like Roy Ho and Lei Jun.

They aren't there yet. Silicon Valley still has a massive advantage: Software knowhow. The best devices have more than just well made hardware, they have the best software and the two are intertwined. In addition to Apple, there are a few exciting new hardware companies that are coming up in the Valley today, including Jawbone, Nest and Square. I'd throw Sonos in that list too.

I hope we see more of them. Hardware is considerably harder to build, and many investors are loathe to fund it. But if America wants to keep even high-level hardware jobs in the future, Silicon Valley needs to get back in touch with its roots and leverage the advantages of brand, design and software. Because bit-by-bit those are going overseas as well.

(Photo credit: Steve Jurvetson.)