Startups Navigating China: Better To Be Yahoo Than Groupon

By Sarah Lacy , written on February 27, 2012

From The News Desk

In the first wave of the Web, almost everyone failed trying to go into China.

eBay and Amazon proved that buying your way in with big acquisitions didn't work. Google proved trying to force a local team to operate under US laws and values wouldn't work. Oddly enough the only company that wound up with a highly valuable Chinese asset was Yahoo. It's possibly the only way in which Yahoo would up sitting prettier than the other three Internet giants.

Not only have Web 2.0 companies received little in the way of best practices regarding China, but the stakes for entering the mega-country have been upped dramatically since the early days of the Web.

The first generation companies had the luxury of focusing on dominating their categories at home first, and focusing on China once they could afford to be distracted. By then, they also had stock currencies they could throw around for dealmaking. Today, China is its own self-contained ecosystem with billions in local venture capital, its own class of serial entrepreneurs and a wave of college kids who are all graduating with entrepreneur religion.

The one thing you can't do is wait. The pace of competition is just too intense. The market won't wait for a good idea to make it saunter across the Pacific, as hundreds and thousands of clones sprout up seemingly overnight. That means startups need a loose China plan -- even if it's just "go" or "don't go"-- from day one.

And if it's the former, they feel pressure to move into China immediately before locally grown competitors win the market. That's far too much distraction and capital expenditure that a fast-growing startup can handle-- as Groupon proved with its disastrous performance in the country.

Add to these factors, China is simply getting harder and harder to ignore, with the largest Internet audience in the world and one that can build highly lucrative businesses. Baidu and Tencent are two of the five largest Internet companies in the world, ranking just barely behind eBay and more than double the market cap of Yahoo.

And when you throw mobile into the mix, the pressure on startups is even greater. The iOS and Android revolutions are global ones, and that means that mobile games and apps are no longer carrier dependent. That means people all over the world can use your app. It also means developers all over the world can copy it and have the same awesome distribution power.

If the prospect of entering China was daunting before, it's downright terrifying now, even as the urgency to have a China plan has gone up. And if those early strategies failed in the Web 1.0 era, they're just non-starters today.

  • Waiting until you win in the US before doing anything overseas dramatically underestimates two things. The first is the quality of entrepreneurs in China. The second is how much the Web incumbents in China dominate the market. Most of the Chinese online live in a semi-permeable walled garden controlled by Baidu, Tencent, Sina or even Alibaba. These four companies dominate search, gaming, social media, news, entertainment, payments, ecommerce and most of the white area in between. They aggressively leverage their huge installed bases to push new products. Tencent is the most dominant. That's lead to a saying among entrepreneurs in China, "You have three fates: Life, death or Tencent." If entrepreneurs in China have a hard time competing with these four, you most definitely won't be able to as a small company from the Valley.
  • Buying an up-and-coming market leader sounds better than it is. First off, culturally Chinese startups just don't want to sell. They still live in that mindset that victory is an IPO. And if they don't want to sell to a Chinese Web giant, they definitely don't want to sell to one from the Valley. Everyone has heard every horror story of US bosses promising autonomy and then micromanaging a company out of market-relevancy. So the only companies likely to sell are the also-rans, with less-committed entrepreneurs. And once those entrepreneurs sell, all the reason acquisitions usually don't work in the US come into play: Promises made at the time of sale are broken, entrepreneurs no longer have skin the game and intensity goes out the window and the best talent leaves.
  • Joint ventures with one of the big four are sloppy. Since Baidu, Tencent, Sina and Alibaba are so dominant, a lot of Valley companies have sought to do joint ventures. This is actually worse than an acquisition. It has all the disadvantages of merging two disparate cultures, and adds to that the meh-ness of no one really taking full ownership for the initiative-- literally and figuratively. Groupon tried this with Tencent, but even partnering with a local Web powerhouse couldn't combat the fact that they didn't hire locals to run the JV. It typically just means the US company owns less of an awful Chinese subsidiary than if they bought something outright.
  • Ignoring China altogether is getting harder. If you are Facebook or Google or a site that favors total freedom of speech and expression over the business case for being in China, you're better off not entering the company than naively thinking you'll change it. But if your company has more to do with entertainment or commerce, it's likely too juicy of a market to ignore.
Let's assume you want to learn from the past mistakes and avoid them. What is a startup today to do? This is the first and the last time I'll type these words: Do what Yahoo did. Buy a strategic venture-sized stake in a start up and hope for the best. 

It's not the greatest option in the world, but it's certainly better than the others. It allows a top entrepreneur-- like Jack Ma-- the guaranteed freedom to execute without US oversight. If you own part of it, and there's a pre-existing relationship, it's more likely that a hot company would sell to you. At a minimum, it's a more sure way to at least create some shareholder value off of the China boom.