When, if ever, will the Chinese competitors graduate from being ‘fast followers’ to become true innovators?

Being number one – the first, the fastest, the best, the biggest – is a natural ambition in business as much as in life and those who succeed are revered, particularly the true innovators. Some of us went to high schools named after Thomas Edison, George Washington Carver, or Eli Whitney. The schools are a tribute to those whose ambitions were so lofty that they spent their lives thinking outside the box. They changed the world as a result.

We have thought a great deal about ambitions to innovate recently, as we consider the motivations of China’s fast-follower companies and develop conjectures about what the future holds. We have written about how Chinese companies do not, at least up to now, emulate the Early Bird that catches the worm, but rather prefer to emulate the Second Mouse that gets the cheese. The business models of Chinese companies vary, but generally are some variation of “offering products that are nearly as good as the global competitors at a much lower price.” Thus far, most have shown little inclination and/or ability to raise the bar on design, technology, or features.

A number of Chinese companies have been agile enough to be first to borrow ideas and concepts and become the Second Mouse, rather than the third or fourth or one-hundredth mouse, in order to dominate its home market in China, where fast follower innovations to reduce cost can easily win the day. A few, like Huawei, have emerged as global giants by first offering a better value proposition to Chinese telecom customers, later to those in other developing countries, and finally to those in Europe, Japan, and North America. During that evolution, the company’s performance improved dramatically in positioning it to succeed in more and more demanding markets. Still, while Huawei touts its extraordinary record of patents, most market participants still consider it to be more Second Mouse than an Early Bird.

The natural question that we are often asked by our clients is: when, if ever, will the Chinese competitors graduate from being “fast followers” to become true innovators. This question is critical because incumbent market leaders can potentially continue to defeat fast followers in the most demanding market segments by staying sharp and innovative. However, if the Chinese become true innovators they will be much more challenged in every market segment, not only in the middle market segments where their price advantages matter.

In this article, we will consider the questions of whether the Chinese companies should want to become Early Birds and then, in the next two parts, speculate about whether these companies should want to. Most Chinese companies today seem very proud of the fast follower position, touting the ability of its engineering department to copy products while making modest improvements and promoting its “performance-price ratio” as the key to success. Dozens of Chinese business-to-business customers that we have spoken with in turn repeat “performance-price ratio” as their objective, almost as a mantra. This business model is targeted correctly at the local Chinese market. But, thinking ahead as Chinese companies aspire to become global powerhouses, the question is will these companies always feel and act this way or will there become a strive to lead, to be first with the best, to compete with the Early Birds from the west that have until now been the global leaders?

To emphasize the human desire to be number one, we have chosen our title with apologies to Queen, whose song “We Are the Champions” is a favorite at stadiums across the world. It doesn’t take much imagination to think of the fan spirit that would be created by a fight song entitled “We are almost as good as most of our competitors and our ticket prices are much lower.” We would guess that the emotional impact of such a ballad would be limited indeed. Does our analogy mean that the scope for Chinese companies, grown up and successful, to be content as Second Mice is equally limited?

“I’ve Paid My Dues” – If you can’t make money at $7, how do these guys drive S-Class Mercedes?

First, we want to address a common misconception that the Second Mouse business model, even today and even in China, is not actually economically viable.

Skeptics see Second Mouse competitors pricing manufactured products at levels that seem impossible, often below the competitors’ costs for raw materials. It is easy to perceive Second Mouse companies as having a business model with unsustainable economics that are being used merely to buy into a market. It appears to skeptics that the Chinese are “paying their dues” slogging it out in the lower reaches of price competition, in order to get established, but will soon be forced to charge prices closer to the global norm for products that are just “almost as good.” Once that happens, the Chinese competition will look very different. If this model of Second Mouse behavior is accurate, competitors may not have so much to worry about as it would first appear.

But, skeptics who so dismiss the Second Mouse competitor out of hand should listen to a story told by one of our clients. Together with the president of a division, he was visiting Chinese competitors who were taking market share in a building materials market segment. Visits with several local competitors ended with the division president exclaiming each time as soon as out of earshot: “We sell our products for $70. This competitor is selling for $7. We would never consider selling something for $7. A few of these products look pretty good, but you can’t make money at $7.” Finally, somewhat exasperated at warnings not being received, our client responded, “You may have noticed that each of these guys are driving an S-Class Mercedes. It is hard to believe that they aren’t interested in making profits and aren’t making money. Isn’t it more likely that they have learned how to make and sell 1,000,000 units at $7 each instead of selling at $70 into a high-end market segment that in total is probably 1,000 units?”

Followers of China business cases will know that there are some situations in which government support allows Chinese companies to lose money, particularly to maintain employment, but our decades of experience make us far more inclined to agree with our client. Most of the Second Mouse competitors we know are companies that have leveraged China economics in creative ways to be profitable at a very different price point from the global competitors. Between leveraging all aspects of local China economics and looking afresh at product and service offerings, these companies are able to deliver something that is acceptable but not over-engineered at a dramatically lower price.

So, we would urge competitors not to automatically assume that these Chinese companies will eventually come to its senses and start charging prices that create room for global competitors to participate on a more even footing. Rather than “paying dues,” the Second Mouse market position may well look like victory itself to the Chinese.

Still, even if the Second Mouse companies are not pushed by economics to start pricing more like the global competition, the market might force them in that direction.

In the remaining two parts to this article, we will examine the implications for western companies of Second Mouse competitors. In the second part, we will look at distinct market segments to assess the outlook for Second Mouse companies, identifying those in which are likely to be able to continue to thrive and those where the future might not be as attractive. Then, in the third part of the article, we will look at whether continued leadership in technology and design and features will allow western firms to remain global market leaders, and also look at whether today’s Second Mouse companies are likely to evolve its priorities and begin to challenge western companies along those exact same dimensions.

Author: George F. Brown, Jr.