For much of the past 2,000 years, China has had the world’s largest economy. Although it lost that distinction during the nineteenth century in the wake of European industrialization and colonization, it recently overtook the United States and made its way back on top.
Capital investment has lifted up China’s economy in recent decades, but the government is seeking to place it on a more sustainable, consumer-based footing.
At present, Chinese software dominates all but the high end of the market, and even here it holds a sizable 50%. International enterprise application providers increasingly have to be content with growing software expertise among Chinese firms. The internet in China could shift the economic paradigm from capital investment and labor growth to greater productivity, innovation, and consumption. The Web is having an increasing effect on Chinese enterprise, and we profile its role in three industrial sectors here. The challenges for international software firms include an unpredictable business and regulatory environment, government procurement policies, bureaucratic protectionism, IP piracy, and a complicated milieu requiring targeted efforts and networking. Software market opportunities involve ERP, mobile ERP, supply chain management, enterprise private clouds, and SaaS solutions.
Current economic plan: Increased consumer spending
The U.S. Commercial Service reports that China’s economy has greatly benefited from fixed-asset investments over the past several decades. The top leadership, however, views this as unsustainable and addressed the issue in the current Five Year Plan (2011-2015), which has the goal of increasing consumer spending from 35% to 50% of GDP by 2015. Comparatively, 70% of US GDP is based on consumption. Areas of high priority in the present Plan include environmental protection, energy efficiency, high-end manufacturing, and biotechnology.
Overall software market in China
The value of China’s software market in 2013 was USD 493 billion, compared to USD 142 billion in 2009. According to an APCO report to the Israel Ministry of Industry Trade, international software companies first entered China in the late 1980s and gained significant market share by leveraging stronger technologies and access to capital. Chinese software firms subsequently gained back much of the market due to government support, a better understanding of the domestic marketplace, more localized offerings, and responsive customer service. The software market is currently dominated by domestic firms. While international companies still have an edge in the high end of the market, domestic firms are catching up there as well, due to greater experience and IT talent.
Chinese enterprise software market
The increasing global reach of Chinese companies is fueling a demand for advanced software with updated features and improved functionality. APCO reports that as of 2009, Chinese firms held 78% of the domestic enterprise software market. International firms held close to 51% of the high-end market, but Chinese technologies are growing more sophisticated. Chinese firms in 2009 held 84% of the middle-end market, and more than 90% of the low-end.
Foreign software providers have gained business primarily from Chinese multinationals, which are a relatively small segment of the overall market. The largest customer segment in this market consists of private Chinese firms and state-owned enterprises, where international companies have seen little success. In some cases foreign firms have had to form joint ventures to gain better access. Another success factor in mid and lower markets for domestic firms: They often charge less for more basic applications, which customers in these segments find more appealing.
The internet: Digital transformation in China
The internet in China could change the nature of growth in the world’s second largest consumer market. China’s economic development over the past two decades has been the product of labor force expansion and heavy capital investment, which McKinsey says can’t be sustained indefinitely. In its 2014 report China’s digital transformation, McKinsey suggests that the internet can facilitate GDP growth based on productivity, innovation, and consumption — much of which it predicts will come from productivity gains. Such a shift will entail disruption but will enable the Chinese government’s goal of sustainable economic growth.
Already, the internet in China has helped create a technology sector, social networks, and e-commerce. However the Web has only just begun to have an impact on Chinese businesses. The enterprise cloud adoption rate in China was 21% in 2013, compared to roughly 60% in the US. Regarding the transformation they envision, the McKinsey report authors said:
“(The internet) intensifies competition, allowing the most efficient enterprises to win out more quickly, and creates information transparency that improves investment decisions so that capital can be better allocated. It can spur skill upgrades within the workforce and create consumer surplus by lowering prices, making information more widely available, and enabling a multitude of new conveniences.”
Internet impact on three industrial sectors
The McKinsey report covers six sectors: consumer electronics, automotive, chemicals, financial services, real estate, and health care. It takes a macroeconomic view of these sectors and reviews how internet applications are used in them. For the purposes of our tech focus here, we’ll consider three of the six industries: consumer electronics, financial services, and health care.
Consumer electronics. Chinese consumers have shown robust demand for digital programming and other media content. In 2013 some 70% of China’s 632 million internet users streamed media online, and roughly half used mobile streaming. Another growth area is consumer cloud services. The sector is now using the internet for productivity gains, thanks to better sourcing and marketing. E-commerce for consumer electronics had a whopping 103% compound annual growth rate from 2009 to 2012, compared to 9% for offline sales. McKinsey projects that the internet could account for 14 to 38% of the sector’s growth through 2025, in particular from the markets for smart appliances, internet televisions, digital media, and cloud computing.
Financial services. Competition in this sector is on the rise due to deregulation and the greater role played by internet finance. These changes compel Chinese financial enterprises to use the internet for cost reduction and expansion into new markets. The internet reduces financial transaction costs, thus lowering the threshold for investment products. At present, Chinese consumers hold 60% of their assets in deposits. Money market funds, discount brokerages and payment platforms have begun to appear online. More data can enable banks to better assess loans, and banks have also built online channels for better marketing and customer interaction. These factors will enable Chinese banks to build their consumer and business customer base. The McKinsey report projects that the internet could add 10 to 25% of the expected GDP growth in financial services through 2025.
Health care. The Chinese population is aging, and long-term diseases are becoming a bigger issue. The government is trying to overhaul its health-care system; 80% of medical resources are in urban areas and many lower-tier hospitals and rural clinics lack technology systems. China has begun setting up Regional Health Information Networks to connect larger hospitals to smaller clinics. Telemedicine has also improved access in rural areas to specialist physicians. The internet can increase the quality of care in China through decision support systems, electronic health records, and Web-based tracking. Consumer access to health information via online portals could impel hospitals to improve their performance. The internet may help the Chinese health-care system save RMB (Chinese currency) 110 billion to 610 billion in annual costs. Above all, the internet holds out the prospect of a better quality of life and healthier workforce in China.
Market challenges in China
In addition to large corporations, which have seen strong returns on their activities in China, the U.S. Commercial Service reports that American SMEs are active in China, and it has been working to promote their entry into the market. It warns of the following challenges:
- Lack of predictability in the business environment. The regulatory environment can be opaque, and implementation of the law is often arbitrary and inconsistent. Intellectual property protection is a major risk factor; US companies should build plans for mitigating it.
- Export-led model and protections. Despite transition to a market-based economy, China still leans on its traditional export model. Elements of the bureaucracy continue to shield local firms and state-owned companies from imports.
- Scale and complexities of the market. The challenges of doing business in an economy and environment like China can overwhelm newcomers. The U.S. Commercial Service links market success to targeted efforts and networks of contacts at numerous levels and across organizations.
Challenges in the software market
APCO lists the following hurdles in the Chinese software market:
- Limited understanding of enterprise software. There is a need for software vendors to provide pre- and post-sale resources to Chinese customers, due to the widely held view that many domestic organizations do not fully appreciate the value of enterprise software applications. This lack of expertise can also hamper product innovation because of the lack of targeted, well-informed feedback on app performance.
- Intellectual property and piracy. Rampant in the Chinese business environment, piracy has forced software firms to compete on price cuts rather than on innovation and enhanced features. There is little incentive for firms to innovate when a cutting-edge development can easily be stolen. The Chinese government’s Document 18 (circa August 2000) outlines stiff penalties for IP piracy, which it has announced plans to address. In October 2010, the State Council began a six-month campaign against software piracy. It remains a significant issue for software firms due to a lack of effective enforcement, and the government’s reluctance to crack down on a piracy industry that employs a substantial number of people.
- Government procurement. The government polices on procurement stem from a political desire to create both economic and security “champions.” The market for government procurement is large, from the national to the local level, and domestic software firms are given strong preference. One strategy of foreign firms to avoid this barrier has been to form partnerships with Chinese companies in the procurement market.
Chinese software market opportunities for international firms
The APCO report also lists the following opportunities:
- ERP (enterprise resource planning) in banking and telecom. ERP is the largest sector in Chinese enterprise software and will continue to expand as large Chinese companies require more advanced ERP applications to consolidate at home and compete abroad. Banking and telecom firms in particular will need ERP to manage branch networks and international investments. This is especially true for telecom firms that need to manage their extended networks. In the high-end market, international firms have a strong opportunity thanks to advanced technologies and expertise. In the banking sector, the current government Five Year Plan emphasizes IT spending.
- Mobile ERP. China’s investments in its 3G telecom network, along with its push into 4G networking, are creating an opportunity for increased mobile ERP. With faster connectivity and a stronger infrastructure, software firms can seek to develop ERP applications for mobile devices.
- Supply chain management (SCM) software. With more Chinese companies wanting to expand internationally, they will need to develop global supply chains. International SCM providers are well placed to service the Chinese demand thanks to greater expertise, which they can also employ to build a customer base among Chinese corporations.
- Enterprise private clouds. APCO predicts that companies will look to enhance their IT management by building private enterprise clouds; it sees this as a key trend as the technology is more widely adopted and accepted over the next several years.
- SaaS (software as a service) applications. Due to anti-piracy issues with traditional software and government support of SaaS, China should see growth in this cloud delivery model. Enterprise SaaS firms could extend their reach to domestic companies, including SMEs, which have limited IT budgets but have demand for applications that boost efficiency and controls. The report authors expect strong demand for conferencing and collaboration tools.