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CEO Daily: Saturday May 27, 2017

I try not to get drawn into debates about whether Chinese companies can innovate. It’s a ridiculous question and invites nasty stereotypes. Plus, if I hear one more genius invoke the iPad to justify his claim of American tech superiority I think my head will explode.

You probably know the argument I mean. It goes: Sure, the iPad is manufactured in China but that doesn’t matter because Americans design such awesome devices and brilliant operating systems that they add most of the value and capture most of the profit. (You’ll find data to support the Apple “value-added” argument here and here.)

I don’t deny Apple’s success. But it doesn’t prove Chinese companies can’t innovate, or that there aren’t a lot of advantages to being heavily involved in both the design and manufacture of your products. Consider the case of another increasingly popular electronic gadget: consumer drones. In that category, the global leader isn’t from Silicon Valley or any other Western economy. It’s a Shenzhen-based company called Da-Jiang Innovations Science and Technology Co. (DJI).

DJI claims 70% of the world’s market for drones. Sales surged 60% to $1.4 billion in 2016. DJI’s financial backers include Accel Partners, and its latest funding-round gives the little known firm a valuation of $10 billion.

This week DJI bolstered its already formidable lead in consumer drones by introducing Spark, a new model mini-drone that is as small as a soda can, can be controlled by hand gestures, and costs less than $500.

As recently as two years ago, there were half a dozen companies competing to produce drones in a price and performance format that would appeal to mainstream consumers. Among them: Parrot, a 22 year-old French electronics manufacturer; Lily Robotics, a San Francisco-based drone startup; and GoPro, the popular maker of portable action cameras.

Parrot surrendered in January, announcing it would eliminate two-thirds of the positions in its drone division. Lily, founded in 2013, released a dazzling video in mid-2015 touting a camera drone that would follow you around and could be launched simply by tossing it into the air. The video attracted millions of viewers, raised $15 million in funding, and sold more than $34 million in pre-orders. But the company ran into production difficulties and burned through all its cash. In January 2017, Lily shut down without shipping a single unit.

GoPro had a well-known brand and a solid following among outdoor adventurers. In 2015, GoPro executives announced plans to release an small, affordable drone called the Karma by spring of 2016. But the release had to be pushed back until November and then, only days before launch, delayed again because malfunctions caused the Karma drones to lose power and fall from the sky. Karma was eventually released in February.

DJI was founded in 2006 by Frank Wang, a Hangzhou native studying engineering at Hong Kong University of Science and Technology. Its first product, the Phantom quadcopter released in 2013, was for enthusiasts and professional photographers. Late last year, the company launched a smaller, more portable consumer drone called the Mavic Pro that was priced under $1000 and delivered on features rivals had only promised. The Mavic Pro can fly for about 30 minutes on a single battery charge and has a range of 7 kilometers. It offers a 4K video and yet is is small enough to fold up and put in a book bag. The best thing about the Mavic is its unique software that enables it to detect obstacles mid-air and avoid crashes, and automatically return to “base” if runs low on power. The product drew rave reviews from customers.

DJI executives cite their location with the manufacturing ecosystem of southern China’s Pearl River Delta as critical to their success. The company has its own manufacturing facilities. Engineers can test prototypes in neighboring facilities, speeding product development. DJI can recruit from a large pool of engineering talent. They can’t imagine trying to manage all that from a research park half a world away.

Spark, the new mini-drone, is a classic example of Chinese innovation. It has a range of only 2-kilometers and can stay aloft for just 16 minutes. But it offers many of the same software features as the Mavic, and can be controlled by hand gestures, a big plus for beginners. (Read TIME’s Spark review here.) Spark’s rollout prompted analysts at the Motley Fool to declare: “GroPro’s Karma is Now Dead in the Water.”

Smug assumptions about China’s “inability” to innovate deserve a similar fate.


Clay Chandler

Trade and Finance

Stephen Roach on China’s changing growth model: Roach, formerly chief economist and Asia chairman at Morgan Stanley and now lecturer at Yale University, was among the first Western observers to call attention to China’s efforts to shift from a growth model driven by investment and exports to one driven by domestic consumption. In this brief essay, he expresses surprise that China is shaping up to be “more outwardly focused, more assertive, and more power-centric than I envisioned” when he started teaching his course on China’s economy in 2010. He also notes that, under Xi Jinping, China manifests “less commitment to a market-based reform agenda featuring private consumption and SOE restructuring.” Project Syndicate

Moody’s doubles down on warning that soaring debt threatens Chinese growth: Beijing decried Moody’s decision earlier this week to downgrade China’s sovereign debt rating one notch to A1 from Aa3. The agency said a downgrade was justified because of runaway credit growth and China’s nearly 300% debt-to-GDP ratio. Chinese government officials attacked the downgrade as alarmist and based on flawed methodology. A front-page editorial in the state-run People’s Daily blasted the decision as “sloppy” and “illogical.” Moody’s was unmoved. On Friday, executives warned China’s risked another downgrade if failed to rein in borrowing. The Guardian 

China tightens its grip on the renminbi: An agency controlled by China’s central bank signaled Friday that it will intervene more aggressively in global currency markets to prop up the value of the renminbi. The announcement follows a series of recent moves by Chinese officials to restrict the ability of Chinese businesses and investors to take money out of China. The shift runs counter to China’s stated desire to allow the renminbi to trade more freely and join the dollar and the euro as a genuine global currency. But the move was a consistent with a broader effort by Chinese authorities to minimize risk in the run up to a crucial Communist Party congress. New York Times

A rust-belt bank regulator urges support for China’s ‘zombie’ enterprises. Bao Zumin, director of the Banking Regulatory Bureau in northeast China’s Heilongjiang province acknowledged in a press conference Thursday that his agency has actively encouraged creditors to roll over loans to companies in coal, steel and other troubled manufacturing sectors to minimize job losses in region. It’s not unusual for China’s bank regulators to prop up floundering manufacturers but acknowledging that support so openly is rare. Beijing has promised to eliminate excess capacity in sectors such as steel, coal, non-ferrous metals and other sectors in which China has been criticized for flooding global markets with cheap exports. Financial Times

China In the World

U.S. asserts “freedom of navigation” in the South China Sea: A U.S. guided missile destroyer sailed Wednesday within 12 nautical miles of Mischief Reef, an artificial island claimed by China in the South China Sea. China claims sovereignty over the 12 nautical miles surrounding Mischief Reef and other manmade islands in the South China Sea. The U.S. doesn’t recognize China’s claims. Wednesday marked the first time since Donald Trump took office that the Pentagon has allowed Adm. Harry B. Harris Jr., commander of the U.S. Pacific Command in Hawaii, to assert the U.S. position that waters surrounding the artificial islands are high seas and therefore the U.S. ships are free to operate there in accordance with international law.  A Chinese Foreign Ministry spokesman said Thursday that Beijing was “strongly dissatisfied” with the operation.  New York Times

Mahathir on the rise of China: Malaysia has moved farther from the U.S. and closer to China over the past year under the leadership of prime minister Najib Razak. But Najib’s predecessor and former patron Mahatir Mohamad, over a chicken burrito lunch with Financial Times Asia Editor Jamil Anderlini, describes China as the biggest threat to Asian stability. “With the changes in [its] leadership, we see more ambitious leaders coming in and maybe they like to flex their muscles a bit and that is very worrisome… Without actually conquering the countries they have managed to increase their influence over many countries in Southeast Asia, even in South Asia.” Mahatir warned of a clash between rising China and the US-dominated world order: “They’re not really communist but they are not democratic; they are inclined towards totalitarianism and obviously this conflicts with western ideas about implanting democracy in the countries of the world.” Financial Times

In Case You Missed It

A Chinese student praised the ‘fresh air of free speech’ at a U.S. college. Then came the backlash Washington Post

Don’t worry, Hollywood. China’s not a threat Los Angeles Times

Does India have more people than China? A U.S. researcher claims Beijing’s population statistics are wrong Washington Post

Technology and Innovation

Alibaba leads $1 billion funding in Chinese food startup. Alibaba Group Holdings Ltd. and its financial services affiliate, Ant Financial, plan to lead an investment round of at least $1 billion in, one of the largest players in a crowded Chinese food-delivery service arena. The financing will value at $5.5 billion to $6 billion and help it compete with a rival service backed by Tencent Holdings Ltd. Alibaba is battling Tencent-backed startup, Meituan Dianping, for dominance in food and meal delivery businesses.  Bloomberg

Google’s defeats China’s best Go master, but is no match for its censors: Google artificial intelligence unit DeepMind teamed up with Chinese authorities to hold a five-day festival focused on the ancient game of Go. The centerpiece of the event was a three-game contest pitting a DeepMind against China’s world Go champion, Ke Jie – all of it livestreamed on Google’s YouTube. DeepMind’s AlphaGo program won by half a point. But Chinese Go fans couldn’t watch the first game on Tuesday because the YouTube livestream was blocked. CNNMoney