By Ricky Wong
At Sinovation Ventures, we have recently put together our inaugural Shenzhen field-trip for our hardware founders, what has been a - very welcome - trend recently (see more on similar trips organized by MIT's Media Lab, HAX, Highway1 or HWtrek's upcoming one). We had several of our "post seed" US-based IoT startups join the trip, including Fictiv, Flybrix, Edyn, Droplet, Compology and Securly. The week was split into group visits, customized small group discussions, and tailored 1:1 for each of the startups. Our group met with, across the board, manufacturing and packaging partners, design houses, production consultants, distributors for the Chinese market, and several local fellow hardware entrepreneurs. The trip received some coverage by the WSJ.
The various insights from the trip are covered in a series of posts below:
- Shanzhai, The Coming of Chinese Brands, and Crowdfunding in China.
- Manufacturing in China, PCB, and Assembly.
- Tooling, Injection Molding, and Packaging.
- Insights from the Heavyweights - Foxconn and BYD - and more.
- How to Pick a Manufacturer.
Shanzhai, The Coming of Chinese Brands, and Crowdfunding in China
One of our first stops was the famous Huaqiangbei. It's a square mile block that sells all kinds of electronics - from end consumer products to individual components - typically at wholesale prices, that can be bought individually or by "pounds" (!).
When we were there we saw plenty of (presumably) electrical engineers bargaining with the vendors over prices. As a test, we also tried to bargain just to test the price elasticity of various products. With Ricky's thick Hong Kong accent, we were able to get the prices to drop as much as 70% for "component" products (e.g. SD cards) when going from 1 unit to 100 units. For more "complete" products such as routers we were able to get ~15% off the retail price. One word of caution, when buying in Huaqiangbei it's hard to tell whether you're buying genuine parts. We were told that locals only come here to see the samples in person, for their prototypes. Some of the shops you see in Huaqiangbei are just a front-end "showroom" for a factory, somewhere far away. This is probably - actually - not the place to buy pounds of components and carry them back to your production assembly line.
We first heard of Huaqiangbei from our local hardware founders and because of "shanzhai" smartphones. "Shanzhai" is a term that is used to describe a large number of grassroot Chinese companies making knockoffs of branded products. Each company makes a slight change to the original product, sometimes resulting from customer feedback, but often driven by resource constraints.
Occasionally, the "shanzhai" ecosystem would create a series of innovative features (e.g. dual-sim cards. However, most of the products that come out of the "shanzhai" system are generally of low quality and often times comical (e.g. Hello Kitty smartphones). Having said that, because of the large number of copycats and the quick feedback loop (by being in close proximity to one another and to the back-end supply chain), the "shanzhai" ecosystem is extremely good at replicating true innovation quickly. An example is the "hoverboard" trend (or fad?) that’s all over the US at the moment, which ironically was a Chinese innovation.
Still, in the last few years, the term "shanzhai" has become a bit of a national pride. It evokes similar emotion as India's "jugaad" or the makers of the Homebrew Computer Club. Interestingly though, at the core, "shanzhai" isn't driven by the idealistic sense of open source sharing. "Shanzhai" comes from China's historically weak IP protection climate and capitalistic greed. Any innovation is quickly copied and most of the value is captured by the end consumer rather by the innovator. The large number of copycat followers created a (what economists would call) perfect competition environment.
Going back to Huaqiangbei in 2015, we're now seeing the end of the "shanzhai" smartphone movement. From our informal discussions with insiders in Shenzhen, the Chinese consumers have moved up in sophistication and brand awareness. "Shanzhai" smartphones that look like Hello Kitty or Mercedes Benz no longer attract any shelf-space in Huaqiangbei. Low cost Android devices and local Chinese smartphone brands such as Xiaomi, Meitu, or One Plus are winning market-share.
The question though is whether the "shanzhai" sub-culture will move on to other product categories or simply die. Folks we know in Shenzhen believe that "shanzhai" smartphones (at least for now) still have demand in frontier markets, such as Africa. For the Chinese domestic market, we believe we're in a transformation phase, where Chinese consumers are now starting to appreciate branded products. By appreciation, we do not mean merely as a status symbol (as in the case of Apple's products) because China has long been a huge market for international luxury brands, but middle-class Chinese consumers finally appreciating that "brand" is a mechanism by which companies establish trust and communicate quality with the general public. This should give rise to many brand-oriented China companies, across all categories, for years to come.
One example is CrazyBaby, one of our own portfolio companies in Shenzhen. Crazybaby recently raised $828K on Indiegogo and $536K (¥3.5M) on Taobao's crowdfunding platform. The founder, Allen Zhang, is a rare entrepreneur among early stage hardware startups in China, who understands both the US and China markets.
They had to do two crowdfunding campaigns, in two different time zones, and at the same time manage manufacturing. We noticed a couple of things about how the Crazybaby campaigns are done differently in each region. First, both campaigns are entirely localized. The text (obviously), videos, and many of the images are different. It's very tempting to reuse as much media assets as possible, but the team decided to customize each campaign for the local audience. The US video is very direct. It immediately goes into sales mode and walks the user through the features of the product. The US video also used the voice over of someone with an American accent so that the customers have an easier time to understand the product. However, midway in the video, the team introduced itself in English and talked about the company's founding story. This is quite common in many Kickstarter and Indiegogo videos, where the startup tries to rally backers behind the vision of the company and to start cultivating a community around a brand. Crazybaby's case study is particularly interesting because it's an example of a Chinese startup coming of age. The founders take pride of where they come from (i.e. not hiding the fact that they’re a China-based startup) and at the same time let the product quality speak for itself. Despite the political rhetorics, we find that the US consumer culture is quite open and willing to accept products from anywhere, on merit.
The Chinese video on the other hand has a slower pace. It picks a music that is much more emotional, and right from the start it is trying to get customers to buy into the broader vision of the company. The fact that the team speaks Chinese natively allows each team member to individually tell their story. The video also get into details on the product development and design decisions. It reminds us of a classic Jonathan Ive videos which are like a Hollywood theatrical trailer and where each design decision is glorified (e.g. Apple Watch andiPad Pro). This conveys to the consumer that the designers are extremely passionate about their product and they vouch on the quality. Another fact is that the Chinese campaign has many endorsements from well-known online media personalities. It is fairly common in Chinese pre-order campaigns to use such endorsements. This can include famous celebrities, well-known tech personalities, other founders, international technical experts (e.g. from the US or Japan), and of course well-known investors. Overall, the Chinese campaign has much more focus on people - both external and internal to the company.
On the flip side, prices for the two target markets are the same (~$249). The production schedule is also more or less in sync. One could make an argument in favour of shipping one region first, in order to workout the bugs, rather than shipping all regions simultaneously. Crazybaby went with the riskier strategy, but in the end they were able to ship ahead of the Christmas holiday and customers have been leaving generally positive comments. We have generally noticed that Chinese hardware startups are able to ship relatively on-time, and often with less upfront capital. The amount of manufacturing experience and the ramp-up speed of Chinese hardware startups is also generally better. For example, what a US hardware founder would call a "prototype" is very different than what a Chinese hardware founder would call a prototype - the latter generally means that the team is ready for DFM (Design for Manufacturing).
On the other hand, the US founders and the US consumer market in general, are much more willing to try innovative (albeit unproven) products. US founders are able to quickly create a "concept" product (and in many cases just a video) and validate the market demand via crowdfunding or other means. The US consumer base is also much more entrepreneurial in the sense that it's much more willing to buy these very early stage (or non-existent) products. If we have to choose, with the exception of highly technical products, the customer development risk is a greater risk to manage than manufacturing. Having said that, both can kill a company. Coincidentally, the week we were in Shenzhen we saw two massive crowdfunding projects hitting brick walls (Coolest and Zano).
Crazybaby is an example of a startup that can learn from both markets. It launched on Indiegogo ~10 months ahead of Taobao - presumably tapping into the early adopter market in the US. At the same time, by being in Shenzhen, it is able to mitigate its manufacturing risk.
On the topic of crowdfunding in China, our US founders also met with folks from Taobao's crowdfunding platform and from JD. A key difference between US and Chinese crowdfunding platforms is that Chinese companies often use it as a marketing channel for quite established brands, like e.g. Hai'er, rather than for new products with genuine crowdfunding needs.
To give a sense of scale, Taobao is the C2C arm of Alibaba, which itself is a $207B company. JD is also a colossal e-commerce company at $45B. In fact, in the crowdfunding space, JD's platform is larger than Taobao's platform, although Taobao is catching up rapidly because it is the overall king of e-commerce in China. By comparison, Amazon is $311B and eBay is $33B.
We had the pleasure to host Gao Zheng (head of Taobao's crowdfunding platform) for a private discussion with our group; he shared a few general insights from Taobao's experience. Crowdfunding in China tends to skew in first-tier cities where consumers have more disposable income. A typical persona is a male who is recently married, still young enough and with no kids, and his wife not in control of the family budget yet - i.e. plenty of disposable income to spend, and personal freedom to decide. Gao Zheng also gave some interesting examples of how Taobao is being used. For example MiniK raised $3.2M (¥21M) from 348K customers - 21X of its original goal. The product is a simple, but very cool, BLE-enabled smart-plug. The company promised shipping within 30 days of the end of the campaign, which is an aggressive goal by itself. In fact, it managed to beat expectations and shipped 2 days after the campaign ended. This is almost unheard of in the US and especially for a company that just had 21X of its original funding goal. How did this startup do it?
For one, this company already had experience building a smartplug. Their old product isn't quite the same as the new product. The new smartplug has an industrial design that is a lot less geeky, comes with multiple colors, and has new features such as automatic prevention of overcharging of smartphones. However, it's clear that the team has substantial experience that is directly related to this product category.
In addition, when a Chinese company enters in crowdfunding mode, it typically already has completed at least the tooling stage. MiniK saw the early traction of the crowdfunding campaign and was able to increase their order size while the campaign was still live - essentially a just-in-time manufacturing process.
In fact, in China, there are now insurance policies that companies can take out, where if a campaign is delayed, the customer will receive 30% of his / her pledge back. The customer still gets the product when the campaign ships and the 30% is a bonus compensation. Note that the best startups (the ones that are the most confident in their ability to ship on-time) would take out these policies to signal to end customers that they are confident of their ability to execute on their production plans.
This brings the question of whether crowdfunding in China is truly crowdfunding at all. Perhaps a more suitable term is simply "pre-orders". This of course means that crowdfunding in the US is more attractive to products that are still at the conceptual stage - where the shipping date is highly unpredictable and in some cases the entire project still has substantial technical risk.
One insider told us that crowdfunding in China, unlike in the US, represents the beginning of the business - not the beginning of a dream. Chinese consumers at the moment have no interest of becoming "angel investors" of a campaign. They see themselves as consumers first and foremost.
We wonder what it would mean for startups that are trying to use crowdfunding to create an early evangelist community. In the US, you often see campaigns with a basic $1 reward as a way for consumers to buy into the early user community (e.g. the privilege to receive exclusive, supporter-only updates). In China, at first glance, you first see a similar basic reward tier. But after a closer look, these rewards are usually future coupons with substantial discounts on the final product. Part of this phenomenon can be attributed to the unique history of donation and civic culture in the US. The culture to support ("invest in") a project just to help an entrepreneur is very much a US phenomenon.
Manufacturing in China, PCB, and Assembly
Startup founders sometimes do not understand that, just because they are the "customers", it doesn't automatically mean that their projects are attractive to manufacturers. In general, manufacturing is an economy-of-scale business. This is quite incompatible with the requirements of early stage startups. Startups have smaller order sizes, more discontinuous order flow, and the products are also - typically - more unusual (i.e. higher learning curve in terms of manufacturing). The future financial prospect of startups is also uncertain, which has implications on the payment terms, and on whether the manufacturer should hold materials' inventory for the startup.
The good news is that the manufacturing sector in China hasn't tru
The good news is that the manufacturing sector in China hasn’t truly recovered yet since 2008. Many vendors are interested in diversifying their client base after the crash and the ensuing slowing down period. Many manufacturers recognize that, by partnering with clients that are growing fast, they themselves will likely grow fast as well. And - of course - it goes a long way if you have products that excite them, and you can also show them that you have backing from reputable investors. There are even cases where manufacturers (or their owners) would invest in the startup themselves.
Manufacturing in Shenzhen
Just like the tech sector in the US is divided into various hubs - e.g. SV (being the main center), NYC, Boston, Austin, etc. - manufacturing in China can also be beyond Shenzhen. Nick from Brinc talked about his experience in creating a watch made of bamboo material. In his case bamboo is sourced from a specific part of China that is far from Shenzhen. He had to factor in the additional cost of transporting the bamboo to his final assembly shop, as well as the added time, to his supply-chain financing model.