Digital China has arrived. It has unicorns, huge market opportunities and a pervasive cultural impact. Everything is now at world-class scale. Unfortunately, the distorting impact of hot money and hype has also scaled up. And this appears to be increasing.
Ride-sharing was the first big escalation in venture-type behavior.
In 2015-16, in both China and the USA, Didi, Kuaidi and Uber were all attracting tons of capital (and media attention). They had been the early movers in mobility. And they were following the familiar strategy of aggressive fund raising to get to scale with a platform business model. It’s is a common pattern in Silicon Valley and China.
- Venture capitalists and tech entrepreneurs are obsessed with growth. Huge opportunities are always better and growth is a priority from day one.
- Two-sided platform businesses (like ride-sharing) often provide user subsidies to get to a size where they function. A platform with few drivers has no value to riders – and vice versa. You have to get to a certain size to be viable as a product.
- Additionally, platform businesses often have winner-take-all dynamics where there is no second or third place. So you are first or second or you die. This increases the early use of capital and subsidies.
- And finally, some platform businesses monetize by mechanisms that only work at large scale. Revenue from ads, gifting, and in-game purchases only become significant when you have tons of usage.
So it was not surprising that venture capitalists (and others) put lots of capital behind Didi, Kuaidi and Uber. There are a lot of good reasons to do this. And we had seen similar behavior in hospitality (Elong vs. Ctrip), food delivery (ele.me vs Meituan), and other spaces. Plus, it meant we all got subsidized rides in China for a year.
What was different about Didi vs. Kuaidi vs. Uber China was the amount of money and attention. Uber spent about $2B in China in 1-2 years. Didi-Kuaidi merged and spent more than Uber. This time the money and subsidy war was fought with billions of dollars – and it had the world’s attention. Everything had escalated.
Post ride-sharing, the money and hype shifted to bike-sharing.
The Didi-Kuadi vs. Uber China war ended in mid-2016. They merged up. Didi got the China market. Uber got 20% and re-focused on SE Asia (but that’s another story).
And the media attention really began focusing on Chinese bike-sharing. It was proclaimed the new frontier of ride-sharing (mostly because both had the word “sharing”). The attention and money rapidly shifted into the space. And 20-30 bike-sharing companies were launched. The leaders went international. And we all got subsidized bike-rides for a year.
But there was definitely something different this time.
- First, bike-sharing isn’t sharing. The companies own the bikes. They buy them and put them on the streets. It’s more like a vending machine business than ride-sharing.
- Second, this isn’t a platform business. There is only one user group (the consumers). There is no chicken-and-egg problem. And there is no need for scale for the service to function.
- Third, it doesn’t have winner-take-all economics. The bigger players will have strengths but the market is not going to collapse to 1-2 players.
Overall, bike-sharing is a pretty traditional service business. But we were seeing the same type of frantic and well-funded race for scale. Everyone was raising money. Companies were deploying tons of bikes and subsidizing prices. The money and hype were similar to ride-sharing. And this was definitely changing the behavior of the market and its players. Everyone was more or less forced to go for growth with big operating losses. When this music plays, you pretty much have to dance.
Fortunately, in bike-sharing this was a short-term phenomenon. The money and hype faded – and underneath this irrationality was still a popular and innovative service. Mobike, the market leader, had successfully pioneered a service based on smart and connected bicycles that could do things traditional bikes couldn’t do. They could be rented on your smartphone. You could hop on and hop off as you wished. It was ultimately a great service and they had massive adoption by Chinese consumers.
Bike-sharing is a nice, medium-sized business that consumers love. It’s not a Google, Tencent or Alibaba. And bike-sharing doesn’t make you a tech god. But it’s ultimately a really popular and clever business with ok economics. But it got overwhelmed and seriously distorted by hype and money for about 1-2 years.
Then came Luckin Coffee, history’s first blitzscaling F&B.
I view Didi as a case of a logical strategy with abnormally large capital deployed. I view Mobike as case of money and hype distorting and distracting an otherwise popular and reasonable business for a short period of time.
But Luckin Coffee is a further departure from these cases.
Luckin launched in early 2018 and went for rapid scale as an F&B with a mobile app. Their business model was halfway between Starbucks and 7-11. You ordered on your phone and then picked-up at a small outlet, always located nearby. Their business model removed a lot of the cost structure of retail coffee and focused on providing fresh brewed coffee at low price and high convenience. It was clever.
Absent the typical retailer real estate, their business model was also very scalable. And they really ran with this. They opened +2,000 outlets in their first year. They also offered lots of subsidies to get customers. And they raised two rounds and went public rapidly. It was the same venture-backed playbook with lots of hype and money. They even went public with dual-class shares, just like a tech company.
Like bike-sharing, Luckin is not a platform business. It doesn’t have winner-take-all economics. So that part is similar. But unlike bike-sharing, it’s still not clear (to me) how much consumers like the product. At least bike-sharing was a widely popular service. So the aggressive scaling made some sense. But why the same investor-financed blitz scaling approach in retail coffee? With a product that is not even clearly popular? Doesn’t product-market fit usually come first?
Now, to their credit, Luckin has targeted a huge opportunity (increasing Chinese coffee consumption). If that happens, it will be a big success. But it’s also clearly a high risk, raise-and-spend-capital approach.
This is all anecdotal but it does kind of look like a pattern. With money and hype increasingly distorting how companies are acting. Perhaps it’s just a normal investment cycle. And things will return to more rational behavior as money becomes harder to access?
Or maybe digital China is an ecosystem where more aggressive behavior is normal? Perhaps it’s just considered better to move fast and be a bit less rational and efficient in capital allocation? Looking at autonomous vehicles and AI right now that certainly seems to be the case.
Note: we have also recently seen a series of deeply unprofitable China tech businesses go public in the US and Hong Kong. In education tech, social commerce, KOL incubation, and so on. Part of the same thing?
I’m not sure. Any thoughts on this would be appreciated.
A final thought: It’s usually not the bad ideas that cause biggest problems. It’s the good ones that get taken too far.
So what is next for Didi, Mobike and Luckin now that the hype and money have faded? Here are my predictions.
Didi will continue rocking and rolling – both in China and internationally.
They have a dominant position in China, which will make them a powerhouse globally.
- Ride-sharing has some real problems with driver churn and multi-homing but Didi is building out their switching costs with drivers. They are providing insurance, financing, maintenance, gas and other services to drivers and this is being rolled into a complementary driver services platform. Watch for this to be turned into a separate service for all car owners.
- They are also partnering with automakers for ride-sharing and autonomous cars (the Didi Alliance).
- And they are integrating into local cities with data-sharing and new traffic control tools.
It’s all pretty fantastic. Although it is important to keep in mind that market dominance (by virtue of a two-sided platform) is not the same thing as good economics. You can be dominant and still lose money (hello Youtube, Iqiyi, Ele.me).
Bike-sharing companies (Mobike, Hellobike, Bluegogo) will be popular services within larger consumer platforms. And they will gradually move towards profitability.
Bike-sharing is popular and has ok but not awesome unit economics. It makes the most sense as a service within a larger consumer platform like Alibaba, Tencent, Didi or Meituan. Donut stores have the same problem. They are pretty popular with consumers but struggle as stand-alone stores. They make more sense as booths within a shopping mall.
I also expect these larger players will focus their bike-sharing services on geographies where fleet utilization is close to profitability. They will avoid unprofitable geographies. And maybe they will bundle bike-sharing with other services, mostly likely through memberships.
Overall, it looks good. I ride almost every day.
Luckin Coffee will rocket upwards or have cash flow problems.
Luckin is still opening outlets aggressively. And if they can move the needle on coffee consumption in China, it is a huge opportunity. Note: if Mainland China drinks coffee at the level of Hong Kong (+200 cups per capita per year), then Luckin could open +20,000 outlets. So it’s a big win if Chinese start drinking more coffee.
But if the demand doesn’t increase significantly, they will probably have cash flow problems pretty quickly. It’s a swing for the fences approach.
That’s it. Thanks for reading. Cheers, jeff
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