Startups in China - Rapid Rise and Fall
Article by Henrik Bork in Think:Act Magazine, Aug. 2019
For startups in China, grabbing market share by burning huge amounts of investors´ money is a common, yet risky strategy. My article in Roland Berger´s CEO magazine Think:Act takes OFO as an example for questionable investment patterns.
The dangerous cycle of rapid start-ups in China
Massive investment drives new ideas, but it is also creating a dangerous dog-eat-dog world in China´s entrepreneurial culture. The result? Grand visions are highly prized, but their fast-pace strategies often fail to deliver long-term success with painful results.
I have to thank Roland Berger´s CEO magazine Think:Act for a recent assignment to look closer into the spectacular failure of China´s bike-sharing company OFO. This case, I believe, offers insights beyond the currently hot “sharing economy”, as questionable investment patterns have become all too common in China´s startup ecosystem. The following is a condensed version of my article.
Bike -sharing, briefly touted as China’s first real invention since paper or gunpowder a few thousand years ago , now seems likely to go down in history somewhat differently: As the business model behind one of the biggest startup failures ever. This failure has a color: yellow . The Ofo bikes that for a short time clogged the sidewalks of Beijing and other cities have spread the color around the world – all the way to the huge bicycle graveyards where they are now being dumped.
“This is a Harvard business case in waiting,” says Jeffrey Towson, Professor of Investment at Peking University’s Guanghua School of Management. Incidentally, the professor’s workplace also happens to be where Ofo’s story started. Dai Wei, now 28 years old, was a student at Towson’s institute. Together with four other members of Peking University’s cycling club, he bought some bikes and placed them at the campus gates in the spring of 2014.
Students could scan a QR code on the frame of the bike with their smartphones, download an app to pay a small deposit, and - click - the bike’s lock snapped open. Welcome to your “shared” bike, which you could ride for usually under or slightly over 1 USD, then drop it again wherever. Inspired by Uber and its Chinese equivalent Didi Chuxing and their “ride-sharing” taxi apps, everybody started to call this “bike-sharing”.
“Fireworks of investment”
What happened next evokes comparisons not so much with gunpowder, but with fireworks, the bright fireworks of investment. A seed round of 9 million RMB (approximately 700.000 USD) by Hongdao Capital and Will Huntington Capital was quickly followed by more millions from investors like GSR Ventures, ZhenFund, and Matrix Partners China.
More and more big investors wanted to place their bets. A Serious C investment of 130 million USD from CITIC Private Equity, Coatue Management and Shunwei Capital in October 2017 was followed by a Serious D with 450 million USD from DST Global, more money from Ant Financial , and then 700 million and 866 million USD from investors like Didi Chuxing and others led by the Alibaba Group in July 2017 and March 2018. Before the fireworks came to an abrupt halt, Ofo’s student founder team had raised a whopping 2.2 billion USD.
But less than four years after Ofo was founded, the company was close to bankruptcy. Even after raising prices, it never seemed possible to earn back this kind of money with bike rides that initially cost 1 RMB per hour in Beijing (around 15 cents US).
The meteoric rise was followed by an equally dramatic crash. After complaining about “immense” cash-flow pressure in an internal letter to employees, both investors and customers abandoned Ofo. Dai Wei compared his situation to Winston Churchill’s after the Dunkirk disaster, inviting his core team to “fight until the end”, the South China Morning Post reported.
“Hijacked by capital”
While employees had once proudly bragged that their company had “too much money to spend” and could never fail, they were now looking down from their office windows on at lines of angry customers queuing to demand their deposit back.
With the Harvard business school case study has not yet been written, explanations of what exactly has gone wrong are still evolving. But it seems likely that the mind-boggling amounts of money pumped into what was essentially not a “bike-sharing” model, but a good old bike rental business pepped up by a smartphone app, had something to do with it.
“Ofo was hijacked by capital,” says Zhang Yi, founder of the Shanghai-based research company Iimedia. “A weak management team embarked on a too fast expansion.” Even the employees felt the money arrived a bit too easily. “We felt the investment we got was way more than the capital we needed,”, the business magazine Caijing quoted a former Ofo employee in December 2018 .
The Ofo team ordered bikes by the millions from manufacturers who are now going unpaid. They had deployed them, with great confidence, in cities around the globe, while members of the founders team ordered Tesla luxury cars for themselves.
“This was a typical liquidity bubble like we keep seeing them periodically here in China,”, says Michael Pettis, a professor of Finance teaching at Peking University. “It is way too easy in China to raise money.” Pettis lives in the center of Beijing, north of the emperor’s palace. When leaving his home to walk to the subway, he is forced to “walk on the street, because the sidewalk had disappeared under heaps of bicycles”.
For a while it looked as if this Chinese “invention” had the potential to make cities around the world more environmentally friendly, a green mobility solution for the so-called “last mile” from subway stations to peoples’ homes and offices. There was the promise of fewer cars, less pollution and more healthy consumers. Now, however, photos of new bikes dumped as waste metal make people shake their heads around the world. The Ofo disaster threatens to harm the attractiveness of the “sharing economy” for investors and their appetite for the future of mobility.
“In my opinion, Ofo can serve as a metaphor for the overall market here in China,”, says Pettis. “Investors are very speculative here. Every kind of crap can reach incredible valuations.” The ingredients needed for more rational investment patterns are still in short supply in China, says the finance professor, from “good corporate governance to a stable macro-economic environment and transparency”. It is, others say, a form of high-stakes gambling. “Ofo spent too much money too fast,” concludes his colleague Jeffrey Towson.
The V2C investment model
What happened to Ofo is actually not unusual for Chinese startups. Especially in the internet and business-to-consumer (B2C) space, investors zero in on two or three companies in emerging industries, then equip them with mind-boggling amounts of cash to quickly acquire customers and grab market share. And then the race is on. “If you are not the Number One or Number Two in your space, you quickly die,”, says Peking University’s Towson.
While this kind of “V2C-investing” (Venture Capital to Consumer), which is subsidizing the customer acquisition of loss-making companies, is also known in Silicon Valley or elsewhere, what makes China stand out is the speed and “ferociousness” of competition, says Towson. “These Chinese companies are out to kill each other. Spending lots of money is necessary, and if your competitor gets a billion dollars and you don’t, you fall behind.”
But: “Bike sharing may not be a sustainable business model, but it is a great service,”, says Towson, who likes to use the bikes.
“There are a lot of variables in this kind of business model, like the repair cost for the bikes, operational costs for moving them around and asset depreciation,”, says Rui Ma, co-host of the popular “Techbuzz China podcast, who is shuttling between Beijing and San Francisco.
Investors don’t seem to care much about the losses of such businesses, not with bike-sharing companies in China and not with the now popular scooter rental companies in the US and Europe, as long as they can claim a successful exit at some point. It will be up to the shareholders of companies that acquire bike-sharing services to find out if the business model is sustainable in the long run.
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What do you think? Should there be a discussion about responsible investing in China? Or should startups get all the money they crave to gamble for success? Please leave your comment below, thank you.
Published August 16, 2019 on Asia Waypoint´s blog “China Notepad”
by Henrik Bork, the founder and Managing Director of Asia Waypoint (www.asiawaypoint.com), a communications consulting and research agency in Beijing, and a co-founder of Lychee.com, a Chinese startup in travel tech. A former correspondent for Germany´s leading daily Sueddeutsche Zeitung in Beijing and Tokyo, he likes talking to people, writing, and traveling.
The original article was published in Think:Act magazine, Roland Berger´s CEO magazine. You can find it here:
https://bit.ly/2MiqL3m
