Developed by American scholars, Richard Thaler and Cass Sunstein, the concept of nudge marketing has been successfully applied in both public and private sectors in the Anglo-Saxon society. The key elements of the nudge theory include the choice   (reducing the mental effort to make a decision). In a nutshell, both governments and enterprises apply nudge in China to entice people to achieve expected behavior.

In the business context, nudge tactics are all around us

Nudge theory was popularized in 2008, but we have been influenced by nudging, even in a consumption context, our whole lives. Simply observing the online and offline ecosystems exposes the abundance of nudge marketing tactics in China. Anywhere a business creates the environment in which a decision is made will inevitably include nudges.

Individuals retain the power to choose among alternatives, but the structure of their choice favors one particular outcome. Nudging affects behavior while also respecting freedom of choice of the consumer. Whether it is placing sweets or other impulse purchases near the cash register, or listing the more profitable product in front of the less profitable one online, consumer choices are influenced by the environment around them.

Photo Source: Daxue consulting, Mechanism of nudge marketing

However, Nudge theory has low academic awareness in China

Even though “nudge” is a popular concept in the western world, it has been rarely cited for academic purposes in China. The official Chinese translation of nudge is “助推理论 (nudge theory)”. Other synonyms such as “助力发展 (development aid)”, “助推器 (industrial propellers)” and “助推 (nudge)” are used in ways irrelevant to the concept proposed by Thaler. According to CNKI, a key national research and information publishing institution in China, the attention degree of nudge theory has remained very low in the Chinese academic world. Even so, mare the translation of western academic papers and analysis of the nudge application in western society. These facts reveal that nudge theory, and nudge marketing in China has yet to become popular.

Photo Source: CNKI, Subject distribution of nudge theory in Chinese literature

Nonetheless, it is interesting to notice some enterprises, including online car-hailing platforms, have utilized nudge marketing in China. On the other hand, Chinese scholars have been discussing applying nudge theory to policy making in China. If so, in which context it is most suitable?

Nudge in the business sector: Software-as-a-service industry and E-commerce platforms have applied nudge marketing in China

With the increasing household incomes, improving legal measures regarding intellectual property and development of the 4G network, the software-as-a-service industry in China is booming. While lots of market players strive for market share, how can they attract consumers in China and stimulate the purchase behavior, by applying nudge in their businesses?

Case Study of QQ Music: auto-subscription and excessive exposure of promoted products are nudges

QQ Music (similar to Spotify), one of the leading online music service providers in China, has applied nudge in promoting their core product. Green Diamond (绿钻) is the premium membership that enables music consumers to unlock premium music services such as music quality, customized themes and profile pictures, and more access to paid digital music. In addition to the premium membership, regular membership is the second promotive product, and it merely consists of the basic service, limited access to paid digital music.

Application of heuristics: information availability

Information availability is related to the observation that as people see or hear something frequently, they tend to believe its perceived credibility. QQ Music has applied information availability successfully. On the home page of the member center, QQ Music mostly promotes the premium membership by placing multiple stimuli regarding Green Diamond. The images below display pages of the QQ Music member center.

Source: QQ Music screenshot, navigating a Chinese app means immersing ones-self in a series of ‘nudges’

Four activities which are circled in blue are related to obtaining premium membership. For users that are not familiar with the platform, these stimuli are likely to entice them to get premium membership directly as they might perceive that Green Diamond is the only membership they can obtain from this online music platform. However, they might not know QQ Music has also provided regular membership as this platform does not place any stimulus to promote it frequently.

Photo source: QQ Music, member center page

Inertia and auto-subscription

Inertia is related to the tendency of people to stay committed to current situations. It is caused by the fact that people are unlikely to be proactive to change things when there is no stimulus to do so. Likewise, QQ Music has applied inertia as the stimulus. Some subscription agreements take effect after users enable the auto-subscription condition. For example, users can pay 12 RMB/month by subscribing to the successively 1-month plan. Otherwise, they cannot have 6 RMB deductions per month as a benefit. Once users enable this condition, they need to cancel the plan manually if they want to terminate the plan.

Moreover, QQ Music does not send any notification to remind users of the end of the monthly subscription. Affected by inertia, users are too passive cancel the plan when they have not been prompted to do so, and thus their subscriptions would continue automatically. QQ Music tactic regarding auto-subscription leverages the other side of nudge marketing; consumers are less likely to react to a stimulus that is not present. 

Case Study of Tmall: Reviews, discounts and particular display of information are nudges

Likewise, Tmall has driven online purchase behavior with nudge marketing in China.

Photo Source: Tmall, Nudge marketing on Tmall platform

Social proof and reviews

High amount of reviews are effective in driving purchase behavior as they give more context and personal experience to products. Reviews are technique of social proof, which states that when uncertain, individuals will look towards the behaviors of others to help them make decisions.

Anchoring and discounts

Anchoring, a psychological pricing technique, is using existing information as a baseline for new judgements. The higher price “anchors” the individual to make the discounted price seem smaller.

Autonomy in decision-making

Being able to choose from various options, such as to check out, add to the bag, or paying in installments, it gives consumers the freedom of remaining autonomous in their decision.

Pushing the sales of a particular product

Placing the most attractive product next to similar products that aren’t perceived to be as good of a deal makes that option look even better. On Xiaomi’s page, the most attractive option would be the middle with its attractive specs, which justifies its higher price.

Photo Source: Tmall, Nudge marketing on Tmall platform

Credibility and labels

Labelling as implicit nudges boosts credibility of the product to make it easier for consumers to find what they want.

Photo Source: Tmall, Nudge marketing on Tmall platform

Similar nudges are widely used in video platforms, paying-for-knowledge apps, gaming platforms

In terms of other digital content and service providers, auto-subscription is a common nudge tactic in this market. It is noticeable that the applied nudge tactic in China’s business can be found in the western context. With the growth of globalization, more and more business tactics born in the west have been adopted in China readily.

Applications of nudge from China’s government

Nudge in the policy establishment is more insightful. More and more Chinese scholars have delved into this field and discussed its feasibility in the Chinese context.

Nudge in China’s public policies: it is applicable in the pension system while focusing on different attribute   

One of the most prominent applications of nudge is in the pension system. In western countries, in order to tackle the low propensity of saving, a nudge has been applied to  trigger their saving habits for retirement. Auto-enrolment and display of selected information are the main characteristics of nudge in the western context.

By 2020, China had established the pension system for over two decades. Considering the relatively high propensity of saving, it has not been a significant issue in China’s pension system. Instead, the main issue has been the low participation rate. Because of the unequal economic development, the penetration rate of the pension system in rural areas is low. Among these nonparticipants, some of them have limited education and do not know the benefits of investment in pensions. To tackle these issues, some Chinese scholars have suggested that the government should utilize the heuristic, framing and availability, to attract more Chinese people to participate in this system. By amplifying the benefits of pensions, offering limited investment plans and using plain descriptions, people’s willingness to participate are likely to increase.

Nudge applied to prevent the spread of Covid-19

On top of strict government measures to control the spread of COVID-19, China also used some more subtle tactics to encourage citizens to follow the rules. Simply putting a hand sanitiser dispenser or a tissue nearby will increase the chances that people use them, before entering a building, even when people are carry their own tissues and sanitiser.

Source: daxue consulting, 50 measures China used to prevent the spread of COVID-19 report, tissues placed at the doors of ATMs

Standing spots also served as a subtle reminder to keep a two meter from others. Though this measure could have been implemented without labeled standing spots, the spots remove the mental effort for people to have to figure out how far to stand from each other.

Source: daxue consulting, 50 measures China used to prevent the spread of COVID-19 report, people are nudged to stand on standing spots

Nudge theory in China has yet to be widely discussed

Regarding the nudge in China’s business sector, enterprises have applied nudge marketing in China readily. Nudge amplifies the universal trait of human behavior. Since nudge works well in the western society, it can also bring similar benefits in Chinese environment.

In regard to the application of nudge in China’s government sector, scholars are questioning the effectiveness of nudge in changing people’s behavior. Influenced by Confucianism, China has been rooted in a traditionally paternalistic system that features control and power. By 2020, the legislation in China has been to affect people’s behavior directly, rather than enticing them to behave in a certain way.

In the future, mitigating the differences might facilitate nudge’s occurrence in China’s policies

Nudge for good is meant as a plea and not necessarily an expectation. Richard Thaler, Nobel Prize winner

“Although there are cultural differences between Asia and the US or Western Europe, fundamental traits of human behavior are relatively stable around the world that would allow China to use the tools to design policies.” Thaler said. He also mentioned that applying nudge in government policy would help China’s government to obtain better outcomes. In line with some Chinese scholars’ opinions, nudge is a valuable tool that cannot be neglected. However, this isn’t to say we should ignore of socio-cultural and economic differences. Hence it is worth doing more research on nudge marketing in the context of China.  

Authors: Amelia Han & Della Yuzhou Wang

Many COVID-19 prevention measures were nudges, spot them in our report

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Westin has over 230 hotels and resorts in 36 countries and districts in the world. It focuses on the market of high-end consumers. All Westin hotels are recognized by local authorities as five-star hotels. Westin prefers to place its hotels (resorts not included) in city centers, providing its customers with the most convenient location if they want to go sightseeing or shopping. Westin’s 160 hotels and resorts are all known for their modern design, exceptional customer service and relaxing atmosphere.

Westin Hotels & resorts provides customers with relaxing accommodations for them to come back to after spending a day enjoying the surrounding locations. Each Westin Hotel is located in areas that offer unique experiences for its customers. Westin has a history of focusing on wellness, and it continues its commitment to its travelers’ well-being and healthy lifestyle.

What is unique about Westin in China

Westin now operates 25 hotels in China Mainland: four in Guangdong, four in Hainan, three in Zhejiang, two in Beijing, two in Fujian, two in Shandong and one in each of Anhui, Jiangsu, Jilin, Hubei, Shanxi, Tianjin, Wuhan, Shanghai. The above hotels are located in Tier 1 or Tier 2 cities. Currently, China is home to the second largest number of Westin hotels worldwide, second only to the United States. In China’s luxury hotel market, Westin ranked eighth in terms of the number of hotels among all international 5-star hotel brands in 2008, while Sheraton had the most number of hotels (70).

Increasing demand in China’s luxury hotel market brings opportunity for Westin China

Since entering China in 1991, Westin has targeted wealthy Chinese customers. In the last 20 years, China’s promising GDP growth and increasingly affluent consumers have led to high demand for luxury goods and services. The growth of high-yielding consumers contributes to the blooming of the domestic high-end travel and China’s luxury hotel market.

According to GlobalData, China was the largest luxury hotel market worldwide in 2018, with year-over-year (YOY) growth of 18.3%. In 2019, China’s luxury hotel market still had a YOY growth rate of 10.2%. It is predicted that China will continue this momentum in the next few years with a growing number of high-net-worth citizens.   

How Westin adds Chinese elements

Westin also pays close attention to the local culture of the city and the country where its hotels lie and holds cultural events to accommodate these differences.

In Wuhan, Westin held a luxury traditional family reunion dinner to celebrate the Spring Festival. The event offered Westin customers dishes from different geographical regions of China. Various types of tea were also available.

In Hefei, the Westin held a “Mooncake Show” in late August. The show was held in preparation for the Mid-Autumn festival where mooncakes are traditionally eaten. The Westin offered each of its customers four different mooncakes at the show to give them a little taste of China.

In Beijing, the Westin offered its customers a variety of crab dishes. Chinese people love to eat crab in Autumn, but crab is not farmed in Northern China. The Westin gives Northern consumers a chance to enjoy a delicacy that they normally cannot enjoy.

Westin in China：leveraging the power of new marketing. Co-branding marketing

Source: Westin China’s Weibo, Co-branding marketing of Westin China × KEEP

Partnering with “KEEP”, an easy-to-use  Chinese fitness app, Westin is able to improve customer experiences and strengthen its brand image. Westin and KEEP cooperate to satisfy business travelers’ sports needs by providing a full range of fitness activities. 

The collaboration covers in-room courses, running-related and fitness center courses. First, for in-room courses, KEEP and Westin jointly open exclusive TV channels provided in Westin Hotel. Based on the space environment of hotel rooms, KEEP customizes a set of sports courses suitable for hotel guests to exercise in the room. Second, Westin China adjusted its “RunWestin” program, generating its characteristic health running map route in the KEEP App. Hotel guests and city runners can easily use the Westin health running map in the App, and the App can record and collect related personal performance data. Third, for fitness center courses, KEEP also provides Westin with a complete solution, including training, yoga and other courses. These are to better serve the personalized fitness needs of travelers. Hotel guests can easily scan the QR code in the hotel gym to get recommended courses and enjoy working out. 

Why the Westin x KEEP co-branded marketing works

Why is this innovative collaboration so successful? Two similarities between two partner brands can explain this.

First, both brands advocate healthy lifestyles and emphasize keeping fit. Westin hotel has focused on fitness since it was created and is committed to bringing customers health and wellness in addition to a comfortable accommodation experience. Westin promises to enable guests to maintain their workout routine during they stay in the hotels. Such a promise aligns with KEEP’s brand image that has always been centered on creating a “free sports ground”. Based on the same idea, two brands can join forces to help travelers stay fit and have a healthy lifestyle.

Second, two brands share a similar customer base. Westin and KEEP team up to explore the material and emotional needs of high-end traveler groups. Through this cooperation, both parties leverage rich experience in different fields to jointly develop deeper customer insights, and achieve a full range of sports needs for the target customers.

Innovative marketing method achieves better results

Different from simple co-branding marketing, in which two brands only jointly hold activities or produce products, the cooperation between Westin and KEEP has more significant meaning and better results. It embodies a common vision of two parties, and tightly integrates brand values, market experience and customer insights.

Partnering with KEEP, Westin creates some brand new elements to its traditional hotel identity. Hotel’s high-tech hardware facilities and services activated by the Internet help Westin shape a more active and rich brand image. Westin will attract more loyal guests by offering them one-stop solutions for sports needs in traveling. 

New marketing strategy: social media marketing

Nowadays, social media has built an instant and tight connection between brands and customers, especially for the hospitality business. More and more Chinese are used to checking peer reviews and comments on popular Chinese social media like Weibo, Xiaohongshu and Tiktok before purchasing products or services. In these cases, social media plays a vital role in deciding travelers’ purchasing choices. Several Westin hotels, which are instagrammable luxury stays, earn their reputation on Chinese social media.

Source: Weibo, Red –KOLs’ posts about Westin China

On Chinese social media platforms, it is easy to find some KOLs (Online Key Opinion Leaders) posts about people’s stay experiences at Westin hotels. Their posts usually show the luxurious decoration, comfortable environment, considerate service and stunning views of the hotels. With more and more KOLs sharing wonderful stay experiences, Westin raises its awareness among Chinese consumers. Currently, Westin hotels in some cities, like the Westin Chongqing Liberation Square, have become “internet-famous” hotels, attracting tons of travelers to stay or just take pictures.

Source: Weibo, Red –Consumers’ posts about Westin China

Many people, especially millennials, are keen to share their high-quality lifestyle experiences on social media. It is trendy for them to post fantastic photos of the hotel and share their feelings when staying in the hotel. These posts can have millions of views, and thus cause a “network effect,” which helps advertisement for the Westin.

Recovering from coronavirus: upscale hotels should take “smart” strategies

The tourism industry and the hotel market have suffered huge losses from the coronavirus outbreak. In order to reduce loss and raise occupancy rates, many hotels made dramatic price-drops during the period of the COVID-19 pandemic. Until now, a lot of hotels have still dropped the price to entice consumers. However, it is not a wise strategy, since starting a race by dropping the prices will hurt profits across the entire industry. All hotels will lose out and it would be hard for the hotel market to recover from the crisis. In addition, price promotion strategies may have a negative impact on brand images of upscale hotels like Westin.

To recover from the COVID-19 pandemic in a relatively short time, hotels could take action more smartly. For example, they should offer more “value-adds” services to attract travelers, like Westin’s co-branding marketing. Also, leveraging popular Chinese social media to have users advertise for brands seems like a wise marketing strategy.

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China’s startup hype started from the central government

Entrepreneurship and innovation have always been on the mind of top decision makers

Since 2008, China’s central government has already extended a warm welcome (in the form of grants and other perks) to attract top talents back to China. Its goal is to promote high-level innovations and technological breakthroughs, which naturally contributes to employment and economy.

In 2014 in the Summer Davos Forum, the Prime Minister Li Keqiang first coined the term “Mass Entrepreneurship and Innovation”. In 2015, he kept advocating the entrepreneur spirit in the National People’s Congress and many other important occasions. Since then, the notion of starting up and being your own boss gained momentum.

Over the years, the Chinese government has focused on the youth as the main propeller of innovation

The plan called “Implementing Opinions on Deepening Innovation and Entrepreneurship Education Reform in Higher Education Institutions” issued by the State Council in 2015 further lowered the entry barriers for university graduates to start a business. All sorts of business plan competitions were put in place with generous grants to realize the winning proposals. For example, China College students’ Internet Plus Competitions are target local graduate students, while the Chunhui Cup targets overseas students. Also, startup experiences could be converted into school credits. What’s more, university entrepreneurs can extend their school years if they decide to pursue a business idea.

All those measures were established to reach the objective in 2020: a sound university entrepreneurship education system, significantly enhanced students’ innovative spirit and skills, and a significant increase in the number of students engaged in entrepreneurial practices.

Internet is transforming almost all the industries, representing great opportunity for mass innovation

The term “Internet Plus” was coined to inspire people with the prowess of information technology, and is regarded as a national-level strategy. All the aspiring entrepreneurs in China’s startup scene are thinking how to disrupt a traditional industry with the mighty internet.

Online to Offline (O2O) is a famous term born in this context. The logic is to combine the online and offline experience to facilitate life. Ride-hailing market leader Didi, food delivery platform Eleme, e-commerce giant Taobao, short-lived bike-sharing unicorn OFO are all examples of the O2O business model. The customer value chain has one part done online, usually product configuration and mobile payment, and another part delivered offline.

In addition to O2O business model, Internet Plus also gave birth to new business models in various industries. Coupled with media, it became new media, embodied by WeChat official accounts. Married with finance, it turned into FinTech, which made investing, money wiring, and short-term renting way more convenient. E-commerce is the best illustration of how internet switched the retail business online and scaled up its influence while cutting down fixed costs.

The benefit of internet spills over to non-for-profit areas too. For example, online education market leader Hujiang put forward a Corporate Social Responsibility program in 2015, with an aim to mitigate the education inequality in China. Ant Forest, a carbon-reduction program introduced by Alipay increased user stickiness by planting real trees on their behalf.

The mobilized public and the honorable badge of failure

The unwavering support from the government and the widespread of internet capabilities enabled the creative minds to unleash their potential.

According to National Bureau of Statistics, the improvement of general business environment in China has given rise to business registrations. Especially in the tertiary sector, where the legal entities registered with IT services has quadrupled from 2013 to 2018. Other booming industries include technological services, leasing and professional services, with a CAGR of 23%. Public administration and social organizations only grew 2% on an annual basis. Those figures clearly outline the confidence and concentration of digital services promoted in the entrepreneurial wave.

Data source: National Bureau of Statistics, Number of Chinese legal entities in 3 sectors

The increased ease of starting up and technological advancements propelled the establishment of enterprises. Compared to individual economic units, registered enterprises soared in 5 years, taking a whopping 75.6% of total legal entities.

Data source: National Bureau of Statistics, Number of Chinese enterprises registered has soared

Furthermore, the tide of Mass Entrepreneurship and Innovation translated into the numerous young enterprises. In 2013, SME (small and medium enterprises) represented 95.6% of the total registered companies. In 2018, they represented 98.5%, showing the liveliness of Chinese entrepreneurial energies.

Data source: National Bureau of Statistics, Young enterprises take the lead

There are many stories and lessons about startup failures, which is how 95% of startups end. But with the mainstream endorsement and regulatory privileges, failures are more and more seen as a badge of honor. For the new generation of Chinese entrepreneurs, many are driven by dreams and opportunities, some are forced to venture for lack of job prospects, yet others are blindly following suit. In 2011, only 1.7% of university graduates opted for starting up a business. This percentage peaked at 3% in 2016 then slightly dropped to 2.7% in 2018. This change implies that government promotion was effective, and that China’s startup scene is cooler headed than before.

On the one hand, it’s the government’s job to put all the necessary support in place to ensure new ideas come out alive after market selection. There are more and more incubators, governmental subsidies, and free startup resources and mentors. On the other hand, it’s entrepreneurs’ job to hone their entrepreneurial skills and think long and hard about their fundamental business logic.

The fallen unicorns made investors more cautious about the fundamental business logic

After the two roles played by the government and the entrepreneurs, the third player in China’s startup scene is the investors. Whether it’s business angels or venture capitalists or private equity firms, they are the guardians of solid business sense and financial resources.

The loudest failure in the recent history of China’s startup scene is the bike-sharing platforms. Began in 2014, OFO and Mobike had been the super stars to solve the last mile mobility issue. Even with around 8 billion RMB of investment across several rounds for each company, they had been controversial in their ability to generate profit, to respect public order, and to protect local environment. In the end, OFO filed for bankruptcy and Mobile got acquired by Meituan for merely 2.7 billion RMB.

This contrast of capital zeal and the market failure illustrate the short-term mindset of some investors. To claim the maximum market coverage, which seemed to be the key success factor in the sharing economy logic, the companies and the capital both prioritized buying bikes over risk control. The lack of a sustainable company culture and conflicts of interest at the top management level went unaddressed.

Source: Sina Finance, the mountain of abandoned sharing bikes

Such a vivid example will lead the investors to favor sound business models over those benefiting from over-evaluations of other investors. It’s good for the society because it creates less bubbles, but it also means tougher financing for the entrepreneurs. For any newcomer in China’s startup scene, there are several dangers that could be detrimental to its fundamental business logic.

Competition and acquisition from conglomerates like BATJ

It’s almost a common knowledge that once a startup is big enough, it will be bought by one of the tech giants in China. The famous Baidu, Alibaba, Tencent, JD and other rising giants like ByteDance, NetEase, Didi, Meituan won’t hesitate to make a bid to make their own ecosystems stronger.

But first of all, the startup has to survive the competition by those giants. A great dark-horse example is Pinduoduo, whose founder Colin Huang recently became the second richest person in China. The notion of Social + Ecommerce in the long tail market made this startup successful, in an era where everyone thought Alibaba and JD had occupied all the room of growth. In theory, the existing e-commerce giants could quickly take over Pinduoduo in its cradle. In practice, neither of them followed the startup to compete in lower-tier cities.

Tencent, being the social networking giant, strategically invested in both JD and Pinduoduo, to combat with Alibaba in the e-commerce arena. That’s the best outcome for the startup, with the owner taking 46.8% of the shares and 89.8% of the voting rights.

Other startups don’t have the same luck, many were bought to be dissembled into existing projects of the giant company. For example, ByteDance bought Zhaoxi Calendar, a niche time-management app, whose product team was integrated into Lark, another acquisition realized only 2 month before.

Copycats and price war

Even if a startup didn’t make enemies out of the tech giants, diligent copycats and the resulting price war could put an end to their cash inflow.

The Chinese market never lack duets. Didi and Uber China in ride-railing sector, Meituan and Eleme in food delivery online business, Mobike and OFO in bike sharing economy. When there is oligopolistic competition, the consumers are the happiest. Huge amounts of discounts are up for the taking, as long as they lead to market share. However, price wars are destructive to both competitors, as the customers attracted by low price are not necessarily loyal. Once the price incentives are out of the table, usually due to the serious drain on financial resources, the market share might shrink back.

One sure thing to note about China’s startup scene is that, there is no shortage of copycats. Demonstrating this, there are more than 20 startups which share the same shared-bike business model.

Source: Tencent news, Shu Ke Shi, 20 startups in bike sharing industry

Illegal activities that suck the margin into the shadow

Luckin coffee has made its fame by publicly stating financial fraud to SEC. Its business model was clearly unsustainable, as it had a loophole in its expansion strategy. It’s strength in marketing and storytelling did not compensate its unsatisfactory risk control department. And this Achilles’ heel has costed its healthy financial performance.

Basically, Luckin’s expansion strategy is based on customer referral. As a startup, the number of referrals is directly linked with GMV, KPI, and valuation of next financing round. It’s therefore understandable how much marketing and budgetary resources are pooled to facilitate leads conversion. However, instead of using elaborative verification methods to ensure the referred customer is a real person, Luckin only used a phone number to validate the referral. Once the referral is validated, both the referrer and the referee enjoy discounts. The result of a weak risk control is constant loss of profit due to a highly developed grey industry of fake phone numbers.

In the highly competitive battlefield as the China’s startup scene, nothing is too despicable to be true. Entrepreneurs owe it to their teams and investors to pay attention to not only the legal competitions, but also illegal activities.

In conclusion, China’s entrepreneurs keep pushing forward despite setbacks

China’s startup scene is quite lively thanks to the government’s Mass Entrepreneurship and Innovation guidelines, mobilized public and responsible investors. Even though system-level crises, industry-level fluctuations, and company-level setbacks keep striking one after another, the qualified entrepreneurs will seize the opportunity in the distressing time, fearless as always.

Author: Della Wang

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1. Baijiu

Baijiu is a strong distilled Chinese spirit, 40%-60% alcohol by volume. It is distilled from sorghum, although other grains may vary according to regions. It is grouped by fragrances, of which the main ones are sauce, thick and light fragrance. The most famous brands are WuLiangYe and MaoTai.

However, the development of Baijiu industry has been slow down in recent years due to several factors. The first factor is the new consumption tax policy, consumers are likely to be charged with more tax than before while purchasing baijiu. The second factor is the impact of covid-19. Baijiu is usually consumed and purchased used in a event or for a big moment such as celebration or wedding. The outbreak of Covid-19 happened during the Spring festival when Chinese people usually host their events and a celebration dinner. Between January and March 2020, the output of large-scale liquor enterprises in China decreased by 15.78% compared to the same period last year. The sales revenue of liquor down by 5.67% compared to the same period last year.

Image source: Zhihu, Chinese liquor that is not sold in the west

2. Cheongsam (Qipao)

Cheongsam is the traditional Chinese dress for women. It can be dated back to the Qing dynasty; back then, it was a symbol of Manchu people. The style has remained since and has become more accepted internationally, but has recently been the subject of cultural appropriation accusations in the west.

RuiFuXiang was one of the most famous Cheongsam brands founded in 1893. It started with its silk business. The modern RuiFuXiang ranges its products from different fabrics to Cheongsam tailoring. RuiFuXiang position itself as high-end Cheongsam tailoring producer. The price for Cheongsam tailoring is from 2,000 to 10,000 RMB. However, RuiFuXiang mainly operates in China and its strategy continues to focus on the local market rather than the global market.

ShanghaiTang is arguably the first Chinese luxurious brand. It is a Hong Kong-based brand founded in 1994. Shanghai Tang starts the clothing line that adds Western aesthetics to the traditional Chinese characteristics. Currently, the brand carries clothing, tailoring, home and decoration. Although ShanghaiTang operates across the world, almost 80% of its revenue was from Hong Kong in 2017. Due to the sales pressure, Shanghai Tang CEO said it has been trying to reduce elements of traditional Chinese characteristics in its design in order to become more modern and acceptable for the younger generation,

Image source: Shanghai Tang SS20 collection, fashion products with Chinese characteristic

3. Traditional Chinese Medicine

More than 3000 herbs and 300 minerals and animal abstracts are used as traditional Chinese medicines with more than 400 different formulas. The medicine focuses on the balance of body and spirit rather than the treatment of a particular disease. One formula may contain 4 to 12 ingredients, of which 1 or 2 are the effective ones while the rest aims at treating minor conditions, directing the formula to specific parts of the body or helping other ingredients to take better effect.

Products with Chinese characteristics must include Traditional Chinese Medicine, frequently used in China, very rare in the west

The top companies are TongRenTang (TRT) and YunNanBaiYao (YNBY). TRT was founded in 1669 and was designated for the royal family of the Qing dynasty. The modern TRT has developed into a company that covers the Chinese pharmaceutical industry, retail and health service. By 2011, it has total assets of 140 billion Chinese Yuan and profit of ¥13.16 billion. After its subsidiary was listed in Hong Kong in 2013, it started to expand the overseas market by launching shops in east Asia countries. However, TRT faced difficulties in the western market due to the lack of awareness of eastern herbal medicine.

YNBY was originally a powder medicine successfully formulated in 1902. The modern corporation expands its products line by exploring medical dressing, medical makeup and health products. In the first three quarters of 2019, the company realized a total operating income of 21.646 billion yuan, up 8.36% year-on-year; Net profit was 3.542 billion yuan, up 7.46% year on year

4. Mooncakes

Mooncake is a traditional pastry consumed on the mid-Autumn Festival. According to iMedia Research, the sales of mooncakes in China reached 1.38 billion yuan in 2019 with a sales volume of 19.67 billion yuan. Recently, there are two trends in the mooncake market in China. First, the innovative packaging design and the second trend is the creative new mooncake flavour.

Despite the traditional way of packaging, retailers launched new packaging design to echo with the current trendy movie or topics on social media. For instance, the Mei Xin used Marvel printed containers to attract the younger consumer. It also remains some of its traditional packaging which is often used as a gift during mid-Autumn Festival. The Xin Hua’s survey indicates that more and more Chinese consumer tend to choose mooncakes with simple and environmental-friendly package. Moreover, compared to a big box with 6 or more mooncakes, the younger generation (the 80s and 90s) like to buy single packaged mooncake.

Mei Xin, Dao Xiang Cun and Hua mei are ranked as top 3 popular mooncake brands in China. According to Xin hua news, Mei Xin was ranked as top 1 brand in search engine. Compare to the mooncake in mainland China, Mei Xin well combined the traditional Chinese pastry and the western style bakery. The taste is much modern and more acceptable than traditional flavours.

Mooncake flavor preferences

People from different regions have different taste preference. Traditionally, the filling of mooncake is red bean, five-kernel or lotus. In 2019, the most popular mooncake flavour of the year is “egg yolk”. Others are also very popular such as red bean and meat filling. Additionally, new creative flavour such as durian and ice cream mooncake were also in the top 10 list. However, people in the north region prefer egg yolk, red beans to other flavours. People from the region such as Guang dong and Shanghai prefer sweet filling more than salty filling. Despite of these modern and traditional flavours, brands such as Starbucks and HEYTEA invent interesting and attractive flavours to target the younger consumers.

Image source: Bazaar, Mei Xin Marvel limited-edition mooncake

Image source: SoHu, Starbucks’ mooncakes which are sold in China

Starbucks launched six different flavour mooncakes in 2019 and position its mooncake as high-end westernized mooncake. The price of Starbucks mooncake is extremely high. Each mooncake was priced 60 yuan compared to the 5 to 10-yuan traditional mooncake. HEYTEA, a Chinese chain tea drink retailer, launched its first limited-edition mooncake gift box called “Jade Rabbit moon”. The packaging-design and the name were designed based on the story of Chang. The main ingredients were infused with tea flavour. Both these two products were welcomed in mooncake market in 2019. Many consumers have to pay three times higher than original price for these mooncakes.  

Image source: news.Winshang, Hey Tea mooncake

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Until June 2018, there were 466 business jets in greater China. Then among these aircrafts, there were 163 private jets owned by 113 Chinese billionaires, which increased by 34 private jets from the year before. However, the business jet market size in China could have 1,900 aircrafts on the basis of Chinese enterpreneurs’ purchase power. Hence, the 1,500 aircrifts difference means China’s private jet market is full of opportunities.

Chinese billionaires’ wealth shrunk during the time of the US-China trade war

During the US-China trade war, Chinese wealthy elites tightened their belts, which depressed China’s private jet market.

The Billionaire Report of 2019 shows that after years of steady growth, the net wealth of Chinese billionaires declined by 12.3% in 2018. The number of billionaires in China fell by 48 to 325. The impact of the US-China trade war is a key reason for the decline. 5 years ago, China’s wealthy had more than doubled their net worth.Since then, millionaires in China became more economically conservative.

Prices of business jets are likely to come down, as potential buyers are now finding that they can no longer afford such high expenses. In addition to purchase fees for private jets, owners also need to pay for their maintenance and operation yearly. Generally, the yearly additional expenses for a private jet takes one fifth of its purchasing price, amounting to 33 million RMB for yearly maintenance costs, 20 million RMB for yearly operation costs and a large expense for crew salaries.

The number of billionaires in China

China’s top 10 billionaires and their private jets

Gulfstream is the most popular aircraft producer. Among wealthiest six Chinese entrepreneurs, give chose Gulfstream 550. In China’s private jet market, Gulfstream G550 is Chinese wealthy favorate private jet model. There are 77 gulfstream jets in China, including 39 G550. In addition, there are 36 Bombardier series and most people bought bombardier challenger 605 (12). Other popular private jet producers include Dassault (23), Airbus (10), Embraer (9), Boeing (5) and Cessna (3).

Geographically, Beijing, with its robust economy, has the largest number of business jets, with a total of 34 and it accounts for 21%. Then there are 29 in Yangtze cities including 9 in Shanghai. The third city with most business jets is Hong Kong (25).

What will happen to the private jet market in China post-Covid-19?

Under the impact of COVID-19 in China, domestic and foreign airlines suspended their flights. Under this circumstance, more flexible and safer private jet has become the first or even the only option for many people, creating the busiest quarter in the history of China’s business aviation. Many wealthy Chinese students who were stuck abroad during COVID-19 chose private jets to come back to China and the price of private jet charter rose dramatically. For instance, the price of chartering a private jet with 14 seats rocketed by 30% from 1.35 million RMB to 1.74 million RMB in March. Some student paid an astonishing 180,000 RMB for a ticket home.

It is a good news for China’s private jet market as the propagation of COVID-19 promoted the demand of private jet and people has become more familiar with it. On April 9th, a new Gulfstream G650 landed in Liaoning, as the first private jet delivered to China after the outbreak of COVID-19. Although the number of certain buyer of private jet in China is not very much, potential customers increases in terms of purchase consultation. Therefore, the vice president of OHFLYER, Haiyang Wang, said that the demand of private jet in China will definitely be higher than before COVID-19.

The private jet charter market and air taxi market are soaring in China

The private jet charter market will promote China’s general aviation development

The charter of private jets is a great choice for Chinese passengers because of its convenience and status symbol. Like luxury watches, social status is an important purchasing impetus for Chinese consumers. We can see a soar in China’s demand for charted private jets as countries become more wealthy and companies adopt more economic travel polices for their trips.

JetSolution, an aviation group based in Hong Kong, is profiting from plane charter service. The company recently bought Embraer Legacy 600 (carrying 13 passengers) to execute flights. The plane features a luxurious interior with large leather chairs and sofa beds and can fly up to seven hours without refueling. Besides, passengers can choose from a selection of fine wines and top-class cuisine.

On another hand, Airports in China are beginning to catch up with the trend. More than 300 airports now accept private jets, with the number expected to increase to about 500 by 2020. This is good news, since the construction and improvement of airports and infrastructures will promote the development of China’s aviation industry.

The “air taxi” will be best mode of transportation in the future

In addition to the charter of private jets, “the air taxi” will be an excellent choice for people to travel in the future in China. The drones market in China has soared in recent years. In 2016, the Ehang 184, invented by China, was unveiled in Las Vegas. The invention of the flying machine marks another breakthrough for robots in the field of urban transportation. The latest drone of Ehang, the Ehang 216, is powered by 16 electric rotors and can fly along a pre-planned route at over 80 mph. The aircraft weighs about 600 pounds and can carry another 500 to 600 pounds of cargo or passengers

Ehang is one of dozens of companies convinced that “flying cars” will become a viable mode of urban transportation in the future. And recently, Ehang received approval from Chinese regulators to launch a commercial air mobility service in Guangzhou. AI in China’s transportation industry is developing dramatically and “the air taxi” could eventually become the best choice for passengers in the near future due to congestion caused by explosive growth of urbanization in China.

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With its emergence as a strong global economy, opportunities for mergers and acquisitions in China have increased in number and scale. However, financial, regulatory and cultural complexities surrounding Chinese transactions present unique challenges. Despite the overall global economic decline, M&A in certain sectors such as TMT and industrials remained active in 2019. The global factors impacting the future of the China’s M&A market are segmented into three scenarios.

These three scenarios include: The U.S. China trade tensions stabilizing through phased agreements. Second, China’s new foreign investment law and policy coming into play. Third, China’s planned new rules to open up certain heavily regulated industries such as automobiles and financial services. Therefore, the 2020 and 2021 the outlook for China’s M&A market be more active than in 2019, especially in those industries and particularly through inbound deals.

Looking deeper into 2020 and beyond, Chinese outbound transactions focused on strategic areas will continue to be a main driver for Chinese outbound M&A activity in the region. However, continued tensions between the U.S. and China in combination with the hurdles presented by national security reviews may dampen China’s interests in outbound activities to the U.S. and Europe. On the other hand, multinational companies in China will continue to review their domestic China market strategy and reevaluate their interests in forming partnerships with Chinese firms. As a result, this will drive support for steady deal activity. Furthermore, sponsors will remain active in Greater China with additional capital to deploy attractive valuations.

Legislation and Policy Changes in China’s M&A market

There is no single law or regulation specifically regulating M&A in China. An M&A deal may involve many laws and regulations. For example, PRC Company Law may be relevant when designing the corporate structure of the target company. PRC Securities Law and its supporting regulations may come into play in a public M&A transaction. Contract Law may govern when an asset purchase is part of the deal. Employment Law and Employment Contract Law may come into play when employees need to be transferred in the transaction. In addition, tax law is always relevant, and foreign exchange policy and regulation is important when payment of the deal needs to be made cross-border. Antitrust Law may be relevant if a deal meets a certain threshold triggering a regulatory requirement to make a filing.

The Foreign Investment Law, which took effect on January 1 2020, will replace a collection of decades old laws with a single, unified and streamlined legal and regulatory framework for foreign investment that is applicable nationwide. The Chinese national legislature passed the Foreign Investment Law with the aim of creating a better business environment for overseas investors. Inbound investment via M&A in China is expected to reach $1.5 trillion dollars over the next 10 years according to a report from Xinhua News.

The Foreign Investment Law seeks to protect the rights of foreign investors and their intellectual property, and clearly incentivizes them to invest in China. It also helps Chinese companies move up the value chain. The evolving nature of China’s consumer economy and the desire for Chinese industry to continue to move up the value chain are two particularly important drivers of economic opportunity. These factors are expected to boost inbound M&A transactions in the future.

Defining M&A: Types of Mergers and Deal Players

A merger is the process by which two or more companies merge together as one new company. Acquisition often refers to the process when a financially stronger company acquires over 50% of shares of another company and brings it into its own operation. Companies can also engage in a minority share, majority share, equal share and buyout scenario acquisition. The decision of which option to take is tied into a corporate’s strategy and growth plans. Additionally, it is important to consider acquisition structure, as each option offers varying degrees of control and various other trade offs. There are five types of mergers: horizontal, vertical, market-extension, product-extension, and conglomerate mergers.

Moreover, M&A acquirers fall under two broad categories. First are strategic investors, which are operating companies looking to buy other businesses in order to expand or defend market share and enhance profitability. The second are private equity investors (or financial buyers). Financial buyers are buyers that purchase minority stakes in start-ups, mid-growth enterprises and mature businesses using funds pooled from individual investors. Financial buyers typically aim to eventually sell out at a profit through exits such as initial public offerings (IPOs) or a sale to strategic investors.

Global M&A Market

Global M&A made a strong showing in 2019. This came as stock markets reached all-time highs, private equity firms raised record funds, and companies searched for growth and other ways to address technological and economic disruptions. This was impressive given the fears of a potential recession, stock pull-backs in certain markets, increasing trade disputes, as well as heightened national security and competition concerns.

However, global M&A value in 2019 lagged behind 2018 numbers for much of the year. But, a surge of deals in Q4 2019 drove total M&A value to $3.9 trillion dollars, just 3% lower than 2018. This made 2019 the fourth biggest year for M&A since 1980. In particular, M&A value rose for deals in the United States and Japan, but fell for deals in Europe and the rest of Asia. Healthcare, technology, and energy were the most active sectors, accounting for about half the overall volume.

[Source: IMAA analysis, Worldwide M&A and Chinese M&A statistics]

In 2019, M&A involving Chinese targets totaled roughly $170 billion dollars, but represented only 5% of all global M&A volume. This is a small share compared to M&A involving U.S. targets, which made up more than half of global M&A volume in 2019. This makes China vastly underrepresented in the global M&A market in consideration of and relation to the sheer size of the Chinese economy. GDP in China was $15 trillion in 2019 compared to $22 trillion in the U.S. Also, 2019’s volume for deals involving Chinese targets was the lowest since 2014, which has been part of a downward trend over recent years following a peak in 2015.

China’s M&A Market: Top Industries 2000-2016

From 2000-2016, China’s industry with the largest M&A activity in terms of transaction value has been the financial sector. Which has represented 16.8% of all deals with a total value of $753 billion dollars. The second most important industry by value is the materials sector with $558 billion dollars worth of transactions. The industrial industry reached the third rank with $527 billion of deals.

The industry with the largest number of transactions has been Industrials, which has represented 14.2% with a total number of over 9,737 transactions. The second most active acquirers are companies from Materials with more than 9,516 deals accounting for 13.8% of transactions. Lastly, Financials companies are the third most frequent industry in terms of consolidation with 13.8% of all deals.

[Source: IMAA analysis, Announced M&A in China and Hong Kong by Industries (2000-2016)]

At the micro level, in 2018, 2,584 takeovers with Chinese participation took place. The leading five sectors of company takeovers with Chinese involvement based on the total M&A transaction values were real estate, financial telecommunications with value-added services, energy, mineral deposits, and chemical processing. The M&A transaction value amounted to around 113 billion yuan in the real estate sector. In terms of volume, the sectors with the largest amount of M&A company takeover transactions in China were the IT, biotechnology/pharmaceuticals, mechanical engineering, finance, and electronics sectors.

[Source: Statista, PEdaily.cn, Value and number of M&A transactions with Chinese involvement by sector]

Assessing China’s M&A Market

To measure China’s M&A market in its entirety, any assessment must include the added values of 1) domestic strategic buyers, 2) foreign strategic buyers, 3) private equity deals, 4) Hong Kong outbound, and 5) China mainland outbound.

In recent years, the landscape of China’s M&A market has changed fundamentally. While the growth of inbound, outbound, and domestic M&A has been affected by global economic downswings and fluctuating Chinese growth, more and more Chinese companies will continue to seek opportunities through oversea Belt and Road M&A and domestic consolidation.  China’s leading sectors for M&A in Belt and Road countries are oil and gas, diversified industrial products, financial services, TMT, power and utilities, consumer products, mining and metals.

China’s M&A market experienced a slow start in the first half of 2019 but picked up considerably after June. Nonetheless, the market has slowed indefinitely. In particular, the principal drivers of the 14% decline in China’s M&A deal values were the domestic and outbound sectors. The drop in outbound M&A and private equity (PE) resulted in the lowest year for deal values since 2013. According to Dealogic, announced M&A deals in China amounted to $486 billion, as compared to $562 billion in 2018 and $661 billion in 2017. While inbound M&A remains stable ($30 billion in 2019, a slight decrease from $33 billion in 2018), both outbound deals ($53 billion in 2019 compared to $72 billion in 2018) and domestic deals ($368 billion in 2019 compared to $440 billion in 2018) saw a notable downturn.

[Source: JPMorgan, Dealogic, China M&A announced $ volume ($billion)]

Most M&A transactions of Chinese companies still take place in the domestic market. Roughly 80% of all Chinese M&A activity is domestic, involving both Chinese acquirers and Chinese targets. The expectation is that the bulk of M&A volume going forward will be accounted for by foreigners investing in, or acquiring, domestic companies. Also, by domestic companies merging with and acquiring each other. The key drivers here include rising purchasing power and private consumption, the government’s desire for foreign funds and expertise for SOEs as it fully opens sectors of the economy to foreign competition, and a more relaxed regulatory regime that, for example, has expanded the scope and geographical reach of wholly owned foreign enterprises (WOFEs).

The economically better developed regions such as China’s largest cities Beijing and Shanghai still lead the market. In 2018, 299 M&A transactions were completed in Beijing with a transaction value of around 207 billion yuan. In line with China’s economic reforms, foreign buyers will increase their activity in China’s M&A market in those sectors and areas favorable to making deals.

In China, especially those MNCs in consumer/retail and enterprise service sectors continued to explore strategic reviews and partnered with local players. Some of which were structured as a divestiture of a controlling stake. High-profile transactions in this category include Metro China’s partnership with Wumart, Carrefour’s partnership with Suning, and DHL’s sale of its supply chain business to SF Express. This is a continuation of a theme that has gained strong momentum since 2017, as companies such as McDonald’s, Yum! China, Heineken, and Salesforce partner with Chinese companies to strengthen their competitiveness in a fast-changing local market.

Outbound and Inbound M&A

[Source: IMAA analysis, Dealogic, Announced M&A from China to abroad (outbound) and M&A by foreign acquirers into China (inbound)]

China was not a major player in global investment until the mid 2000s. Driven by policy loosening by Beijing and favorable global conditions, its outbound FDI (OFDI) grew from next to nothing to an average of almost $50 billion per year in the late 2000s. Easy money and loosening of Chinese policy in 2014 boosted flows to more than $200 billion in 2016, eliciting both enthusiasm about fresh capital and anxiety about economic and security risks.

Since 2016 China’s outbound investment has been on a downward trajectory. Outflows dropped precipitously in 2017 and 2018 after Beijing restricted “irrational” outflows. In addition to domestic regulators, Chinese investors also were confronted with greater regulatory and political scrutiny abroad, as economies tightened investment screening regimes due to concerns about China’s compatibility with their democratic market economies.

Global outbound direct investment dropped

In 2019 this downward trajectory continued with China’s global outbound foreign direct investment dropping back to 2014 levels. Official Chinese statistics show a modest decline in outbound FDI for the year: MOFCOM reports outbound FDI at $117 billion for January-December 2019, a decrease of 9.8% from the same period in 2018 in dollar terms. The global M&A component shows a deep drop, with newly announced 2019 deals at $50 billion, versus $80 billion in 2018, amounting to the lowest level in eight years.

Thus, China’s efforts to cut debt levels combined with the negative effects from the trade war have cut into outbound deal activity by Chinese firms. China’s outbound M&A fell back relatively to 2015 levels in value terms, with various factors combining to severely curtail large sized cross border transactions. However, there is still a good amount of smaller sized outbound transactions taking place with overall deal volumes holding up.

Chinese outbound M&A players are segmented by three categories: state owned enterprises (SOEs) , privately owned enterprises (POEs), and financial buyers.

POEs remained the most active overseas buyers in terms of volume although the overall value of those deals fell with considerably fewer mega deals. Mirroring the domestic scene, outbound deal values were strongest in the industrial and consumer sectors, but larger-sized high-tech deals took a significant hit due to the various sensitivities in this vertical. Furthermore, outbound M&A in the energy and power sectors, materials, and healthcare saw relative downturns in deal value.

Smaller outbound transactions less affected

However, in terms of deal volumes, outbound activity continues to be reasonably robust with smaller transactions being less affected. China’s strategy to acquire technology know how, IP, and brand strength to put to use in the Chinese market is continuing despite the headline declines in larger deals. Therefore, Chinese outbound M&A in the high technology, industrials, consumer, healthcare, financial, and materials sectors all carried out a high number of deal volumes.

Outbound M&A with Europe

In terms of geographies, the squeeze in outbound deal values is now evident in Europe with significant declines in the bigger markets of Germany ($6.5 billion in 2019 from $11 billion in 2018) and UK ($1.4 billion in 2019 from $4.5 billion in 2018). Chinese FDI in the European Union declined for a third straight year in 2019. The combined value of completed Chinese FDI transactions in the EU fell to EUR 11.7 billion, down 33% from 2018 levels (EUR 17.4 billion). This represents the lowest investment level since 2013 and a drop of 69% from the peak of EUR 37.3 billion in 2016.

But, this drop was not specific to the EU. Chinese global FDI fell in 2019 due largely to domestic variables which made it more difficult for Chinese firms to raise funding and get approval for overseas investments. The global decline also reflected a growing political and regulatory backlash against Chinese acquisitions, particularly in the U.S., but also in Europe.

Belt and Road countries and Latin America

Outbound activity to Belt and Road countries held up reasonably well in the context of the otherwise significant declines in deal values seen elsewhere. Furthermore, despite China’s outbound volume being down y-o-y, outbound activities remained active for investments into the Asia Pacific (outside China), Latin America, and EMEA. Consistent with China’s strategic needs, outbound investments in power and utilities, technology, and industrial sectors experienced strong momentum in 2019, with notable transactions including Three Gorges’ $3.6 billion cash acquisition of an 84% stake in Peruvian electric company Luz del Sur, Beijing Auto’s acquisition of a 5% stake in German automaker Daimler, and Jiangsu Shagang Steel Group’s $2.2 billion acquisition of London-based Global Switch Holdings.

In sum, the trade war between the U.S. and China along with a tightened CFIUS approval processes made Chinese buyers increasingly cautious when considering targets with significant business presence in the U.S. The expanded CFIUS jurisdiction that is expected to be implemented in 2020 will likely generate further headwinds for Chinese investment in the U.S., particularly for targets involved with advanced technologies, critical infrastructure, or sensitive personal data.

Added to the mix were national security reviews in Europe, which further drove the decline in outbound M&A from China. Thus, the uncertainty in M&A deals increasingly came from antitrust regulators across the globe. This trend makes early planning and engagement with the regulatory bodies in the cross-border deal making process a priority.

Concerning Chinese inbound M&A, while overall deal values and volumes posted marginal annual declines of 1% each, the M&A market avoided much deeper downtrends amid trade tensions with the U.S. and economic growth uncertainties domestically. Real estate, financial services and telecoms remain the sectors where M&A transactions with the largest deal values took place.

Dealmakers in the Chinese M&A market can expect to find opportunities in industries such as AI, advanced manufacturing, Fintech and healthcare. Particularly, the industrials and technology areas amongst other sectors are showing signs of robust growth. Moreover, on the regulatory front, China has begun a campaign to ease restrictions on foreign investment as it continues to open up the market. This could result in further inbound M&A, particularly from the U.S. should there be a thaw in trade negotiations currently taking place.

Important Considerations for Navigating China’s M&A Market

1. Magnitude of investment
2. How it varies across industries and locations
3. How it compares to levels of greenfield FDI over time
4. Horizontal (market access) versus vertical (integrating supply chains) transactions
5. Mode of financing
6. Diversifying transactions versus those in the same industry
7. Patterns of control acquisition
8. Strategic versus financially motivated transactions

Takeaway: What CEOs are saying?

According to the 2019 KPMP China CEO outlook survey results, 48% of CEOs in China believe that the most important strategy for achieving their growth objectives in the next three years are forming strategic alliances with third parties and conducting M&A transactions. In that same survey 56% of CEOs are reported to having a moderate M&A appetite, with 29% having a strong M&A appetite, and 15% having a low M&A appetite. Thus, in spite of the current global economic and investment climate, CEOs are still focusing on the opportunities in the Chinese M&A market.

The primary drivers for M&A among China’s CEOs ranked (in order) are: to reduce costs through synergies/economies of scale, to diversify the business, to transform the business model faster than organic growth, to increase market share, to on-board new digital technology/innovation, to take advantage of favorable valuations, to eliminate direct competitors, and to utilize cheap financing before interest rates rise.

Thus, in M&A consideration, it is important to assess the market value and proposition for each party in the deal, specifically what benefit a foreign stakeholder may bring to a Chinese enterprise. Concerning the benefits of M&A dealmaking with foreign MNCs, Chinese participant enterprises stated that expanding brand awareness, increasing market share, improving technology and productivity, increasing margins, and reducing costs were some of the benefits of engaging with oversea businesses in M&A deals. In addition, M&A benefits include: extending their upstream and downstream industrial chains, industrial transformation and upgrading, and cross-industry diversified operations. Thus, leading overseas businesses can reference these contributions from foreign MNCs to Chinese enterprises following the M&A deal to craft their own proposition.

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About Lexus

Lexus is the luxury vehicle division of Japanese automaker Toyota Motor Corporation. First introduced in 1989 in the United States, Lexus is now sold globally and has become Japan’s largest-selling make of premium cars. The Lexus marque is marketed in over 70 countries and territories worldwide, and ranks among the ten largest Japanese global brands in market value. Lexus is headquartered in Nagoya, Japan. Operational centers are located in Brussels, Belgium, and Torrance, California, United States. Since officially entering the Chinese market in 2004, Lexis has been in China for over 15 years and the demand for Lexus China is strong during the period.

Since its inception, Lexus has advertised its products to luxury consumers using specific marketing strategies with a consistent motif of luxury. Industry observers have attributed Lexus’ early marketing successes to higher levels of perceived quality and lower prices than competitors, which have enabled the marque to attract customers upgrading from mass-market cars. Lexus’ marketing efforts have also extended to sporting and charity event sponsorships.

Lexus in the Chinese car market

The Chinese car market is shrinking while the revenue of luxury auto brands continues increasing

The Chinese car market the world’s largest car market, saw consecutive drop after decades of growth in 2018 and 2019 because of a cooling economic and trade war pressures. According to data released by the China Passenger Car Association, the number of passenger vehicles sold in China dropped to 20.7 million in 2019, decreasing for 7.4% from 2018. That exceeded the 3% drop in 2018. However, the sales and revenue of luxury car market in China showed a stable upward trend in recent years. In the period from Jan. to Nov 2019, the market share of luxury car brands in China reached around 10.8%, increased steadily from 6.1% in 2015. The sales of luxury cars amounted to 200.24 thousand in the September of 2019, with a 18.6% year-by-year rise.

[Data source: huaon.com, Luxury car market in China growth]

Lexus China saw strong sales in recent years

Despite the downward pressure in the Chinese car market, Lexus reported 148,976 sales in China from January to November 2018, up 24% year over year. In 2019, Lexus China maintained double digit sales growth of 25% and delivered 200,521 vehicles in China. 2019 was the third year that Lexus has a sales growth of more than 20% and was the year in which Lexus sole its millionth vehicle in China. Lexus was the fifth-largest luxury car brand in China in 2019, following BMW, Mercedes-Benz, Audi and Cadillac. Lexus accounted for approximately 5% of the Chinese luxury car market and wished to occupy 10% of the market by the end of 2020.

The market strategy of Lexus in China

Create a strong brand image

Breaking away from Toyota’s brand system, Lexus has committed to establishing its unique brand values ​​and propositions in order to be recognized as a luxury lifestyle brand. The core brand value of Lexus, the luxury vehicle division of Toyota corporation, is comfort, luxury and pursuit of perfection, which contradicts that of Toyota. So, Lexus creates its own brand culture as well as the matching marketing strategy.

For brand identity, while Mercedes Benz always tries to convey that it is a matter of pride and prestige to own a Mercedes and BMW emphasizes “the pure driving pleasure”, Lexus lays emphasis on its “3S” spirit (SEIKAKU +SHINSETSU=SHINRAI) when marketing. It is wise for Lexus to emphasize “customers first” since it satisfies customers’ increasing demand for high-quality service in the background of consumption upgrades. The core marketing philosophy helps Lexus build a positive brand image among Chinese customers.

Word-of-mouth marketing

In the new era of consumption, brands must try their best to create word of mouth among their fan groups. Lexus attaches great importance to the user experience, and perform word-of-mouth marketing based on user experience. For example, Lexus China invited well-known designers to create five-star 4S stores as well as generally praised exhibition hall, and it launched a Mysterious Visitor Plan in order to increase customer satisfaction. Also, to ensure the customer loyalty, Lexus focus on building fans communities. Since 2006, Lexus in China has implemented a maintenance plan, launching a series of campaigns such as golf tournaments, concerts, tree planting, and environmental protection days. Through the building of communities, Lexus is able to established emotional resonance with its customers and thus deepen the connection between the brand and the customers in China.

New marketing

[Source: Lexus China weibo account, “Lexus’s film – ‘Life Movie’”]

Lexus China has launched its new marketing strategy and held a series of diversified and creative campaigns including crossover marketing (IP marketing) and microfilm marketing. Lexus officially launched the Lexus UX into China’s market on January 23 and held the conference for this brand-new model teamed up eight other brands: ThinkPad, Kindle, New Balance, Godiva, Monster, Visa, 3M and Coca Cola. Jointly designed poster as well as the brand windows of all brands displayed at the press conference aimed to convey the common concept “Attention to details”. In this case, Lexus’s brand image of obsessing over details is more well-known among Chinese consumers. Also, Lexus successfully attract the young and sophisticated urban consumer with this crossover marketing campaign since all these brands are targeting the same consumer group.  

Another example is the launch of Lexus’s film to promote RX line of luxury SUVs in October, 2019. The short film, one of Lexus “Life Movie” series films, explores intergenerational conflict and the power of music with the thesis of musical nostalgia. Yu Qian, a popular Chinese crosstalk performer, and Huang Bo, a famous Chinese actor, played two main characters. The nostalgia-driven film successfully appealed to Lexus’s target consumers, relatively older, affluent people by evoking a feeling of sentimentality. The film got more than 3 million views on Weibo, and received numerous positive feedbacks, which showed the success of the new market strategy of Lexus in China. 

Under the spread of coronavirus: Impact on auto manufacturing in China caused a crisis for Lexus

Toyota opposed producing its premium Lexus cars in China for years because of concerns over quality and profitability. However, this may lead to great troubles of Lexus under the spread of coronavirus.

On the one hand, as the first country to break out of the epidemic, China has made achievements in the fight with the virus, and reopened Wuhan after a 76-day lockdown, which means all the country is able to resume work. At the same time, Japan declared a Coronavirus Crisis on April 7 and is still struggling to contain the outbreak. Since all the Lexus cars in the Chinese market are built in Japan, the production of Lexus might be affected due to the possible shutdowns. On the other hand, the competitors of Lexus in China, like Mercedes and BMW, reopened their Chinese factories and resumed production in February. In this case, the gap between Lexus and its competitors may widen due to the shortage of production capacity.

From a demand-side perspective, the negative impact of COVID-19 on the Chinese economy may last for a long time and there will be a fall in demand for luxury cars. In addition, the price-fixing on Lexus cars last year harmed Chinese customers’ rights and caused complaints among consumers, causing a decline in the reputation of Lexus cars. So, a decreased demand for Lexus cars in the Chinese market this year is expected.

Overall, under the spread of coronavirus globally, Lexus in China is facing crisis. However, if Lexus can come up with good solutions to ensure its production and continue taking advantage of marketing, it may succeed in the luxury car market in China again.

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China has become Swarovski’s Largest Market

In 2016, the annual sales of Swarovski in China reached 1.7 billion Yuan, with a 13% increase from the year before. Since then, China has surpassed the United States to become the biggest market for this Austrian Crystal producer.

Swarovski’s Consumers in China

According to Swarovski’s investigation, Chinese consumers, on average, are ten years younger than consumers in the rest of the world. Specifically, young consumers in China are digital-savvy. They are keen on sharing products and shopping experiences on social media and social network platforms.

Exploiting Business Opportunities in China: Swarovski’s Marketing Strategies

Swarovski has long placed great emphasis on Chinese consumers. According to Swarovski’s CEO Robert Buchbauer, Swarovski has strategically grown and nurtured the Chinese market by focusing on three aspects: quality products, market distribution, and e-commerce.

Using Traditional Chinese Elements in Designs

Swarovski has shown appreciation for the profound history and culture of China. In addition to offering the highest quality glass crystals, Swarovski has devoted to understanding the Chinese culture and consumers’ preferences for the products and designs. In 2019’s Chinese New Year, Swarovski unveiled limited-edition collections for this traditional festival. For instance, red, symbolizing good fortune and joy, is the theme color during the Chinese New Year. With this insight, Swarovski issued the iconic swan bracelet and pendant in a red color, which became quite popular among Chinese consumers.

Source: VOGUE China, Advertising of 2019’s Chinese New Year Red Iconic Swan Collection

In 2019, Swarovski in China started to cooperate with the Palace Museum intensively. Diving deep into the Chinese culture, Swarovski is skilled in mixing fashion with traditional Chinese elements. Furthermore, on Nov 21, 2019, Swarovski signed a cooperation agreement with the China Cultural Heritage Foundation to protect cultural heritage in China. The China Cultural Heritage Foundation initiated the project “Growing Sapling”. The project works to protect, promote, and better the inheritance of intangible cultural heritage in China.

Swarovski’s attempt of New Retail in China

Swarovski is a popular jewelry brand in China. At the end of 2019, Swarovski has almost 400 stores in China. These stores have covered more than 100 cities.

Swarovski’s precise positioning and product segmentation contribute to its popularity in both first-tier cities (e.g., Shanghai, Beijing) and second and third-tier cities without jeopardizing the brand value. For instance, as a high-end line, Swarovski’s Fine Jewelry uses high-end materials with stylish designs while the price of Swarovski’s Fashion Jewelry is more affordable. The Fashion Jewelry collection is fit for every woman for any occasion. As a result, Swarovski has tapped the new opportunities created by the upcoming boom in China’s second- and third-tier cities. Swarovski is trying to raise its brand awareness among Chinese consumers in these cities with a plan in 2020 to cover an additional 30 cities.

Source: ctrip, Traditional Swarovski Store

New retail Crystal Studios

Swarovski has opened two Crystal Studios in Shanghai and Beijing, respectively, in 2019. As an attempt to dip a toe in the realm of new retail in China, Crystal Studio is a dynamic and creative space. The studio offers a memorable, highly interactive, and socially focused environment.

Compared to traditional Swarovski stores, the Crystal Studio is more open and interactive. The heart of the shopping experience in the Crystal Studio is at the Sparkle Bar. It is an immersive jewelry station where consumers can spend time discovering new products, curating looks with styling consultations from Swarovski’s in-store experts, and exploring product ranges virtually. Shoppers are encouraged to touch and try on a range of products by using the variable lighting settings at the Sparkle Bar mirror.

They are also encouraged to explore the digital styling inspiration by themselves. The Crystal Studio is digital, with a warm and enchanting color palette. The Crystal Studio discarded the traditional advertising lightbox. Instead, it uses LED screens to display the latest brand information and the newest product collections. The Crystal Studio also provides digital devices and even has a wireless phone charging area. This way, consumers can easily share their photos and shopping experiences on their social media.

Source: Baidu, Swarovski’s Crystal Studio in Bejing

E-Commerce: How Swarovski in China is Winning over Consumers

Tmall

Among the first wave of western brands taking advantage of the vibrant Chinese e-commerce market, Swarovski opened a flagship store on Tmall in 2015. Today, the flagship store on Tmall has 4.86 million followers. In 2019’s Double 11, the sales of Swarovski ranked No. 4 among jewellery brands on Tmall.

Unfortunately, Swarovski’s flagship on Tmall faces the trouble of counterfeit products. In 2017, Alibaba sued two Tmall merchants for selling fake Swarovski watches on the online platform. Counterfeit products caused the loss of sales as well as damage to the brand reputation. However, Swarovski’s CEO Robert Buchbauer took a supervising perspective in dealing with counterfeit products. He said that consumers who purchased counterfeit products were not the target consumers of the brand. As a result, Swarovski’s expansion in Chinese e-commerce has not been restricted by counterfeit products.

Today, Swarovski in China has set up a presence on JD.com, another key player in e-commerce. It also has its own official website.

Source: Tmall, Swarovski’s flagship on Tmall

WeChat

On May 10, 2017, Swarovski launched a mini-program on its WeChat Official account. Consumers can order products, manage their membership status, and look for offline stores by using their WeChat mini program. WeChat store is believed to increase consumer engagement, brand awareness, and purchases (both online and offline).

Besides, Swarovski benefits from WeChat’s interactive campaign. In 2018, Swarovski in China discovered through the success of its Christmas campaign on WeChat. Over the month of December, Swarovski teased an “Advent Calendar” box of products that included three full-price gifts and twenty-one free gifts (sales price: 2,980 Yuan). Every day, consumers visited the mini-program, took part in various kinds of games, and interacted with their friends who also joined the campaign.

The campaign allowed Swarovski’s WeChat official account to generate a significant increase in the number of followers. The sales of the “Advent Calendar” box was also remarkable. It sold out within ten days.

Source: Luxury Society, Swarovski’s 2018 Christmas Campaign on WeChat

Other Social Media and Platforms

Swarovski has official accounts on Weibo, Xiaohongshu, Douyin, and more. Content and recommendations generated by consumers in these platforms have promoted Swarovski’s online and offline sales as well.

In 2019, Swarovski uncovered the Lifelong Bow edition for Valentine’s Day. The Lifelong Bow Y Necklace became quite popular and is highly recommended by key opinion leaders on Xiaohongshu—even has a nickname “fairy’s necklace” (in Chinese: 仙女链). As a result, the necklace was quickly out of stock around the world. 

Source: Xiaohongshu, A Trending Post Considering Lifelong Bow Y Necklace on Xiaohongshu

Combination of offline and online marketing

Swarovski in China has found success through a combination of online and offline. O2O strategies in China are increasingly common. This model of new retail is fit for a population with an increasingly high mobile phone adaption. Digital strategies on Tmall and Xiaohongshu bring the brand to consumers all over China, while the experiential stores bring the brand to life.

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Full transcript below:

Matthieu David: Hello everyone. This is China Paradigm, where we, Daxue Consulting, interview seasoned entrepreneurs in China. Hello everyone. Today, I am with Vincent Ghossoub. I met you in Hong Kong at an event for tech startups and I thought I had to interview this guy because you are in between China and the Middle East. I’ve interviewed many people who were in between the US and China or Europe in China, but you’re in between two parts of the world we rarely talk about and still, there’s a lot to do. You’re in an industry where China is playing a big part. It’s China’s game industry.

Tencent and many other studios are developing games for the world. That’s something I discovered through research we did for one of our clients. One-third of the top 100 apps in India are Chinese. Now people understand how China can be big in apps when we talk about TikTok. But so far it has been a bit unknown how big it could be. So, you have co-funded Falafel games. Maybe, you will tell us more about your co-founders later. You co-founded Falafel Games in April 2010 and you are still the CEO up till now. So, for close to 10 years, you’ve been adapting and developing games for the Middle East from China. I’m sure you’re going to correct me about what you do exactly, but you are adapting and developing games for the Middle East from China and you are also pushing them, doing some marketing, and contributing towards the acquisition of this game in the Middle East, and further than Middle East—Arab-speaking countries, if I’m correct.

You have raised money. You have raised several million. My number is 4.7 million so far from very actually interesting investors such as the Irish SME Association, Middle East Venture Partners, and twofour54 which is an Abu Dhabi-based incubator. And again, that shows me how the links between the Middle East and China can be. One more number: you are attracting, on your different platforms and games, more than 2 million users. And in one interview, we found out that you have been able to monetize on average $0.50 per day per user. Thank you very much for being with us. So, what do you do exactly? What’s your business model? Who are your clients?

Vincent Ghossoub: First of all, thank you very much, Matthieu, for having me. You did a great presentation and introduction explaining what I do. To answer specifically, the clients of Falafel games are basically end-users mostly based in Arabic speaking countries as you mentioned. And half of our revenue comes from Saudi Arabia. 

Matthieu David: Okay. When you say that your clients are the users, does it mean that you develop games for the Middle East from China? It’s not what I understood initially. I understood that you were taking games from China or from wherever in the world to adapt them to Arabic speaking countries.

Vincent Ghossoub: We do have this line of business currently. So, basically, we publish games. We find games that perform well in China’s game industry that are just about launched and the KPIs are okay. We approach the developer and we offer them the opportunity to promote the game in new markets such as Arabic-speaking markets and now increasingly Persian-speaking markets. So that’s one line of business. We do also develop our own games in parallel. And we have a live streaming platform from China also. 

Matthieu David: True. I remember when we met, you actually insisted on your live streaming platform from China mainly initially. Would you share a bit more about the size of the company now? I mentioned $4.5M raised so far as investment and 2 million users. I don’t know if it’s daily or yearly users. Would you mind sharing a bit more numbers, your offices, the size of the team, or the size of the company? Can you share some revenue numbers and confirm the numbers I just mentioned? 

Vincent Ghossoub: Yes. So, your numbers are not too far off—maybe they date since our last discussion. In fact, from the Arabic-speaking markets, we have 3 million cumulative users. This is the number of members of users who have installed any one of our games. And our games are focused on the mid-core category. So, the mid-core category is generally speaking very lucrative per capita. But in terms of volume, it’s quite niche. So, 3 million installs out of a market of, let say, 50 million people in Saudi and GCC, which we specifically focus on as a specific target market in the whole Arabic-speaking market. I think it’s quite an okay penetration. In terms of company size, we have sales of a few million. We have about 28 people in most places between China and Beirut, Lebanon. Yeah, as you said, we raised $4-5M over the course of the years. Yeah, generally speaking, this is the outline.  We have launched six or seven titles so far.

Matthieu David: So, thank you very much for clarifying the size and what you do. More precisely in China’s game industry, you are talking about a niche of games or apps. What’s the name of this niche you’re targeting?

Vincent Ghossoub: Most of us in the industry call it mid-core. So, it’s between casual and hardcore. I’ll try to simplify it with as few parameters as possible. It’s basically the time commitment needed by a user to spend on a game. And the attention needed to put on a game while playing is more or less what defines the whole continuum from casual to mid-core to hardcore. 

Matthieu David: I see. Are there some examples that people can know? 

Vincent Ghossoub: Yes, of course, instead of being too abstract with the definitions. So if you were to spend, for example, both hands on your phone screen on a game and 100% of your attention over the span of one hour and a couple of hours every day and over a few months, this is a lot of time commitment, especially that your full attention is taken when you’re playing the game and both hands are taken. So, this is hardcore. But if you are, let’s say, to spend one or two hours a day over a few months also, but with much less attention when you use it… let’s say you open the game, you do a couple of turns, you switch to email and nothing happens, you have a discussion, you have a call, you come back to the game, and you readjust your situation on the game and then keep going. With sessions of say, 30 seconds and maybe 30 sessions a day, this is mid-core. And then casual is like you can play in a minute and then you don’t have to commit for days or months.

Matthieu David: So, one example that everyone knows is Tetris. Will Tetris be casual, mid-core or hardcore? 

Vincent Ghossoub: Yeah, Tetris is casual. 

Matthieu David: It’s casual. 

Vincent Ghossoub: You can play it for a minute or a session and you can drop the game for six months and nothing happens. Then you come back and you can still play.

Matthieu David: What would be a well-known hardcore game? Will Final Fantasy be a hardcore game? 

Vincent Ghossoub: Final Fantasy is quite a heavy-duty, mid-core game. For a hardcore game, you need to have your full attention focused on it. So, for example, the recent Call of Duty does require full attention over 30 minutes. You cannot get distracted while you’re playing. Call of Duty Mobile released based by Tencent Studios basically is something I would call hardcore. Now, a lot of people in China’s game industry or anywhere else would agree with me on how this is defined. Generally speaking, those two defining parameters—time spent per session and attention spent per session—are something we all agree on.

Matthieu David: I see. By listening to what you said before, I feel that I overstated, in fact, the link with China’s game industry because I feel actually you develop your own games, you develop games for the Middle East from China or the live streaming platform from China. I’m not seeing the link with China as obvious as before except that you have an office in Hangzhou.

Vincent Ghossoub: The gaming business is a global business and our presence in Hangzhou is in China. And our foundation is in China. So, I founded the company in China. The company had spent six years in China before establishing anywhere else—seven years even. So, the presence in China has been essential in a few ways. So, we have employees in China. We have talent in China. We learn best practices in China’s game industry. And we do find games and partners who have games in China which we could promote outside. So, both for the games we develop, for the games we publish, and for the talent we need, China is always a part of the recipe.

Matthieu David: I see. I see. So, I understand now that China has been the place where you founded it. So that’s why actually you have a link with China; because you were there. I think you were at that time studying at CEIBS for your MBA in Shanghai or maybe in other cities because it should be Europe and China Business school. I understand that it’s by that circumstance that it started in China. And then you learned from this environment in transformation with digitization. It’s so big and so advanced in China and especially in Hangzhou. Okay. I get it. 

Vincent Ghossoub: Beyond digitization, there were some very specific trends that made it make sense to set up in China. At that time, China’s gaming freemium model (free-to-play models) were extremely nascent in the West while it was growing and becoming dominant in Asia (Korea and China) for many reasons. Mainly the Koreans started implementing it because of the situation in China where piracy was rampant back then because people wouldn’t pay to buy a box game. They would want it for free. They were used to free content back then. And then Chinese companies kind of perfected this art way before it was adopted and completely embraced in the West—in the US and Europe. So, at that time, China’s gaming freemium model which was emerging made very much sense for the Middle East because it shared a lot of similarities with the environment in China. Piracy used to be rampant back then in the Middle East also. And the internet had just come of age whereby you could actually play a game on the internet while just a couple of years before that, you had to buy it on CDs as box games. So, we shared the same attributes in terms of piracy and in terms of the need for free content and no fluency at all with buying paid content and the emergence of acceptable internet infrastructure. So, it was sort of two very similar markets except for the language difference obviously. So, beyond just digitization, very specifically in the games business, China was a good reference and model back then.

Matthieu David: What has changed? What has changed that China’s gaming freemium model now is not the mainstream and then you can have a premium? What has changed that now people can pay? Now you are monetizing like $0.5 per user on average per day. It’s a huge number for me. When you multiply it by 360 days and by 2 million, it seems huge. So, what has changed?

Vincent Ghossoub: We don’t make $0.50 per day per the millions. 

Matthieu David: Yeah, I calculated it. It’s like $300M. 

Vincent Ghossoub: Yeah, hopefully soon. But basically, if I have like a hundred users enter my games today or are active today whether it’s their first time or their nth time, I make 40 to 50 cents per these users per day. So, it’s not over 2 million. Hopefully soon. We have tens of thousands of users, a few thousands of daily active users, basically. 

Matthieu David: So, the question is what has changed?

Vincent Ghossoub: Do you mean what has changed from premium to freemium or China’s gaming freemium model being bashed these days and turning back to premium?

Matthieu David: You said that similarities were between China and the Middle East and that China’s gaming freemium model and the willingness for people to pay were low. And that freemium then became more mainstream and it had to be freemium if you wanted people to use the games. So, people want to use the games. But now it turns out that in China’s game industry, and I don’t know if it’s the case in the Middle East (you know it), people pay for games. People pay to be VIP clients of QQ email. Just because you have a bigger box, you pay for that in China. So, they accept to send small money to KOLs. What has changed in China and in the Middle East if the similarities continue to be built? What has changed that now you can ask them to pay?

Vincent Ghossoub: Yes. So, first of all, there’s a disconnect and this behavior these days between China and the Middle East. Chinese users have become much more willing to pay outright for content. While this hasn’t happened yet in the Middle East, they still expect free content and try to do their best to work around getting free content. But, of course, you can monetize them well in different ways. So, certainly, China has gone very fast through this transformation of going from ‘we want all the contents free’ to ‘we are happy to pay and even at rates much higher in some cases and in some categories than the West (paying outright for content)’. Just thinking of it, generally speaking, I don’t think much has changed. I just think the natural evolution of things is taking place.  

So when you think about it, if I want to go out with my friends today and watch a movie, let’s say, we’re going to spend ¥100 or ¥200 per person, basically, we’re watching a movie and spending time together while increasingly we are spending time together online, separate physically, but spending time online and we can get that same movie for ¥2 or for a ¥20 subscription or ¥30 VIP subscription on some video-on-demand platform or something. So that’s online entertainment. It’s the same thing for China’s game industry. If we were to go out to a bar or play tennis or something, we’re going to spend a couple of hundred RMBs also, while we might spend ¥2-3 per hour if we’re like having fun online. So, it’s just normal. Online entertainment is still by far the cheapest form of entertainment on a per hour basis. 

So, one thing that really changed and made people realize that it is actually quite cheap to have fun online is maybe the increased penetration of payment systems such as WeChat and Alipay. So, they’re used to buying. We’re more used to ordering online and transferring money all with our phones. So, it’s really one click away. It completely removed the friction from seeing, let’s say, a movie online for ¥2 or for a ¥20-30 subscription and paying for it. But that pricing had always made sense. In fact, I think if you look at how much disposable income goes online, it’s still a tiny portion. I think we can still spend much more online than we are today.

Matthieu David: So generally speaking, we know that users moved from China’s gaming freemium model to a little bit of premium which is $0.5 per day when they are active, as you said, on average. What do they pay for?

Vincent Ghossoub: It’s a bit less than $0.5 in our case. And in our case, it’s still China’s gaming freemium model. So, when I tell you it’s $0.4-5, it’s the average. If I take today’s revenue and divide by the daily active users, it’s $0.4-5, but only 1% of these users paid and they subsidize the remaining 99%. So, it’s still freemium. As you mentioned, you can pay for a lot of things online like the outright content subscriptions, premium games, and items inside of games. So, specifically, for items inside of games such as our case, basically you can categorize what the payers pay for in three categories. First of all, it’s utilities. Utilities are, for example, making my experience of the game easier. Let’s say you want to send two coins or one unit of stamina to all of your friends in the game. With one button, you can send it to all of them and that’s going to cost you a few gems. And the gems convert to dollars. They are bought with dollars. Instead of sending to all of them one by one, it just makes the experience smoother. We remove the ads if you pay a small amount. That’s utilities.

The second category is cosmetics. It’s just cosmetics. You just want to make your avatar look nicer. You want to add skins. You want to make your gun brighter. You want to have a crown on top of your icon. It’s things like that, that don’t perform in the game experience, but just look better. And when you spend enough time on the game, you might want to say, “It’s time for me to put my signature on the game”. The third category is performance items. So, for example, sometimes in strategy games. You mentioned Final Fantasy in games. Similar to Final Fantasy, you need to upgrade your heroes and find the items for your heroes and upgrade the items and go to battle. And you have very few stamina points for the battles. So, for all of these, for the waiting, you can accelerate it. For the finding, you can increase the chance of finding. For the battle, you can battle more by getting stamina. So, all of these bonuses—less waiting, more chance of finding, more battles—are paid for with gems.

Generally speaking, it varies with the markets. But in our case, a fraction is the performance. So, people just want to perform better in the game. And we can discuss a little bit of the psychology behind that. Cosmetics and utilities are a couple of percentage points of the overall spending of gems. Now, why do people want to perform so well? You have different kinds of gamers. You have the gamers who play on their own. They just want to feel they’re achieving. What is the Olympic slogan? Higher, further, stronger or something like that. So, they’re happy with beating themselves time after time. So, they might want to improve their performance from time to time. You have the killers—those who really want to compete. They want to perform better than others. So, you have leaderboards for them to compare. Sometimes, there are direct confrontations between them. So, someone wins and someone loses. You have the socializers who just want to spend their time lubricating the system and doing alliances and chatting and messaging with each other. You have the explorers who are just curious about finding out more and more hidden corners of the game.

Generally speaking, the killers are the most lucrative in the performance. That’s at least in our category of games. Now you would say we have killers who pay thousands of dollars a month. Now you can say, why do these people spend so much? And I can make the case why this is actually, first, a very proportion of their disposable income. Second, it’s much cheaper than all of their other entertainment options. But most importantly, what you do when you’re a leading killer is you’re basically showing status. You are getting a certain puff of psychological satisfaction by being the leader, by being the number one. And here, I can showcase a few situations why this is still taking place outside of games. And it’s much healthier inside of games.

So outside of games, you can go to the hottest mall in Beijing and check the cars parked by the gate. So, these cars are the most luxurious cars in the country and they’re parked there at the front of the gate. Why are they parked at the front of the gate? They’re parked right at the gate for two hours because it’s to a very large degree, one utility, but most importantly a status symbol. And that car was expensive compared to the status symbol you can get inside of a game, especially that only a few hundred thousand people are going to walk in and out of that mall and see the car while tens of thousands are going to see you for over an extended period of time inside of an online game.

So basically, I’m selling you the psychological puff, that satisfaction, without selling you the metal, wheels, alloys, and all the pollution that goes along with it. Basically, it also goes down to the question of what are you buying when you buy a pair of jeans? Why was your pair of jeans more than ¥1000? Tell me. What’s the reason? Why wasn’t it ¥50? Why that premium? That premium is basically a puff of emotional satisfaction. So, I’m selling you that puff without selling you the denim and for a much more extended period of time. So, it completely makes sense. If you’re willing to buy a ¥1000 pair of jeans, it completely makes sense to spend ¥500 on a much better level of satisfaction inside of an online game. In fact, let me go even further. There were Imperial colonial wars waged on colonies. Let’s say Holland in Indonesia or France and other places just so that a person in Paris drinks a cup of coffee and gets that satisfaction. That cup of coffee, let’s say, was sold for 5 Francs in some Parisian cafe and maybe the ton was bought for 5 Francs from the colony. So, the coffee shop was not selling coffee beans. The coffee shop was selling that puff of emotional satisfaction. 

Matthieu David: Interesting. So, what you are saying is one of the reasons for paying is social status. You believe that people want to compare to others. They want to be the first. They are competitive. As a killer, the psychology, as you said, is to be above all the others. Actually, we moved a bit further in your core business and how people convert from China’s gaming freemium model to premium. Actually, before that, I wanted to talk about the beginnings of Falafel Games in China. I believe Shanghai and Hangzhou because you have been studying in Shanghai at CEIBS and you have your office in Hangzhou. Could you tell us more about how you started and with whom? Why games? Are you a developer yourself? Why did you start this business? How did you start to develop games for the Middle East from China, with which money, and with whom? I need a bit of understanding of how it started for people to get a better sense of what the start was.

 Vincent Ghossoub: It’s a long story. I like to say I started it when I was three years old, ever since I could hold a controller because from whenever I was three years old until I started the company after my MBA graduation, there had always been a very obvious lacuna in the Middle East market. And there were not many games with authentic Arabic content. And that was not like, ‘Oh, such a discovery’. It was so obvious. It turns out when I was doing my MBA in CEIBS (China Europe International Business School) in Shanghai, it was the time when the trend we just discussed—the growth of China’s gaming freemium model and the maturity of the internet infrastructure—was taking place. And I had a few classmates also who had been in China’s game industry. It just clicked in my mind—the fact that now you can make a game that does not need to be pirated, that is free, and that can still make money in areas where the internet is just coming of age and solving the problem of lack of content. It just made perfect sense. Now, it’s really a no-brainer. It’s a very simple proposition.

Matthieu David: I take myself as an example. I’m French. I grew in France in a very French family and environment. I didn’t know what I didn’t have. Suddenly, if some movies were not translated in French or games weren’t translated in French, I just couldn’t know them. But I believe that your ability to assess that there were more games in English that were not in the Arabic language is because you have been educated in a very international environment. Because when I go on your LinkedIn, I see that you have been at the American University of Beirut. You have been in Toronto. And you have been at CEIBS. So, from the very beginning, you had an international mindset in order to be able to compare with other countries, behaviors, and so on. Am I correct with that? 

Vincent Ghossoub: Now, you’re asking me to come out of my shell and look at it and analyze. Maybe. Maybe, but I don’t think it’s so extreme really. I think I wouldn’t attribute so much the realization and the articulation of the opportunity to, let’s say, my experience in living in many places and international outlook. I just used to play games. 

Matthieu David: Okay. 

Vincent Ghossoub: So, imagine you loved watching movies when you were a kid in France and all the movies were in English. Let’s say that was the case. I know that this was not the case, but let’s say that was the case. Then you don’t need to be like Marco Polo to realize that it would be nice to have a movie in French—or at least to have it translated to French or dubbed. So that was my trigger. It wasn’t like so much international outlook. I used to play games and they were in English. What can I do? And you don’t need a lot of languages to be able to play the game. But the actual lacuna I noticed is content, not language. So, it’s not just about a matter of translating the shape of the heroes, the story, the narrative, and all of that. So, that’s one, but I think that’s in terms of articulating the opportunity.

But I think in terms of execution, this is where the international outlook really helped me. So, just in terms of context, I also lived in France during the Lebanese civil war for a couple of years during my childhood and in North America and the Middle East, in Lebanon, in Iraq, and in China. So that’s like three or four continents and four or five countries. It just made things easier. I didn’t see the barriers like doing cross-border business of like negotiating with my first Chinese partner. For me, it was just like some dude. He’s a guy. There’s a lot of them all over though. I didn’t see a big barrier in doing that. The travel needed, the cross-language communication required, and all of that including my international outlook maybe made me reckless. It gave me a reckless attitude toward it, which in a way can be good as long as it’s not too reckless.

Matthieu David: So as far as I understand, you had an understanding but also a passion for games. And it was obvious to you that you would do something in games. I mean there was basically an attraction to games. And you were in China studying at CEIBS. Because you were studying in China, for you, it was a laboratory to see what’s happening, digitally speaking, with China’s game industry. And maybe, Korea as well as a laboratory for you. And you started that to get inspired to learn the best practices and so on. It’s a bit counter-intuitive for me because what I get from most people in the development and online businesses is that China is expensive. China is not a place where actually developers are cheap. It’s not a place where you can find developers easily. It’s not a place where they can develop for the world because it’s very China-centric compared to India for instance. So that’s why for me, it was a bit contrarian. How do you react to that?

Vincent Ghossoub: Yeah, I always get that. So why are you in China? Is it because of the costs? 

Matthieu David: That’s not the case, right? 

Vincent Ghossoub: Costs are very high. Yes, of course, there’s a lot of competition from most multinationals and from a lot of software companies to get the talent. And despite the big volume of talent supply, in fact, if you divide it by the number of companies competing on that talent supply, it’s quite competitive. And it just jacks up the salaries basically but there are a lot of reactions. There are a lot of justifications for that. First of all, it’s the best practice developed. So, China is a bloodbath in terms of China’s game industry and it’s leading in terms of competition.

Matthieu David: Would you mind sharing two examples of the best practices? What best practices have you learned from China?

Vincent Ghossoub: It’s just doing good game design. So, if you look around the whole world, teams that could do good game design develop a game efficiently. There are very, very few places. And China is one of them where suppliers are big enough or large enough. And if you compete, if you are able to acquire, you can come up with something. So, let me boil it down to you to a very simple equation. You want to make a game in China. You want to make games in China. So, let’s say you have a certain cost; let’s say $1M to make the game. So, your cost per game is $1M divided by one. You spent $1M to make a game. If you make it elsewhere, it might cost you $500,000, but you’re not sure you’re going to get a game. So, it’s $500,000 divided by zero. You end up with zero games and it’s practically infinite costs. So, per human resources, it might be cheaper elsewhere. But per game, you might end up with no games.

I’m not saying it’s only China that can deliver that. Of course, there are other places that are still much more expensive than China. Northern Europe, the US, and Canada can deliver good quality games. And there are even developing countries. It’s not like it’s the monopoly of advanced places. But the idea here is that you need to get a good game so that you can compete. And then you stop asking about the cost of your human resources, especially that your cost of human resources is practically not the cost of goods sold. It’s not like I’m buying cheap and selling slightly with a markup. In games, if you think of the cost structure, the development team is a fixed cost. You have to pay for the salaries every month. And then the revenue is variable. So, it’s very high operational leverage. The revenue can grow ad infinitum in theory. It can grow infinitely in theory without much growth in your fixed costs. I’m not mentioning here the variable cost of the marketing.

Matthieu David: Yeah, that’s the beauty of it. 

Vincent Ghossoub: Yeah, exactly. So, if you’re in a situation like this and you’re chasing the utopia whereby you get high revenue compared to the fixed cost, then you will accept to have a fixed cost that’s still okay and relatively high because the revenue is so much higher. And if you try to save a little bit on your fixed costs, let’s say bring it down by 20-30%, you might be killing the chances of the game even breaking even on your fixed costs.

Matthieu David: So, we understand that there is an investment.

Vincent Ghossoub: Yeah.

Matthieu David: Initially, you need to invest for a period of time to develop games for the Middle East from China. How did you invest? Was it your own money? Did you raise money from the very beginning?

Vincent Ghossoub: A bit of everything. So, early on, we just discussed the proposition. The proposition is quite simple. And if you look at the Middle East market, generally speaking, it’s around 400 million people, a homogeneous language or quasi-homogeneous religion, a lot of common cultural norms, they have a young population, and they are well-connected. So, it’s a good opportunity. So initially, I put in some of my money. I was able to convince a couple of friends to put in a little bit of money. And most importantly, I found a whole team because, in games, you need multiple skills. 

Matthieu David: What skills do you need?

Vincent Ghossoub: The art, engineering, game design, and management. You need to glue them all together. And then, of course, a few sub-skills within these. You need them all. You cannot have one link missing.

Matthieu David: Designers. 

Vincent Ghossoub: Yes, design. Game design. So, I was lucky to find a game development company based out of Hangzhou which agreed to partner with us for equity to go after the opportunity and put in their own team. 

Matthieu David: Wow. 

Vincent Ghossoub: And I had the option to bring that team in-house and I did exercise that option. So, I don’t have the exact numbers in my mind. We needed a few hundred thousand dollars to come up with that first game. And we only had tens, maybe a couple of hundred thousand, in cash commitments early on. But along with the team that was working on it for equity, we were doing progress and this allowed us to raise our first institutional round.

Matthieu David: How much time did you take to develop your first game for the Middle East from China? Did you talk about two months, three months, six months? 

Vincent Ghossoub: No, no, no. A lot of time. Generally speaking, our category of games has a very variable production cost. In our case, it’s about 15 people over 15 months.

Matthieu David: 15 people over 15 months. I see. 

Vincent Ghossoub: Yeah. So, 225 man-months. But you have similar games in the same category that might cost tens of millions of dollars—10, 20, 30 million sometimes just because it’s so easy to spend bottomless pits of money on, let’s say, perfect art, more art, and more stages. And you always have a critical decision of when you should launch and start harvesting or collecting money. When you’re at 50% or 99% or 150% of the development progress in the game, it’s something that affects your upfront investment. But generally speaking, now more and more, the upfront investment in developing games for the Middle East from China, whether a few hundred thousand dollars like our case or a few million dollars like many cases or even tens of millions in very few cases, is generally not the main upfront investment. The main upfront investment eventually turns out to be the user acquisition spend. 

Matthieu David: But this is like less of an investment and variable cost because you should cover your cost after the acquisition, right?

Vincent Ghossoub: Yes. So, I mean it also depends on policies cause it’s so variable. You can spend $100 on user acquisition per day or you can spend $10,000 per day. You can spend millions per day. It’s extremely variable. Essentially, it boils down not only to that, but an easy parameter is a cost per install. So, you put your target installs and then you know your budget needed per day. And that can be extremely highly variable. Let’s say you have a policy of like 90-day-payback on your ROI or your ad spend. So, you have this initial trust that you have to go through and you need the cash balance for it. Some companies go for a 360-day-payback. So basically, the idea is if I spend, let’s say, $100 on Facebook ads today, from the cohort of users that get acquired from this $100, how long do I need to earn back the $100? So, I keep optimizing my targeting and my budget allocations until I need a certain payback target. So, if my payback target is 90 days, depending on the game, the game quality, and the advertising quality, I might reach a high volume of players or a low volume of players. But the longer my payback target period target is—I know some companies who have 440 days payback period target—then your cash balance needs to sustain all that trust. That valley is huge.

Matthieu David: I think another question that many people who are listening to us are asking—and I am myself—is how were you able to connect with this Chinese company to convince these Chinese company to work with you and to actually work well with the Chinese company when you are just an MBA student or you just got out of the MBA? I think those three items—how you found, how you convinced, and how you worked with them—are kind of a mystery for us right now.

Vincent Ghossoub: It’s kind of a mystery to me too. The secret word here in my case in how I found this Guanxi. I’m sure you have like 50 podcasts where you discuss Guanxi. It’s a friend who knows a friend who knows a friend and then it’s a chain of favors. And then, things get done. I was very lucky that my MBA gave me sort of like a soft landing in China and I was able to build a small network of well-connected businesspeople in China. But you have to push through. The first layer of your Guanxi is never the one that gets you the connection. Then you have to ask one person for the next and build trust. Then they ask the next for the following and build trust. And you don’t know in which branch of your Guanxi network where you can eventually get the click where there’s a good synergy for good business.

So, I had a friend basically. I have one of my alumni who was into gaming too. And we were going around looking at opportunities in games and going to conferences. And then he remembered that he had that friend who had a development company who does things that I might be interested in. And then we discussed that. He was interested in my market and my proposition and he agreed to put in his team. Another thing in games and software, in general, is that you could, to some degree, build one cell infinitely many times. So, from the perspective of our first development partner who entered for equity, they could build our games skinned for us once and reskin it infinitely many times for other markets. And that was their idea. So, they had actually every skin of our very game in the Chinese market for themselves. 

Matthieu David: I see. 

Vincent Ghossoub: Let’s say his investment in nine months was $500K. But that $500K also went into his own games. 

Matthieu David: I see. 

Vincent Ghossoub: So, the margin of cost he had for us was not so much. It was like tens of thousands. So, that’s how we found it. How we worked was much more difficult. And I think luck and perseverance were big factors because I completely moved to Hangzhou. I stayed on top of it. I knew we were not going to understand each other. They barely spoke English. We barely Chinese. So, our proposition was bringing Arabs with Chinese together and develop games for the Middle East from China. I can barely work with Arabs. I can barely work with the Chinese. Now I have to work with both and let them work together. So, it needed a lot of perseverance, I think. And one of the mottos I had is whatever the problem is, consider it a cultural gap problem first. Put that off the table. Sometimes, it’s coordination. Sometimes, it’s bad code. Sometimes it’s implementation not as per requirements. I didn’t start like this, but I got to the point where whatever this problem is, let’s see whether it’s a cultural communication? Should we just sit and cross the cultural bridge and put it out of the way? And then if I make sure all the possible cultural gaps are not there, then it’s a normal professional problem that you handle normally and professionally. But guess what? Most of the problems were of that first category.

Matthieu David: I see. Very interesting. Very, very interesting. When did you raise your first round from institutional investors? I mean, understand it was from a partner first and then from institutional investors. Actually, I’m surprised about the investor you have. You have the iSME. I didn’t know about them—Irish SME Association. I didn’t know they would invest in it. And then you have the Middle East Venture Partners. I understand better because they are Middle-East focused. And then you have an Abu Dhabi based incubator. 

Vincent Ghossoub: We might be mistaking the iSME you are mentioning here. So, the iSME that invested in me is basically a Lebanese financial entity which is a joint venture between a large loan insurance company in Lebanon and the World Bank. Half, half.

Matthieu David: I see. So, it’s not Irish at all. So, my team wrote wrong. Right?

Vincent Ghossoub: It seems it’s the same name. Maybe, I shouldn’t say iSME. I should just say Kafalat which is the name of the loan insurance company because iSME is almost like an internal name for them. It’s that small initiative. It’s just a small fund of maybe $25M or $50M or something like that which they put half and the World Bank puts half. It’s for equity investment. In fact, it’s for equity matching. They don’t invest. They match. And in my case, they matched MEVP with this venture partner which is my lead investor in a couple of rounds—two rounds, basically. 

Matthieu David: When did you raise? One year after? 

Vincent Ghossoub: Yeah, about one year after. Like they say in the stories and when you listen to podcasts, I got Series A or Series B, very finite, opened round or closed round… maybe because I’m in a market with very little equity financing liquidity. So, it’s like an ongoing thing with me. My round is always open. My valuation is always going up and down and those windows are not so well defined. So, to tell you how it went—this kind of like flexible, ongoing thing—I got $100,000 convertible loan by MEVP first and they had three conditions to enter with their follow-up equity round. I think it was $500,000 or $600,000. One of them was getting a co-investor. Two of them are operational. One of them was getting a co-investor. And I was really, really lucky that the game we were working on, met the branding of a TV series that MBC (Middle East Broadcasting Corporation) was working on. So, they accepted to join that round and I cleared that condition. I also cleared the other two conditions. So, they entered with an equity round then of 800 more or less. Yes, 800, including the convertible and they converted their convertible note to equity with a discount. And then the following round was also led by MEVP and followed by twofour54 and iSME. 

MATTHIEU DAVID: Did you raise money because you were not profitable or did you raise money to go faster and develop new markets?

Vincent Ghossoub: Both.

Matthieu David: Okay.

Vincent Ghossoub: It went hand in hand. 

Matthieu David: Are you profitable now? 

Vincent Ghossoub: We are if we want to. 

Matthieu David: Okay. I see.

Vincent Ghossoub: So, we are investing heavily in our live streaming platform from China. And it’s eating from profits and from the capital in our live streaming business. 

Matthieu David: I see. 

We have not talked enough about live streaming and we’ve been talking for one hour already. So, I’d like to take five minutes to talk about the live streaming platform from China which actually seems to be the masterpiece of Falafel games. I feel that it’s the cornerstone of it. Could you tell us more about what it is, how you monetize, how important it is, and where it came from?

Vincent Ghossoub: Yes, of course. So, today the interactive live video multiplayer platform is indeed the masterpiece of our strategy moving forward. And in fact, it’s even a separate kind of department and even a subsidiary in the whole Falafel Group. So, we have the developing games for the Middle East from China part and the live streaming part set up in two separate legal entities, but it wasn’t designed that way at the beginning. In the beginning, it started as a simple product to solve one challenge we had in the game part, which was that the cost per installs (CPIs) were rising dramatically and significantly fast. And ROIs were thinning. So, we were thinking, “Okay, where is this going and what is an approach we can do so that we dramatically reduce our CPI?”. And we found a nice category of games with experimentation. And after the experimentation, we realized how nice it is and we were able to articulate it.

It’s basically games that are not in Arabic and cannot be played by Arabic users such as word games or quiz games. A competitor from, let’s say, the US can come with the best quiz game in the world but if it’s not good Arabic content, my crappy game in comparison will do better. And people will want to install mine because of the content. It’s basically the difference between necessary local content and nice-to-have local content. Consider yourself a user and going through a journey. And I tell you to come to play this tank battle game. Whether it’s an English or Arabic or French, it’s not going to make a big difference for you. The language is nice to have, but if it’s a quiz game or a word game or crossword game, whatever, it’s a must. So, we put out a crossword game which was a really cool game by the way. And it just sucked traffic like crazy. In fact, I don’t count this traffic as part of the official KPIs I gave you early on because it was more of an experiment and outside of our core back then.

But to give you a comparison, when we launch a mid-core game, let’s say a strategy RPG game, our cost per install is $2 to $7 depending on the channel and the quality. It averages out at about $4. It’s a bit less than $4. It’s $3.5. When we launched that crossword game, it was a must-have Arabic game so there was very little competition in that category. And although, in general, Arabic-speaking people don’t like too much reading games or games that involve texts, with only $13,000, we were able to get 500,000 installs. Make the comparison. Yes. In terms of CPI, it’s very big. I don’t know; is it like $0.3 CPI or something like that? So, it’s a very big difference and we concluded that the reason was that this game is a must-have. It must be Arabic. It doesn’t have much competition. And then we stumbled upon a second problem.

We thought, “Okay, let’s go after this category”. But then we stumbled upon the second problem. It’s that text medium doesn’t monetize as good as a strategy or role-playing games. So, lifetime value (LTV) of your user is very low. Then you go back to the problem of low ROI. In the case of mid-core, it’s a high cost to acquire and high lifetime value per user with a thin margin. In the case of a quiz, it’s low CPI but also lows LTV with a thin margin. So, what are we doing? And so, now we set out to bring up the LTV and we thought, “Okay, let’s move from the quiz or text medium to the live video medium where we have real hosts who present the game”. It’s much more engaging.

So basically, it turns out like Who Will Be The Millionaire game kind of whereby instead of having one participant, everybody’s competing at the same time on a leaderboard. Everybody’s talking, chatting, and interacting with each other and especially between themselves and an audience and the host who is streaming live. And the LTV was slightly better. So, we found a good chance here—high ITV, low CPI. We can go after this. And it solved in a way another problem which we had in China’s game industry and the world’s one, which was the sunrise, sunset reality. You know, for every game, you have to launch it, you harvest for a while, and then it sunsets. Then you have to go again with new games or revise the game somehow. So, there are almost always up and downs. But the live video content is basically kind of like YouTube. You always have new content that you can put out there. So, we’re hoping and it’s starting to prove that it’s much more sustainable. It grows slowly but it’s sustainable. 

Matthieu David: Sorry to interrupt.

Vincent Ghossoub: Yes.

MATTHIEU DAVID: Livestreaming platform from China. Live video. I mean Facebook, as you mentioned, is doing it well. How do you differentiate yourself from them for instance?

Vincent Ghossoub: Did you say Facebook? 

Matthieu David: Yeah.

Vincent Ghossoub: So, of course, there’s Facebook. There’s YouTube. There is Twitch even. But our proposition is basically mostly interactive live streaming platform from China with a lot of different ways to interact with the game. So, we have games set up on top of overlay—on top of our live video feed—where a host or an influencer can come and set up. So now we have variations of quiz games. We have roulette games whereby the host is practically the dealer in a social casino setting. So, no cash-out. And we are releasing, I guess, what’s in the box game. So basically, the video feed technology is the same but we have a lot of gamification on top, which I don’t think Facebook or YouTube even want to do. It’s not their DNA. So, we’re a completely separate DNA from what they’re doing. And we’re geared towards maximizing revenue for hosts and influencers. So basically, our product road map is going to the influencers and hosts and telling them, “What do you want now that can help you make more engagement and more money and we’ll just do it for you”.

Matthieu David: I see. Do I understand well if I say that during a live stream, for instance, you will have someone playing with cards with an audience of people watching and they may ask some people to pay if they want to interact in the game with him? Would it be this kind of live streaming?

Vincent Ghossoub: Almost. So, it’s not only cards. It’s not only a live social casino. 

Matthieu David: Yeah. It’s just an example.

Vincent Ghossoub: Yes. So, any interaction or participation will include some spending on virtual items of credits in the game. So, if you earn, you earn credits, if you lose, you lose credits. If you like the game enough, you reach a point where you run out of credits and then you want to top up.

Matthieu David: What’s the closest version in China to what you do? What’s the closest version in the US?

Vincent Ghossoub: Yes. So, there are a few attempts in China and the US to crack this system which is basically the interaction of traditional media and interactive games. Some went well and then crashed. Some are going well and some are exploring. So, I’ll name a few. The most famous one in the US was HQ Trivia and it had a couple of clones in China such as ChongDing DaHui where it’s one or two 15-minute sessions per day and there’s a cash payout at the end. So, it became really popular because of the cash payout or prize, but then it went down and people realized that they were not able to win so much because so many people were joining. And for a lot of regulatory reasons, this was stopped in China. You have other kinds of a live streaming platform from China or anywhere else which I allow myself to call soft sex cams. So, it’s basically Facebook Live but with tipping and gifting. But most of the monetization comes from quasi-nudity or at least users flirting with the host. 

Matthieu David: Do you have this issue? How do you tackle this issue with your own platform?

Vincent Ghossoub: Yes. So, let me go to the third category. Then I’ll tell you how I tackle this issue. 

Matthieu David: Yeah. Okay. 

Vincent Ghossoub: Another one is obviously live casinos—the real money gambling. They do it and they’re doing it well. It’s probably the fastest-growing category. And you have a horde of people exploring it to which we belong and some others belong. It’s like a company in the US called Joyride. Another one is called Tele. So basically, the reincarnation of live game shows on mobile is in a much more interactive way whereby the interaction is no longer message-in or call-in or rate or poll or vote. We have all sorts of possible interactions which you can do through the mobile. Now how did we tackle the issue of sex cam business when we started our own live streaming platform from China. In fact, we did have a host monetizing crazy amounts per hour of broadcast and we had to figure out why. And eventually, it was sort of like she was pushing a certain behavior from the users. She was incentivizing them to send her a lot of gifts. So, she was using us as an appointment platform and as a payment gateway basically because the gifts are paid.

So, they sent the virtual gifts on the platform and then we’ll give her her revenue share on the back end. Now, you mentioned it’s an issue for a lot of companies. It’s the core business. If you look at the numbers, they are not so bad. So many of these companies in China are listed. Some of them are listed in the US running this as a core monetization scheme for them and making billions a year. So, putting aside the ethical issue, we didn’t even consider it for ethical reasons. Luckily, we did not have to confront that dilemma. At least, for business reasons, we thought it wasn’t sound for us to do so. We were at the same time finding in one room housewives who wanted to play and males who just wanted to flirt with the host. And this could not cohabitate. So basically, we just removed all incentives to the host to redeem revenue shares from gifts and we focused the whole experience on the gaming part. So, you come and you play the game. You don’t just do social interaction forever without playing the game. You must play the game. 

Matthieu David: I see. Is the game designed by you or it’s just someone live streaming the game?

Vincent Ghossoub: It’s designed by us. So, it’s a functional overlay on top of the live video. Maybe in the future, but not very soon. We could open up an API for other people to put their functional overlay on top of the live video. But today, it’s too early. So, we’re just coming up with our own functional overlays on top of the live video feed which represents different kinds of games.

Matthieu David: I see. Thank you very much for your time. It’s already more than one hour. Actually, I had more questions. Maybe we could have one session on the live streaming platform from China part, but it was very, very interesting and instructive on how you partner with the Chinese company which invested in you at a very early stage. Thank you very much. I hope you enjoyed. I can tell you I enjoyed talking to you. 

Vincent Ghossoub: Thank you very much, Matthieu. I enjoyed too. 

Matthieu David: Thanks again. 

Vincent Ghossoub: Thank you. 

China paradigm is a China business podcast sponsored by Daxue Consulting where we interview successful entrepreneurs about their businesses in China. You can access all available episodes from the China paradigm Youtube page.

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This article Podcast transcript #86: A promising company developing games for the Middle East from China is the first one to appear on Daxue Consulting - Market Research China.

The Coronavirus China Economic Impact report covers the spread of the outbreak in China, what industries are growing and which industries are severely impacted. We also zoom in on the economies of Wuhan and Hubei, as well as Coronavirus impacts on the global supply chain. Lastly we share how the Chinese government is reducing the burden on enterprises. Our Coronavirus China Economic Impact report is available for free to anyone seeking to understand the COVID-19 outbreak’s effect on businesses in China.

This report is routinely updated and contains everything businesses need to know about the economic impact of the Coronavirus in China. It is a collection of research from many respected firms and organizations combined with our own careful analysis.

Overview of COVID-19 spread in China

Coronaviruses are common causes of respiratory infections. They have previously been implicated in viral outbreaks, including SARS-CoV and MERS-CoV, but are also responsible for some common colds. From the perspective of virus evolution, COVID-2019 is more advanced type than its two predecessors. It has never been found in humans before.

How COVID-19 starting during the Lunar new year affected spread

The 2020 Spring Festival migration started on January 10 and ended on February 18. The estimated number of people who have had contact with confirmed cases gradually increased at beginning of the Lunar new year and stabilized until the end of it. That’s because flow of people participating in the Spring Festival Transport is very large, which makes the chance of cross infection increase and directly lead to the peak of the epidemic. Government restrictions on the flow of people helped to reduce the spread of the virus by decreasing contact and increasing physical distance between those who have COVID-19 and those who do not. However, within China, the confirmed cases have flattened since February 13.

How long will the coronavirus last in China?

As of early March, the number of infections in China continues to decline, with the exception of Hubei, the infection in all regions seems to be controlled. As long as no new infections appear during the duration of a full incubation period, then the epidemic can be considered to be officially over. Currently, the rate of infection is minimized by the quarantine efforts and shutting down of workplaces and public places.

What is the Coronavirus economic impact in China

Do we need to worry about the impact of coronavirus on GDP?

According to chief economist from Zhongtai Securities and Donghyun Park from Asian Development Bank, the coronavirus economic impact in China is expected to be between 1.5% and 2% in terms of GDP growth, which will not change the long-term trend of China’s economy. The epidemic has a large impact on the economic growth rate in the first quarter, or negatively affects the GDP growth rate of about 2%-3%. However, as the virus continues to spread globally, there will be many more factors to include in the coronavirus economic impact on China including global demand of Chinese goods and commodities. The largest economic impact comes from the service sector, especially the catering, transportation, hotel, tourism, and accommodation industries.

Up close on the economies of Wuhan & Hubei

The huge outbreak in Hubei province contributed a lot to coronavirus economic impact in China, as it is the most developed province in the central region of China with 3.9 trillion RMB GDP in 2018. Hubei has a large number of industrial clusters in R&D and manufacturing, such as automobile and electronics.

According to government work report of Wuhan in 2019, electronic information, bio-technology and new medical and medical appliance, and the automobile industry are the three pillars of the manufacturing industry. 

Hubei province is an important part of the global supply chain. It accounts for 9% of total Chinese auto production. German engineering firm Bosch, the world’s largest auto component manufacturer, has dozens of factories in China 2 of them are in Wuhan. Hubei also plays a significant role in the global supply chain of critical electronics components. The province is the production base of Taiwan’s PCB factories, including Taiwan Optoelectronics, Xinxing, Jianding, Nanzi Electric, and Dingying.  Industry insiders pointed out that PCB is the “mother of the electronics industry” and is an indispensable key component of all electronic products. If the PCB factory in Taiwan and the Hubei factory are obstructed, it will affect the global electronics industry.  

Hubei contributes much to the progress of the chemical industry. It is the largest province of chemical fertilizer in China, its output has reached to 596.56 tons in the first three quarters of 2019, which increased 19% compared to last year. Hubei has a high production capacity of sub industries including the phosphorus chemical industry, pesticide industry, and the vitamin industry.

COVID-19 affects industries in Hubei

Coronavirus impact on supply chain in China can be also seen in some industries in Hubei.

Electronics industry

After Wuhan postponed production of electronics, China’s supply chain of critical electronics components is facing a catastrophic disruption. About 70% of the world’s smartphones has been affected. According to Strategy Analytics, overall shipments of phones will reduce by 2% in 2020, some consultants believe that COVID-19 will cause demand side decrease. Besides, the first quarter is normally off-season of China‘s semiconductor industry, COVID-19 may further dampen the sales of semiconductors.

Automotive industry

China auto sales fell 2.8% in 2019 amidst global trade tensions, the first decline in nearly two decades, which also affect Hubei auto sales because Hubei province account for 9% of total Chinese auto production. Global automakers forecasted further sales decline in 2020, prior to knowledge of the coronavirus outbreak.

COVID-19 China economic impact: online industry growing

Due to the coronavirus epidemic, Chinese daily life goes online. For example, gaming industry experienced an unprecedented growth. While the Chinese mobile gaming industry is stimulated by the coronavirus, the development of 5G is expected to accentuate the trend and support the growth of the industry.

Coronavirus economic impact in China is also observed in short video platforms sphere. Between January 20 and February 2, 574 accounts on the short video platforms Douyin and Kuaishou each gained between 100k-500k new followers. The Coronavirus is accelerating the shift towards live-streaming, which already exploded in 2018, with a 745% growth year on year, thanks to improved connectivity and video maturity. The short video sector recorded 569 million daily active users in the post-holiday period, far exceeding 492 million on a regular daily basis.

E-commerce purchases during the Coronavirus outbreak in China

During the Chinese New Year in 2020, people were likely to purchase medical products, hygiene products and food online. To support the new growing online demand, more than 35,000 jobs were created across China from the following online retailers: Hema, Suning Xiaodian, Meicai, JD Logistics, JD daojia, and Dada.

Studying and working go online during coronavirus outbreak

Most companies have set-up remote work policies to avoid contamination at work. Hence, Enterprise Collaboration Apps facilitated remote working for 200 million Chinese workers after the Chinese New Year. To keep in touch, they use apps produced by two China’s online-giants: Alibaba and Tencent. During the outbreak, Alibaba’s Ding Talk skyrocketed to the very top of the App Store in a few days while Tencent Meeting and WeChat Work are in the second and fifth position, respectively.

The Coronavirus outbreak does not stop Chinese students from studying. Universities across the country organize online lectures to ensure the safety of their students. They rely on QQ, a Tencent streaming platform to carry out online teaching. The downloads of some education apps such as Tencent Classroom, and China University Mooc experience a significant increase. However, unlike fitness and co-working apps, the online education peak during the coronavirus may not last after the epidemic, with the return of students back to school.

Coronavirus impact on tourism in China

The damage to the Chinese tourism industry because of outbreak is equivalent to a loss of 1 trillion RMB GDP. Many travel enterprises estimated the ongoing shutdown costs the industry about ¥17.8 billion every day.

Only 2% Chinese tourism related companies felt that they had not been significantly affected after the COVID-19 outbreak. Coronavirus impact on tourism in China especially visible among travel agents, hotels, and retailers (related to tourism), as they badly need sales revenue during the epidemic. 

Chinese tourists contribute to the tourism industry in many countries. For instance, in 2018, Chinese tourists represent more than 70% total tourism in Hong Kong and Macao, similarly, more than 25% total tourism in Thailand, Japan, Vietnam and Korea. The impact on the economies of these countries will be catastrophic, if the coronavirus outbreak lasts for three to six months.

Coronavirus impact on tourism in China opened the opportunities for new online approach in this sphere. During the COVID-19 outbreak, many scenic areas and museums used live-stream to increase exposure and attract tourists, which attracted a lot of traffic. Even after the outbreak, the live-stream still can be watched by elderly and people with disabilities, it also can be used as a preview before travel.

Short-term and long-term coronavirus impact on tourism in China

Coronavirus impact on the food and beverages industry

Although many restaurants in China strengthened their delivery safety during the outbreak in China, food delivery alone is not enough to keep their profits in the positive. The Chinese New Year is usually a hot season for the F&B industry, the total revenue of Chinese restaurants in 2019 CNY has reached 724.1 billion RMB (occupied 15.5% of the whole revenue in 2019). Because of the Coronavirus outbreak, large catering brands have to reduce expense to balance their finance, such as permanently shut down some offline stores and redundancies. Many small restaurants are facing with the risk of bankrupt, since they have very fragile anti-risk capability. Many Chinese restaurants (around 62%) could not get rent reduction and they still need purchase epidemic prevention products, such as protective facemasks and thermometers.

Currently, many restaurants try to focus on delivery to get some profits, but actually revenue of online food delivery business is much less their normal business.

In order to manage the losses, some restaurants sell food materials to consumers and communities at low price and provide free food to medical staff and government units in epidemic areas. From 1^st February 2020, many restaurants temporarily lend employees to Hema (盒马鲜生) which relieved their labor costs. At the same time, KFC launched a contactless delivery service on food ordering platforms, such as Meituan (美团). Because of a lack of funds, some restaurants tried to seek investments and loans. For instance, Pudong bank offered 120 million RMB loans to Xibei (西贝) restaurant. The large food ordering platform Meituan (美团) worked with banks to finance some restaurants.

Coronavirus impact on supply chain in China: what businesses can expect

How Coronavirus will impact the Global Supply Chain by Mid-March

Most Chinese manufacturing slowly started resuming operations at the end of February, but the delays could have a devastating impact on the global supply chain.  For most companies, the inventory in stock will is enough to keep up with demand for two to five weeks. Shipping by sea to either the U.S. or Europe can take around 30 days. This implies that if Chinese plants stopped manufacturing prior to the beginning of the Chinese holiday on January 25, the last of their shipments arrived the last week of February. If lead time from China is shorter than 30 days, the disruption occurs earlier. This is already the case with Hyundai which announced on February 14^th the suspension of its production lines from its plants in Korea.

Assessing the coronavirus impact on supply chain in China, the electronics industry seems to be more affected. Intermediate products, which produced in China, are deeply integrated in the global technology supply chain.

Operations are concentrated near the affected areas (~290 of about 800 plants named in Apple’s global supplier list are located in regions that have delayed returning to work). Overall, 84% of manufacturers are concerned about delays related to the outbreak.  As the components are often heavily customized, it is challenging for factories to relocate outside of China in the short term.  

COVID-19 economic impact on Chinese manufacturing

As Chinese government shut down Wuhan and delayed the returning to work, many factories have to face the huge losses, limited supply chain and insufficient raw materials. Labor-intensive manufacturers (such as textile, clothing and plastic products) are significantly impacted, small and medium-size factories are worst-hit areas.

According to Morgan Stanley’s report in mid-February, Chinese production had only reached 30% to 50% percent of the usual levels. However, health and medicine related products have a huge demand during the COVID-19 outbreak.

Mask manufacturing demand

After the COVID-19 outbreak, the demand of masks has risen rapidly. Although many companies have started cross-border production, the shortage of raw materials could not be resolved in the short term. China contributes 50% of global mask production. Mask related manufacturers will benefit during the period, however most believe that it is a short-term demand. Expanding production would result in oversupply after the outbreak recession.

China is getting back to work

The week after 9^th February is the time for migrant workers to return to work, small and medium-sized enterprises need to resume production to boost cash flow.

Manufacturing learning points from COVID-19

Although epidemic outbreak is a black swan event in the manufacturing industry, it is likely that COVID-19 China economic impact will be positive. For example, it will promote manufacturing enterprises to strengthen the management of employees’ health and safety. The leaders of manufacturing companies will pay more attention to intelligent manufacturing. Due to online working, manufacturing enterprises will demand software such as task management, project management, and workflow management for remote collaboration. The Coronavirus economic impact in China will also be seen in science industry and smart technologies industry.

Coronavirus economic impact in China: what should exporters to China know

COVID-19 to impact China’s trading partners

After a slowdown in 2016, China’s imports and exports grew despite the trade war. Due to manufacturing and supply chain shortages during the epidemic, this growth rate is expected to slow down. A rebound in export activities may take place in April, while import activities would slow down until July. China’s top trading partners will suffer from the impact of the coronavirus on the main Chinese export products such as computers, broadcasting equipment, integrated circuits, and smartphones.

Coronavirus impact on supply chain in China is expressed in slowing shipments across the country, making transport routes congested. Currently, overall trucking supply resumed operation at around 60% and is a bit higher in the Southern areas of China. Overall intercontinental rail capacity has recovered to 60%.

How to improve supply chain during the epidemic

Government response to soften the Coronavirus economic impact in China

Policy support from the Chinese government

Production stop, isolation of staff and transportation restriction were a consequence of coronavirus China economic impact. Policy support and costs reduction are desperately needed. The Chinese local governments released some polices to relieve this situation, such as financial support of small businesses, flexible employment policies, social insurance, rent subsidy and tax concessions.

Long-term economic impact of the Coronavirus in China

The epidemic further boosted digitalization

During the epidemic, both the number of users and the time spent online had a dramatic increase. The total mobile Internet traffic increased by 36.4% compared with 2019 CNY. The number of daily active mobile shoppers grew by 14.6% during the 2020 CNY compared with 2019 CNY. In the meantime, some traditionally offline industries have turned to e-commerce to relieve losses.

Coronavirus China economic impact on the luxury market

COVID-19 is a downturn to the global luxury market. In Shanghai, Beijing, Shenzhen, Guangzhou and Wuhan, the passenger flow in large shopping malls and luxury brands stores declined more than 80% during the 2020 CNY. Also, due to the COVID-19, most Chinese consumers are more focus on healthy and rational consumption, many luxury products buyers plan to spend less on luxury goods, more on medical products and necessities. When COVID-19 is under control, this trend may still continue so long as the economy is impacted and until consumer confidence returns.

Coronavirus economic impact in China: big data innovation

During the epidemic, more than 20 provinces’ governments worked with technology companies to build “epidemic prevention system”.  The reports helped to see related data, epidemic feedback, quickly find and isolate suspected cases. The cooperation between government and big data platforms is promoting the practical application of big data in public crisis management and driving more technology innovation. Along with the development of the epidemic, more Chinese people are getting used to using big data tools in their daily lives, which speed up the process of digital life. 

Coronavirus economic impact in China: AI developments

The epidemic promoted the actual use of artificial intelligence products in medical and public safety areas. For example, in order to improve the efficiency of the diagnosis for COVID-19, Beijing Haidian hospital is using an AI assisted diagnosis system that can process 300 chest X-ray in 10 seconds. Many consumers fear the coronavirus cast a shadow over the food delivery industry. Therefore, JD launched autonomous delivery robots to reduce human-to-human contact during the Coronavirus outbreak. Besides, AI medical robots have started to work in Wuhan’s hospitals, they help doctors and nurses with disinfection, cleaning and delivering medicine.

Coronavirus China economic impact: financial assets may surpass fixed assets

Due to the COVID-19 outbreak, most Chinese people have to stay at home, real estate transactions are almost completely frozen. However, financial assets are not limited by places, the bond market has been very active since the Chinese New Year. The Chinese people have more time to invest bank financing products and bonds. Besides, growing savings may increase the demand for investments with stable income, such as bank financing and bond funds.

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This article Coronavirus China Economic Impact Report by daxue consulting is the first one to appear on Daxue Consulting - Market Research China.