By Yougang Chen, Jeongmin Seong and Jonathan Woetzel
Some 18 months ago, the McKinsey Global Institute published a report on the explosive growth of e-tailing in China, noting that the Internet was producing real macroeconomic effects by spurring incremental consumption. Today China’s consumer-focused Internet is transforming into a more enterprise-oriented Internet. This next wave of digital development promises to have an even deeper impact on China’s economy – contributing not only to faster GDP growth but also to growth that is based on productivity, innovation, and consumption.
Over the past decade, China’s Internet economy has been largely driven by rapid adoption by consumers The country leads the world in the number of Internet users, and local internet companies constantly drive locally relevant innovation to serve the fast growing digital consumers. On the other hand, Chinese enterprises, especially small and medium size ones, have been slow in embracing the digital trends. They have lagged behind the United States in using the Internet to run key aspects of their businesses to improve productivity while creating new market. (Exhibit 1).
This is changing as the Internet penetrates more deeply across major sectors of the economy. As companies embrace Web technologies, their operations become more efficient, translating into productivity gains. While this process is likely to displace some workers from existing roles, the Internet also creates new markets for innovative products and services, increasing demand for workers with digital skills.
The Internet provides a platform for millions of daily online transactions and communications that make a significant contribution to individual economies. China’s Internet has already given rise to a dynamic technology sector, thriving social networks, and the world’s largest e-tailing market. But the Web is just beginning to penetrate many Chinese businesses — and the most sweeping changes are yet to come. We project that the next wave of digital transformation in China could enable 7 to 22 percent of the total increase in China’s GDP projected from 2013 to 2025.
Perhaps even more important, the Internet will help China shift toward a model of economic growth that is based on productivity, innovation, and consumption. The Internet is fueling the ongoing process of moving China’s industry from less productive to more innovative and technologically advanced business models. Indeed, much of the Internet’s impact will likely come in the form of productivity gains. As individual companies step up their adoption of Web technologies, they will streamline their operations, from product development and supply chain management to sales, marketing, and customer interactions.
Beyond its impact on GDP and productivity, the Internet will create convenience and generate substantial consumer surplus. Enhanced transparency and competition can lower prices while increasing the quality of goods – and the resulting savings become available for additional consumption. The Internet can also create broader benefits to society by connecting individuals with learning tools and huge stores of information and by enabling government at all levels to deliver public services more efficiently.
More specifically, our exploration of how Chinese enterprises are integrating the Internet into their processes suggests five implications for competition and market dynamics:
1. Digitally Driven Productivity
The combination of slowing growth and excess capacity is increasing pressure on China’s auto industry to boost productivity. The Internet will help Chinese automakers and other companies in the associated value chain meet these challenges and create new models for growth. Connectivity will open up a series of new markets and service opportunities. In addition to offering safety features and driving assistance, it can be used to deliver maintenance alerts and run remote diagnoses, saving servicing costs for dealerships as well as time for car owners
China’s chemical industry traditionally spends less on IT than other industries but it is exploring ways to employ big data on inventory levels and shipments to improve forecasting and product planning. To capture the full potential of the Internet, chemical companies will need to increase their technology investment.
In China’s dynamic real-estate sector, online markets operated by players such as Anjuke and SouFun are streamlining information-search and transaction processes, thus shaving commissions and bringing down prices for customers. Beyond that it will cause value shifts as buyers and renters become more informed and greater transparency reduces price premiums based on information asymmetries.
China is engaged in ambitious effort to reform its health-care system, which is coming under pressure as the population ages and chronic diseases become more prevalent. Hospital funding will be perhaps the most crucial determinant of whether this effort succeeds – and if it does, the Internet could be an important tool for making the entire system more effective. Today many lower-tier hospitals, community health centers, and rural clinics lack technology systems. Even in top urban hospitals, information remains scattered. Shifting from paper records to an electronic health record system could dramatically improve China’s public health management.
2. Greater Access to Financing
An underdeveloped financial infrastructure has constrained some areas of China’s economy. The growing use of Internet platforms, combined with increased data and analytics capabilities, means that China’s financial institutions can allocate their scarce resources more effectively and expands the economy’s base of borrowers and investors.
One of China’s most significant gaps is in lending to small and midsize enterprises. Data concerning a growing number of companies and new analytics tools are giving banks better ways to target risk, thereby lowering the incidence of nonperforming loans and increasing the confidence of lenders. Digitally mediated transactions, meanwhile, are reducing lending costs – another benefit for smaller business borrowers.
A parallel trend is unfolding in consumer lending. Digitisation allows banks and other credit suppliers to monitor huge numbers of transactions and to evaluate the risks posed by borrowers more effectively while expanding loans. Regulators are authorising pilot programmes in online lending by newly formed pvrivate players.
In financial services a whole new batch of competitors has emerged from the technology side to challenge traditional financial institutions. Alibaba’s Yu’ebao, a money market fund linked to its Internet payment accounts, is luring bank depositors away with much higher yields. In some cases, companies that emerge from the technology side may be more adept at mining data for insight and advantages than long-established industry leaders – which could opt to make a leap forward by acquiring or establishing a partnership with an attacker.
Banks, securities firms, and insurance companies have built online channels for more efficient marketing and customer interactions. The Industrial and Commercial Bank of China estimates that an online transaction entails only one-seventh the cost of a transaction at a branch counter. The combination of improved risk management and lower transaction costs will allow banks to serve more retail customers.
3. A Growing Base of Consumers
Social technologies and new digital platforms ease the way for richer interactions with customers and allow companies to meet demand from a more diverse range of buyers, often in new or hard-to-reach markets. Jiangsu Sanfangxiang and Shandong Chambroad, early movers among China’s domestic chemical manufacturers, are using e-commerce platforms to cut administrative and transaction costs and to provide a base for closer collaboration with their customers.
Chemical manufacturers in the agricultural sector are sizing up the potential for big data to help farmers monitor crop conditions in real time, allowing these companies to customise their offerings of products to increase farm yields. Other types of customised offerings include water-treatment solutions for industrial companies.
Automakers, meanwhile, are finding that popular vehicle-shopping sites, such as Autohome and BitAuto, help them to identify and inform likely car buyers. That is proving to be an important tool for increasing conversion rates among undecided shoppers. Chinese car buyers are demanding systems offering GPS, maintenance alerts, and diagnostics that not only improve the customer experience but also offer robust data to manufacturers for improving products and marketing efforts. In addition, Internet sites are sparking China’s online used-car markets, where companies like Cheyipai and Youxinpai are bridging the information gap and helping dealerships source quality used cars.
Across consumer markets, companies are using China’s established social and search sites to mine data on ever-changing tastes and customer preferences. Their ability to expand delivery through mobile channels is growing as well. For example, in real estate, China’s big residential-property developer Vanke has experimented with location-based advertising, using Tencent’s advertising platform, Guangdiantong, to build awareness among potential buyers.
4. Digitally Enabled Innovation
The Internet blazes new pathways to innovative products, services, and business models. Digitally enabled innovation will add a new dimension to the efforts of Chinese companies, large and small, to compete as they climb the learning curve.
In consumer electronics, companies are gaining familiarity with open-source processes that can transform research and development. These processes widen access to innovative designs that can differentiate products and get them to market faster. Mobile-device maker Xiaomi has built a community of fans who provide feedback and recommendations for smartphone designs, consumer-friendly features, and other improvements. The company selects a few top ideas to address and releases software updates every week. Computer maker Lenovo held a competition where 50,000 participants contributed close to 100,000 product ideas. Some participants even developed their products with funds raised on crowdsourcing platforms.
As Internet capabilities are integrated with a growing number of products, new business models are arising. China’s fast-moving Internet-TV market is a case in point. Because Chinese consumers are highly price sensitive, vendors often make little money from hardware. Instead, they are looking for ways to use digital platforms to create markets where revenue streams flow from services such as media content and advertisements. LeTV, for instance, provides its Internet-TV set-top-box hardware for free but charges 490 RMB for a 12-month subscription. This model has sparked new collaborations between China’s TV manufacturers and content providers seeking to bundle services with hardware offerings. Some companies are swiftly turning to successful new models pioneered beyond China’s borders. Following the trend in Western cities where popular smartphone apps have revolutionized taxi services, residents of China’s major urban areas now use Didi and Kuaidi to summon the nearest available cab.
5. New Competition as the Internet Empowers Entrepreneurs and Small Businesses
Internet technologies lower entry barriers across sectors, giving unexpected competitive power to new players, from online insurers without field agents to mobile-service providers with capital-light models. This new competition may render the business models of some established players obsolete, weeding out companies that can’t adapt. In China, businesses with fewer than 1,000 employees contribute 70 percent of GDP. Yet, for the most part, they lag behind bigger players in productivity. Going digital will neutralise some of the disadvantages these enterprises face, by helping them manage supply chains more effectively, cement customer loyalty, lower transaction costs, and achieve wider distribution.
We expect that a growing number of smaller Chinese enterprises will eventually become “micro multinationals” by operating from new platforms, particularly as the number of digitally savvy Chinese entrepreneurs continues to grow.
Managing in the New Environment
Since the Chinese market lies at the heart of growth strategies for many global companies, senior executives must ready them to compete on the new terrain.
Given the size and rapid growth of China’s consumer market, companies have often prospered by focusing on large-scale production and mass-market channels. Looking forward, customer needs will become increasingly disjointed. To meet this challenge, companies will have to widen their choice of suppliers and produce a broader and more complex portfolio of products targeted to what consumers really want.
Moreover, the Internet has unleashed a new era of intense competition and companies will need to be fast and flexible to stay ahead. Competition can emerge rapidly from unexpected corners and as barriers between sectors become blurred, start-ups based on digital models will gain momentum. Leaders will need to commit resources to the digital transformation to maintain their position. Although the cost of these efforts will strain companies in the short term, they will open the way for long-term benefits.
Across the new Chinese landscape, Internet capabilities will require much more than a focus on customer-facing operations. A new operating strategy will integrate Internet technologies into back-office functions, production processes, and supply chains, to achieve new efficiencies. CIOs and other technology specialists will need to change their mind-set about big data, adopt multichannel models, and champion operational improvements.
Across China, companies are facing talent shortages for highly specialised roles in big data analytics, particularly in sectors such as finance, where changes are coming fast. Meantime, labor-intensive industries will need to attract more knowledge workers, as digital technologies become “wrappers” for many goods and services. Outside hiring to attract new talent will be needed, but companies must also be creative about developing their talent pipelines, exploring industry collaboration to create skills in short supply in China, and seeking out partnerships with universities.
The fluid nature of Internet technology will challenge traditional business models in China. The next phase of change will tax the capabilities of companies and executives should be open to collaborative ecosystems involving partnerships with upstream suppliers, downstream vendors, and consumers. China’s increasingly wired landscape is changing the face of business and is challenging the strategies of companies that have prospered through earlier waves of chaotic and massive growth.
Excerpted from “China’s digital transformation: The Internet’s impact on productivity and growth”, McKinsey Global Institute, July 2014
Feature Image: Chris Heuer/flickr.com/photos/chrisheuer/8381615946/
About the Authors
Yougang Chen is a principal in McKinsey’s Hong Kong office; Jeongmin Seong is a senior fellow of the McKinsey Global Institute, where Jonathan Woetzel is a director.
