Gauging
the strength of Chinese innovation
The events of 2015 have shown that China is passing through
a challenging transition: the labor-force expansion and surging investment that
propelled three decades of growth are now weakening. This is a natural stage in
the country’s economic development. Yet it raises questions such as how
drastically the expansion of GDP will slow down and whether the country can tap
new sources of growth.
New research by
the McKinsey Global Institute (MGI) suggests that to realize consensus growth
forecasts—5.5 to 6.5 percent a year—during the coming decade, China must
generate two to three percentage points of annual GDP growth through
innovation, broadly defined. If it does, innovation could contribute much of
the $3 trillion to $5 trillion a year to GDP by 2025. China will have
evolved from an “innovation sponge,” absorbing and adapting existing technology
and knowledge from around the world, into a global innovation leader. Our
analysis suggests that this transformation is possible, though far from
inevitable.
To date, when we have evaluated how well
Chinese companies commercialize new ideas and use them to raise market share
and profits and to compete around the world, the picture has been decidedly
mixed. China has become a strong innovator in areas such as consumer
electronics and construction equipment. Yet in others—creating new drugs or
designing automobile engines, for example—the country still isn’t globally competitive.
That’s true even though every year it spends more than $200 billion on research
(second only to the United States), turns out close to 30,000 PhDs in science
and engineering, and leads the world in patent applications (more than 820,000
in 2013).
When we look ahead, though, we see broad
swaths of opportunity. Our analysis suggests that by 2025, such new innovation
opportunities could contribute $1.0 trillion to $2.2 trillion a year to the
Chinese economy—or equivalent to up to 24 percent of total GDP growth. To
achieve this goal, China must continue to transform the manufacturing sector,
particularly through digitization, and the service sector, through rising
connectivity and Internet enablement. Additional productivity gains would come
from progress in science- and engineering-based innovation and improvements in
the operations of companies as they adopt modern business methods.
To develop a clearer view of this potential,
we identified four innovation archetypes: customer focused, efficiency driven,
engineering based, and science based. We then compared the actual global
revenues of individual industries with what we would expect them to generate
given China’s share of global GDP (12 percent in 2013). As the exhibit shows,
Chinese companies that rely on customer-focused and efficiency-driven
innovation—in industries such as household appliances, Internet software and
services, solar panels, and construction machinery—perform relatively well.
However, Chinese companies are not yet global
leaders in any of the science-based industries (such as branded
pharmaceuticals) that we analyzed. In engineering-based industries, the results
are inconsistent: China excels in high-speed trains but gets less than its
GDP-based share from auto manufacturing. In this article, we’ll describe the
state of play and the outlook in these four categories, starting with the two
outperformers.
1. Customer-focused innovation: The Chinese
commercialization machine
China benefits from the sheer size of its
consumer market, which helps companies to commercialize new ideas quickly and
on a large scale; even a relatively small market like online gaming is bigger
than the auto industry in Turkey or Thailand. Chinese companies have learned
how to read the requirements of their rapidly urbanizing country and to scale
up new products and services quickly to meet them.
Manufacturers of
appliances and other household goods dominated the first wave of
customer-focused innovators in China. Their innovations were “good enough”
products such as refrigerators and TV sets. But these offerings no longer
suffice to gain a growing share of consumers. Companies like smartphone
manufacturer Xiaomi are responding with cheaper and better products designed to
offer hardware features as good as those from global brands but priced for the
Chinese market. Like other customer-focused innovators in China, Xiaomi also
uses the massive consumer market as a collaborator, rapidly refining its
offerings through online feedback. Internet service providers are another
hotbed of customer-focused innovation. Alibaba, Baidu, and Tencent have become
global leaders in online services, largely thanks to their success in the
enormous Chinese market.
Customer-focused innovation could reshape
large swaths of China’s service sector, where productivity lags behind that of
its counterparts in developed economies. The government already is pushing to
modernize traditional businesses through its Internet Plus initiative,
announced in early 2015. Innovations are needed to expand access to services
(for example, remotely monitoring the health of rural patients), to improve the
quality of offerings (greater choice and customization in financial and
educational products), and to optimize operations (crowd-sourced logistics). Chinese
companies will also have opportunities to use their skills in customer-focused
innovation to take a lead in selling to other emerging markets.
2. Efficiency-driven innovation: The ecosystem
advantage
In manufacturing, China’s extensive ecosystem
has provided an unmatched environment for efficiency-driven innovation. The
country has the world’s largest and most highly concentrated supplier base, a
massive manufacturing workforce, and a modern logistics infrastructure. These
advantages give Chinese manufacturers a lead in some important knowledge-based
manufacturing categories, such as electrical equipment, construction equipment,
and solar panels.
Today, Chinese companies improve their
efficiency with a variety of cutting-edge approaches, including agile
manufacturing, modular design, and flexible automation. The apparel
manufacturer Everstar, for example, uses automated equipment and online design
and e-commerce systems that help consumers to customize designs for clothing
and receive finished goods within 72 hours. China is also pioneering the use of
open manufacturing platforms.
The challenges are mounting, however. As wages
rise, the country becomes less competitive for the most labor-intensive work.
At the same time, a worldwide transition is under way toward a new kind of
manufacturing, sometimes called Industry 4.0: a much more intense digital
linkage of manufacturing components, processes, and logistics. As a result,
Chinese companies will face pressure to improve their performance in utilizing
assets, matching supply with demand, and controlling quality. Success will
depend on how well China can exploit the scale of today’s manufacturing
ecosystems and clusters to extend their benefits beyond individual factories
through digitally linked networks.
Some efforts are under way to mobilize rapid,
flexible manufacturing. In Guangdong province, for example, manufacturers have
set up joint platforms to share the benefits of R&D and operations among
companies in the same clusters. Elsewhere, companies are looking at ways to
mass-customize products by combining flexible manufacturing with the
aggregation of a huge Internet consumer base. New manufacturing gains may also
emerge from the aggressive use of robots, which could make China’s huge pool of
semiskilled factory workers more effective.
Entrepreneurs are poised to play a bigger
role. In Shenzhen, a rich ecosystem of component suppliers, design services,
business incubators, and outsourced assembly capacity has helped start-ups
prototype products and scale up global manufacturing businesses quickly.
3. Engineering-based innovation in ‘learning
industries’
China has had mixed success with
engineering-based innovation. The best performers are found in Chinese markets
where motivated domestic industries are nurtured by national and local
governments that create local demand, push for innovation, and facilitate the
transfer of knowledge from foreign players. China has used this formula
successfully in high-speed rail (Chinese companies have a 41 percent share of
the global railroad-equipment revenues, according to McKinsey estimates), wind
power, and telecommunications equipment.
In 2008, the Ministry of Railways launched a
major program to develop a new generation of high-speed trains—a top-down,
nationwide effort that has been China’s equivalent of the Apollo space program
in scale and complexity. We estimate that the country has accounted for 86
percent of global growth in this market since then. Using technology transfers
from overseas partners as a knowledge base, Chinese companies tailor their
offerings to local requirements, such as terrain and temperature conditions,
through incremental innovation.
Learning and innovation have been slower to
come in automotive manufacturing. To date, most domestic Chinese carmakers have
relied on platforms from their global partners or on designs from outside firms
to bring products to market quickly. Thanks to exploding domestic demand and
strong profit streams from joint ventures, they have felt little pressure to
innovate.
Deregulation, a rapid increase in China’s base
of engineering talent, and continued high levels of government investment
promise to make engineering-based companies more motivated and effective
innovators in the future. In some sectors, such as nuclear power, explicit
state support will continue to be critical. China has an ambitious government
plan to build nuclear plants resulting in a total installed capacity of 58
gigawatts by 2020, which can support its goal of obtaining 20 percent of its
energy from non–fossil fuel sources by 2030.
In other industries, such as medical
equipment, the private sector will drive innovation. Mindray, United Imaging
Healthcare, and other smaller new Chinese players will continue to make inroads
in market categories (for instance, CT scanners and MRI machines) that foreign
suppliers now dominate. Government programs to subsidize purchases of
Chinese-made equipment by the country’s hospitals are providing a boost even as
a new generation of medical entrepreneurs draws from global knowledge and
partnerships.
4. Science-based innovation: Novel Chinese
approaches
A massive government push to raise R&D
spending, train more scientists, and file more patents has yet to give China a
lead in science-based innovation. The slow progress has a number of
explanations—not least that this type of work takes a long time to pay off and
requires an effective regulator to protect intellectual property. Huge
investments by government and the private sector to shepherd projects from the
lab to commercial deployment are needed, as well. What’s more, despite the
large number of Chinese students trained in scientific and technical fields,
companies struggle to find capable talent.
The government is addressing some of these
obstacles. For example, recently launched reforms to the drug-review process
could reduce the time to get a new drug to patients by two or more years.
Efforts such as the Thousand Talents program bring overseas Chinese to the
country to launch their own companies and work in scientific organizations and
universities.
Even as these reforms play out, Chinese
innovators are adopting novel approaches—for instance, using the country’s
massive market size and huge pool of low-cost researchers to industrialize and
speed up experimentation and data collection. One such innovator, BeiGene,
gained ground in the biotech industry by developing drugs to treat cancers and
other diseases. The company has accelerated the drug-discovery process by
deploying a large-scale drug-testing team, testing compounds on human tissue
(such as cancerous tumor samples) during the preclinical phase to get early
indications of issues that might arise in human testing, and capitalizing on
access to China’s large pool of patients. In genomics research, another
company, BGI, is deploying massive scale (2,000 PhDs and more than 200
gene-sequencing machines) to power its way through biotech problems.
The extent and speed of China’s advances in
innovation will have significant implications for the country’s growth and
competitiveness and for the types of jobs, products, and services available to
the Chinese people. They will also have powerful consequences for
multinationals (competing at home and abroad with Chinese companies), some of
which are now using China as an R&D base for global innovation.
Fortunately, that isn’t a zero-sum game: a more innovative China ought to be
good for a global economy that seeks new sources of growth.
byErik Roth, Jeongmin Seong, and Jonathan
Woetzel
This McKinsey Quarterly article is based on the new
McKinsey Global Institute report The China effect on global innovation.
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