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Bright Prospects For China’s Cold Chain Logistics Sector

Column chart showing China's cold chain logistics market size (in RMB billions). China's cold chain logistics market was valued at RMB 81 billion in 2011, RMB 109 billion in 2013, RMB 181 billion in 2015, RMB 236 billion in 2017 (forecast), RMB 368 billion in 2019 (forecast), RMB 470 billion in 2020 (forecast).

China’s cold chain logistics market has been growing steadily over the past several years. According to management consulting firm L.E.K. Consulting, China’s cold chain market grew from RMB 81 billion in 2011 to RMB 181 billion in 2015 representing a growth rate of over 20% annually.

Column chart showing China's cold chain logistics market size (in RMB billions). China's cold chain logistics market was valued at RMB 81 billion in 2011, RMB 109 billion in 2013, RMB 181 billion in 2015, RMB 236 billion in 2017 (forecast), RMB 368 billion in 2019 (forecast), RMB 470 billion in 2020 (forecast).

Yet, there is still ample potential for growth. China’s cold chain logistics network currently represents a relatively small part of the overall logistics industry, with just about 19% of the Chinese market having access to cold chain technologies, compared to 85% in Europe and Japan. This explains why the cargo damage to fresh product (such as fruits and vegetables which accounts for the greatest demand for cold chain logistics services) within China’s cold chain is reportedly as high as 20% to 30% – which is considerably higher than the average 5% to 10% in developed countries.

Furthermore, the market for cold chain logistics is expected to be driven by consumption upgrades (for instance with regards to consumer expectations on product freshness and quality), and growing demand for agricultural commodities such as fresh fruits and vegetables, as a result of rising incomes and living standards.

Considering these growth drivers, market research firm Reportlinker, projects China’s cold chain logistics market to reach RMB 522.5 billion in 2025 from RMB 295.6 billion in 2018 representing a CAGR of 8.5% between 2018 and 2025.

Fundamental growth drivers: rising fresh produce demand along with increasing quality and freshness expectations as living standards rise, driven by rising incomes, and an expanding fresh food e-commerce sector

Demand for cold chain logistics stems largely from five agricultural products including meat, aquatic products, quick-frozen foods, fruits and vegetables, and dairy products, among which cold chain for fruits and vegetables accounts for the greatest demand. With incomes growing and its middle class expanding, demand for such agricultural products are enjoying robust demand in China.

According to data from the China Chamber of Commerce for Import and Export of Foodstuffs, Native Produce, and Animal By Products, in 2019 China imported approximately 6.83 million tons of fruit with a total value of US$ 9.5 billion, representing a year-on-year increase of 24% 25% respectively.
With China’s fruit exports amounting to 3.61 million tons at a value of US$ 5.5 billion in 2019, up just 4% and 14% year on year respectively, China is a net fruit importer and is likely to remain so, as per capita fruit consumption grows while economic policy focuses on high-tech industries and high-value manufacturing sectors.
Data released by the National Bureau of Statistics show that per capita consumption of fresh fruits among urban residents was 56.423 kilograms in 2018, up from 47.6 kilograms 2013. With per capita fruit consumption growing steadily, the Chinese Academy of Agricultural Sciences projects China’s fruit market will reach US$ 460 billion in 2024.

China’s growing interest in milk and dairy products is also poised to contribute to demand for cold chain logistics. China today is the second largest dairy market behind the United States, the third largest milk producer in the world, with about 13 million dairy cows up from just 120,000 cows in 1949.  The average dairy product consumption per capita has increased from almost just 6 kilograms in 1999 to 36 kilograms in 2019. Yet, there is plenty of potential with China’s per capita consumption of dairy products being half of the rest of Asia and less than one third of the world average according to Milk Quotient report published by the China Dairy Industry Association and Dutch dairy producer Royal Friesland Campina last month in Beijing.

China’s burgeoning fresh food e-commerce sector is expected to drive some of the demand for these products. China fresh food e-commerce industry has been growing steadily over the past few years; according to Euromonitor and Qianzhan Industry Research Institute, in 2019, China’s fresh food e-commerce market was valued at around RMB 288.8 billion up 19.1% 2018 when the market was valued at RMB 242.4 billion in 2018. Yet, with fresh food e-commerce accounting for just 5.6% of the total fresh food industry market in China in 2019, there is tremendous potential for growth.

Column chart showing China's fresh food e-commerce market size, growth, and proportion of total fresh food market size. China's fresh food market was valued at RMB 43.6 trillion in 2015, RMB 47.3 billion in 2016, RMB 47.4 billion in 2017, RMB 49.5 billion in 2018, and RMB 51 billion in 2019. China's fresh food ecommerce market was valued at RMB 828 million 2015, RMB 1.324 billion in 2016, RMB 1.752 billion in 2017 RMB 2.424 billion in 2018, and RMB 2.888 billion in 2019. China's fresh food ecommerce market's sure of the country's overall fresh food market stood at 1.9% in 2015, 2.8% in 2016, 3.7% in 2017, 4.9% in 2018, and 5.66% in 2019. China's fresh food ecommerce market growth rate was 80.7% in 2015, 59.9% in 2016, 32.3% in 2017, 38.4% in 2018, and 19.1% in 2019. Data from Cushman and Wakefield.

However, the bigger growth driver is from fresh food e-commerce’s need for cold storage warehouses closer to the consumer to enable cheap and fast delivery as opposed to the conventional notion that warehouses and distribution centers should be near ports and airports. Much of China’s cold storage warehouse stock is located in provinces with some of the world’s busiest ports. For instance, Liaoning which has the biggest warehouse stock by area in China is home to the Port of Dalian (the world’s 16th busiest port), Guangdong which has the 5th largest logistics warehouse stock is home to the Port of Guangzhou (the world’s 5th busiest port), and Shanghai which has the 11th biggest logistics warehouse stock in China is home to the Port of Shanghai (the world’s busiest port).

Bar chart showing China's cold storage logistics warehouse distribution by storage area (in square metres). The Province with the highest cold storage logistics warehouse by storage space area is Liaoning with 1.065 million square metres, followed by Henan with 1.059 million square metres, Sichuan with 684.9 thousand square metres, Jiangsu with 567.5 thousand square metres, Guangdong with 399.2 thousand square metres, Shandong with 387.3 thousand square metres, Shaanxi with 373 thousand square metres, Tianjin with 363.5 thousand square metres, Beijing with 282.9 thousand square metres, Hubei with 258.5 thousand square metres, Shanghai with 235 thousand square metres, Heilongjiang with 150 thousand square metres, Hebei with 132 thousand square metres, Hainan with 81.7 thousand square metres, Zhejiang with 80 thousand square metres, Hunan with 75 thousand square metres, Chongqing with 72,600 square metres, Fujian with 58,680 square metres, Guangxi with 49,850 square metres, Anhui with 49,218 square metres, Jiangxi with 40,000 square metres, Yunan with 36,000 square metres, Shanxi with 25,300 square metres, Guizhou with 12,000 square metres.

Opportunities in China’s fragmented cold storage warehouse market

Cold storage is a major part of the cold chain logistics industry; according to projections from L.E.K. Consulting, transportation, cold storage, and other services are expected to make up 40%, 30%, and 30% of China’s cold chain logistics market, respectively in 2020.

Currently cold chain storage represents a small part of China’s logistics warehouse stock; according to Warehouse In Cloud (WIC), China’s total cold storage logistics warehouse stock was about 6.65 million square meters in 2019, accounting for just 2.15% of the total logistics warehouse market. Along with the development of China’s cold chain industry, the market for refrigerated warehousing is poised to experienced solid growth.

China’s cold storage market is fragmented with the top 10 cold storage operators commanding a market share of around 21%. One of the country’s largest property developers China Vanke (HKG:2202), is a notable player in China’s cold storage space. The company purchased Swire Cold Chain Logistics from Swire Pacific (HKG:0019) in 2018, propelling Vanke into the ranks of China’s 10 largest temperature controlled-storage providers.

Under its logistics and warehousing Service Platform ” VX Logistic Properties”, has been aggressively acquiring and building its portfolio of high-standard warehouses, cold storage warehouses, as well as cold storage integrated logistics parks. In 2019, China Vanke served more than 850 customers, covering e-commerce, manufacturing, catering, retailing, etc. According to their 2019 financial results, the annual utilization rate of their cold storage warehouses stood at around 82% in 2019. China Vanke is also one of the consortium of investors that participated in the buyout of GLP, cheap the world’s leading logistics solution provider.

Another player worth watching is Alibaba (NYSE:BABA) whose logistics subsidiary Cainiao has been actively building distribution centers equipped with cold storage and delivery facilities to offer B2C cold chain logistics services, which are expected to grow along with the country’s growing fresh food e-commerce sector.
Alibaba’s cross-border ecommerce platform TMall Global offers end-to-end cold chain logistics services including warehousing, processing, packaging, and transportation enabling merchants from around the world sell fresh foods to Chinese buyers. Once in China, the goods are stored in TMall Global’s warehouses and are delivered to consumers within 24 hours.
Alibaba’s marketplace TMall Global has introduced a cold storage logistics option to enable foreign merchants to sell fresh food to Chinese buyers. The service supports refrigeration across warehousing, processing, packaging, and transportation. It also offers customs clearance online. Once the goods have reached China they can be delivered within 24 hours. Cainiao Logistics offers the full chain of services, from cargo storage in bonded warehouses, to packaging and last mile delivery.

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China’s Software-As-A-Service (SaaS) Market Offers Tremendous Growth Potential

A column chart showing China's cloud computing market size in billions of yuan. China's cloud computing market was valued at RMB 9.7 billion in 2015, RMB 17 billion in 2016, RMB 26 billion in 2017, RMB 41.3 billion in 2018 (forecast), RMB 60.8 billion in 2019 (forecast), RMB 84.3 billion in 2020 (forecast), and RMB 110.9 billion in 2021 (forecast).

The public cloud market is growing at a rapid clip around the world. The worldwide public cloud services market is projected to grow from US$ 182.4 billion in 2018 to US$ 331.2 billion by 2022 representing a CAGR of 16.08% according to research from Gartner. The fastest growing market segment is expected to be cloud system infrastructure services, also known as Infrastructure as a Service (IaaS) which is expected to grow from US$ 30.5 billion in 2018 to US$ 76.6 billion by 2022, representing a CAGR of 25.89%. The second fastest growing market segment is expected to be Cloud application infrastructure services, also known as Platform as a Service (PaaS), which is expected to grow from US$ 15.6 billion in 2018 to US$ 31.8 million by 2022 representing a CAGR of 19.49%. Meanwhile the market for cloud application services, also known as Software-as-a-Service (SaaS) is expected to grow from US$ 80 billion in 2018 to US$ 143.7 billion by 2022 representing a CAGR of 15.77%.

The story is the same in China where, much like the rest of the world, China’s cloud market has also been on an uptrend.

A column chart showing China's cloud computing market size in billions of yuan. China's cloud computing market was valued at RMB 9.7 billion in 2015, RMB 17 billion in 2016, RMB 26 billion in 2017, RMB 41.3 billion in 2018 (forecast), RMB 60.8 billion in 2019 (forecast), RMB 84.3 billion in 2020 (forecast), and RMB 110.9 billion in 2021 (forecast).

China’s IaaS market is the fastest growing cloud computing segment and is dominated by homegrown tech giants Alibaba (NYSE:BABA) and Tencent (HKG:0700). And although the country’s SaaS market has received relatively little attention compared to the IaaS segment, it is a significant part of China’s overall cloud computing market, being estimated to reach a market value of RMB 47.3 billion in 2020 which accounts for about 56.1% of China’s cloud market which is estimated to reach market value of RMB 84.3 billion the same year.

China’s SaaS market has been growing steadily over the past several years.

A column chart showing China software-as-a-service market size (in RMB billions). China's software-as-a-service market was valued at RMB 3.49 billion In 2013, RMB 5.98 billion in 2014, RMB 9.89 billion in 2015, RMB 12.75 billion in 2016, RMB 16.87 in 2017, RMB 23.21 billion in 2018 (forecast), RMB 33.7 billion) in 2019 (forecast), and RMB 47.34 billion in 2020 (forecast).

Yet, there is still ample potential for growth. China’s SaaS market is expected to reach approximately RMB 47 billion (US$ 6.7 billion) in 2020 according to Statista while the global SaaS market is expected to reach US$157 billion by 2020. This means China would account for just about 4% of the global SaaS market while accounting for about 16% of global GDP indicating ample potential for growth.
Furthermore, according to a 2019 report issued by Alibaba Cloud Research Center, while the number of Chinese companies is 3 times that of the United States, China’s SaaS output is just 24% of the U.S.

There are several growth drivers to support China’s SaaS market. Unlike in the west, a growing number of Chinese firms are not tied to legacy IT infrastructure and they are increasingly moving directly to the cloud, leapfrogging the traditional enterprise software generation in much the same way Chinese citizens leapfrogged the desktop/laptop phase and went straight to mobile. In the medium term, the COVID pandemic may prompt SMEs to accelerate cloud adoption to control costs, facilitate remote working, and online sales. Over the longer run, the industry is likely to enjoy tailwinds thanks to China’s made in China 2025 initiative which aims to upgrade China manufacturing base by developing high-tech Industries including electric cars, robotics, artificial intelligence, agricultural technology engineering new synthetic materials. Cloud computing is among the many technologies expected to drive this development (others include big data and IoT).

Opportunities for local and international SaaS companies

China’s higher end SaaS segment is largely dominated by foreign SaaS behemoths such as Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), and SAP (ETR:SAP) whose product offering often comes with a hefty price tag. Homegrown SaaS companies such as Kingdee (HKG:0268), Digiwin, and Yonyou (SHA:600588) on the other hand are not as powerful in terms of functionality compared their foreign counterparts, however their product offering has been improving in terms of sophistication and capabilities, and they are usually significantly cheaper which makes them a very compelling option to fulfill the needs of China’s Small and Medium Enterprises (which make up almost 99% of business establishments in China) as well as state enterprises. This has helped local SaaS providers carve out a niche for themselves in China’s nascent SaaS market while competing against foreign, well-established players.

The country’s SaaS market is highly fragmented the top 10 vendors accounting for only about 30% that the market as of 2018 according to research from PR Underground. Local rising star Kingdee dominated the market with a market share of just 5%, followed by Microsoft, SAP, Salesforce (NYSE:CRM), Oracle, Veeva Systems (NYSE:VEEV), Zoho, Beisen, Yonyou, and Newdo which collectively made up the top 10.

Pie chart showing the market share of China's SaaS vendors during the first half of 2018. Kingdee was the market leader with a 5.1% market share followed by Microsoft (5%), SAP (4.3%), Salesforce (4%), Oracle (3.8%), Veeva Systems (2.6%), Zoho (2.6%), Beisen (2.2%), Yonyou (2%), Newdo (1.8%), and others accounted for the balance 64.5%,

Many of China’s SaaS market verticals are also dominated by homegrown companies. Kingdee for instance, leads in HR, ERP, and accounting. Beijing-based Forceclouds, and Shanghai-based MacroWing lead in document and data management tools for the clinical research, pharmaceutical, and medical device industries. Beisen and DOIT provide CRM solutions in partnership with Tencent.

America boasts a number of SaaS behemoths; in one category America has born-in-the-cloud SaaS companies such as Salesforce, Workday (NASDAQY:WDAY), ServiceNow (NYSE:NOW), Splunk (NASDAQ:SPLK), and Atlassian (NASDAQ:TEAM); in another category there are established software giants with a growing cloud business such as IBM (NYSE:IBM), Oracle, Microsoft, SAP, and Adobe (NASDAQ:ADBE); and finally there are IT vendors with a growing SaaS cloud offering such as Google (NASDAQ:GOOGL) and Cisco. The world’s top three SaaS companies are American; Microsoft, Salesforce, Adobe with market shares 17%, 12%, and 10% respectively of in 2019 when the SaaS market reached US$ 101 billion according to analysis by Synergy Research.

Chinese SaaS companies on the other hand are still at a relatively early stage of growth. However, in much the same way America’s SaaS market growth spawned a number of homegrown SaaS giants, there is potential for Chinese SaaS companies to blossom along with the growth of China’s SaaS market. Notable SaaS companies worth watching include:

Kingdee

Kingdee is one of China’s largest providers of ERP software with a focus on SMEs, and is one of China’s leading SaaS players with a market share of 5%. Kingdee first started out as an ERP software company building a large user base of enterprise customers. This user base helped Kingdee’s cloud transformation, enabling it to introduce its own cloud products to its existing user bas

In FY 2019, Kingdee’s cloud services revenue grew 54.7% year-on-year accounting for 39.5% of revenue during the year up from 30.2% in 2018 according to their 2019 annual report. Cloud revenue’s share of total revenue is likely to increase going forward as traditional ERP customers migrate to the cloud. Traditional ERP systems are gradually being replaced by SaaS which is generally more cost-efficient and easier to use and manage compared to traditional ERP systems. Notable enterprises upgrading to Kingdee’s “Kingdee Cloud Cosmic” (a cloud platform for large enterprises) include one of China’s largest courier companies SF Express (SHE:002352), Chinese edtech unicorn VIPKid, and Chinese state-owned defense corporation Norinco. The company is targeting cloud revenue to contribute 60% to total revenue by 2020.

While it may seem that cloud can cannibalize Kingdee’s traditional software business, according to figures from its annual report, it is evident that this is not the case with much of Kingdee’s cloud growth being driven by new customers During FY2019, of Kingdee’s “Kingdee Cloud Galaxy” (a digital cloud service platform for medium and large enterprises, and fast-growing enterprises) customer base, 77% of clients were new to ERP, 13% were from competitors, and just 10% were existing clients.

Armed with a wide product range of cloud software spanning e-commerce, supply chain and intelligent manufacturing, a healthy balance sheet (the company’s borrowings stands at RMB 199 million while it has a cash pile of RMB 3.18 billion), a strong brand name among local SaaS companies, and an impressive user base of SMEs as well as large enterprises suggest Kingdee is well placed to capitalize on China’s growing SaaS market.

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Chinese EdTech Startups With Tremendous Growth Potential

Bar chart showing leading edtech unicorns worldwide in 2020, by valuation, (in US$ billions). The startups are ByJu’s (from India) valued at US$ 5.8 billion, VIPKid (from China) valued at US$ 4.5 billion, Yuanfudao (from China) valued at US$ 3 billion, Duolingo (from the United States) valued at US$ 1.5 billion, Udacity (from United States) valued at US$ 1.1 billion, and iTutorGroup (from China), Guild Education (from United States), HuJiang (from China), Huike (from China), 17zuoye (from China), Zhangmen (from China), Knowbox (from China), Age of Learning (from United States), and Coursera (from United States) valued at US$ 1 billion each.

Chinese edtech startups accounted for 50% of all global VC investment in edtech, during the period 2016-2018 according to market research firm HolonIQ.

Chinese have traditionally placed tremendous importance on education. The gaokao, China’s notoriously tough entrance examination, is known as one of the toughest exams in the world, and gaokao scores are now being increasingly accepted in universities worldwide for admissions purposes. The sheer competition for top schools, and jobs, is driving demand for tutoring Chinese parents spare no expense so it is not surprising that education is big business in China.

However, the distribution of quality educational resources to match demand for such resources is inconsistent; urban students generally have greater access to top-notch educational resources while their rural peers often do not.
Experienced, highly qualified teachers also tend to teach in urban schools while schools in lower tier cities generally grapple with lesser-experienced teachers, and some schools suffer shortages. But the problem is not just limited to urban vs rural educational resource distribution. Even within urban cities, the distribution of English teachers for instance is inconsistent, with some cities and schools being able to hire native English teachers while others struggle.

Online education is a feasible solution to these problems. Online education offers numerous other benefits as well. Lesson schedules can be made flexible, lessons can be customized to suit the student’s learning pace and existing knowledge, artificial intelligence and other technologies can be utilized to make the learning experience more fun,
and parents can be given updates on the child’s progress, and areas that need to be improved. VIPKid for instance, a leading platform connecting Chinese children with English tutors from North America provides progress data to parents such as what the child has learnt, and what needs to be improved.

With, more and more Chinese students having access to the internet, mostly through smartphones, and some others through desktop devices such as laptops and PCs, long-sighted edtech startups have been quick to capitalize on the opportunity of using the internet to bring forth a more even and equitable distribution of online resources to match demand which has been growing along with rising disposable incomes which enable a growing number of China’s ambitious tiger parents to shell out top dollar for online after-school supplemental education resources.
China’s after-school tutoring revenue has grown from RMB 2 billion in 2011, to RMB 3.9 billion in 2017, representing a CAGR of 11.6% according to figures from research firm Frost & Sullivan. The market is expected to reach RMB 5.6 billion by 2021, representing a CAGR of about 9% during 2017-2021.

This has helped spawn a vibrant edtech market, which has emerged to be one of the biggest in the world. Of the 14 leading global edtech unicorns, 8 are from China (five from the United States, and one from India).

Bar chart showing leading edtech unicorns worldwide in 2020, by valuation, (in US$ billions). The startups are ByJu’s (from India) valued at US$ 5.8 billion, VIPKid (from China) valued at US$ 4.5 billion, Yuanfudao (from China) valued at US$ 3 billion, Duolingo (from the United States) valued at US$ 1.5 billion, Udacity (from United States) valued at US$ 1.1 billion, and iTutorGroup (from China), Guild Education (from United States), HuJiang (from China), Huike (from China), 17zuoye (from China), Zhangmen (from China), Knowbox (from China), Age of Learning (from United States), and Coursera (from United States) valued at US$ 1 billion each.

Online education accounts for just about 10% of China’s overall education market according to Deloitte. However, as online learning gains acceptance, this share is expected to climb in the years ahead. The number of online education users in China is expected to climb to 263 million by 2022, up from 42 million in 2012 according to research from iResearch.

Column chart and line graph showing the number of online education users in China, 2012-2022 (estimate), (in millions of people). The number of online education users in China is expected to reach 263.7 million people in 2022, up from 42 million in 2012. Data from iResearch.

Here are some notable startups poised to grow along with China’s online learning opportunity.

VIPKid

Backed by tech giant Tencent (HKG:0700), VIPKid connects Chinese students (aged 4-15) and English teachers from around the world (predominantly North America). VIPKid has been a notable beneficiary of China’s demand for English language training for children; in 2018 the market was valued at RMB 21.3 billion (approximately US$ 3 billion), registering a 104% growth year-on-year. The number of users jumped a whopping 168% from 5.7 million in 2017 to US$ 15.3 million in 2018 according to a 2019 report from data monitoring firm Trustdata.

Founded in 2013, and launched in 2014, the startup was one of the first to capitalize on the shortage of native English speakers in China at the time. While taking advantage of what seems to be very strategic timing, VIPKid also established a strong brand for itself by building a reputation for maintaining high quality standards with all tutors undergoing a rigorous assessment before being accepted as VIPKid teachers (the startup reportedly receives about 20,000-30,000 teacher applications per month, and 90% of them are rejected).

This focus on quality, as well as its first-mover advantage, among other reasons helped VIPKid’s meteoric rise to unicorn status in less than five years. VIPKid boasts 700,000 students, 100,000 teachers, a student retention rate of 95%, and according to data in a 2018 Chinese Online Youth English Education white paper published by the Chinese Academy of Sciences, VIPKid has been noted as a market leader with a market share of 67.2%. According to a report by Trustdata, VIPKid held a market share of 68.4%, followed by 51Talk (11.6%), Da Da English (7.8%), and vipJr (5.7%) as of 2018.

Pie chart showing leading online English education platforms in China by market share (%) in 2018. VIPKid led the market with a market share of 68.4%, followed by 51Talk (11.6%), DaDa English (7.8%), vipJr (5.7%) and others (6.5%) according to figures from market research firm Trustdata.

English language training (ELT) is still very much in demand by parents of school-aged children in China; the ELT market is expected to grow from US$ 41.51 billion in 2017 to US$ US$ 75 billion in 2022, representing a CAGR of 12.56% according to Statista with much of that being driven by the online English education segment as noted in a research report by research firm Global Information Inc.

While demand is growing, the supply side on the other hand is not expected to keep pace. China has tightened regulations on teachers’ backgrounds and qualifications which may have the effect of smaller language schools struggling to recruit qualified foreign teachers.

This suggests plenty of runway left for VIPKid’s growth story. However, competition is increasing, particularly with online learning giants such as TAL Education and New Oriental Education rolling out their own online English education courses. Furthermore, VIPKid’s one-on-one classes are generally not as profitable as group classes so VIPKid, which has so far yet to turn a profit, may find itself struggling with greater losses as it fights for market share.

However, VIPKid has made efforts to differentiate itself, for instance all of VIPKid’s teachers are from North America ; by comparison, 69% of 51talk’s teachers are from Southeast Asia. Additionally, VIPKid is working to increase the efficacy of its teaching materials (such as syntax, vocabulary, accents etc) by utilizing its vast trove of data from the more than 2 million English classes it offers monthly. VIPKid has also taken its global model a step further by aiming to bring quality native speaking Chinese teachers to students overseas where demand for Chinese language education is growing in leaps and bounds. VIPKid has already gained some ground as an education platform in North America so the startup may find it easier to enroll overseas students compared to most of its rivals who have a very limited presence beyond China’s boundaries.

Makeblock

STEM education and robotics startup Makeblock develops hardware, software, and robotics hardware targeted at schools, educational institutions, hobbyists, children, and families. With a userbase of more than 10 million, Makeblock are sold in more than 140 countries, and its products are used in more than 25,000 schools around the world. The robotics education market is expected to witness tremendous growth in the coming years driven in part by schools’ continuing emphasis on STEM (Science, Technology, Engineering, and Mathematics) education. Market research firm HolonIQ foresees the global robotics education market to nearly triple to US$ 3.1 billion by 2025, from US$ 1.3 billion in 2019.

The market is riding on the back of a large and fast-growing robotics market in the Middle Kindgom; Chinese companies installed 154,000 industrial robots in 2018, more than double that of Japan’s 55,200 and more than triple that of the United States’s 40,400 according to the International Federation of Robotics. This strong performance helped China maintain its position as the world’s largest industrial robot maker for the sixth consecutive year, accounting for 36% of global robot installations. By value, China’s robot installations grew 21% year-on-year to reach US$ 5.4 billion in 2018. China’s robot density (the number of robots per 10,000 persons used in the manufacturing industry) has also been on an uptrend, growing from 68 in 2016, 97 in 2017, and 140 in 2018.

Bar chart showing the number of installed industrial robots per 10,000 employees in the manufacturing industry in 2016, by leading countries. At 631 industrial robot installations per 10,000 manufacturing sector employees, the Republic of Korea had the highest robot density in the world, followed by Singapore 488, Germany 309, Japan 303, Sweden 223, Denmark 211, United States 189, Italy 185, Belgium 184, Chinese Taipei 177, Spain 160, Netherlands 153, Canada 145, Austria 144, Finland 138, Slovenia 137, Slovakia 135, France 132, Switzerland 128, Czech Republic 101, Australia 83, United Kingdom 71, China 68, Portugal 58, Hungary 57. Data from the International Federation of Robotics.
Bar chart showing the number of installed industrial robots per 10,000 employees in the manufacturing industry, 2017. At 710 installed industrial robots per 10,000 manufacturing sector employees, the Republic of Korea had the highest robot density in the world in 2017, followed by Singapore (658), Germany (322), Japan (308), Sweden (240), Denmark (230), United States (200), Chinese Taipei (197), Belgium (192), Italy (190), Netherlands (172), Austria (167), Canada (161), Spain (157), Slovakia (151), Slovenia (144), Finland (139), France (137), Switzerland (129), Czech Republic (119), China (97). Data from the International Federation of Robotics.
Bar chart showing the number of installed industrial robots per 10,000 employees in the manufacturing industry, 2018. At 831 installed industrial robots per 10,000 manufacturing sector employees, Singapore had the highest robot density in the world in 2017, followed by the Republic of Korea (774), Germany (338), Japan (327), Sweden (247), Denmark (240), Chinese Taipei (221), United States (217), Italy (200). Belgium (188), Netherlands (182), Austria (175), Slovenia (174), Canada (172), Spain (168), Slovakia (165), France (154), Switzerland (146), China (140), Finland (140),Czech Republic (135). Data from the International Federation of Robotics.

Since 2017, China’s robot density has exceeded the world average.

Column chart showing China’s robot density (number of industrial robots per 10,000 employees in the manufacturing sector) vs world average. In 2016,2017, and 2018, China’s robot density was 68, 97 and 140, respectively while the world average was 74, 85, and 99 respectively. Data from the International Federation of Robotics.

China’s robot density is expected to continue its upward march in the years to come. With China’s robotics industry growing at a rapid clip, the need for skilled robotics professionals and talent will no doubt increase in the future, suggesting bright prospects for Makeblock.

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Healthy Opportunities In China’s Blossoming Healthcare Market

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China, the world’s second largest healthcare market in the world after the United States, is growing rapidly driven by an ageing population, government support,  and rising urbanization (which is contributing to an increase in lifestyle diseases such as diabetes and cancer.

China is currently the fastest growing major healthcare market in the world with a five-year compound annual growth rate (CAGR) of 17% compared with just 4% for the United States and -2% in Japan according to 2015 information from the World Bank. Healthcare spending in China has risen four-fold from about CNY 1 trillion (US$ 126 billion) in 2006 to CNY 4.6 trillion in 2016 (US$ 698 billion).

Yet, the Chinese healthcare market is still relatively immature compared to developed economies such as the United States and Germany. China holds nearly 20% of the world’s population but the country accounts for just about 3% of the world’s healthcare spend.

As a percentage of GDP, China’s healthcare expenditure is about 5.6% of the country’s GDP compared with 17.1% for the United States, 11.3% for Germany and 10.3% for Japan according to 2013 data from the World Health Organization.

Furthermore, despite being the world’s second biggest healthcare market, China’s per capita healthcare spending is only a fraction of mature markets such as the United States, Luxembourg and Germany. China does not even make it to the list of the world’s top 10 countries with the highest per capita health expenditure indicating huge potential for spending increases.

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China’s healthcare market is expected to continue its rapid growth in the years to come propelled by growth drivers such as an greying population, increasing lifestyle diseases as a result of increasing urbanization and government support.

China’s population is ageing with the country’s over-65 year olds accounting for 11.4% of the total population in 2017, up from 10.8% in 2016 and less than 8% in 2000 according to data from the statistics bureau. That equates to over 150 million Chinese over the age of 65 which is slightly less than half of the entire population of the United States. This number is expected to grow with the State Council expecting 25% of China’s population to be aged 60 and over by 2030, up from 13% in 2010 which is expected to drive healthcare costs going forward.

China’s urbanization rate has been on the rise and it currently stands at 59% according to the National Statistics Bureau. This compares with the United States which is at 82%, the United Kingdom which is at 83% and South Korea which is at 83%. China’s increasing urbanization has contributed to a greater incidence of lifestyle diseases such as diabetes and cancer. China has the most number of obese children in the world and has the world’s second -biggest population of obese adults after the United States according to the Global Burden of Disease report by a team at the University of Washington.

The urbanization process is continuing in China and thus as Chinese get increasingly wealthier and urbanized which leads to unhealthy diets and sedentary lives, the country’s lifestyle disease burden is expected to increase thereby driving China’s healthcare market.

Recognizing the need for a robust healthcare industry to meet the country’s increasing healthcare needs, the Chinese government has undertaken a series of reforms and supportive government policies such as the blueprint “Healthy China 2030” which aims to improve the level of health throughout the country by improving health services, expanding the medical industry and encouraging private investment in the local healthcare sector.

By 2030, the National Health and Family Planning Commission (NHFPC) estimates China’s health-related industries will reach CNY 16 trillion (approximately US$ 2.4 trillion).

These factors are expected to drive China’s healthcare industry going forward. According to a 2017 report by Research ad Markets, China’s healthcare market is poised to expand from around US$ 710 billion in 2016 to over US$ 1.11 trillion in 2020 creating numerous opportunities.

Pharmaceuticals

Pharmaceuticals is the largest sector of China’s healthcare market and China’s pharmaceuticals industry has been growing rapidly; the Chinese pharmaceutical market grew at a CAGR of 9.4% from 2013 to 2017 helping China overtake Japan to emerge as the world’s second largest pharmaceutical in the world after the United States.

Bar chart showing the world’s top 10 pharmaceutical markets in 2016 by market value (US$ billion). The top 10 markets are U.S.A. (US$ 461.7 billion), China (US$ 116.7 billion), Japan (US$ 90.1 billion), Germany (US$ 43.1 billion), France (US$32.1 billion), Italy (US$ 28.8 billion), U.K. (US$ 27 billion), Brazil (US$ 26.9 billion), Spain (US$ 20.7 billion), and Canada (US$19.3 billion).

Yet, China’s pharmaceutical market lags far behind the United States in sales; despite having a population that is three times the size of the United States, at US$ 122.6 billion in 2017, China’s pharmaceutical market was worth less than a quarter of the United States’ which was valued at US$ 466.6 billion the same year according to data from health information vendor IQVIA. However, with drug demand expected to grow due to factors such as a greater incidence of lifestyle diseases and faster drug approvals, IQVIA forecasts China’s pharmaceutical market to expand from US$ 122.6 billion in 2017 to reach US$ 145 billion to US$ 175 billion by 2022.

In 2017, China announced new rules aimed at speeding up the country’s inefficient drug approval process, which could be a revenue boost for pharmaceutical companies.

Foreign pharmaceutical companies in particular stand to benefit as the new rules allow foreign drug makers to file for drug approval in China using data from international, multinational trials (provided China is included as a study site) which enables them to gain greater inroads into the Chinese market and eliminates the necessity of conducting additional costly and often time-consuming clinical trials in China after receiving approval overseas.

Swiss pharmaceutical giant Novartis AG (VTX: NOVN) aims to double China sales over the next five years.

AstraZeneca (LON:AZN) has deepened its substantial China business with the announcement of a new company Dizal Pharmaceutical, which is a drug development joint venture with the Chinese Future Industry Investment Fund (FIIF).

French pharma giant Sanofi (EPA:SAN), one of the leading insulin providers in the world and in China, expects to maintain double-digit sales growth in China thanks to China’s growing diabetes population. One third of the world’s approximately 420 million diabetic population live in China which amounts to over 100 million diabetic Chinese, accounting for about 11% of Chinese adults as of 2015 up from less than 1% in 1980, a dramatic increase over the past 35 years. China’s growing insulin demand has been a boon to Sanofi’s rival insulin makers as well, Novo Nordisk (CPH:NOVO-B) and Eli Lilly (NYSE:LLY).

Local drug makers also stand to benefit from accelerated drug approvals.

Hutchison MediPharma, a subsidiary of Hutchison Meditech (LON:HCM) is expected to receive approval this year for its fruquintinib capsule for colorectal cancer, the second-most common prevalent cancer in China with about 380,000 new cases annually according to the National Central Cancer Registry of China. The market potential for cancer drugs in China is substantial with cancer rates rising nationwide as a result of aging, and environmental factors among other reasons. With China seeing approximately 700,000 new cancer cases annually, the country has one-third of new cancer patients in the world.

While China is the world’s biggest producer of APIs, the country lags behind the U.S. and other developed markets in drug innovation, and most innovative drugs are produced by foreign pharmaceutical companies. To help its pharmaceutical industry move up the global value chain, the Chinese government has been actively creating a supportive regulatory framework to galvanize homegrown pharmaceutical companies through grants and tax breaks for research, and through initiatives such as the ‘Made in China 2025’ plan which mentions innovation in pharmaceuticals, among 10 other key sectors, a national priority.

With the results of such initiatives likely to bear fruit in the long term, in the shorter term Chinese pharmaceutical companies’ expansion efforts are likely to remain focused on capturing market share in the global generic drugs market. China’s drugs market is dominated by generics, accounting for 85% of total drug sales as of 2016 according to data from Fitch, and over 95% of the 170,000 drug approvals by the China FDA according to data from the National Health Commission. China’s generics market is dominated by a large number of low-cost domestic pharmaceutical companies, and these Chinese pharmaceutical companies are now venturing out to overseas markets. In the United States, the world’s largest generics market, Chinese generic drug manufacturers have reportedly won approval for 38 generic drugs from the U.S. Food & Drug Administration in 2017, up from 22 in 2016. Jiangsu Hengrui (SHA;600276), Zhejiang Huahai Pharmaceutical (SHA:600521), Zhejiang Hisun Pharmaceutical (SHA:600267) are among the Chinese pharmas that received U.S. FDA approval.

Meanwhile the world’s largest exporter of generic drugs, India, (which won U.S. FDA approval for 300 drugs, roughly one third of the 927 generic drugs granted U.S. FDA approval in 2016)  has seen its imports of Chinese generic drugs soar 50% in dollar terms over the past four years (2012/2013 – 2016/2017) according to data from the Pharmaceuticals Export Promotion Council (Pharmexcil).

Medical devices

One of China’s fastest growing sectors, the Chinese medical device industry has grown in leaps and bounds, with the industry maintaining double digit growth for over a decade. According to data from China Medical Pharmaceutical Material Association, China’s medical device market expanded from CNY 53.5 billion in 2007 to CNY 370 billion in 2016, representing a CAGR of 23.97%, which is three times faster than the global average growth rate of 8%.

Bar chart showing China’s medical device market size (US$ billions) in 2014, 2015, 2016 and 2017 (estimate). China’s medical device industry has been growing at double digits over the past few years with the market valued at US$ 39.32 billion in 2014, US$ 47.38 billion in 2015, US$ 53.62 billion in 2016 and an estimated US$ 58.63 billion in 2017.

The stellar growth has helped boost sales of multinational medical device manufacturers such as Siemens (ETR:SIE), J&J (NYSE:JNJ), Philips, and General Electric (NYSE:GE).

Yet the Chinese medical device market is still at a relatively immature stage considering the fact that globally, the medical device market is about 42% the size of the pharmaceutical market but in China however, the percentage is considerably lower at about 14%, indicating an attractive growth opportunity for medical device manufacturers.

China is Johnson & Johnson’s second largest market after the United States and the company expects China to remain as a key growth engine in the years to come.

Carlyle Group (NASDAQ:CG) owned American in-vitro diagnostics company, Ortho Clinical Diagnostics plans to build manufacturing facilities in China, as it banks on the mainland to be its “No. 1 growth country”. China’s in-vitro diagnostics (IVD) market is expected to grow at a CAGR of over 14% by 2021 according to research firm Technavio, which could be a boon for Swiss healthcare giant Roche Holdings (VTX:ROG), which is the dominant player in China’s IVD market.

But much like China’s pharmaceutical industry, foreign-made medical device brands are perceived to be of superior quality compared to those produced by domestic manufacturers. Consequently, while Chinese medical device manufacturers dominate the local market in general, the vast majority of them compete in the low to mid-range medical device product categories (according to figures from the International Trade Administration, more than 80% of Chinese medical device manufacturers compete in the low to mid-end medical device categories).

Meanwhile foreign medical device manufacturers such as those from the United States, Germany and Japan tend to dominate the higher-end, high-value medical device product category; medical device brands from the United States, which is the number one foreign supplier of medical devices in China, rake in nearly 75% of their local revenue from China’s top tier i.e., Tier III hospitals with the rest from Tier II hospitals according to figures from the International Trade Administration.

In an effort to help local medical device manufacturers play a greater role in the higher-end medical device segment, the Chinese government unveiled its ‘Made in China 2025’ plan which focuses on domestic high-end medical devices in sectors such as diagnostic imaging, medical robots, wearable devices and telemedicine.

Under the plan, China hopes to increase the use of domestically produced medical devices in hospitals to 50% by 2020 and 75% by 2025. The move could further accelerate the rise of local device manufacturers which have been growing faster than multinationals, (albeit from a smaller revenue base), and as a result of continuous product improvement, they have been increasingly taking market share from foreign rivals in medium-level segments of the country’s medical device sector.

For instance, multinationals’ share of China’s orthopedic implant market has dropped from 80% to less than 50% over the past five years, multinationals’ share of China’s drug-eluting stents market (which stood at about 90% as recently as 2004), has declined considerably with local manufacturers such as Biosensors International, Lepu Medical, and MicroPort selling about 80% of China’s drug-eluting stents and multinationals’ share of China’s direct radiography market has dropped from 100% in 2004 to about 50% currently according to data from Boston Consulting Group.

Buoyed by their growing financial, technological and R&D capabilities and supportive government initiatives, Chinese medical device manufacturers appear poised to take further market share in more of China’s medical device sectors in the long term.

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China’s $150 Billion AI Ambition Opens New Growth Opportunities

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

China is aiming be the world’s leading player in artificial intelligence (人工智能) by 2030 and by some measures, the country appears to be on track.

According to a report by CB Insights, Chinese companies seem to be overtaking their US counterparts in AI-related patent applications; the number of patents published in China containing the words “artificial intelligence” and “deep learning” have grown rapidly over the past few years, and the middle Kingdom finished 2017 with six times more patent publications containing those words than the United States in 2017.

Line graph showing the number of AI related patent publications published in China and the United States, 2013-2017.

While the United States continues to lead in terms of the number of AI startups and equity deal volume, it has seen its share of global AI equity deal volume shrink from 77% in 2013 to 50% in 2017. By comparison, China accounts for a mere 9% share of the world’s AI equity deal volume.

Bar chart showing global AI equity deal share (US vs Non-US deal share), 2013-2017.

However, in terms of global AI funding value, China is the dominant player accounting for 48% of global equity funding in 2017 representing a major increase from the 10% share China held in 2016 and surpassing the United States for the first time. By comparison, the United States accounted for 38% while the rest of the world accounted for the balance 13% of global AI funding value in 2017.

The numbers are likely to be just the beginning for China’s AI industry expansion which, driven by government funding, an encouraging regulatory environment, and the natural advantage of having the world’s largest population yielding unrivaled quantities of data (AI systems need to be “trained” with real-world data and the more data fed into a system, the more accurate it is) positions China as a hotbed of AI opportunities for investors and entrepreneurs.

The Chinese government has set forth a plan for the Development of a New Generation of Artificial Intelligence Industry, which runs in three stages during which the country’s AI capabilities will be steadily developed through 2020 and 2025 and conclude in 2030 when the government aims China will be the leading player in artificial intelligence.

Towards this end, the Ministry of Industry and Information Technology (MIIT) unveiled the first stage of the plan in December 2017, a detailed Three-Year Action Plan (2018-2020) which supports the local AI sector as a strategic area by developing AI-related technologies, bolstering AI talent and investing in AI research through various initiatives, incentives, grants, and funding commitments. The plan focuses on the development of some key AI areas namely,

  1. Intelligent Networked Vehicles (智能网联汽车)
  2. Intelligent Service Robots (智能服务机器人)
  3. Intelligent Drones (智能无人机)
  4. Medical Imaging Diagnostic Systems (医疗影像辅助诊断系统)
  5. Video Image Recognition (视频图像识别)
  6. Intelligent Voice Systems (智能语音)
  7. Intelligent Translation Systems (智能翻译)

 

This creates tremendous business opportunities. By 2030, the Chinese government expects China’s AI sector to blossom into a CNY 1 trillion (US$ 150 billion) industry which could stimulate as much as CNY 10 trillion in related businesses.

The opportunity has attracted local and foreign tech giants eager to profit from China’s burgeoning AI industry. Google (NASDAQ:GOOGL) for instance has opened an AI research facility, Google AI China Center, in Beijing to hire China’s top talent in artificial intelligence while homegrown tech giants such as Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU), Tencent (HKG:0700), Xiaomi, Huawei and JD.com (NASDAQ:JD) are making hefty investments in AI technologies.

 

Artificial Intelligence chips

AI systems depend on powerful AI chips to run and while numerous Chinese tech giants such as Alibaba, Baidu and Tencent are actively deploying AI technologies to improve their core offerings, much of the AI chips that power their systems are made by foreign suppliers such as Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC).

Although China is the world’s largest semiconductor market, accounting for about 45% of the world’s demand for chips (also known as integrated circuits), much of the country’s demand for chips is met through imports which account for about 90% of China’s total consumption of integrated circuits.

AI chips make up the basic infrastructure of AI systems and having a greater presence in the supply of such strategic components could potentially facilitate the Chinese government to achieve its goal of becoming an AI powerhouse.

Furthermore, as the global AI industry expands at a rapid clip, the global AI chips market is expected to witness extraordinary growth as well. According to research from ResearchAndMarkets, the AI chipset market is poised to expand from US$ 7.06 billion in 2018 to US$ 59.26 billion by 2025, representing a CAGR of 35.5% during 2018-2025.

Globally, chip startups have raised more than US$ 1.5 billion from in venture capital funding last year, nearly double the amount the year before according to CB Insights.

The Chinese government appears intent on capturing some of that profit potential too; in its Three Year Action Plan (2018-2020), the Chinese government aims to mass-produce neural network processing chips by 2020. China’s previous attempts to build the local semiconductor sector (from as way back as the 1990s) had mixed results partly due to the fact that government incentives and funds were concentrated on research and academia than on business.

This time however, Chinese AI chip businesses seeing greater government support, putting them in good position to participate in the growing global AI chip market.

Within 18 months of its founding by scientists at the Chinese Academy of Sciences (CAS), Chinese AI chip developer Cambricon Technologies raised US$ 100 million in Series A funding making it China’s first AI unicorn. Led by SDIC Chuangye Investment Management which is a subsidiary of China’s State Development and Investment Corporation, the funding round attracted prominent investors including e-commerce giant Alibaba Group, computer manufacturer Lenovo (HKG:0992), robotics company Zhongke Tuling Century Beijing Technology and the investment arm of the Chinese Academy of Sciences (CAS).

Scientists and engineers from Beijing’s Tsinghua University (which is known as China’s ‘MIT’) have developed “Thinker” a multi-purpose AI chip that can support any neural network and is extremely energy efficient. Beijing-based chip manufacturer Tsinghua Unigroup, a subsidiary of Tsinghua Holdings which is owned by Tsinghua University received up to US$ 22 billion in state financing in early 2017.

Chinese e-commerce goliath Alibaba is also reportedly developing its own chips, joining global tech giants such as Google, Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) which are already working building their own AI chips. Called the Ali-NPU, Alibaba’s AI chips will be made available for anyone to use through its Alibaba Cloud service.

 

Facial recognition

 Over the past few years, China’s facial recognition market has seen a rapid growth in investment in terms of deal value and volume.

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

According to CB Insights, of all countries in the world, China appears to be making the greatest use of facial recognition software with the technology being widely used throughout the country from supermarkets, airports, streets, office buildings, apartments, hotels, bank counters and ATMs.

The business opportunity has given birth to a number of Chinese facial recognition startups such as Alibaba-backed AI unicorn SenseTime (the most valuable AI startup in the world as if April 2018), Megvii (which develops Face++, one of China’s most common facial recognition platforms used for applications such as to manage entry in places such as Beijing’s train stations and Alibaba’s office building, and to enable Alipay customers to authenticate payment), CloudWalk Technology (a facial recognition software developer whose clients include the Zimbabwean government and Bank of China), DeepGlint, Zoloz and Yitu Technology (which counts the Malaysian Police as a client).

Chinese police are already using facial recognition sunglasses to track its citizens and the Chinese government is reportedly aiming to build a national database that will recognize any of the 1.3 billion citizens in China (the world’s most populous country) in three seconds. Already, more than 4,000 people have been arrested by Chinese authorities, helped by facial recognition technology.

Alipay, China’s most popular mobile payment app owned Alibaba affiliate Ant Financial has rolled out the world’s first payment system that uses facial recognition to enable customers to authenticate payments using just their face and a second authentication using their mobile phones.

In spite of China seeing rapid advancements in facial recognition, there is still considerable potential for the industry to grow driven by the growth of intelligent vehicles in China.

 

Intelligent vehicles

While autonomous cars are gathering momentum worldwide, China, the world’s largest car market is speeding towards intelligent vehicles with the country’s top economic planning agency, the National Development and Reform Commission naming intelligent vehicles as a national priority in a three year action plan unveiled in December 2017.

Autonomous cars refer to vehicles that are equipped with sensors and GPS while intelligent vehicles (the so called “smartphones on wheels”) refer to cars with technologies such as road safety monitoring, interactive entertainment, facial recognition, voice interaction systems and in-vehicle payment systems.

By 2020, the Chinese government expects the market share of smart vehicles to reach 50% of total new vehicles sold in China. Towards that end, the Chinese authorities have taken steps to boost the country’s intelligent and connected vehicle industry such as through talent training and research, encouraging investment, and encouraging cross-border mergers and acquisitions.

Strong regulatory support coupled with Chinese car buyers’ seemingly high enthusiasm for connected vehicles which presents a potentially sizeable market for smart cars suggests the government’s target could be within reach. According to a survey conducted by McKinsey in 2017, 64% of Chinese consumers would switch brands for better in-car connectivity. By comparison, 37% of Americans would switch brands for better in-car connectivity and just 19% of Germans would do the same.

Bar chart showing desire for in-car connectivity from consumers in China, United States and Germany. 64% of Chinese consumers surveyed were willing to switch brands for better in-car connectivity compared with just 37% of American consumers and 19% of German consumers. For 33% of Chinese consumers, having in-car connectivity is critical while 20% of American consumers and 18% of German consumers felt the same. 62% of Chinese consumers were willing to pay a subscription for in-car connectivity while just 29% of American consumers and 13% of German consumers were willing to do the same.

The opportunity has turned China’s intelligent connected vehicle market into a hot sector attracting a raft of companies, from established tech giants to smaller startups, keen to participate.

Alibaba has signed agreements with auto companies such as Ford (NYSE:F), Dongfeng Peugeot Citroen and SAIC Motor (SHA:600104) to develop connected vehicles which use its AliOS automotive operating system which was unveiled in 2016.

Chinese social media behemoth Tencent has teamed up with Changan Automobile, while Chinese internet giant Baidu has partnered with Great Wall Motors towards develop intelligent connected vehicles.

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China’s Geely: A Formidable Global Automaker In The Making?

Bar chart showing the world's top 10 fastest growing car brands in 2017 (by YoY sales volume growth %).

Chinese automaker Geely (HKG: 0175) (OTCMKTS: GELYF) is on a hot streak. The company reported record sales in 2017 selling 1.24 million units, a 63% year-on-year increase, emerging as the world’s second-fastest growing automaker by sales volume in 2017.

Bar chart showing the world's top 10 fastest growing car brands in 2017 (by YoY sales volume growth %).

Much of Geely’s sales were concentrated in its home country China, the world’s largest passenger car market, which accounted for over 99% of the brand’s sales volume in 2017 according to data from its annual report. Geely’s strong sales performance in China helped boost its market share to 5.06% of China’s passenger car market in 2017, an increase of 1/75% from the previous year.

Outside China, Geely’s subsidiary Volvo Cars which Zhejiang Geely Holding Group acquired in 2010 is also on a run, reporting its fourth straight year of record sales; revenues grew 17% in 2017 to 210.9 billion Swedish crowns while operating profit rose jumped 28% to 14.1 billion ($1.76 billion) from 11.0 billion in 2016. Volvo sold 571,577 Volvo cars globally last year, up 7% thanks to strong sales in China its biggest market, which accounted for 20% of Volvo’s sales in 2017.

After years of lackluster performance under the Ford Motor Co umbrella, the upscale Sweden-based Volvo Cars is now a success story, enjoying a remarkable turnaround under Geely’s ownership.

Global expansion

For Geely, already a major automaker in China, Volvo’s success could be a sign of bigger things to come as Geely sets its sights on going global. The company has been aggressively amassing a formidable portfolio of international car brands thereby expanding its geographical reach and broadening it technical expertise; the company gained an avenue into Europe through its acquisition of Volvo Cars while its 49.9% stake in Malaysia’s Proton Holdings Bhd gives it an inroad into Southeast Asia.

Geely’s 51% stake in British sports car maker Lotus Cars will give the company a presence in the sports car segment while its acquisition of American flying-car startup Terrafugia gives it access to the nascent flying car industry. The investments may also play a part in uplifting the brand’s image going forward; having started life as a cheap, low-cost, no-frills car brand, Geely has already come a long way since its inception boasting four design studios around the world (specifically in Los Angeles, Barcelona, Gothenburg and Shanghai) employing over 500 designers (headed by Geely’s chief designer Peter Horbury who formerly worked at Volvo and Ford), and four R&D centers (in Hangzhou Bay, Ningbo, Coventry and Gothenburg) employing nearly 7,000 full-time engineers.

With average e-x-factory selling prices of its vehicles steadily climbing from RMB 47,872 per unit in 2012 to RMB 73,550 per unit in 2017 according to its latest annual report, the company is now making inroads into the midscale auto segment with its new car brand Lynk & Co which is being developed with technology from Gothenburg-based Volvo.

“Born global and connected”, the millennial-aimed Lynk & Co car brand which made headlines as the “most connected car ever” (a ‘smartphone on wheels’) is unique in several aspects; the company’s cars can be purchased outright, or they could be leased, or they could be subscribed to via the company’s subscription model, or they could just be borrowed via the car’s unique ‘sharing’ feature. The company’s focus on mobility rather than car ownership means it fills a niche that taxi companies, ride-sharing solutions such as Uber, and traditional auto companies such as Honda do not fulfill. Lynk & Co is also differentiating itself by building a direct-to-consumer sales model, allowing customers to purchase a car online thereby bypassing traditional dealer networks.

Geely’s new marque holds promise; in November last year, Lynk & Co held a three-day sales campaign in China for the brand’s ‘01’ SUV model. In just over two minutes, the stock of 6,000 vehicles was sold out.

However, while the Geely brand is expected to continue its goal of being a leading automotive brand in China, Lynk & Co which is European designed and engineered, aspires to be a global auto brand, competing against global car giants such as Volkswagen and Ford. Lynk & Co plans to launch sales of its cars in Europe in 2019 and in the United States in 2020. The brand is aiming to sell 500,000 cars globally by 2021.

Over in Southeast Asia, Geely has been busy trying to turn-around struggling Malaysian car company Proton, which it acquired last year. Established in 1983, Proton reached its zenith in 1996 when the company accounted for 64% of Malaysia’s car sales, and exported its cars to over 50 countries including Australia, Ireland, New Zealand, Sri Lanka and Brunei. That was also the year Proton acquired sports car brand Lotus Cars.

Fast forward to today, Proton’s market share has dwindled to less than 15% with sales dropping to 70,991 last year from 72,291 units in 2016. Meanwhile local rival Perodua, and Japanese car company Honda are flying high in the country with market leader Perodua’s sales exceeding 200,000 units and Honda notching record-breaking sales of 109,511 last year.

Bar chart showing Malaysia passenger car sales (number of units) by car brand, 2016 and 2017.

Determined to regain lost ground, Proton is now on an aggressive transformation path with CEO Dr Li Chunrong introducing multiple changes for Proton dealerships and service centers in the country aimed at strengthening the brand and improving customer experience, as well as tapping into Geely’s technical know-how and expertise to help Proton expand its current model lineup to include SUVs (Proton is reportedly developing its first SUV model from Geely’s best selling SUV model the “Boyue”), and move up from producing fossil fuel vehicles to plug-in hybrid and electric vehicles. Malaysia is Southeast Asia’s third largest automotive market after Thailand and Indonesia, and if Geely could repeat its Volvo turnaround success story with the currently loss-making Proton, Geely could be sitting on a potentially profitable investment as well as a platform to develop a beachhead in Southeast Asia.

Under its former owner Proton, iconic British sports car brand Lotus Cars struggled due to lack of funds and currently offers a handful of models dating back several years. However under its new deep-pocketed owner, Geely, it could be light at the end of the tunnel for Lotus Cars as Geely could do for Lotus Cars what it did for Volvo; offer much-needed financial support along with a relatively hands-off management to allow Lotus Cars to unlock its full potential.

The partnership could also result in a cross-pollination of technology, know-how and possibly other resources as well such as suppliers and distribution networks among Geely’s portfolio of automotive marques similar to the way the Geely-Volvo tie-up gave birth to Lynk & Co which uses technology jointly developed by the two companies. Volvo and Lotus Cars are reportedly exploring options on sharing their technologies (Lotus Cars is renowned for lightweight engineering while Volvo is known for safety features and hybrid drivetrains).  The resulting partnerships could generate significant cost savings such as through shared development costs and procurement costs.

Eye on costs 

While Geely’s global aspirations could boost top-line growth, such international expansion plans are expensive and hence if unchecked could negatively impact bottom-line performance resulting in poor investment returns. However, Geely seems to have its eye on costs as well. Geely’s new marque Lynk & Co is reportedly aiming for success by being “brutally simple” by limiting model variations that rotate seasonally and offering limited options which the management believes is not only cost effective since production costs are lower but also offers a better, less-complex customer experience since Lynk & Co cars will be sold at a flat rate throughout Europe so buyers won’t have the trouble of haggling for a discount.

Although the car companies under Geely’s umbrella operate independently and maintain their own unique identity, they are forging close ties to cut costs. Volvo is deepening links with Geely and Lynk & Co to cut electric car development costs for instance by sharing knowledge and thereby cutting costs on developing expensive new technologies.

Volvo is also exploring ways to share technology with Lotus Cars for mutual benefit while Proton is depending on know-how from Geely to develop its first SUV.

Lynk & Co meanwhile has tapped into Volvo and Geely’s jointly developed CMA platform (Compact Modular Architecture platform), a cost-effective move, particularly since the new CMA platform was developed to be highly scalable, allowing multiple models to be developed using the same platform.

Geely’s global ambitions are clear and how far the company gets remains to be seen, however the company is worth watching.