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China’s Alternate Internet Universe

Guo Hong is a startup founder trapped in the body of a government official. Middle-aged, Guo is always dressed in a modest dark suit and wears thick glasses. When standing for official photos at opening ceremonies, he looks no different from the dozens of other identically dressed Beijing city officials who come out to cut ribbons and deliver speeches.

During the two decades leading up to 2010, China was governed by engineers. Chinese officialdom was packed with men who studied the science of building physical things, and they put that knowledge to work transforming China from a poor agricultural society into a country of bustling factories and enormous cities. But Guo represented a new kind of official for a new era—one in which China needed to both build things and create ideas.

Put Guo alone in a room with other entrepreneurs or technologists and he suddenly comes alive. Brimming with ideas, he speaks quickly and listens intently. He has a voracious appetite for what’s next in technology and an ability to envision how startups can harness these trends. Guo thinks outside the box and then takes action on the ground. He is the kind of founder that venture-capital investors love to put their money behind.

All of these habits came in handy when Guo decided to turn his slice of Beijing into the Silicon Valley of China, a hotbed for indigenous Chinese innovation. The year was 2010, and Guo was responsible for the influential Zhongguancun (“jong-gwan-soon”) technology zone in northwest Beijing, an area that had long branded itself as China’s answer to Silicon Valley but had not really lived up to the title. Zhongguancun was chock-full of electronics markets selling low-end smartphones and pirated software but offered few innovative startups. Guo wanted to change that.

To kick-start that process, he came to see me at the offices of my newly founded company, Sinovation Ventures. After spending a decade representing the most powerful American technology companies in China, in the fall of 2009 I left Google China to establish Sinovation, an early-stage incubator and angel investment fund for Chinese startups. I made this move because I sensed a new energy bubbling up in the Chinese startup ecosystem. The copycat era had forged world-class entrepreneurs, and they were just beginning to apply their skills to solving uniquely Chinese problems. China’s rapid transition to the mobile internet and bustling urban centers created an entirely different environment, one where innovative products and new business models could thrive. I wanted to be a part of both mentoring and funding these companies as they came into their own.

When Guo came to visit Sinovation, a core team of ex-Googlers and I were working out of a small office that was located northeast of Zhongguancun. We were recruiting promising engineers to join our incubator and launch startups targeting China’s first wave of smartphone users. Guo wanted to know what he could do to support that mission. I told him that the cost of rent was eating a big chunk of the money we wanted to pour into fostering these startups. Any relief on rent would mean more money for building products and companies. No problem, he said—he would make some calls. The local government could likely cover our rent for three years if we relocated to the neighborhood of Zhongguancun.

That was fantastic news for our project, and even better, Guo was just getting started. He didn’t want to only throw money at one incubator. He wanted to understand what really made Silicon Valley tick. Guo began peppering me with questions about my time in the valley during the 1990s. I explained how many of the area’s early entrepreneurs went on to become angel investors and mentors, how geographic proximity and tightly woven social networks gave birth to a self-sustaining venture-capital ecosystem that made smart bets on big ideas.

As we talked, I could see Guo’s mind working in overdrive. He was absorbing everything and formulating the outlines of a plan. Silicon Valley’s ecosystem had taken shape organically over several decades. But what if we in China could speed up that process by brute-forcing the geographic proximity? We could pick one street in Zhongguancun, clear out all the old inhabitants, and open the space to key players in this kind of ecosystem: VC firms, startups, incubators, and service providers. He already had a name in mind: Chuangye Dajie—Avenue of the Entrepreneurs.

This kind of top-down construction of an innovation ecosystem runs counter to Silicon Valley orthodoxy. In that worldview, what really makes the valley special is an abstract cultural zeitgeist, a commitment to original thinking and innovation. It’s not something that could have been built merely using bricks and rent subsidies.

Guo and I both saw the value in that ethereal sense of mission, but we also saw that China was different. If we wanted to bootstrap this process in China today, money, real estate, and government support mattered. The process would require getting our hands dirty, adapting the valley’s disembodied innovation ethos to the very physical realities of present-day China. The result would leverage some of the core mechanisms of Silicon Valley but would take the Chinese internet in a very different direction.

That ecosystem was becoming both independent and self-sustaining. Chinese founders no longer had to tailor their startup pitches to the tastes of foreign VCs. They could now build Chinese products to solve Chinese problems. It was a sea change that altered the very texture of the nation’s cities and signaled a new era in the development of the Chinese internet. It also led to an overnight boom in production of the natural resource of the AI age.

UNCHARTED INTERNET TERRITORY

During the copycat era, the relationship between China and Silicon Valley was one of imitation, competition, and catch-up. But around 2013, the Chinese internet changed direction. It no longer lagged behind the Western internet in functionality, though it also hadn’t surpassed Silicon Valley on its own terms. Instead, it was morphing into an alternate internet universe, a space with its own raw materials, planetary systems, and laws of physics. It was a place where many users accessed the internet only through cheap smartphones, where smartphones played the role of credit cards, and where population-dense cities created a rich laboratory for blending the digital and physical worlds.

The Chinese tech companies that ruled this world had no obvious corollaries in Silicon Valley. Simple shorthand like “the Amazon of China” or “the Facebook of China” no longer made sense when describing apps like WeChat—the dominant social app in China, but one that evolved into a “digital Swiss Army knife” capable of letting people pay at the grocery store, order a hot meal, and book a doctor’s visit.

Underneath this transformation lay several key building blocks: mobile-first internet users, WeChat’s role as the national super-app, and mobile payments that transformed every smartphone into a digital wallet. Once those pieces were in place, Chinese startups set off an explosion of indigenous innovation. They pioneered online-to-offline services that stitched the internet deep into the fabric of the Chinese economy. They turned Chinese cities into the first cashless environments since the days of the barter economy. And they revolutionized urban transportation with intelligent bike-sharing applications that created the world’s largest internet-of-things network.

Adding fuel to this fire was an unprecedented wave of government support for innovation. Guo’s mission to build the Avenue of the Entrepreneurs was just the first trickle of what in 2014 turned into a tidal wave of official policies pushing technology entrepreneurship. Under the banner of “Mass Innovation and Mass Entrepreneurship,” Chinese mayors flooded their cities with new innovation zones, incubators, and government-backed venture-capital funds, many of them modeled on Guo’s work with the Avenue of the Entrepreneurs. It was a campaign that analysts in the West dismissed as inefficient and misguided, but one that turbocharged the evolution of China’s alternate internet universe.

Thriving in this environment required both engineering prowess and raw manpower: armies of scooter-riding deliverymen schlepping hot meals around town, tens of thousands of sales reps fanning out to push mobile payments on street vendors, and millions of shared bikes loaded onto trucks and dispersed around cities. An explosion of these services pushed Chinese companies to roll up their sleeves and do the grunt work of running an operations-heavy business in the real world.

In my view, that willingness to get one’s hands dirty in the real world separates Chinese technology companies from their Silicon Valley peers. American startups like to stick to what they know: building clean digital platforms that facilitate information exchanges. Those platforms can be used by vendors who do the legwork, but the tech companies tend to stay distant and aloof from these logistical details. They aspire to the mythology satirized in the HBO series Silicon Valley, that of a skeleton crew of hackers building a billion-dollar business without ever leaving their San Francisco loft.

Chinese companies don’t have this kind of luxury. Surrounded by competitors ready to reverse-engineer their digital products, they must use their scale, spending, and efficiency at the grunt work as a differentiating factor. They burn cash like crazy and rely on armies of low-wage delivery workers to make their business models work. It’s a defining trait of China’s alternate internet universe that leaves American analysts entrenched in Silicon Valley orthodoxy scratching their heads.

THE SAUDI ARABIA OF DATA

But this Chinese commitment to grunt work is also what is laying the groundwork for Chinese leadership in the age of AI implementation. By immersing themselves in the messy details of food delivery, car repairs, shared bikes, and purchases at the corner store, these companies are turning China into the Saudi Arabia of data: a country that suddenly finds itself sitting atop stockpiles of the key resource that powers this technological era. China has already vaulted far ahead of the United States as the world’s largest producer of digital data, a gap that is widening by the day.

As I contended in the first chapter, the invention of deep learning means that we are moving from the age of expertise to the age of data. Training successful deep-learning algorithms requires computing power, technical talent, and lots of data. But of those three, it is the volume of data that will be the most important going forward. That’s because once technical talent reaches a certain threshold, it begins to show diminishing returns. Beyond that point, data makes all the difference. Algorithms tuned by an average engineer can outperform those built by the world’s leading experts if the average engineer has access to far more data.

But China’s data advantage extends from quantity into quality. The country’s massive number of internet users—greater than the United States and all of Europe combined—gives it the quantity of data, but it’s then what those users do online that gives it the quality. The nature of China’s alternate universe of apps means that the data collected will also be far more useful in building AI-driven companies.

Silicon Valley juggernauts are amassing data from your activity on their platforms, but that data concentrates heavily in your online behavior, such as searches made, photos uploaded, YouTube videos watched, and posts “liked.” Chinese companies are instead gathering data from the real world: the what, when, and where of physical purchases, meals, makeovers, and transportation. Deep learning can only optimize what it can “see” by way of data, and China’s physically grounded technology ecosystem gives these algorithms many more eyes into the content of our daily lives. As AI begins to “electrify” new industries, China’s embrace of the messy details of the real world will give it an edge on Silicon Valley.

This sudden data windfall for China wasn’t the result of some master plan. When Guo Hong came to see me in 2010, he couldn’t have predicted the exact shape China’s alternate universe would take or how machine learning would suddenly turn data into a precious commodity. But he did believe that given the right setting, funding, and a little prodding, Chinese startups could create something both totally unique and very valuable. On that point, Guo’s entrepreneurial instincts were right on the money.

THE MOBILE LEAPFROG

I left Google China and founded Sinovation Ventures a few months before Google decided to pull out of the mainland market. That move by Google was a major disappointment to our team, given the years of work we had poured into making the company competitive in China. But that departure also created an opening for Chinese startups to build an entirely new suite of products for the most exciting new trend in technology, the mobile internet.

After the iPhone’s 2007 debut, the technology world began slowly adapting websites and services for access via a smartphone. In its simplest form, this meant building a version of one’s website that worked well when transposed from a large computer screen onto a small smartphone. But it also meant building out new tools: an app store, photo-editing apps, and antivirus software. With Google leaving China, the market for Android-based apps in this space was now wide open. Sinovation’s earliest batch of incubated startups looked to fill these gaps. In the process, I wanted us to explore a new and exciting way of interacting with the internet, a space where Silicon Valley had not yet defined the dominant paradigm.

During China’s copycat era, the small portion of its population that accessed the internet did so in the same way as Americans, through a desktop or laptop computer. Chinese users’ behavior differed significantly from that of Americans, but the fundamental tools used were the same. Computers were still too expensive for most Chinese people, and by 2010 only around one-third of China’s population had access to the internet. So when cheap smartphones hit the market, waves of ordinary citizens leapfrogged over personal computers entirely and went online for the first time via their phones.

Simple as that transition sounds, it had profound implications for the particular shape that the Chinese internet would take. Smartphone users not only acted differently than their desktop peers; they also wanted different things. For mobile-first users, the internet wasn’t just an abstract collection of digital information that you accessed from a set location. Rather, the internet was a tool that you brought with you as you moved around cities—it should help solve the local problems you run into when you need to eat, shop, travel, or just get across town. Chinese startups needed to build their products accordingly.

This opened a real opportunity for Chinese startups backed by Chinese VCs to break new ground in order to foster Chinese-style innovation. At Sinovation, our first round of investment went into incubating nine companies, several of which were eventually acquired or controlled by Baidu, Alibaba, and Tencent. Those three Chinese internet juggernauts (collectively known by the abbreviation “BAT”) used our startups to accelerate their transition into mobile internet companies. Those startup acquisitions formed a solid foundation for their mobile efforts, but it would be a secretive in-house project at Tencent that first cracked open the potential of what I call China’s alternate internet universe.

WECHAT: HUMBLE BEGINNINGS, HUGE AMBITIONS

Hardly anyone noticed when the world’s most powerful app waltzed onto the world stage. The January 2011 launch of WeChat, Tencent’s new social messaging app, received only one mention in the English-language press, on the technology site the Next Web. Tencent already owned the two dominant social networks in China—its QQ instant messaging platform and Q-Zone social network each had hundreds of millions of users—but American analysts dismissed these as mediocre knockoffs of American products. The company’s new smartphone app didn’t even have an English name yet, going only by the Chinese name Weixin, or “micro-message.”

But it did have a few other things going for it. The app lets you send photos and short voice recordings along with typing out messages. The latter was a major benefit given how cumbersome inputting Chinese characters on a phone was at the time. WeChat was also created specifically for smartphones. Instead of trying to transform its dominant desktop platform, QQ, into a phone app, Tencent aimed to disrupt its own product with a better one built just for mobile. It was a risky strategy for an established juggernaut, but one that paid off big time.

The app’s clean functionality took off, and as WeChat gained users, it also tacked on more functions. In just over a year it had hit 100 million registered users, and by its two-year anniversary in January 2013, that number was 300 million. Along the way it had added voice and video calls and conference calls, functions that seem obvious today but that WeChat’s global competitor WhatsApp waited until 2016 to incorporate.

WeChat’s early tweaks and optimizations were just the beginning. It soon pioneered an innovative “app-within-an-app” model that changed the way media outlets and advertisers used social platforms. These were WeChat’s “official accounts,” subscription-based third-party content streams that lived within the app and were sometimes compared to Facebook pages for media companies. But instead of Facebook’s minimalist platform for posting content, the official accounts offered much of the functionality of a standalone app without the hassle of actually building one. These accounts quickly became so dominant in the social media space that many media and consumer companies simply stopped building their own apps, choosing instead to live entirely in WeChat’s world.

In the span of two years, WeChat went from a no-name app to a powerhouse of messaging, media, marketing, and gaming. But Tencent wanted even more. It already monopolized users’ digital lives, but it wanted to extend that functionality beyond the smartphone.

Over the ensuing five years, Tencent painstakingly built WeChat into the world’s first super-app. It became a “remote control for life” that dominated not just users’ digital worlds but allowed them to pay at restaurants, hail taxis, unlock shared bikes, manage investments, book doctors’ appointments, and have those doctors’ prescriptions delivered to your door. This metastasizing functionality would blur the lines dividing our online and offline worlds, both molding and feeding off of China’s alternate internet universe. But before it could do that, WeChat had to get inside its users’ wallets, and that meant taking on the top dog in digital commerce.

THE PEARL HARBOR OF MOBILE PAYMENTS

The attack came on the most festive night of the Chinese calendar—Chinese New Year’s Eve, 2014—and the weapon drew inspiration from the occasion. Chinese tradition calls for the gifting of “red envelopes” during Chinese New Year, small and decorative red packets with cash inside. That cash is the Chinese equivalent of a Christmas present, something usually given by older relatives to children, and by bosses to employees.

Tencent’s innovation was so simple—and such pure fun for users—that it masked the magnitude of the power grab. WeChat gave its users the ability to send out digital red envelopes containing real money to WeChat friends near and far. Once users linked their bank accounts to WeChat, they could send out envelopes worth a set amount of money to one person or into a group chat and let their friends race to see who could “open” it first and get the money. That money then lived inside users’ WeChat Wallet, a new subdivision of the app. The money could be used to make purchases, transferred to other friends, or added to their own bank account if they linked it with WeChat.

It was a seamless translation to digital of an age-old Chinese tradition, one that added a gaming element to the process. WeChat users loved the envelopes, sending out 16 million of the packets during Chinese New Year and in the process, linking 5 million new bank accounts to WeChat Wallet.

Jack Ma was less amused. He called the move by Tencent a “Pearl Harbor attack” on Alibaba’s dominance in digital commerce. Alibaba’s Alipay had pioneered digital payments tailored for Chinese users back in 2004 and later adapted the product for smartphones. But overnight WeChat had taken all the momentum in new types of mobile payments, nudging millions of new users into linking their bank accounts to what was already the most powerful social app in China. Ma warned Alibaba employees that if they didn’t fight to hold their grip on mobile payments, it would spell the company’s end. Observers at the time thought this was just typical over-the-top rhetoric from Jack Ma, a charismatic entrepreneur with a genius for rallying his troops. But looking back four years later, it seems likely that Ma saw what was coming.

The four years leading up to Tencent’s Pearl Harbor moment saw many of the pieces of China’s alternate internet universe fall into place. Gladiatorial competition between China’s copycat startups had trained a generation of street-smart internet entrepreneurs. Smartphone users had more than doubled between 2009 and 2013, from 233 million to a whopping 500 million. Early-stage funds were fostering a new generation of startups building innovative mobile apps for this market. And WeChat demonstrated the power of the super-app installed on virtually everyone’s smartphone, an all-in-one portal to the Chinese mobile ecosystem.

When Tencent’s flood of red envelopes lured millions of Chinese into linking their bank accounts to WeChat, it put in place the last crucial puzzle piece of a consumption revolution: the ability to pay for anything and everything with your phone. Over the coming years, Alibaba, Tencent, and thousands of Chinese startups would race to apply these tools to every nook and cranny of Chinese urban life, including food delivery, electricity bills, live-streaming celebrities, on-demand manicures, shared bikes, train tickets, movie tickets, and traffic tickets. China’s online and offline world would begin rubbing shoulders in a way not seen anywhere else in the world. They were refashioning China’s urban landscape and the world’s richest real-world datascape.

But building an alternate internet universe that reaches into every corner of the Chinese economy couldn’t be done without the country’s most important economic actor: the Chinese government.

IF YOU BUILD IT, THEY WILL COME

On that front, Guo Hong was ahead of the curve. In the years after his first visit to my office, his dream of an Avenue of the Entrepreneurs had been turned into a plan, and that plan turned into action. Guo chose for his experiment a pedestrian street in Zhongguancun that was home to a mishmash of bookstores, restaurants, and knockoff electronics markets.

Back in the 1980s, the government had already transformed this street for the sake of an economic upgrade. At the time, China was in the throes of export-driven growth and urbanization, two projects that required engineering expertise that the country lacked. So officials turned the walking street into a “Book City” packed with stores carrying modern science and engineering textbooks for students at nearby Tsinghua and Peking University to pore over. By the year 2010, the rise of the Chinese internet had driven many of the bookstores out of business, replacing them with small storefronts hawking cheap electronics and pirated software—the raw ingredients of China’s copycat era.

But Guo wanted to turbocharge an upgrade to a new era of indigenous innovation. His original small-scale experiment in attracting Sinovation Ventures via rent subsidies had succeeded, and so Guo planned to refurbish an entire street for high-tech tenants. He and the local district government used a combination of cash subsidies and offers of space elsewhere to move out almost all the traditional businesses on the street. In 2013, construction crews took jackhammers and paving equipment to the now-empty street, and after a year of laying bricks and building sleek new exteriors, on June 11, 2014, the Avenue of the Entrepreneurs opened to its new tenants.

Guo had used the tools at his disposal—cash, cement, and manual labor—to give a strong nudge toward indigenous innovation in the local startup. It was a landmark moment for Zhongguancun, but one that wasn’t destined to stay sequestered to this corner of Beijing. Indeed, Guo’s approach was about to go national.

INNOVATION FOR THE MASSES

On September 10, 2014, Premier Li Keqiang took the stage during the 2014 World Economic Forum’s “Summer Davos” in the coastal Chinese city of Tianjin. There he spoke of the crucial role technological innovation played in generating growth and modernizing the Chinese economy. The speech was long and dense, heavy on jargon and light on specifics. But of note during the speech, Li repeated a phrase that was new to the Chinese political lexicon: “mass entrepreneurship and mass innovation.” He concluded by wishing the attendees a successful forum and good health.

To outside observers, it was an utterly unremarkable event, and there was almost no coverage in the Western press. Chinese leaders deliver speeches like this almost every day, long, plodding, and full of stock phrases that ring hollow to Western ears. Those phrases can act as signals during internal debates within the Chinese government, but they don’t necessarily translate to immediate changes in the real world.

This time was different. Li’s speech lit the first spark of what would become a raging fire in the Chinese technology industry, pushing activity in the investment and startup space to feverish new heights. The new phrase—“mass entrepreneurship and mass innovation”—became the slogan for a momentous government push to foster startup ecosystems and support technological innovation. Guo Hong’s proactive approach to innovation was suddenly being scaled up across the world’s second-largest economy, and it would turbocharge the creation of the only true counterweight to Silicon Valley.

China’s mass innovation campaign did that by directly subsidizing Chinese technology entrepreneurs and shifting the cultural zeitgeist. It gave innovators the money and space they needed to work their magic, and it got their parents to finally stop nagging them about taking a job at a local state-owned bank.

Nine months after Li’s speech, China’s State Council—roughly equivalent to the U.S. president’s cabinet—issued a major directive on advancing mass entrepreneurship and innovation. It called for the creation of thousands of technology incubators, entrepreneurship zones, and government-backed “guiding funds” to attract greater private venture capital. The State Council’s plan promoted preferential tax policies and the streamlining of government permits for starting a business.

China’s central government laid out the goals, but implementation was left up to thousands of mayors and local officials scattered around the country. Promotion for local officials in China’s government bureaucracy is based on performance evaluations conducted by higher-ups within the Communist Party’s internal human resources department. So when the central government sets a clear goal—a new metric on which lower-level officials can demonstrate their competence—ambitious officials everywhere throw themselves into advancing that goal and proving themselves capable.

Following the issuance of the State Council directive, cities around China rapidly copied Guo Hong’s vision and rolled out their own versions of the Avenue of the Entrepreneurs. They used tax discounts and rent rebates to attract startups. They created one-stop-shop government offices where entrepreneurs could quickly register their companies. The flood of subsidies created 6,600 new startup incubators around the nation, more than quadrupling the overall total. Suddenly, it was easier than ever for startups to get quality space, and they could do so at discount rates that left more money for building their businesses.

Larger city and provincial governments pioneered different models for “guiding funds,” a mechanism that uses government money to spur more venture investing. The funds do that by increasing the upside for private investors without removing the risk. The government uses money from the guiding fund to invest in private venture-capital funds in the same role as other private limited partners. If the startups that fund invested in (the “portfolio companies”) fail, all the partners lose their investment, including the government.

But if the portfolio companies succeed—say, double in value within five years—then the fund’s manager caps the government’s upside from the fund at a predetermined percentage, perhaps 10 percent, and uses private money to buy the government’s shares out at that rate. That leaves the remaining 90 percent gain on the government’s investment to be distributed among private investors who have already seen their own investments double. Private investors are thus incentivized to follow the government’s lead, investing in funds and industries that the local government wants to foster. During China’s mass innovation push, use of local government guiding funds exploded, nearly quadrupling from $7 billion in 2013 to $27 billion in 2015.

Private venture funding followed. When Sinovation was founded in 2009, China was experiencing such rapid growth in manufacturing and real estate that the smart money was still pouring into those traditional sectors. But in 2014, this all turned around. For three of the four years leading up to 2014, total Chinese VC funding held steady at around $3 billion. In 2014, that immediately quadrupled to $12 billion, and then doubled again to $26 billion in 2015. Now it seemed like any smart and experienced young person with a novel idea and some technical chops could throw together a business plan and find funding to get his or her startup off the ground.

American policy analysts and investors looked askance at this heavy-handed government intervention in what are supposed to be free and efficient markets. Private-sector players make better bets when it comes to investing, they said, and government-funded innovation zones or incubators will be inefficient, a waste of taxpayer money. In the minds of many Silicon Valley power players, the best thing that the federal government can do is leave them alone.

But what these critics miss is that this process can be both highly inefficient and extraordinarily effective. When the long-term upside is so monumental, overpaying in the short term can be the right thing to do. The Chinese government wanted to engineer a fundamental shift in the Chinese economy, from manufacturing-led growth to innovation-led growth, and it wanted to do that in a hurry.

It could have taken a hands-off approach, standing aside while investment returns in traditional industries fell and private investment slowly made its way into the high-tech sector. That shift would be subject to the ordinary frictions of human endeavors: imperfect information, old-school investors who weren’t so sure about this internet thing, and plain old economic inertia. Eventually, though, those frictions would be overcome, and money would make its way into private venture funds that might spend each dollar more efficiently than the government could.

But that’s a process that would take many years, if not decades. China’s top leadership did not have the patience to wait. It wanted to use government money to brute-force a faster transformation, one that would pay dividends through an earlier transition to higher-quality growth. That process of pure force was often locally inefficient—incubators that went unoccupied and innovation avenues that never paid off—but on a national scale, the impact was tremendous.

A REVOLUTION IN CULTURE

The effects of China’s mass entrepreneurship and mass innovation campaign went far beyond mere office space and investment dollars. The campaign left a deep imprint on ordinary people’s perceptions of internet entrepreneurship, genuinely shifting the cultural zeitgeist.

Chinese culture traditionally has a tendency toward conformity and a deference toward authority figures, such as parents, bosses, teachers, and government officials. Before a new industry or activity has received the stamp of approval from authority figures, it’s viewed as inherently risky. But if that industry or activity receives a ringing endorsement from Chinese leadership, people will rush to get a piece of the action. That top-down structure inhibits free-ranging or exploratory innovation, but when the endorsement arrives and the direction is set, all corners of society simultaneously spring into action.

Before 2014, the Chinese government had never made clear exactly how it viewed the rise of the Chinese internet. Despite the early successes of companies like Baidu and Alibaba, periods of relative openness online were followed by ominous signals and legal crackdowns on users “spreading rumors” via social media platforms. No one could be sure what was coming next. With the mass innovation campaign, the Chinese government issued its first full-throated endorsement of internet entrepreneurship. Posters and banners sprung up around the country exhorting everyone to join the cause. Official media outlets ran countless stories touting the virtues of indigenous innovation and trumpeting the successes of homegrown startups. Universities raced to offer new courses around entrepreneurship, and bookstores filled up with biographies of tech luminaries and self-help books for startup founders.

Throwing even more fuel on this fire was Alibaba’s record-breaking 2014 debut on the New York Stock Exchange. A group of Taobao sellers rang the opening bell for Alibaba’s initial public offering on September 19, just nine days after Premier Li’s speech. When the dust settled on a furious round of trading, Alibaba had claimed the title of the largest IPO in history, and Jack Ma was crowned the richest man in China.

But it was about more than just the money. Ma had become a national hero, but a very relatable one. Blessed with a goofy charisma, he seems like the boy next door. He didn’t attend an elite university and never learned how to code. He loves to tell crowds that when KFC set up shop in his hometown, he was the only one out of twenty-five applicants to be rejected for a job there. China’s other early internet giants often held Ph.D.s or had Silicon Valley experience in the United States. But Ma’s ascent to rock-star status gave a new meaning to “mass entrepreneurship”—in other words, this was something that anyone from the Chinese masses had a shot at.

The government endorsement and Ma’s example of internet entrepreneurship were particularly effective at winning over some of the toughest customers: Chinese mothers. In the traditional Chinese mentality, entrepreneurship was still something for people who couldn’t land a real job. The “iron rice bowl” of lifetime employment in a government job remained the ultimate ambition for older generations who had lived through famines. In fact, when I had started Sinovation Ventures in 2009, many young people wanted to join the startups we funded but felt they couldn’t do so because of the steadfast opposition of their parents or spouses. To win these families over, I tried everything I could think of, including taking the parents out to nice dinners, writing them long letters by hand, and even running financial projections of how a startup could pay off. Eventually we were able to build strong teams at Sinovation, but every new recruit in those days was an uphill battle.

By 2015, these people were beating down our door—in one case, literally breaking Sinovation’s front door—for the chance to work with us. That group included scrappy high school dropouts, brilliant graduates of top universities, former Facebook engineers, and more than a few people in questionable mental states. While I was out of town, the Sinovation headquarters received a visit from one would-be entrepreneur who refused to leave until I met with him. When the staff told him that I wouldn’t be returning any time soon, the man lay on the ground and stripped naked, pledging to lie right there until Kai-Fu Lee listened to his idea.

That particular entrepreneur received a police escort rather than a seed investment, but the episode captures the innovation mania that was gripping China. A country that had spent a decade dancing around the edges of internet entrepreneurship was now plunging in headfirst. The same went for Guo Hong. While creating the Avenue of the Entrepreneurs, Guo caught the entrepreneurial bug himself, and in 2017 he left the world of Chinese officialdom to become the founder and chairman of Zhongguancun Bank, a financial “startup” modeled on Silicon Valley Bank and dedicated to serving local entrepreneurs and innovators.

All the pieces were now in place for the flourishing of China’s alternate internet universe. It had the leapfrog technology, the funding, the facilities, the talent, and the environment. The table was set to create internet companies that were new, valuable, and uniquely Chinese.

HERE, THERE, AND O2O EVERYWHERE

To do all of this, the Chinese internet had to get its hands dirty. For two decades, Chinese internet companies had played a role similar to that of their American peers: information nodes on a digital network. Now they were ready to dive into the nitty-gritty details of daily life.

Analysts dubbed the explosion of real-world internet services that blossomed across Chinese cities the “O2O Revolution,” short for “online-to-offline.” The terminology can be confusing but the concept is simple: turn online actions into offline services. E-commerce websites like Alibaba and Amazon had long done this for the purchase of durable physical goods. The O2O revolution was about bringing that same e-commerce convenience to the purchase of real-world services, things that can’t be put in a cardboard box and shipped across country, like hot food, a ride to the bar, or a new haircut.

Silicon Valley gave birth to one of the first transformational O2O models: ride-sharing. Uber used cell phones and personal cars to change how people got around cities in the United States and then around the world. Chinese companies like Didi Chuxing quickly copied the business model and adapted it to local conditions, with Didi eventually driving Uber out of China and now battling it in global markets. Uber may have given an early glimpse of O2O, but it was Chinese companies that would take the core strengths of that model and apply it to transforming dozens of other industries.

Chinese cities were the perfect laboratory for experimentation. Urban China can be a joy, but it can also be a jungle: crowded, polluted, loud, and less than clean. After a day spent commuting on crammed subways and navigating eight-lane intersections, many middle-class Chinese just want to be spared another trip outdoors to get a meal or run an errand. Lucky for them, these cities are also home to large pools of migrant laborers who would gladly bring that service to their door for a small fee. It’s an environment built for O2O.

The first O2O service other than ride-hailing to truly take off was food delivery. China’s internet juggernauts and a flood of startups like Wang Xing’s Meituan Dianping all made O2O food delivery plays, pouring subsidies and engineering resources into the market. Crowds at Chinese restaurants thinned out, and streets filled up with swarms of electric scooters trailing steam from the hot meals they carried on board. Payments could be made seamlessly through WeChat Wallet and Alipay. By the end of 2014, Chinese spending on O2O food delivery had grown by over 50 percent and topped 15 billion RMB. By 2016, China’s 20 million daily online food orders equaled ten times the total across the United States.

From there the O2O models became even more creative. Some hair stylists and manicurists gave up their storefronts entirely, exclusively booking through apps and making house calls. People who were feeling ill could hire others to wait in the famously long lines outside hospitals. Lazy pet owners could use an app to hail someone who would come right over and clean out a cat’s litter box or wash their dog. Chinese parents could hire van drivers to pick up their children from school, confirming their ID and arrival home through apps. Those who didn’t want to have children could use another app for around-the-clock condom delivery.

For Chinese people, the transition took the edge off urban life. For small businesses, it meant a boom in customers, as the reductions in friction led Chinese urbanites to spend more. And for China’s new wave of startups, it meant skyrocketing valuations and a ceaseless drive to push into ever more sectors of urban life.

After a couple of years of explosive growth and gladiatorial competition, the manic production of new O2O models cooled off. Many overnight O2O unicorns died once the subsidy-fueled growth ended. But the innovators and gladiators who survived—like Wang Xing’s Meituan Dianping—multiplied their already billion-dollar valuations by fundamentally reshaping urban China’s service sector. By late 2017, Meituan Dianping was valued at $30 billion, and Didi Chuxing hit a valuation of $57.6 billion, surpassing that of Uber itself.

It was a social and commercial transformation that was powered by—and which further empowered—WeChat. Installed on more than half of all smartphones in China and now linked to many users’ bank accounts, WeChat had the power to nudge hundreds of millions of Chinese into O2O purchases and to pick winners among the competing startups. WeChat Wallet linked up with top O2O startups so that WeChat users could hail a taxi, order a meal, book a hotel, manage a phone bill, and buy a flight to the United States, all without ever leaving the app. (Not coincidentally, most of the startups WeChat picked to feature in its Wallet were also the recipients of Tencent investments.)

With the rise of O2O, WeChat had grown into the title bestowed on it by Connie Chan of leading VC fund Andreesen Horowitz: a remote control for our lives. It had become a super-app, a hub for diverse functions that are spread across dozens of different apps in other ecosystems. In effect, WeChat has taken on the functionality of Facebook, iMessage, Uber, Expedia, eVite, Instagram, Skype, PayPal, Grubhub, Amazon, LimeBike, WebMD, and many more. It isn’t a perfect substitute for any one of those apps, but it can perform most of the core functions of each, with frictionless mobile payments already built in.

This all marks a stark contrast to the “app constellation” model in Silicon Valley in which each app sticks to a strictly prescribed set of functions. Facebook even went so far as to split its social network and messaging functions into two different apps, Facebook and Messenger. Tencent’s choice to go for the super-app model appeared risky at the start: could you possibly bundle so many things together without overwhelming the user? But the super-app model proved wildly successful for WeChat and has played a crucial role in shaping this alternate universe of internet services.

THE LIGHT TOUCH VERSUS HEAVYWEIGHTS

But the O2O revolution showcased an even deeper—and in the age of AI implementation, more impactful—divide between Silicon Valley and China—what I call “going light” versus “going heavy.” The terms refer to how involved an internet company becomes in providing goods or services. They represent the extent of vertical integration as a company links up the on- and offline worlds.

When looking to disrupt a new industry, American internet companies tend to take a “light” approach. They generally believe the internet’s fundamental power is sharing information, closing knowledge gaps, and connecting people digitally. As internet-driven companies, they try to stick to this core strength. Silicon Valley startups will build the information platform but then let brick-and-mortar businesses handle the on-the-ground logistics. They want to win by outsmarting opponents, by coming up with novel and elegant code-based solutions to information problems.

In China, companies tend to go “heavy.” They don’t want to just build the platform—they want to recruit each seller, handle the goods, run the delivery team, supply the scooters, repair those scooters, and control the payment. And if need be, they’ll subsidize that entire process to speed user adoption and undercut rivals. To Chinese startups, the deeper they get into the nitty-gritty—and often very expensive—details, the harder it will be for a copycat competitor to mimic the business model and undercut them on price. Going heavy means building walls around your business, insulating yourself from the economic bloodshed of China’s gladiator wars. These companies win both by outsmarting their opponents and by outworking, outhustling, and outspending them on the street.

It’s a distinction captured well by comparing well-known restaurant platforms in two countries, Yelp and Dianping. Both were founded around 2004 as desktop platforms for posting restaurant reviews. They both eventually became smartphone apps, but while Yelp largely stuck to reviews, Dianping dove headfirst into the group-buying frenzy: building out payments, developing vendor relationships, and spending massively on subsidies.

When the two companies went into online ordering and delivery, they took different approaches. Yelp moved late and went light. After eleven years as a purely digital platform that lived off advertising, in 2015 Yelp finally took a baby step into deliveries by acquiring Eat24, an ordering and food-delivery platform. But it still asked restaurants to handle the majority of deliveries, just using Eat24 to fill in gaps for restaurants that didn’t have delivery teams. The lightweight process offered restaurants few real incentives to participate, and as a result, the business never fully took off. Within two and a half years, Yelp had given up, selling Eat24 to Grubhub and retreating to its lightweight approach. “[The sale to Grubhub] allowed us to do what we do best,” explained Yelp CEO Jeremy Stoppelman, “which was to build the Yelp app.”

In contrast, Dianping went into commerce early and went very heavily into food delivery. After four years in the trenches of the group-buying wars, Dianping began piloting food delivery in late 2013. It spent millions of dollars hiring and managing fleets of scooter-riding teams that delivered orders from restaurant to doorstep. Dianping’s delivery teams did the legwork, so every mom-and-pop shop suddenly had the option of expanding its customer base without having to hire a delivery team.

By throwing tons of money and people at the problem, Dianping could attain economies of scale in China’s dense urban centers. It was an expensive and logistically taxing endeavor, but one that ultimately improved efficiency and reduced costs for the end customer. Eighteen months after debuting its delivery service, Dianping doubled down on those economies of scale by merging with archrival Meituan. By 2017, Meituan Dianping’s valuation of $30 billion was more than triple that of Yelp and Grubhub combined.

Other examples of O2O companies in China going heavy abound. After driving Uber out of the Chinese ride-hailing market, Didi has begun buying up gas stations and auto repair shops to service its fleet, making great margins because of its understanding of its drivers and their trust in the Didi brand. While Airbnb largely remains a lightweight platform for listing your home, the company’s Chinese rival, Tujia, manages a large chunk of rental properties itself. For Chinese hosts, Tujia offers to take care of much of the grunt work: cleaning the apartment after each visit, stocking it with supplies, and installing smart locks.

That willingness to go heavy—to spend the money, manage the workforce, do the legwork, and build economies of scale—has reshaped the relationship between the digital and real-world economies. China’s internet is penetrating far deeper into the economic lives of ordinary people, and it is affecting both consumption trends and labor markets. In a 2016 study by McKinsey and Company, 65 percent of Chinese O2O users said that the apps led them to spend more money on dining. In the categories of travel and transportation, 77 percent and 42 percent of users, respectively, reported increasing their spending.

In the short run, this cash-flow stimulated the Chinese economy and pumped up valuations. But the long-term legacy of this movement is the data environment it created. By enrolling the vendors, processing the orders, delivering the food, and taking in the payments, China’s O2O champions began amassing a wealth of real-world data on the consumption patterns and personal habits of their users. Going heavy gave these companies a data edge over their Silicon Valley peers, but it was mobile payments that would extend their reach even further into the real world and turn that data edge into a commanding lead.

SCAN OR GET SCANNED

As O2O spending exploded, Alipay and Tencent decided to make a direct bid for disrupting the country’s all-cash economy. (In 2011, Alibaba spun off its financial services, including Alipay, into a company that would become Ant Financial.) China had never fully embraced credit and debit cards, instead sticking to cash for the vast majority of all transactions. Large supermarkets or shopping malls let customers swipe a card, but the mom-and-pop shops and family restaurants that dominate the cityscape rarely had point-of-sale (POS) devices for processing plastic cards.

The owners of those shops did, however, have smartphones. So China’s internet juggernauts turned those phones into mobile portals for payments. The idea was simple, but the speed of execution, impact on consumer behavior, and resulting data have been astonishing.

During 2015 and 2016, Tencent and Alipay gradually introduced the ability to pay at shops by simply scanning a QR code—basically a square bar code for phones—within the app. It’s a scan-or-get-scanned world. Larger businesses bought simple POS devices that can scan the QR code displayed on customers’ phones and charge them for the purchase. Owners of small shops could just print out a picture of a QR code that was linked to their WeChat Wallet. Customers then use the Alipay or WeChat apps to scan the code and enter the payment total, using a thumbprint for confirmation. Funds are instantly transferred from one bank account to the other—no fees and no need to fumble with wallets. It marked a stark departure from the credit-card model in the developed world. When they were first introduced, credit cards were cutting edge, the most convenient and cost-effective solution to the payment problem. But that advantage has now turned into a liability, with fees of 2.5 to 3 percent on most charges turning into a drag on adoption and utilization.

China’s mobile payment infrastructure extended its usage far beyond traditional debit cards. Alipay and WeChat even allow peer-to-peer transfers, meaning you can send money to family, friends, small-time merchants, or strangers. Frictionless and hooked into mobile, the apps soon turned into tools for “tipping” the creators of online articles and videos. Micro-payments of as little as fifteen cents flourished. The companies also decided not to charge commissions on the vast majority of transfers, meaning people accepted mobile payments for all transactions—none of the mandatory minimum purchases or fifty-cent fees charged by U.S. retailers on small purchases with credit cards.

Adoption of mobile payments happened at lightning speed. The two companies began experimenting with payment-by-scan in 2014 and deployed at scale in 2015. By the end of 2016, it was hard to find a shop in a major city that did not accept mobile payments. Chinese people were paying for groceries, massages, movie tickets, beer, and bike repairs within just these two apps. By the end of 2017, 65 percent of China’s over 753 million smartphone users had enabled mobile payments.

Given the extremely low barriers to entry, those payment systems soon trickled down into China’s vast informal economy. Migrant workers selling street food simply let customers scan and send over payments while the owner fried the noodles. It got to the point where beggars on the streets of Chinese cities began hanging pieces of paper around their necks with printouts of two QR codes, one for Alipay and one for WeChat.

Cash has disappeared so quickly from Chinese cities that it even “disrupted” crime. In March 2017, a pair of Chinese cousins made headlines with a hapless string of robberies. The pair had traveled to Hangzhou, a wealthy city and home to Alibaba, with the goal of making a couple of lucrative scores and then skipping town. Armed with two knives, the cousins robbed three consecutive convenience stores only to find that the owners had almost no cash to hand over—virtually all their customers were now paying directly with their phones. Their crime spree netted them around $125 each—not even enough to cover their travel to and from Hangzhou—when police picked them up. Local media reported rumors that upon arrest one of the brothers cried out, “How is there no cash left in Hangzhou?”

It made for a sharp contrast with the stunted growth of mobile payments in the United States. Google and Apple have taken a stab at mobile payments with Google Wallet and Apple Pay, but neither has really attained widespread adoption. Apple and Google don’t release user figures for their platforms, but everyday observation and more rigorous analysis both point to massive gaps in adoption. The market research firm iResearch estimated in 2017 that Chinese mobile payment spending outnumbered that in the United States by a ratio of fifty to one. For 2017, total transactions on China’s mobile payment platforms reportedly surpassed $17 trillion—greater than China’s GDP—an astounding number made possible by the fact that these payments allow for peer-to-peer transfers and multiple mobile transactions for items and services throughout the chain of production.

LEAPING FROGS AND TAXI DRIVERS

That massive gap is partly explained by the strength of the incumbent. Americans already benefit from (and pay for) the convenience of credit and debit cards—the cutting-edge financial technology of the 1960s. Mobile payments are an improvement on cards but not as dramatic an improvement as the jump straight from cash. As with China’s rapid transition to the mobile internet, the country’s weakness in incumbent technology (desktop computers, landline phones, and credit cards) turned into the strength that let it leapfrog into a new paradigm.

But that leap to mobile payments wasn’t just a product of weak incumbents and independent consumer choices. Alibaba and Tencent accelerated the transition by forcing adoption through massive subsidies, a form of “going heavy” that makes American technology companies squirm.

In the early days of ride-hailing apps in China, riders could book through apps but often paid in cash. A large portion of cars on the leading Chinese platforms were traditional taxis driven by older men—people who weren’t in a rush to give up good old cash. So Tencent offered subsidies to both the rider and the driver if they used WeChat Wallet to pay. The rider paid less and the driver received more, with Tencent making up the difference for both sides.

The promotion was extremely costly—due to both legitimate rides and fraudulent ones designed to milk subsidies—but Tencent persisted. That decision paid off. The promotion built up user habits and lured onto the platform taxi drivers, who are the key nodes in the urban consumer economy.

By contrast, Apple Pay and Google Wallet have tread lightly in this arena. They theoretically offer greater convenience to users, but they haven’t been willing to bribe users into discovering that method for themselves. Reluctance on the part of U.S. tech giants is understandable: subsidies eat into quarterly revenue, and attempts to “buy users” are usually frowned on by Silicon Valley’s innovation purists.

But that American reluctance to go heavy has slowed adoption of mobile payments and will hurt these companies even more in a data-driven AI world. Data from mobile payments is currently generating the richest maps of consumer activity the world has ever known, far exceeding the data from traditional credit-card purchases or online activity captured by e-commerce players like Amazon or platforms like Google and Yelp. That mobile payment data will prove invaluable in building AI-driven companies in retail, real estate, and a range of other sectors.

BEIJING BICYCLE REDUX

While mobile payments totally transformed China’s financial landscape, shared bicycles transformed its urban landscapes. In many ways, the shared bike revolution was turning back the clock. From the time of the Communist Revolution in 1949 through the turn of the millennium, Chinese cities were teeming with bicycles. But as economic reforms created a new middle class, car ownership took off and riding a bicycle became something for individuals who were too poor for four-wheeled transport. Bikes were pushed to the margins of city streets and the cultural mainstream. One woman on the country’s most popular dating show captured the materialism of the moment when she rejected a poor suitor by saying, “I’d rather cry in the back of a BMW than smile on the back of a bicycle.”

And then, suddenly, China’s alternate universe reversed the tide. Beginning in late 2015, bike-sharing startups Mobike and ofo started supplying tens of millions of internet-connected bicycles and distributing them around major Chinese cities. Mobike outfitted its bikes with QR codes and internet-connected smart locks around the bike’s back wheel. When riders use the Mobike app (or its mini-app in WeChat Wallet) to scan a bike’s QR code, the lock on the back wheel automatically slides open. Mobike users ride the bike anywhere they want and leave it there for the next rider to find. Costs of a ride are based on distance and time, but heavy subsidies mean they often come in at 15 cents or less. It’s a revolutionary, real-world innovation, one made possible by mobile payments. Adding credit-card POS machines to bikes would be too expensive and repair-intensive, but frictionless mobile payments are both cheap to layer onto a bike and incredibly efficient.

Shared-bike use exploded. In the span of a year, the bikes went from urban oddities to total ubiquity, parked at every intersection, sitting outside every subway exit, and clustered around popular shops and restaurants. It rarely took more than a glance in either direction to find one, and five seconds in the app to unlock it. City streets turned into a rainbow of brightly colored bicycles: orange and silver for Mobike; bright yellow for ofo; and a smattering of blue, green, and red for other copycat companies. By the fall of 2017, Mobike was logging 22 million rides per day, almost all of them in China. That is four times the number of global rides Uber was giving each day in 2016, the last time it announced its totals. In the spring of 2018, Mobike was acquired by Wang Xing’s Meituan Dianping for $2.7 billion, just three years after the bike-sharing company’s founding.

Something new was emerging from all those rides: perhaps the world’s largest and most useful internet-of-things (IoT) networks. The IoT refers to collections of real-world, internet-connected devices that can convey data from the world around them to other devices in the network. Most Mobikes are equipped with solar-powered GPS, accelerators, Bluetooth, and near-field communications capabilities that can be activated by a smartphone. Together, those sensors generate twenty terabytes of data per day and feed it all back into Mobike’s cloud servers.

BLURRED LINES AND BRAVE NEW WORLDS

In the span of less than two years, China’s bike-sharing revolution has reshaped the country’s urban landscape and deeply enriched its data-scape. This shift forms a dramatic visual illustration of what China’s alternate internet universe does best: solving practical problems by blurring the lines between the online and offline worlds. It takes the core strength of the internet (information transmission) and leverages it in building businesses that reach out into the real world and directly touch on every corner of our lives.

Building this alternate universe didn’t happen overnight. It required market-driven entrepreneurs, mobile-first users, innovative super-apps, dense cities, cheap labor, mobile payments, and a government-sponsored culture shift. It’s been a messy, expensive, and disruptive process, but the payoff has been tremendous. China has built a roster of technology giants worth over a trillion dollars—a feat accomplished by no other country outside the United States.

But the greatest riches of this new Chinese tech world have yet to be realized. Like the long-buried organic matter that became fossil fuels powering the Industrial Revolution, the rich real-world interactions in China’s alternate internet universe are creating the massive data that will power its AI revolution. Each dimension of that universe—WeChat activity, O2O services, ride-hailing, mobile payments, and bike-sharing—adds a new layer to a data-scape that is unprecedented in its granular mapping of real-world consumption and transportation habits.

China’s O2O explosion gave its companies tremendous data on the offline lives of their users: the what, where, and when of their meals, massages, and day-to-day activities. Digital payments cracked open the black box of real-world consumer purchases, giving these companies a precise, real-time data map of consumer behavior. Peer-to-peer transactions added a new layer of social data atop those economic transactions. The country’s bike-sharing revolution has carpeted its cities in IoT transportation devices that color in the texture of urban life. They trace tens of millions of commutes, trips to the store, rides home, and first dates, dwarfing companies like Uber and Lyft in both quantity and granularity of data.

The numbers for these categories lay bare the China-U.S. gap in these key industries. Recent estimates have Chinese companies outstripping U.S. competitors ten to one in quantity of food deliveries and fifty to one in spending on mobile payments. China’s e-commerce purchases are roughly double the U.S. totals, and the gap is only growing. Data on total trips through ride-hailing apps is somewhat scarce, but during the height of competition between Uber and Didi, self-reported numbers from the two companies had Didi’s rides in China at four times the total of Uber’s global rides. When it comes to rides on shared bikes, China is outpacing the United States at an astounding ratio of three hundred to one.

That has already helped China’s juggernauts make up ground on their American counterparts in both revenue and market caps. In the age of AI implementation, the impact of these divergent data ecosystems will be far more profound. It will shape what industries AI startups will disrupt in each country and what intractable problems they will solve.

But building an AI-driven economy requires more than just gladiator entrepreneurs and abundant data. It also takes an army of trained AI engineers and a government eager to embrace the power of this transformative technology. These two factors—AI expertise and government support—are the final pieces of the AI puzzle. When put in place, they will complete our analysis of the competitive balance between the world’s two superpowers in the defining technology of the twenty-first century.