Is there money to be made through Second Mouse investments, focusing on Chinese firms that have the potential to achieve a global leadership position in their industry? How do we get into the game?’
The question is provocative and important. The emerging economies, lead by China, will provide most of the growth of the coming decade, and the winners from that robust business environment will include many domestic companies as well as participants from the more established countries of the west. In the articles previously cited, we’ve referred to these firms as Second Mouse companies, from the saying “The early bird gets the worm, but the second mouse gets the cheese”. The incredible fast learner and fast follower skills of these companies have, in many instances, propelled them to positions of prominence in global markets.
Investing in Chinese firms remains a complicated process, as are most business transactions in China, but are increasingly feasible. Being able to cite success stories was a challenge a decade ago. There are many of them today. Ten years from now, we will have dramatic success stories available of firms that made fortunes through investments in Chinese firms, and we will probably then wonder how it could have been so easy. But today, it is anything but that.
Spotting Mice
The first task is that of spotting the candidates. This has been a challenge for any decision that requires identifying companies in China. The list usually starts with 1000s of candidates that claim to be participants in the industry or line of business of interest, with only 100s of them actually meaningfully engaged in that industry or line of business, and perhaps 10s of them serious companies with potential. That truth continues today.
In our research on the stages of evolution of Chinese Second Mouse companies, we’ve focused upon these stages:
Competency Development. In its formative years, Second Mouse companies focus upon practicing strong “fast learner” competencies. They develop world-class skills in mastering products and technologies developed elsewhere. They master strong competencies related to manufacturing and sourcing, practicing the unique strengths that define “China economics”. In combination, those two competencies allow them to produce almost as good products at a great price point.
We look for companies that have gone beyond knock-offs to actual innovation, at least in drawing the best from a number of global vendors. While many highly successful companies got that way by making blatant copies, that is not a sustainable business model against all the rest of the companies that are also good copiers and also hungry for business. There is also a plethora of companies trying to be high-end market competitors through quirky innovation. These are not the companies that are likely to become the mid-market champions.
We have seen situations in which dozens of companies are producing from the same design and making no attempt to distinguish their “Copy of ___” brand from the others. But, if one company has achieved some advantage in the eyes of customers, either by tweaking designs or producing to higher specs, they have a head start in the “mouse race.”
In terms of “China Economics”, we have emphasized that it comes in two flavors. The easiest way to achieve low cost in China is to use relationships with the government to cut corners – not paying taxes, not following labor and environmental laws, selling products that do not meet China’s standards, and borrowing money at attractive rates with no intention to repay. A company whose success is based on such “cheating” might well move ahead of the pack initially, but its position is vulnerable to a change in local leaders and the political atmosphere.
While China is evolving rapidly, it does not yet have the infrastructure elements that make such expansion easy. But this is a critical stage, one that culls the winners from the losers.
Mastery of the China Market. Most western companies look to identify those Chinese companies that they see as competitors in their own efforts to grow in China, but that is wrong. There are some such Chinese companies targeting the elite segments that are for the most part dominated by global firms. By contrast, the Second Mouse company is growing in the middle market, reaching and serving customers at price points typically below those of interest to western companies. Outside of some branded consumer products, the middle market is the territory of the Second Mouse firm, and the firms that are gaining share in those segments are candidates worthy of attention.
At this stage of evolution, it is also likely that the Second Mouse firm will develop a robust roster of friends in government and business, as such relationships are critical to growth in China. Relationships, for all but the most important companies of national interest, are local. That means that a company has a home-field advantage in selling to other local companies, even private ones who often have suppliers recommended by government officials. But it doesn’t help all that much when moving outside the region. Depending on relationship to support a poor product-service offering has often been a hindrance in the longer run.
Global Expansion, by Stages. China’s Second Mouse firms are not content with China’s market, despite its scale and ongoing rapid growth. They see other attractive markets where their offer of almost as good products at a great price point can once again win. Most of them initially target other emerging Asian markets such as Indonesia and India, then move into the markets of the Middle East, Africa, and Latin America, and only finally to the developed country markets of North America, Europe, and Asia.
Companies that thrive in a local China market based on copying for their products, cheating for their cost position, and only local relationships for sales do not have a business model that can in any respect transfer to a new environment.
Today, in some industries, and tomorrow, in more and more industries, there will be a Chinese Second Mouse firm on the short list of global leaders. They will probably not be considered the equals of their western firms in terms of technology leadership and other dimensions. But they will be growing faster, making more money, and have a higher market cap than those other firms.
China’s tremendous growth will ensure that wealth will be created in the coming decade, perhaps at a rate that will stagger imaginations. Participating in this exciting opportunity will be a challenge for western venture capitalists, but one that can be addressed and that can yield enormous rewards.
