Disconnect: China needs to move beyond harsh boom/bust startup trends

Disconnect is a weekly column in which Tech in Asia’s Charlie Custer pokes at holes, plays devil’s advocate, or otherwise attempts to rain on the tech industry’s parade.

China’s internet industry has developed at breakneck pace over the past couple of decades. Nobody with functioning eyes could deny that. But increasingly, the startup scene in particular seems to follow a ridiculous bubble/pop cycle that everybody would be better off avoiding.

Big bubbles, then loud pops

I first observed this with China’s group buying/daily deals craze. Although you may have first heard of it via the American company Groupon, group buying as a widely practiced ecommerce phenomenon began much earlier than that in China, with savings-chasing shoppers teaming up on BBS forums to get bulk deals on merchandise they wanted. Once Groupon proved it was a viable business model, though, China’s startup scene exploded. Everybody and their mother jumped in on a group buying startup. VC money flowed freely and startups were expanding fast. At one point there were well over 5,000 group buy sites operating at the same time in China.

That, of course, was completely unsustainable, and in 2011 the other shoe started to drop. Beaten by competitors in the vastly overcrowded market, more than 2,000 group buying startups closed that year. By 2012, high-profile companies had started to fall. Executives were jumping ship, the market plunged to 12-month lows, and by August another 3,000 group buying companies had closed their doors.

That’s not really a unique phenomenon, though. You can see the same thing happening in other new internet industries right now. Online P2P lending has exploded over the past year, and there are more than 2,600 P2P lenders operating in China right now. There’s no way the market can support them all, yet new P2P lending companies continue to pop up.

China’s robotics industry reportedly looks to be in for a similar shock. In early 2014, China had around 200 different robotics companies. Now there are more than 800, and industry insiders are already concerned that the rapid growth is unsustainable in a market where engineering talent is limited and the potential market for robots is increasingly crowded. They’re probably right.

This picture is a metaphor. A very subtle metaphor.

Drawing a line

To be clear, I don’t fault the second guy, or the tenth guy, or even the hundredth guy, to look at a new business model and say “I can make that work better than the existing players are.” And competition is generally good for the market. But you’ve got to draw a line somewhere.

First, from the founder’s perspective, there has to be a certain point beyond which you need to realize your idea has been done, and you can’t do it better. If there are 10 P2P lenders on the market and you’ve got a unique angle, sure, take a shot at becoming number 11. But when there are thousands, the chances of you having a unique angle are virtually nil. The chances of you beating out all those companies that have a big head start on you are also virtually nil. If you want to form the 3,000th P2P lending startup in China, unless you’re Xi Jinping’s cousin all you’ll be doing is throwing your VC’s money into the toilet.

From the VC’s perspective: what the hell, guys? I mean seriously: why were some of you still funding seed rounds for generic P2P lending sites in mid-2015 like somehow the 2,347th time was going to be the charm?

The real issue with this boom/bust cycle is what it does to the scene as a whole, though. The hype tends to build up so high that when it comes crashing down, good companies get taken down with the bad. Innovative new products get missed out on because startups are forced to spend their money beating back dozens and dozens of competitors instead of investing in R&D. And the impetus to set one’s own company apart from the massive pack can lead to stupid decisions and crimes that have regulatory consequences for the entire industry.

We’re probably seeing that play out in real time in the P2P lending industry right now. With thousands of competitors, lending site Ezubao tried to set itself apart by promising massive returns. When it couldn’t deliver, executives turned to fraud. Now that the house of cards has come crashing down, it looks likely that Ezubao will bring a lot of others down with it. Regulators will likely look to tighten oversight of the sector, consumer trust in P2P investment products will almost certainly plummet, and as a result every P2P lender is likely in for an unpleasant squeeze.