China’s startup scene is on fire – everybody agrees on that. In just the past couple of weeks, for example, Baidu CEO Robin Li said investors are so desperate to throw money at Chinese startups that they’re camping outside Baidu headquarters to tempt Baidu employees into founding a startup. JD CEO Liu Qiangdong told attendees at a Harvard China forum that startups are so hot that “right now all you need is an idea to get US$30 million in funding.”
But China has seen this kind of startup craze before. Does all this heat mean that investors are about to get burned?
A brief history of the group buying craze
In 2010, China’s internet sector was awash with a new trend: group buying sites. Although Groupon had existed in the United States since 2008, China’s interest in the idea wasn’t another example of east-copies-west: it arose organically from BBS forums, where thrifty users would band together to buy items in bulk for the discount. Seeing that the model could work on a larger scale, a few Chinese entrepreneurs founded daily deals companies.
They took off fast, and by 2011, China’s early group buying startups were beginning to bring in serious funding. Lashou, one of the industry’s early leaders, was founded in March of 2010 and by April of 2011 it had raised more than US$170 million across three rounds of funding. Thousands of would-be entrepreneurs saw big money flowing, and jumped at the chance to get on the gravy train. By September of 2011, China had more than 5,000 group buying startups, although very few of them were making money.
But what goes up must come down, and China’s group buying industry came down hard. Smaller startups began to shut down, bigger startups like Lashou, 55tuan, 24quan, and Tuanbao were forced into massive layoffs to offset losses.
By November, nearly 1,500 group buying startups had shut down. By the beginning of 2012, that number had shot up to more than 2,000, and by August an additional 3,000 group buying sites had closed. A few local winners had emerged, and everybody else either got assimilated into one of the big players or shut down.
China is experiencing a boom in almost every sector of tech startups. But there’s no denying that O2O startups are popping up – and nabbing investor cash – with incredible frequency these days. In just the past month, we’ve seen funding come in for Chinese startups doing O2O auto repair, more O2O auto repair, O2O massage, O2O movie tickets, O2O food, more O2O food, even more O2O food, and O2O education.
That’s just a partial list, of course, and it’s a tiny fraction of the O2O startups out there. The O2O startup craze has been bubbling just under the surface of China’s tech industry for a couple of years, and now it’s rising to the surface thanks to all of the high-profile investment coming in. That increased profile is only attracting more entrepreneurs to the sector.
“Just in the past 48 hours I got pitched an ‘eyebrow staining and shaping’ O2O service and a ‘get a nurse to go to the hospital with you’ O2O service,” 500 Startups partner and China investor Rui Ma told Tech in Asia with a laugh. Other investors said the same thing: O2O pitches are coming in thick and fast.
China’s O2O craze is as hot, if not hotter, than its group buying craze was back in 2010 and 2011. If the O2O sector mirrors what happened with group buying, it would seem to be fast approaching the fall of 2011, where things took a sharp turn and thousands of startups shut down in just a few months.
History repeats itself? Not likely
Thankfully, investors agree that the current O2O craze in China is a bit different from the group buying craze that drove thousands of founders off a cliff four years ago. For one, Infinity Ventures’s Akio Tanaka points out, “during the group buying fever everyone was doing the same thing, mostly undifferentiated services. [But] during the current O2O boom many startups are solving different problems/sectors. There is competition in each sector, but that is very different from everyone doing the same thing.”
In other words, while an O2O food delivery company and an O2O education service share the same fundamental business model, they’re not competing directly with each other even if they’re in the same region. Customers come to different kinds of O2O startups for different kinds of services. Group buying sites all tended to offer the same kinds of services – restaurant vouchers, discounted movie tickets, etc. – and that placed them in direct competition with all the other group buying sites in their market.
Of course, there’s still bound to be intense competition in the hottest O2O sectors. Competition in on-demand food delivery services, for example, is already fierce. Major players like Daojia, Ele.me, and Meican have all raised big rounds in the relatively recent past, and there are also smaller startups like Call a Chicken and Keruyun generating buzz and attracting investment.
Even so, though, the O2O sector is far more diverse than the group buying sector ever was.
Moreover, some investors see a fundamental difference between group buying and on-demand services when it comes to economic viability in China. Chinaccelerator director and SOS Ventures partner William Bao Bean explains that group buying “didn’t make economic sense for the vast majority of businesses using it.” In order to partner with group buying sites and attract customers, they had to offer steep discounts. Many ultimately couldn’t afford to, and without local partners, group buying sites went under fast. But O2O services, in contrast, don’t demand businesses offer discounts, they just bring them customers. In essence, William Bao Bean says, O2O is “a trendy new name for the age old practice of brick-and-mortar businesses marketing themselves […] in the end most of it is just advertising.”
Rui Ma also thinks that O2O is different from the group buying craze, and she pointed out another big reason: it’s pretty easy to do. “It’s generally a marketplace-plus-transaction (basically a directory) model which is one of the easiest businesses models to understand and to test,” she said. “There’s not too much tech involved and the unit economics are much easier to calculate.”
And of course, it doesn’t hurt that the O2O model fits in quite nicely with Chinese Premier Li Keqiang’s “Internet Plus” plan to use the internet to reinvigorate traditional businesses.
What does the future hold?
So the current O2O explosion is different from the group buying craze that ended in a grim culling of thousands of similarly-focused startups. But some consolidation – and plenty of startup failures – is inevitable for China’s on-demand services industry, too. And if you’re not in the game already, there’s a good chance it’s too late. GGV Capital managing partner Hans Tung told Tech in Asia that while GGVC still gets a lot of O2O pitches, he thinks “some of the major [O2O] categories are already decided.” By way of example he mentioned Ele.me in the food delivery sector as one company that new food delivery startups are unlikely to be able to compete with.
While consolidation across categories of O2O is likely in the long run, Tung said that he doesn’t see the O2O industry as winner-take-all. Each major category of O2O – like food delivery, education, etc. – will have likely have a category winner or two, decided by who executes the concept best. Winners in smaller, more niche categories of O2O may well see themselves absorbed by the larger category winners.
But while the group buying industry saw clear winners emerge within a couple of years, Tung says he thinks the battle over O2O could take much longer. O2O requires “even more execution,” according to Tung, because of the difficulty of standardizing services across the various providers and locations. That means the ultimate winners may take longer to emerge.
And although the battle for the top spot in major O2O categories is likely to leave a stream of failed startups in its wake, the final result should be good for everyone. Successful O2O platforms should help local economies, increase economic efficiency, and ultimately result in more capable service providers, according to Tung. That’s in addition, of course, to the convenience factor that they offer consumers.
So while China’s on-demand services market is heating up, there’s no need to be afraid. Many O2O startups will fail, but the “bust” cycle of this boom is likely to be less sudden and less harsh than it was for during the group buying startup boom that preceded it.