China's Big Boom in Small Companies

By Steven Butler and Ben Halder

March 8, 2015

The rapid growth of small companies in China just might prevent the country’s economy from crashing.

Gao Ning sits in her spacious, meticulously decorated apartment on the outskirts of Beijing, amid matched sets of new furniture, wide-open floor spaces, and grand Chinese watercolor paintings adorning the walls. Gao, in her mid-30s, with long straight black hair and two young children, explains how she arrived there: private investing in startups. “There were so many different startup companies that I could have gotten involved with,” she says. Last year, she chose to put about $320,000 into the health device company Picooc, which on its website advises prospective customers to “realize an even better self.” Indeed.

Small companies are booming in China. The rest of the economy looks pretty sour these days, yet simple changes in government regulations that took effect in March of last year have led to a huge surge of new businesses. In the six months following the new rules, which cut red tape and sharply lowered the amount of up-front money needed to get going, more than 1.76 million companies registered for business, an increase of 68 percent over the previous year.

Investors like Gao have wasted no time getting on board. Picooc sells scales and smartphone apps that measure weight, BMI (body mass index) and bone density, and then link to health and diet applications. It employs more than 100 people, and last year sold just over 100,000 scales at roughly $70 each. The business fit right into the profile of companies that Gao was looking for. Young, middle-class Chinese consumers, she explains, are on the hunt for technologies or services that make their lives easier. And with easy delivery of a service over the Internet, “it’s not difficult to find investment funds and succeed in the market,” Gao says.

The Picooc scale.

The decision to open the door to small companies was part of an ambitious reform agenda introduced early last year by incoming President Xi Jinping, and just in time. While most of the agenda has yet to be implemented, the growth of startups has been a boon for China’s otherwise sagging economy. “This is a very smart policy,” says economist David Dollar, senior fellow at Brookings Institution, a think tank in Washington, D.C. Dollar points out that China created a healthy 10.4 million jobs last year, despite the slowing of its mainstay industries: real estate, heavy industry and exports. Small, new service companies could be especially useful, since China’s services are relatively undeveloped, tend to be labor-intensive and therefore create more jobs.

Many of the new companies, says Beijing lawyer Jerome Beaugrand-Champagne, had been operating in a gray area, doing business on Taobao, the consumer-to-consumer market platform run by Internet leader Alibaba. Once these new businesses are registered, “the government can now regulate and, more important, tax these enterprises,” he says. The companies can also gain access to more avenues for finance as they grow and reduce the risk of running afoul of officialdom. (Something you don’t want to do in China, of course.)

“Once you introduce a new product, within six months there will be three or four identical versions competing for market share.”

Beijing lawyer Jerome Beaugrand-Champagne

Gao seems to have hit the jackpot with Picooc, which was founded in 2013. Gao says she chose the company largely because of her confidence in the management. So far that confidence has been well-placed, and she got in close to the ground floor, before subsequent rounds of financing. Jingdong, one of China’s largest online retailers, and part-owner Internet giant Tencent recently invested around $20 million in Picooc. The hope is that big players like these will help take small businesses and transform them into recognizable brands, much the way Facebook and Google buy smaller companies to take advantage of their growth potential. Along the way, they can make millions for the original investors.

Of course, it’s not always smooth sailing. The country’s lax patent laws make protecting new products nearly impossible. “Once you introduce a new product, within six months there will be three or four identical versions competing for market share,” says Beaugrand-Champagne. Even if the market is big enough to accommodate all, one company often ends up bearing the cost of research, development and design. Sometimes, of course, that company might be foreign. Xiaomi, just 5 years old, has vaulted to third place in the global league table for cellphone makers, selling phones in China that look almost exactly like Apple products. As it has expanded overseas, it has run into patent disputes in India with Swedish technology company Ericsson. Even so, Xiaomi has its own business model and looks set to continue growing.

The sheer amount of money pouring into new businesses has also spawned intense competition, says John Kung, who started his company Beilin International Education in Beijing over 10 years ago. “It is more risky now than before,” he says.

Still, with a middle class estimated to be 300 million strong and growing, the potential market is gigantic, and that helps to create confidence. Beaugrand-Champagne says the Chinese people are “much more entrepreneurial than their Western counterparts.” Whether or not that’s true, they now have an opportunity to show their stuff as never before.