Silicon Valley is the paragon of innovation ecosystems. The combination of strong research universities, venture capital and a remarkable accumulation of risk-taking talent continues to produce some of the world’s most valuable companies. The magic sauce, which is more than a simple combination of elements, has been chronicled in books like The Code: Silicon Valley and the Remaking of America.
But halfway across the world, in a once-sleepy fishing village called Shenzhen, a fundamentally different model has emerged. It started as a manufacturing hub but shifted first to knockoff products; then to innovation tailored to specific markets; and from there to the innovation of distinctly new products. The innovation model in Shenzhen, built on uniquely Chinese ways of working, challenges many Western assumptions about how successful innovation happens.
Two Distinct Models
Silicon Valley’s innovation model is built on university research, intellectual property protection, and the availability of plentiful venture capital. Companies compete fiercely, protect their innovations through patents and retention agreements, and aim for market dominance in new markets. The system rewards bold technological breakthroughs and disruptive thinking.
In contrast, Shenzhen’s ecosystem more closely resembles “a farmer’s market of entrepreneurs who make components and collaborate to quickly bring new products to market,” according to David Li, a scholar of the Shenzhen innovation ecosystem. Li, who is director of the Shenzhen Open Innovation Lab, explained the ecosystem to me in an interview. “What makes it work is the speed at which experiments happen and the focus on collaboration as opposed to intellectual property,” he said. “It is vibrant like Silicon Valley, but in a very different way.”
The Evolution of Shenzhen
Shenzhen began in the late 1970s as China’s first Special Economic Zone, an early experiment in a Chinese version of capitalism. It was located across the river from Hong Kong and was initially walled off from the rest of China as a precaution. At first, it followed a development trajectory similar to that of other Asian tigers, like Taiwan and South Korea and focused on low-cost manufacturing and on the development of knockoff products.
The ecosystem’s distinctive character emerged in a third phase, when local engineers began tinkering with the products that they were producing and improving them to meet the market needs of particular segments. Li cited the example of DVD players as pivotal: “One of these engineers in Shenzhen came up with a DVD player that could read everything, even scratched DVDs. And they were able to sell that DVD for only $80,” compared to the $1,000-2,000 cost for Sony players available at the time. The product with the new innovation went global – not to the US and Western Europe, as with earlier global expansion, but to developing countries around the world.
The success of the DVD created growth and wealth for Shenzhen – and a lot of duplicate products. But “rather than being upset at someone knocking off their product,” Li says, the original entrepreneur would help. “If the new manufacturer didn’t know how to manufacture a part of the system, a competitor would just sell it to them… The original maker just saw the counterfeiters as extra revenue.”
This model was repeated with smart phones. The infrastructure and wealth that accumulated during the DVD phase, combined with the Chinese government’s build-out of a standard GSM cell network, created a whirlwind of innovation in phones – from the cosmetic to the functional. According to Li, “By about 2008 or 2009, the Shenzhen ecosystem had 45 to 50 percent of the global GSM market.”
Open IP and Rapid Innovation
Perhaps the most striking difference between Shenzhen and Western models is their approach to intellectual property. Western startups seek to create strong patents at their core and to develop thickets of IP to support them. VCs value this intellectual property in making investments. The Shenzhen ecosystem, in contrast, thrives on openness.
“Nobody cared about IP [back then] because everyone was working in an environment of very rapid growth,” Li explains. Instead of guarding innovations, companies in Shenzhen focus on speed, collaboration, customization, and market responsiveness. As a result, the Shenzhen system has developed specialized players, most notably, engineering solution houses and industrial design firms. These permit entrepreneurs to implement new ideas rapidly without requiring any single company to master all aspects of product development.
This open approach has fostered the emergence of entirely new product categories, like hoverboards and affordable drones. Ideas often originate around a “tea table” where entrepreneurs discuss opportunities. As Li describes, “You get people together… They’re sitting around drinking tea in the afternoon, brainstorming what else they can build.” When an idea takes hold, the ecosystem mobilizes quickly, with participants often making deals on handshakes rather than formal contracts.
Part of this magic is the central tech market. Li describes it as “one of the foundations of all the crazy things that emerged over the next few decades. Everybody copied everybody, and everybody still made money.” People share ideas as well as components, which enables the ecosystem to continue to grow, with specialized companies for everything. Everyone specializes in something and communicates constantly with others to sense market needs and adapt quickly.”
Ecosystem Advantages
The Shenzhen model offers several benefits:
- Speed: Without IP concerns and with a network of specialized partners, new ideas can go from concept to market in weeks instead of months or years.
- Market responsiveness: The system excels at identifying and filling niche market needs, often globally, leveraging the electronic markets at the center of Shenzhen.
- Cost efficiency: The ecosystem’s density and specialization are built for low cost.
- Experimentation: The low cost of failure encourages ongoing iteration and experimentation.
Li describes it as “a farmer’s market on steroids” where everyone specializes but communicates constantly to sense market needs and adapt quickly.
Implications for Global Business
The Shenzhen model has already expanded beyond electronics to other sectors. China’s electric vehicle industry, for example, has followed a similar pattern. “The Nio was developed in a car parts market very much like the electronics market I described in Shenzhen,” Li says. But there is an even larger auto market in Shanghai. “It’s two streets with back-to-back shops. You can find every car component on those two streets. You can walk from the beginning of the street to the end and put together your own EV by the end of the walk.”
For multinational companies, the emergence of these innovation ecosystems presents both challenges and opportunities. They may find themselves competing not with individual companies but with entire ecosystems that can innovate and iterate faster than traditional corporate structures allow.
Advice for Executives
How should Western executives respond to this alternative innovation model? Li suggests:
- Engage directly with the ecosystem: Experiment with it, for example, by creating smart versions of your current product and testing them with customers.
- Let go of traditional business assumptions: “For many companies, this is uncomfortable in a lot of ways… The MBA teaches you to ask: Where is my IP? What is my technology advantage? What is my competitive edge in technology? But this way of thinking is going to slow you down when you have customers screaming for innovation.”
- Focus on speed and customer needs: “Worry about getting an ecosystem that can produce something quickly and cheaply. You will freak out your existing customers at a fraction of the price.”
- Be comfortable with ambiguity: The ecosystem operates with fewer contracts and more informal relationships than Western businesses typically prefer. Decide where this might be beneficial for your company.
The Shenzhen model, in many ways, is complementary to Western ways of innovating. It does, however, have the potential to disrupt segments of your market, not by replicating your product but by innovating to make it fit broader segments. Properly managed, it may represent new opportunities for growth for Western companies.