China’s ‘little giants’ are its latest weapon in America’s tech war

(Bloomberg) — In today’s China, behemoths like Alibaba Group Holding Ltd. and Tencent Holdings Ltd. are out of favor, but the “little giants” are on the rise.

Bloomberg’s Most Read

It is the designation of a new generation of startups that have been selected as part of an ambitious government program aimed at fostering a technology industry capable of competing with Silicon Valley. These often obscure companies have demonstrated that they are doing something innovative and unique, and they are targeting strategically important sectors like robotics, quantum computing and semiconductors.

Wu Gansha won the Little Giants title for its self-driving startup after a government review of its technology. This gave Beijing-based company Uisee an extra dose of credibility and financial advantage. Last year, he raised more than 1 billion yuan ($157 million), including money from a public fund. It’s also become a unicorn, with a valuation of at least $1 billion.

“It’s an honor to wear the little giant label,” Wu said. “The essence of the project is that companies should have a specialty that others don’t.”

The program has been around for more than a decade, but it took on new prominence after Beijing launched a sweeping crackdown on top companies like Alibaba and Tencent. The Little Giants label has become a popular measure of government approval, a signal to investors and employees that companies are safe from regulatory sanctions. President Xi Jinping gave his personal blessing to the program.

“It’s helpful for startups in many ways: It’s a grant. It’s a grant. It’s an honor. It’s a stamp of approval,” said Lee Kai-Fu, founding CEO of venture capital firm Sinovation.

The program is key to the Communist Party’s ambitious strategy to reposition the country’s tech industry. For two decades, China has largely followed the Silicon Valley model, allowing entrepreneurs to pursue their ambitions with little government control. This has led to huge hits including e-commerce pioneer Alibaba, social media giant Tencent and ByteDance Ltd., creator of the hit short video app TikTok.

But in a series of regulatory moves over the past year, Beijing has made it clear that the tech industry needs to realign itself to align with government priorities. Alibaba and Tencent were quickly forced to eliminate anti-competitive practices, while gaming companies had to limit minors to three hours of online play per week. More broadly, the government has signaled that more flexible Internet services are no longer in vogue.

Instead, Beijing aims to shift resources to strategically important technologies like chips and enterprise software. The Ministry of Industry and Information Technology has named 4,762 Little Giants since 2019, many of them in the semiconductor, machinery and pharmaceutical industries. The designation usually comes with lucrative incentives from the central government or provincial authorities, including tax cuts, generous loans, and favorable talent acquisition policies.

“What the country is trying to promote is more hardcore technology,” said Yipin Ng, founding partner of Yunqi Partners, a venture capital fund that invests in small giants. “In that sense, it’s more in line with what they’re trying to promote — things that make China more competitive.”

Governments from the United States to Africa have programs in place to support small businesses, but China’s efforts eclipse them in scale, resources and ambition. Xi, the country’s most powerful leader since Mao, has implemented half a dozen programs that will collectively shell out trillions of dollars in pursuit of economic might, social stability and technological independence.

The US trade war strengthened the Communist Party’s determination to build a self-sufficient industry. The country’s vulnerability was revealed when Donald Trump’s administration blacklisted national champions like Huawei Technologies Co. and Semiconductor Manufacturing International Corp. This prevented them from buying American components such as chipsets and industrial software, crippling operations.

Find out how Beijing’s crackdown unfolded over a year

The concept of little giants dates back at least to 2005, when the local government of Hunan province instituted policies to support small businesses. The central government’s powerful MIIT endorsed the Hunan campaign, which included land grants and financial support, as a model for private sector development. Local governments in places like Tianjin have launched their own initiatives.

It was in 2018, with the trade war, that the central government began to seriously push the program. MIIT announced a plan to create about 600 little giants that would develop core technologies. The procedure for obtaining the designation has been designed to foster competition and identify the most promising companies.

Applicants apply with a six-page form detailing financial status, number of patents, and research achievements. In the first round of selection, each province could only name about ten companies. The country’s three main tech hubs – Beijing, Shenzhen and Shanghai – had a combined quota of just 17 applicants.

Guan Yaxin, chief operating officer of Beijing-based ForwardX Robotics, said the process was relatively smooth for her company as it has a proven track record, with 121 patents worldwide, including 25 in the United States.

“This government approval is very helpful as I grow the business because customers will understand that we are not just a random startup,” she said.

MIIT has since expanded the program to thousands of companies, with about 1,000 “priority little giants” at the top of the hierarchy. Members of this rarefied club, which includes Wu’s Uisee, receive direct funding from the central government. In January, the Ministry of Finance earmarked at least 10 billion yuan to fund small and medium-sized enterprises through 2025, with the lion’s share directly funding priority research for startups. The goal is to create 10,000 little giants by 2025.

“It’s clear that this is a selection of companies that are highly subordinate to China’s specific industrial policy and needs,” said Barry Naughton, a Chinese professor and economist at the University of California, San Diego. . “They were selected partly because they are good companies, but an equally important criterion is that they meet the government’s pressing policy needs at this time.”

There are significant risks. The success of China’s tech industry over the past 10 years has come from entrepreneurs like Alibaba’s Jack Ma and ByteDance’s Zhang Yiming giving free rein to building their businesses. Flipping the model to focus on government priorities risks leading to waste and failure, Naughton said.

“It is small companies that are encouraged because they can potentially be alternative suppliers. How do you feed them? You throw money at them,” he said.

The smaller giants have become popular targets for venture capitalists, many of whom lost money on their portfolio companies during Beijing’s crackdown. A VC said some startups in the program have been able to raise capital in the past six months while increasing their valuations by 50% to 75%. Another VC would only invest in companies identified as small giants by the government.

Zhang Hui, co-founder of Guizhou Changtong Electric Ltd., applied for the program in Guizhou Province in 2020 and received the award last year, based on his company’s electrical equipment technology. The startup quickly landed more than 100 million yuan in state-backed funds, and other investors knocked on its door to offer additional capital.

“Of course, venture capitalists will chase smaller giants to invest,” he said. “It would be a surprise if they didn’t.”

Venture capital investment in China hit a record high last year despite the crackdown. The value of deals increased by around 50% in 2021 to $130.6 billion, according to research firm Preqin.

Learn how venture capital investment in China hit a record high last year

EcoFlow Inc., a portable battery startup in Shenzhen, announced a 100 million yuan fundraising led by Sequoia as the company won the small giant label from MIIT. The four-year-old company now plans an initial public offering in its hometown within three years.

The government also facilitates the IPO of these startups, another incentive for entrepreneurs and venture capitalists. China set up a dedicated stock exchange in Beijing last year to help small businesses raise capital.

ForwardX Robotics’ Guan pointed out that founders retain control of their companies even if they participate in such government programs. His company, which makes mobile robots used in manufacturing and logistics, has about 300 employees and plans to expand into Japan and the United States. She sees government support as a big plus as the little giants try to grow.

“A lot of them are very small now compared to multinationals,” she said. “But the government sees the potential for them to one day become true giants.”

Bloomberg Businessweek’s Most Read

©2022 Bloomberg LP