Innovations and Trends in China’s Digital Economy

China is both a global leader in e-commerce and the world’s manufacturing powerhouse. And yet the development of an industrial Internet is far behind the booming consumer Internet, which creates a tremendous divide between consumer demand and the supply side. A distinctive feature of the recent surge of digital economy in China is the strong push from the rising consumer demand for quality products, which has a major impact on the industrial digitization.⁴

China has over 1.3 billion mobile Internet users, the largest online shopper population, the largest amount and highest ratio of mobile payment in the world.¹ According to China Statistical Yearbook (CSY) 2020, 25% of the national retail took place online in 2019, amounting to $1.8 trillion,^3,11 over 90% of which was via mobile payment.¹¹ These forces have given rise to Internet giants such as Alibaba, Tencent, JD.com, and Xiaomi, which have not only shown leadership in global digital innovation⁸ but also created a digital ecosystem in China. For example, the digital economy based on the Alibaba ecosystem accounted for over 69 million jobs.¹² As a result, the digital economy in China has been growing rapidly, at an annual rate of 16.6%¹³ between 2015 to 2020, the fastest in the world, and its size, ranked second in the world behind the U.S.,⁴ exceeded $6.07 trillion or 38.6% of the GDP in 2020.⁶

Figure. Saturnbird Coffee’s colorful capsules.

Though China has been the largest manufacturer in the world for over a decade, the majority of firms fall behind in digital transformation. One-third of them do not have a website and only 10.2% manufacturers conduct online transactions, according to CSY 2020. Moreover, industrial digital economy accounts for only 19% of industrial GDP,⁵ which is below the global average 23.5% and far lower than Germany’s 45.3%, the highest in the world.⁴ An Accenture report on digital transformation shows that digital technologies did not yield a satisfactory return in two-thirds of the firms in China.⁹ Therefore, the manufacturing industry has become the primary battlefield in the era of digital economy in China.¹⁰

Meanwhile, millennials (those born between 1980–1994) and Generation Z (born between 1995–2009) account for nearly 40% of the Chinese population, who are indigenous netizens representing the most powerful force in the Chinese consumer market.⁷ The mobile Internet has become an indispensable part of their daily life. The new generations of consumers exhibit a strong dependence on smartphones and social media, reliance on key opinion consumers (KOCs) and key opinion leaders (KOLs) in making purchasing decisions, pride in domestic brands, preference for smart products and visual attractiveness, attention to product attributes related to health, entertainment, and experience, and willingness to pay extra for high quality. Their attitudes toward digital technologies, lifestyles, and shopping experiences create both opportunities and challenges for traditional firms.

It is against such a backdrop that a new breed of digital start-ups has emerged, and some of them have rapidly evolved into a unicorn in its industry, by bridging the demand and supply sides with the mobile Internet. This emerging trend could represent the future of digital economy. This article examines how the fusion of the world’s largest consumer Internet and manufacturing powerhouse has created this new breed of digital firms in the highly competitive red ocean of consumer product industries, in terms of the critical success factors, and what lessons can be learned by other parts of the world.

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Critical Success Factors for the Digital Start-ups

This article examines three successful digital start-ups, which share many common characteristics in becoming the top domestic brand in their respective industry (see accompanying table) in three to four years after foundation, in terms of five critical success factors.

Table. Profile of the three focal cases.

The first factor is product innovation that fulfills a consumer need and relieves their pain with traditional products. For example, Saturnbird Coffee produces quality instant coffee that offers the taste and healthy ingredients of fresh coffee and yet the convenience of instant coffee together. Similarly, YQSL provides “healthy and tasty” beverages, which are in short supply on the market. Perfect Diary addresses consumers’ headaches with expensive international brands of cosmetics, and their desire for affordable domestic brands for young women in the 18–28 age group.

Moreover, Saturnbird Coffee designed capsules in bright yellow, red, and brown colors, with an attractive visual identity to appeal to the younger generation of consumers, who prefer distinctive and fun packaging. YQSL paints a big Japanese character “気” on beverage bottles to be conspicuous among competing brands. Perfect Diary’s highly popular lipsticks take the shape of a narrow high heel of ladies’ shoe.

The second and the most distinctive factor is consumer-centric operation based on the Internet, which is also the fundamental difference between these digital start-ups and traditional firms. Starting from R&D, every phase of the operation involves extensive interactions with consumers. KOCs are invited for trial use and feedback in an iterative manner, till the product becomes satisfactory. Subsequently, a wide range of consumers are invited for product sampling, and the iteration could repeat several rounds before product releases. During the sales and adoption phases, the digital start-ups encourage content-generation by consumers to share their experiences on the Internet. Such end-to-end interaction with consumers allows precise and timely insights to consumer needs, while increasing brand recognition and emotional attachment. Moreover, not only do the extensive interactions with consumers shorten R&D cycle time, but also allow frequent releases of new products. For example, Perfect Diary rolled out five to six new designs per month on average, releasing over 1,500 new SKUs (Stock Keeping Unit, corresponding to a scannable bar code for inventory management) during 2019 and 2020. The typical cycle time is less than six months from idea conception to product release, much shorter than the 7–18 months required by international brands.

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New digital start-ups collect and use big data extensively to gain insights to consumer behaviors and to optimize interactions with consumers.

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Attractive product packaging draws the attention of KOCs and consumers and prompts the sharing of photos and stories. In fact, over 90% of the content about Saturnbird Coffee on a popular social media platform is user-generated, which draws additional consumers. Information on popular products and promotional activities is also disseminated via the Internet in the forms of product sampling, seminars and short video tips, and infomercials.

Consumer engagement is established to maximize coverage via all channels including major online marketplaces, WeChat (similar to Facebook), social commerce apps, Weibo (Twitter equivalent), and online forums. For example, Perfect Diary uses a WeChat personal account to post promotion materials on its moments first, and then broadcasts details to subscribers of the firm’s official WeChat account, and lastly disseminates promotions and URLs for purchasing in WeChat groups, in a closed circle. The timing of each of these steps is based on big data on consumers’ daily Internet use habits, to maximize exposure and impact.

The third factor is big data-driven decision-making. The new digital start-ups collect and use big data extensively to gain insights to consumer behaviors and to optimize interactions with consumers. For example, Perfect Diary established an IT and data team, which accounted for 20% of the headcounts at the firm’s headquarters. The team built up the IT infrastructure, consumer big data, a social media-based marketing engine, and a consumer interaction platform. Saturnbird Coffee made use of business analytics from Tmall (the leading business-to-consumer online marketplace for brand name stores to sell products to consumers), which revealed that a consumption habit would be established if someone drinks 50 capsules of coffee in two consecutive months followed by additional purchase in 90 days. In response, the previous nine-capsule package was replaced with the 24-capsule one, and incentives were given for purchasing two packages together. Furthermore, a 64-capsule package was launched later, which became a best-seller.

Fourth, contract manufacturing was used along with collaborative R&D. For example, Saturnbird Coffee collaborated with a manufacturer in experimenting with cold extraction and freeze-dried powder techniques used in other industries and adapted it to the making of instant coffee. The result was pour-over coffee that could melt in water of any temperature in just three seconds. YQSL and Perfect Diary collaborated with contract manufacturers for international brands of similar products, with capabilities and experience for technological innovation.

This collaboration model entails a low start-up cost, drawing upon the strength of China’s manufacturing industries. Working with established manufacturers provides not only quality guarantee, but also flexibility in adjusting production techniques and new supplementary ingredients for rapid iterations and scaling-up. However, after significant growth in brand power, sales, and financing, the digital start-ups often chose to build their own factory and R&D center for stronger control over technological innovation and processes. This could result in more fundamental reshaping of the industry.

Fifth and lastly, the digital ecosystem played an empowerment role, including facilitating international expansion and providing Internet talents, in addition to big data and business analytics. Soon after product launching, these digital start-ups started exporting via existing online platforms, contrary to the practices of earlier generations of Internet firms such as Alibaba and Tencent, which entered overseas market only after achieving dominance in China. For example, Perfect Diary launched its website for overseas consumers at its third anniversary, by establishing its storefront on Tmall & Taobao Overseas e-commerce website. Similarly, YQSL and Saturnbird Coffee also took the same route. YQSL beverages are sold in over 30 countries and regions including the U.S., Japan, and Canada. Furthermore, each of these digital start-ups attracted much needed talents from e-commerce firms, and thus the founder team involved a combination of talents from the traditional businesses and e-commerce firms.

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A Digital Economy Driven by the Consumer Internet and Empowered by a Digital Ecosystem

The success of the three digital start-ups demonstrates a winning formula for digital economy (see the accompanying figure), which is to capture consumer needs via the Internet, contract manufacturing along with collaborative product innovation, and extensive consumer participation in R&D and marketing. The consumer Internet is pulling the industrial Internet forward, which narrows down the huge gap between their different stages of development. In general, the fusion between the flourishing e-commerce and the robust manufacturing powerhouse has created fertile soil for the rapid growth of digital economy in China.

Figure. The ecosystems for digital start-ups.

A distinctive characteristic of the current wave of digital economy in China is that it is driven by strong emerging consumer demand, which pushes technological and business model innovation.⁴ This driving force is quite different from that in the developed world, for example, technological innovation in the U.S.,⁴ and advanced industrial bases in western Europe, Japan, and South Korea. Moreover, Chinese digital start-ups are consumer-centric, and their operation heavily depends on the Internet, featuring end-to-end consumer interactions from conception of product idea to consumer experience after-sales and adoption. Such a process helps create not only best-seller products but also consumer loyalty.

This research offers two key insights for other parts of the world for reference. First, it is important to leverage the consumer Internet and ecosystems, which enable digital start-ups in many ways such as providing channels for engaging consumers directly, gaining big data on consumer behaviors, and facilitating expansion overseas. Connectivity of the Internet makes it feasible for novel products to gain consumer recognition in a much shorter time period than before. Moreover, online marketplaces offer not only business analytics but also talents who understand how the Internet and social media can be used to operate in a consumer centric manner. This growth pattern of digital economy might hold true for other parts of the world, that is, a well-established consumer Internet and digital ecosystem play a key role in enabling digital start-ups. Second, in keeping pace with the digital economy, there will be a surge in the demand for digital talents needed not only for developing the IT infrastructure, natural language processing tools, and analytics platforms, but also acquiring and analyzing user-generated contents and consumer behavioral data on the Internet. The computer science and related fields would be a primary source for providing such digital talent and should be prepared for this new demand.

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Future Challenges and Directions

The three digital start-ups analyzed in this article demonstrate exciting new trends in the digital economy in China, which represents a fusion with the traditional economy, and efficient bridging between consumer demand and the supply. These new trends could also be instrumental for integrating the Chinese economy into the global value chain and supply chain. Nevertheless, the digital economy in China faces serious challenges ahead.

First, there is a huge disparity in regional development of digital economy. Digital economy accounts for over 40% of the GDP in the more developed eastern coastal regions, compared to under 25% in the northwestern regions with insufficient innovation and resources. Given the differences in regional industry structures and resource endowment, a universal development path for digital economy does not exist. Therefore, a key challenge is how to promote the fusion between traditional economy and digital economy along with cross-regional collaboration.

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These new trends could be instrumental for integrating the Chinese economy into the global value chain and supply chain.

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Second, the disparate distribution of digital infrastructures and human talents is another major hindrance for digital transformation in the majority of Chinese firms, which creates a new digital divide. The best digital talents and advanced digital infrastructures are concentrated in Internet companies, leaving few for the traditional economy. As a result, many traditional firms are unable to take advantage of the consumer Internet, despite the existence of digital ecosystems including social media, online marketplaces, and online payment systems. Therefore, a national priority remains to upgrade the IT infrastructure to enable digital innovation, and to educate digital talents.

Third, as demonstrated earlier in this article, digital start-ups must expand overseas for greater success and economies of scale, while maintaining a leading position in the domestic market. To this end, they should pay close attention to global product standards and technological innovation and stay committed to R&D collaboration with overseas partners for mutual benefits.