The transformation of Silicon Valley from farmland into the center of the technological universe has been attracting envious looks from around the world for a generation or more.  Indeed, the French president Charles de Gaulle famously visited the sprawling research parks of companies such as Hewlett-Packard and Applied Technologies back in the 1960s.

This fascination with replicating the magic that has produced the digital champions of today continued in the intervening years, with Minitel perhaps coming to unfortunately typify the unsuccessful attempts in Europe to recreate the secret sauce.

The concern across the EU has only risen as China has appeared to have considerably more success.  Consulting giant McKinsey recently argued that the talk about Asian economic hegemony has been largely underestimated. They suggest that while the last 30 years have been typified by increasing Asian consumption and integration into the global flow of trade and innovation, the coming decades will see Asian economies driving and determining the direction of these flows, with the region set to account for 50% of global GDP by 2040.

IMD Business School’s Mark Greeven and Imperial College London’s George Yip suggest that the engine of this growth is in what they refer to as China’s hidden champions.  In their latest book they lift the lid on the thousands of Chinese companies that have grown to dominate their markets, and suggest that these companies have progressed beyond copying western firms or providing a low-cost manufacturing base for western giants, and now drive the agenda as a result of a high-skilled workforce and innovative behavior.

Digital dominance

In many ways, these firms act as a microcosm of the transition chronicled by McKinsey, but while there is undoubted value in the innovative firms operating in sectors such as energy and industrial machinery, the innovation lens inevitably falls most intensely upon the digital giants that are going toe to toe with American giants such as Facebook, Google and Apple.

Central to the success of companies such as Baidu and Tencent has been their ability to place digital financial services at the heart of their offerings.  This has driven tremendous investment in fintech across China, with data from Accenture showing that of the $55 billion that was invested in fintech ventures around the world in 2018, $25.5 billion of it was in China, which represents a nine-fold increase on the previous year.

While the bulk of this investment was wrapped up in the $14 billion raised by Ant Financial, there were also numerous other significant deals, including the $4.3 billion raised by Baidu spinoff Du Xiaoman Financial and the $1.3 billion raised by the wealth management platform Lufax.

The Chinese hegemony in fintech should perhaps come as no surprise, as there are a number of factors that are unique strengths for the nation.  Firstly, financial services in China were not well developed, which allowed startups to leapfrog legacy systems, and especially allow companies such as Alibaba and Tencent to offer financial services to customers despite lacking heritage in the space.  This lack of technological legacy has enabled such a rapid pace of innovation to unfold that the majority of financial transactions are now completed via mobile phones.

There is also a supportive regulatory environment that has helped fintech innovators to emerge.  There exists a safe zone within the country for startups to test new ideas and applications, which has led to Chinese startups leading the world in terms of technology.

Last, but not least, there is a large, previously underserved population that are digitally savvy and online in huge numbers crying out for new ways to access financial services, both in their personal and professional lives.

Lagging behind

It’s a level of success that Europe has struggled to match, despite concerted effort by the European Union to create a cabal of digital champions that stretches back at least a decade.

“Europe has great potential to draw level with its American and Asian competitors and win the race on data platforms for industry and ethical AI applications. At EIT Digital, we believe that only a concerted effort of all stakeholders can sustain the competitiveness of a sector that is vital for Europe’s economic success. Our mission is to bring tech ‘makers’ (i.e. tech firms and universities) and ‘shapers’ (i.e. regulators) together to create the digital world that respects European values,” Willem Jonker, CEO of EU accelerator EIT Digital said at their recent annual conference in Brussels.

One clear advantage for both Chinese and American digital startups is the huge domestic market they have to build within.  Despite the worthy efforts of the EU to create a single market across the continent, and the attempt by bodies such as EIT to facilitate trade across Europe, this remains a clear barrier to scale.

The single market was created at a time when most trade was in goods, and reform has not matched the shift towards a service-based economy in much of the developed world.  It’s no surprise that 21 of the 25 biggest firms in the EU trade in goods rather than services.  The picture used to be similar in the United States a few decades ago, but their domestic market has been sufficiently supportive to allow a transition so complete that now 17 of the biggest 25 American firms are tech driven service firms, with many of these considerably younger than European giants like Unilever and Royal Dutch Shell who were founded at the start of the 20th century.

Despite the EU startup monitor revealing that around 85% of startups want to trade outside of their home country, few were doing so at the time of writing, with challenges over rules and regulations commonly cited.  Indeed, American firms do roughly twice as much trade outside of their ‘home state’ as European firms do outside their home market.

Scaling challenges

Entrepreneur James Liang highlights the tremendous benefits a large domestic market can bring in his latest book The Demographics of Innovation.  He argues that demographics have a huge part to play in innovation, and outlines three core ways they impact a country’s creative output:

• The scale factor – Economies of scale are well known in business, but Liang argues that scale is also vital for innovation.  Not only do countries with high populations have more researchers etc., but crucially, they have a large domestic market for budding innovators to sell to.
• The agglomeration factor – This can be seen with the emergence of innovation hubs, such as Silicon Valley, in recent decades.  Liang argues that a large population is not enough if that population is not fairly well concentrated.  Cities and hubs benefit from the concentration of talent and resources in one place.
• The age factor – The age of the population is also important.  Liang suggests that 72% of the greatest inventions in history were made by inventors in their 30s and 40s.  This is because they have had time to gain an education but are not sufficiently embedded into the status quo to see no other way of working.

It’s notable that the majority of users and revenue for the big Chinese firms come from the domestic market, whilst even western giants such as Amazon only generate around 30% of their revenue from overseas markets.

With fewer than 10% of unicorns emanating from the EU, there is a clear need for change, but with the UK set to leave, the EU will be driven by the twin-engines of France and Germany, both of whom remain heavily goods rather than services driven.  With Ursula von der Leyen, the new president of the European Commission, making no mention of single market reforms in her agenda for the coming years, it seems likely that the EU will continue trying to apply bricks-and-mortar rules to a digital economy.  As a result, they should not be surprised if their search for digital champions remains a forlorn one.