Why China Is Emerging as a Tech Superpower to Rival the U.S.
A dogfight in the world of drones was about to begin. It was November 2016, and Da-Jiang Innovations Science and Technology, better known as DJI, was preparing to launch its killer new product: the Mavic Pro. Weighing just 1.6 pounds, the Mavic was compact enough to fit into a book bag and featured a four-mile flight range and a built-in camera capable of shooting pin-sharp 4K video from hundreds of feet up. Though priced below $1,000, the Mavic sported sophisticated gimbals to stabilize the camera and cutting-edge software enabling it to lock on subjects and follow them around, detect and avoid midair obstacles, and automatically return to its launch point before running out of power.
The executives at DJI knew they had a great product. But would it sell? DJI had little brand recognition even in China, and Mavic was its first product for mainstream consumers. Moreover, DJI was up against a formidable roster of U.S. and European competitors flocking to market with similar devices—including Parrot, a 22-year-old French electronics manufacturer; Lily Robotics, a Silicon Valley startup that raised $15 million on Kickstarter; and GoPro, the maker of portable action cameras. How would DJI’s technology fare vs. the best in the West?
It wasn’t even a close contest.
DJI president Roger Luo says he knew immediately they had a winner—and a huge production challenge. Within three days of release, DJI had received three times more orders for the Mavic than it had expected to sell the entire month.
Meanwhile, the drone contenders from the West fell back to earth one by one. Parrot was the first to surrender, announcing in January it was axing workers from its drone division. Then Lily revealed that, despite collecting more than $34 million in preorders, it had burned through all its cash and would close without shipping a single unit. The real surprise was GoPro. The San Mateo, Calif., company had established its brand by selling more than 20 million “wearable” cameras. And CEO Nick Woodman had vowed GoPro would return to profitability with the release of a heavily marketed drone called Karma. But the Karma, it turns out, was bad—heavier and slower than its Chinese rival, and lacking its tracking or detect-and-avoid capabilities. Worse, the first Karmas had an alarming tendency to lose power and drop from the sky. After an embarrassing recall, GoPro relaunched in February. By then, DJI had taken off.
Fast-forward to today, and DJI controls more than 70% of the commercial drone market, a category that could soar to $15 billion by 2022, according to global research firm Interact Analysis, up from $1.3 billion last year. With venture funding from Accel Partners and Sequoia Capital, DJI has a valuation of $10 billion. The company doesn’t disclose financial results, but it has been widely estimated by analysts that sales this year will exceed $1.5 billion, with earnings approaching $500 million.
DJI has been hailed by many electronics industry analysts as the “Apple of consumer drones.” But the comparison is misleading. Unlike Apple aapl , which proudly proclaims its products are “Designed in California, Assembled in China,” DJI products are designed and manufactured in the southern Chinese city of Shenzhen, which today has no equal for sourcing the rotors, transmitters, batteries, and other components in DJI products.
DJI’s success highlights one of the global economy’s most momentous transformations: China, after a century of subordination to foreign nations, three decades of isolation under Mao Zedong, and three decades of “opening and reform” measures initiated by Deng Xiaoping, is returning to its historical position as one of the world’s great centers of innovation and technological development.
Until only a few years ago, talk of China as an innovator would have elicited scorn from most Western business and government leaders. The country was widely derided as a haven for copycats and pirates, or grudgingly acknowledged as an efficient manufacturing platform whose factories depended on the uneasy union of cheap Chinese labor and foreign technology.
Business in China today, however, is being led by innovation-obsessed execs like Ren Zhengfei, founder of Huawei Technologies, which last year filed more patent applications than any other company in the world. And Allen Zhang, who led the team that developed Tencent’s WeChat, the smartphone app that allows its 900 million users to chat, shop, pay, play, and do just about anything else. And Robin Li, CEO of Baidu, the Beijing-based search company, who has vowed to have autonomous vehicles ready for sale in China by next year.
Their success is fueling a virtuous cycle of innovative activity. The country’s two largest Internet companies, Alibaba Group baba and Tencent Holdings tcehy , lead the world in e-commerce, mobile payments, social media, and online gaming. They and other Chinese tech giants are investing aggressively in new businesses, helping to transform China into a massive market for venture capital investments. Those ventures, in turn, are nourished by China’s huge and growing market and its unique ecosystem of suppliers, logistics specialists, and manufacturers. The result: China has spawned a new generation of homegrown entrepreneurs who are creating world-class products, developing their own technologies, and rolling out new business models on a scale and with a speed the global economy has never seen. “The copycat era is behind us,” says Kai-Fu Lee, CEO of Sinovation Ventures and the former head of Google China. “We are way beyond that.”
Consider that between 2014 and 2016, China attracted $77 billion in venture capital investment, compared with just $12 billion in the preceding two years. China is now among the world’s top three markets globally for venture capital in digital technologies including virtual reality, autonomous vehicles, 3D printing, drones, and artificial intelligence. And about a third of the world’s 262 “unicorns” (startups valued at more than a billion dollars) hail from China, according to McKinsey & Co., and account for 43% of the global value of such companies.
To explore the implications of this high-speed economic evolution, Fortune will be convening business leaders from around the globe in Guangzhou, China, in early December at a pair of events: the Fortune Global Forum and the Brainstorm Tech International conference.
“China and the U.S. are the world’s only true technology superpowers,” says Richard Ji, cofounder and managing partner of Asia All-Stars Investment, a Hong Kong–based and technology-focused investment fund that has invested in some of China’s most successful tech companies. “No other economies come even close.”
China’s rising class of innovators benefits from several built-in advantages. One is the vast scale of China’s market, which drives powerful efficiencies as new products and services are rolled out to hundreds of millions of people. Another is that Chinese consumers are enthusiastic adapters of new technologies, and that entrepreneurs operate in a developing market unencumbered by legacy infrastructure. China’s shoppers have taken quickly to online shopping and digital payments in part because they didn’t have to unlearn habits of shopping at traditional brick-and-mortar stores.
China overtook the U.S. as the world’s largest market for e-commerce in 2015. This year online sales are expected to top $1.1 trillion, according to eMarketer, a data research firm. McKinsey says China alone now accounts for nearly half of worldwide e-commerce—up from less than 1% only a decade ago. Goldman Sachs expects online retail sales in China to grow at an annual average of 23% over the next four years, topping $1.7 trillion by 2020.
While government meddling in the private sector may be a negative for China’s overall growth, in many cases regulatory flexibility, or nonchalance, has encouraged innovation. China’s banking officials turned a blind eye as Tencent, an online gaming company, experimented with an app that used QR codes to facilitate digital payments—and as Alibaba, an e-commerce company, developed Alipay, its own online payment system, and then Yu’e Bao, an online investment fund for Alipay users. The result is that China, the land where paper money was invented, is now rapidly going cashless. And Yu’e Bao, in little more than a year, has become the largest mutual fund in the world.
A final advantage is China’s indifferent attitude toward privacy and antitrust rules. It enables Chinese tech giants to collect and analyze data not only from a huge number of consumers, but also in a way that allows the companies to know the minute details of their customers’ lives: where they live, where they travel, where they shop, what they buy, what music they like, who they socialize with, what kind of health care they’re receiving.
Well before the rollout of Apple’s iPhone X, which features Face ID technology, Alibaba’s financial services affiliate, Ant Financial, began allowing its 450 million users to log in to their online wallets by taking a selfie. Internet giant Baidu, China Construction Bank, and ride-hailing company Didi Chuxing use the technology to identify employees as well as customers. Ant is steadily extending the use of its “Sesame Credit” system, which assigns customers a “financial reliability” score according to criteria such as their online spending records and how regularly they pay their utility bills or credit cards. The ranking even factors in the scores of acquaintances.
So far, however, Chinese customers don’t seem worried about the loss of privacy, as long as such personalized technologies make their lives far more convenient.
While venture capital continues to pour into China, it is beginning to flow the other way too. The country’s technology behemoths have global ambitions. And increasingly they are taking their battles with each other overseas—in the form of VC investments outside China. Alibaba’s U.S. investments, for example, include Snap, Lyft, and the Florida augmented-reality startup Magic Leap. Alibaba spent $1 billion last year to secure a major stake in Singapore-based Lazada, the largest e-commerce company in Southeast Asia. Meanwhile, Ant Financial holds shares in PayTM, the largest ride-sharing venture in India, and has snapped up stakes in fintech companies in Korea, Thailand, the Philippines, and Indonesia.
Last month, Alibaba announced that in addition to those strategic investments, it plans to spend $15 billion over the next three years to strengthen its global research and development capabilities and will establish laboratories for deep research in seven locations including San Mateo; Bellevue, Wash.; Moscow; Tel Aviv; and Singapore.
Rival Tencent, for its part, has snared stakes in Snap, Tesla, and an Indian message app called Hike Messenger. Last year, Tencent paid $8.6 billion to gain control of Finland’s Supercell, bolstering Tencent’s position as the world’s leading provider of online games. In Southeast Asia, the company has invested in Sea, an online gaming, shopping, and mobile payment portal that is the region’s most valuable startup, and Go-Jek, the biggest ride-sharing service in Indonesia.
Meanwhile, Alibaba and Tencent are bankrolling competing dockless bike-sharing companies that launched this year in scores of overseas cities including Washington, D.C.; San Francisco; Nagoya, Japan; Singapore; and Sydney. (In Shanghai, meanwhile, abandoned bicycles from Tencent-backed bike-sharing startup Mobike and Alibaba-backed Ofo have become so numerous that authorities impounded thousands of them earlier this year. Chalk it up to growing pains.) But the two have joined forces in ride sharing. Both are investors in Didi Chuxing, which owns stakes in ride-sharing ventures in Europe, India, Southeast Asia, the Middle East, and Africa.
“China’s tech companies are determined to expand globally, and that determination will only grow,” says Connie Chan, partner at California venture capital firm Andreessen Horowitz. In years to come, she argues, “every company will need a China strategy,” whether they do business in the Middle Kingdom or not.
As spectacular as China’s progress in innovation may be, skeptics cite a long list of shortcomings. China, the world’s most voracious consumer of semiconductors, has been trying to build a domestic chip industry since the 1970s, and yet the country still imports 10 times more microchips than it can produce. The nation’s drugmakers lag far behind Western counterparts. And executives at Boeing ba and Airbus are hardly losing sleep over the prospect of competition from China’s state-owned Commercial Aircraft Corporation of China (COMAC), which unveiled in May the C919, the nation’s third attempt to build a commercial passenger jet.
In a detailed 2015 assessment of Chinese innovation, the McKinsey Global Institute identified four categories of innovation: consumer-led (such as e-commerce, mobile payments, or online financial services), manufacturing-led (the production of consumer electronics or automobiles), engineering-led (such as the construction of high-speed railways), and research-led (for example, breakthroughs in the manufacture of semiconductors or the development of pharmaceuticals). The report’s conclusion: China is already a global innovation leader in the first two categories and “has the potential” to become a world leader in the latter two.
That mixed review remains broadly accurate. In the most daunting segments of the economy—semiconductors, pharmaceuticals, commercial aircraft, or high-speed railways—Beijing has held fast to a heavy-handed, statist approach to development that has done more to stymie innovation than stimulate it.
Consider semiconductors. Beijing has spent billions over the past four decades to promote development of an indigenous chip industry, which it sees as vital to national security and the success of China’s technology industry. China’s share of worldwide wafer fabrication capacity rose to 14% last year, up from virtually nothing in 2000. But China’s chipmaking capabilities remain concentrated in the low- and mid-range of the industry. Last year China spent about $200 billion to import chips, which remains China’s second-largest import category after crude oil.
Chinese President Xi Jinping, the country’s most powerful leader in decades, is leading an ambitious effort to jump-start development of China’s semiconductor industry. Under a plan announced in 2014, the government set a goal of raising the share of domestic production of China’s chip consumption to 50% by 2020 and vowed Chinese firms would compete successfully with global industry leaders by 2030. To that end, Beijing is channeling $150 billion in public and private funds to domestic chipmakers through 2025.
In Washington, Republicans and Democrats have sounded the alarm. Commerce Secretary Wilbur Ross calls China’s chip program “scary.” And a presidential council on science and technology recently found that the U.S. must “respond forcefully” to China’s lavish subsidies. But Dieter Ernst, a senior fellow at Hawaii’s East-West Center, doesn’t buy it. “Industrial policy may gradually enhance China’s standing in the global semiconductor industry, but the U.S. in particular has little to fear,” he argued in a recent issue of the China Quarterly. The U.S. semiconductor industry “remains by far the world’s market and technology leader.”
Will China dominate the technologies of the future? Beijing has moved forcefully to promote development of artificial intelligence and encourage the use of industrial robots. For now China remains a laggard in “robot density.” In 2016, it had only 68 robots per 10,000 manufacturing workers, according to the International Federation of Robotics, compared with 631 in South Korea, 309 in Germany, 303 in Japan, and 189 in the U.S. China has been the world’s largest buyer of robots since 2013. Last year it bought about 87,000 robots—or about one in three of 294,000 robots sold in the entire global economy. China’s planners have set a goal of raising the ratio of industrial robots to 100 per 10,000 workers by 2020. Xi Jinping, meanwhile, has called for a “robot revolution” in China.
A.I. is also a priority. In July the Chinese government laid out a plan to be the global leader in artificial intelligence by 2030 and to develop an industry worth some $150 billion. Billions in VC funding are already flowing into Chinese A.I. startups.
One of these promising young companies is Toutiao, a news aggregator launched in 2012 by 34-year-old former Microsoft msft employee Zhang Yiming. Toutiao’s parent company, Beijing ByteDance Technology, already has raised over $1 billion from Sequoia Capital and others, and is seeking an additional $2 billion that would value it at $20 billion. (And in November it agreed to buy U.S. lip-syncing video app Musical.ly for a reported $800 million.) Toutiao uses A.I. to create personalized news feeds of short articles and videos from content generated by its network of 4,000 outside media companies. Analysts say its content-recommendation tech is among the most sophisticated in the world.
It’s quite possible that Toutiao will soon be going head-to-head in the market with rivals from Silicon Valley. If so, remember DJI—and think twice before betting against the Chinese company.
A version of this article appears in the Dec. 1, 2017 issue of Fortune with the headline “Innovation Takes Off in China.”