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Gobi Partners' Michael Zhu: Reflections on the Value of Focusing on the Corporate Service Industry

Lieyunwang.com's "CEO Summit and VC Awards Ceremony" 2018 was recently held at the Hyatt Regency Hotel in Beijing, China. At the Summit, Gobi's Michael Zhu took the stage to speak on the topic of "Reflections on the Value of Focusing on the Corporate Service Industry." 

According to Zhu, the corporate service or enterprise-facing industry has always been a main focus for Gobi Partners, especially the enterprise applications sector. When evaluating the business models of these startups, Gobi will prioritize those critical applications with inelastic demand. 

Regarding his thoughts on the VC industry at large, Zhu said that this was an especially "slow" year, and the first-mover advantage in terms of access to users and capital for startups has gradually diminished. A lot of private equity firms have readjusted their strategy, including their investment focus. In addition, the domestic private market has also undergone great changes in relation to declining valuations or fundraising amounts. 

Zhu also added that the IPO market seems very lively at the moment; however, after being listed, many companies' performances regarding fundraising size, liquidity, and market cap have been relatively poor. Although there are a myriad of reasons to explain this phenomenon, a key point is that the popularity of the B2C and C2C business models in the capital market has waned. 

Zhu believes that we must look beneath this bubble and return to the basics of business nature and logic: to enhance the working efficiency of supply and demand. Ultimately, this creates many opportunities in the enterprise applications and Industrial Internet sectors. 

However, the cost of labor has also increased dramatically in recent years. In Zhu's opinion, this factor, coupled with the fact that the economy itself is in the process of deleveraging, is causing an unfavorable fundraising process, so companies are now focusing on improving efficiency, and simultaneously keeping costs down. 

Due to these rising costs, more companies are now willing to allocate budget for productivity tools. Additionally, other enterprise platforms have given many startups access to users, thanks to their own large user base, which is similar to how Tencent helped so many B2C and C2C startups with WeChat's own user base in the past. Zhu thinks that this development has significantly lowered the barrier between access to users and businesses that are just starting out. 

Furthermore, he believes that China already has the upper hand when it comes to artificial intelligence (AI) and machine learning, thanks to the country's sophisticated big data and AI industries, as well as its possession of highly standardized and centralized data. He is optimistic that this advantage will allow China to surpass the US and become the world leader in AI; the amount of data available and the variety of application environments (AE) allows AI to be applied to more use cases, which other countries are unable to replicate. 

The following passages contain excerpts from Zhu's speech: 

"I am very glad to have this opportunity to share my experience and about Gobi Partners with you all. The enterprise-facing vertical has been our main focus for the past two or three years, and it will continue to be a key industry for us over the next few years as well. Today, I am going to explain why. You've probably seen this story unfolding elsewhere this year: as the VC scene cools down, it is harder now for startups to acquire users and funding. A lot of private equity firms have also readjusted their strategy, including their investment focus. 

First and foremost, it has been predicted that there will be a period of negative growth for the smartphones and vehicles industries within the next 10 years, with the latter being in quite a worrying state at this moment. This development will undoubtedly have an impact on future investment strategies. 

Secondly, the domestic private equity market has also undergone great changes in terms of declining valuations and fundraising amounts. Currently, the IPO market is very lively, but after being listed, many companies' performances, in terms of fundraising size, liquidity, and market cap are relatively poor. There are a million ways to explain this phenomenon, however, what is clear at present is that the popularity of the B2C and C2C business models in the capital market has waned. This is a strong contrast to a few years ago, when companies achieved significant growth after listing. 

Looking at China's current economic environment, what can we, as entrepreneurs, do when the consumer-facing businesses, such as smartphones and cars, suffer from negative growth and reduced support from investors? How do we find the industries with the greatest investment potential? I believe that this has been a very trendy topic for panel discussions recently. I also feel that we should return to the basic principles of economics. We have to look beneath the bubble and get back to the basics of business nature and logic - to enhance the working efficiency of supply and demand. Ultimately, this creates many opportunities in the enterprise applications and Industrial Internet sectors. Firstly, let's look at the current cost of labor. The advantage of one of China's biggest economic drivers in the past does not exist anymore. In the past decade, labor costs have in fact increased by about 4x. Of course, there are other opportunities available, such as opening a milk tea shop. But in reality, not only has the cost gone up for industrial sectors; employee recruitment is also a problem for other industries like original equipment manufacturing (OEM) factories or factories that have poor environmental quality, because employees have more job options than before. 

I would say that this phenomenon is coupled with the fact that the economy itself is in the process of deleveraging, which in turn is causing this unfavorable funding situation; companies are therefore focusing more on improving efficiency, which helps to keep operational costs down. The emergence of new B2C and C2C use cases are also driving the transformation of IT and infrastructure for small and medium enterprises (SMEs). 

The best example of this is the increasing popularity of cloud computing. 

Currently, China's usage of cloud computing is only 1/8th or 1/10th the amount used by the US. This means that there is a lot of opportunity still available for the sector. Taking data migration as an example, if data is migrated to the cloud, there is no doubt that this would increase the efficiency price-performance ratio, even when it comes to B2C or C2C use cases. 

The company that is paying attention to this development is Tencent. A typical consumer-facing company, they are also constantly improving their applications and products for businesses, and enriching their cloud computing products. As such, I truly believe that China's cloud computing market is booming, with opportunities available for software-as-a-service (SaaS), platform-as-a-service (PaaS), and infrastructure-as-a-service (IaaS). The current popularity of open source technology in China is very similar to the situation in the US six or seven years ago. In my opinion, China has the upper hand when it comes to AI and machine learning, thanks to the country's sophisticated big data and AI technology, as well as its ownership of highly standardized and centralized data. I also believe that this advantage will allow China to surpass the US to become the world leader in AI, because of the amount of available data and the variety of application environments (AE), which allows AI to be applied to more use cases; this is something which other countries have been unable to replicate thus far. 

In addition, other enterprise collaboration platforms have provided startups with access to users, thanks to their large user bases, similar to how Tencent has enabled so many B2C and C2C startups with WeChat's user base in the past. This has significantly lowered the threshold for access to users, and to starting a business, which is very good news. In fact, foreign companies have already been distributing enterprise applications via several distribution channels to employees; China has been focusing on consumer-facing businesses all this while, so the infrastructure is not as developed as the US. However, I think that the time is ripe now, after so many years of progress. 

We have been looking into the enterprise application space for the past three or four years, from consumer-facing apps to PaaS and IaaS. From an entrepreneur's perspective, of course [the] SaaS [business model] is easier to develop (which is why there are more of them), but as business-critical applications, PaaS and IaaS business models also have a huge opportunity to grow. When evaluating the business models of these startups, we (Gobi) will prioritize the most business-critical applications - those that have inelastic demand such as CRM and ERP. Due to the recent rise in costs however, more companies are also now willing to allocate a budget for spending on productivity tools for communications, copywriting, and even editing. This trend is not only happening in China, but across Asia as well. Most companies would not edit their documents in DingTalk, so there is a real demand here [by enterprises]. 

Not only do you need inelastic demand and core competencies, you should also have a better understanding of the specific industry and how the chosen system would be deployed. 

Things get more complicated when you are dealing with different enterprises. For example: terminal management systems used by an energy company would be different than the one used by an automobile company; a pharmaceutical company and a transportation company would have different requirements for productivity tools. Therefore, VCs, like startups, need to have significant knowledge of their targeted sectors and how they operate. If not, you will face trouble understanding the lingo of different industries. 

We also look at how compatible a startup is with the [Internet] giants, such as whether they can benefit from the user bases of DingTalk or WeChat. If they can benefit from leveraging on these platforms, I believe that this is a very big plus point, especially for SaaS startups. 

In the future, we will continue to focus on and deep dive into several industries: 

First of all, I firmly believe the Industrial Internet still has value. Everyone has been talking about the Internet Plus sector, but I think of it more as the "Plus Internet" (i.e. bringing businesses online), which emphasizes every industry's own attributes. For the automobile industry for example, our colleague from Singulato shared that the vehicle manufacturing process demands a high volume of Internet of things (IoT) technology; the requirements for informationization in manufacturing is particularly high as well. If you are serving a business-facing company, there is a need to have a deep understanding of that specific industry, otherwise you would not understand what the users need. As a general-purpose company, I want to satisfy my company's needs so that my products will be used by more users. 

Secondly, AI will play a bigger role in business operations. As I've mentioned earlier, there is a lot of data in China, and with the migration of this data to the cloud, the concentration and learnability of this information has actually increased. With improved algorithms, the products being created have become more specific, and the knowledge learned can be replicated throughout the different processes in an organization easily. Therefore, if companies can use machine learning and AI to develop new products, it will open up countless opportunities in this industry. 

Thirdly, products and services must be deeply integrated. If you look at the US, IT companies are still hiring customer service staff. This is because customer service becomes even more crucial as their customer base becomes larger. Companies should even serve their clients as though they are "dummies." A lot of a company's products have their own complexities, so if a product does not have a customer service contact, a problem would be created, even in the US. In China, this fact is especially true, given that the IT development of many companies is not at optimum status. Because there is a lack of IT staff in most companies, there is less expertise available to configure a product - even routers require an IT engineer to configure them. I believe that this issue happens a lot in this industry. Take Industrial Internet users, for example. Hardware may not be a main part of its business, because its business model is based on data, but this would be like a hero with no way to display his prowess if he doesn't know how to "wield his sword". Consequently, in some industries, it is necessary to provide IT customer service, and I think it would be more suitable in China's context. 

Today, I have shared with you some of our learnings in the enterprise applications vertical, and I hope it will help you on your entrepreneurial journey or your investment decisions. 

Thank you."