China eyes 'creative' industries in IP push

As China reaches beyond its reputation as a destination for low-tech, ultralow-cost manufacturing, assembly and design, the country is getting creative. The turning tide of strategic industrial development in China has brought a surge of government support for innovation and an influx of investment from the West.

And in a sea change, the activity is focused on the market potential at the top of the food chain — what one industry watcher called the "creative, high-value intellectual-property industries."

The recent announcement by Intel Corp.'s China Technology Fund of its first venture capital placements in the country hint at this shift upward in venture funding for technological innovation.

Indeed, the flow of funds from VC firms as well as top Silicon Valley companies is reaching promising startups across China. Against that backdrop of offshore interest, China's national and regional development agencies are accelerating their own efforts to promote homegrown up-market innovation and development in consumer electronics, digital media and the related creative industries — video games, animation, advanced computer graphics and multimedia communications.

Next week, the municipality of Beijing and the Zhongguancun Technology Zone will host The China International Creative Industry Forum, a high-profile conference focused on building bridges between China's growing digital-content industries-especially electronic gaming and animation-and the outside world. China's Ministry of Science and Technology, the national Ministry of Education and the People's Government of Beijing are sponsoring the summit. Analysts expect China to become a proving ground for breakthroughs in such areas as networking equipment and wireless Web services, with attendant implications for the global standards process and the deployment of new hardware, software and services.

Certainly, the sheer size of the potential market is a driver. China is home to 350 million cell phone subscribers, with the total expected to reach 600 million in four years. In only two years, meanwhile, China's base of Internet connections is expected to surpass the size of its U.S. counterpart. Those two factors are expected to intensify the country's demand for the most advanced telecom, digital-media and mobile-media features.

"We will see China in a few years going from being a follower to being a leader in defining consumer electronics trends," Philips Semiconductors executive vice president Leon Husson said in a recently published interview.

"China's recognition of the importance of the creative industries to industrial development is strategic," said Etan J. Ayalon, managing director of technology tracker GlobalTech Research LLC (New York). "The government's interest in this aspect of technology development goes well beyond just fostering growth of a domestic game-development industry. Its creative-industries emphasis cuts across all creative, high-value intellectual-property industries-not just movie production, animation, software and semiconductor design, but also biotech, nanotech, alternative energy [fuel cells] and other technology areas."

Ayalon called the effort "part of a worldwide trend," adding that "technology development is proliferating and decentralizing" around the globe and that "companies, regions and nations are trying to move up the IP value chain, recognizing that much more value comes from IP creation than from incremental improvements in efficiency, distribution, etc."

Beijing is targeting commercial development within its domestic digital-entertainment, digital-media and creative-industry segments. Beijing is encouraging both foreign investment and industry partnerships in technology-dominated up-market industries, especially computer games, as a means of establishing China-based competencies.

"The Chinese understand that videogaming and virtual technologies are more than entertainment; they are enabling technologies that can benefit education, training, collaboration and other activities," Ayalon said. "South Korea [understands this] as well; it even offers military deferments for those working in the gaming industry," the growth of which is viewed as "a national imperative."

According to Ayalon, Gamedaily.com has reported that the Chinese government plans to invest $1.8 billion to develop approximately 100 varieties of online PC games over the next five years. The drive to move tech development up-market in China has also yielded a government-backed standards push aimed at securing the country a place among the world's most powerful technology standards setters for IT, telecommunications and consumer electronics. A joint U.S.-China ICT Standards seminar, held last week in the city of Chengdu, covered a wide range of standards-related issues, including the contentious topic of IP development and licensing.

But despite its wealth of engineering and scientific talent and its deep pool of low-cost labor, China faces hurdles. As the country's leadership realizes, most of the intellectual property and specialized technologies-and know-how-needed to build an industrial base and domestic infrastructure in the creative industries lie on the other side of the Great Wall, in places like the United States, South Korea, Singapore, Japan and Western Europe.

China thus is faced with creating a complex, global ecosystem to support its increasingly knowledge-driven economy. That spells huge opportunities, and challenges, for semiconductor, electronics, IT, communications, consumer electronics, media, content and IP companies around the world. And it is certain to influence the balance of market power and economies of scale in all of those industries.

Recent VC fund formations and investments in China help tell the tale. According to the National Venture Capital Association, the total number of U.S. venture capital deals in China last year reached its highest level in 10 years, exceeding $557 million; total deals, including those involving non-U.S. VCs, reached $1.27 billion.

Intel Capital recently disclosed that it had made three investments in Chinese companies from its $200 million Intel Capital China Technology Fund. While two targeted emerging semiconductor businesses, the third involves Onewave Technologies Inc., a Shanghai-based provider of broadband entertainment technology solutions that fits the profile of targeted digital-media investment opportunities. Onewave makes end-to-end solutions for network operators in the exploding Internet Protocol TV, streaming-media, video-on-demand and time-shifted-TV sectors.

Indeed, Internet and digital media are on a fast ramp in China, which has more than 100 million Internet users, about 71 percent of whom are less than 30 years old. In recent interviews following its first VC placements, Intel Capital's president, Arvind Sodhani, was unequivocal about China's enormous potential. "China is a force for technology innovation in the worldwide marketplace," he said.

Intel's $200 million China fund is the tip of the iceberg. In the first seven months of 2005, foreign direct investment in China reached $33.2 billion, according to the country's commerce ministry. A recent addition to that large and growing pool is Accel Partners, which last month announced the formation of a $250 million China Growth Fund with IDG Technology Venture Investment. The fund is focused primarily on IT and consumer technologies.

Grass-roots movement

"What's really more interesting and significant than Intel's recent China investments is the grass-roots investing that's starting to happen with other U.S. based VCs," observed Paul Krasinski, CEO and founder of Lion Strategy Advisors, a New York-based investment group. "China is driving hard to be the next Silicon Valley."

Krasinski offered a caveat to those who would invest in China, saying it remains to be seen whether VC investors from the United States and elsewhere "are going to get to see the best deals-if the [Chinese] government is going to allow that. There's a tendency to protect your own."