Executive summary
Internet services are an underrated part of the US-China decoupling narrative; to date, the tech-related portion of that conversation has largely focused on hardware supply chains.
Operating on their own technology “island”, Chinese internet companies have grown into formidable players in a vast domestic market with unique characteristics.
In the past, Chinese companies often followed US innovation (at times explicitly) and may as a result be underrated as a source of disruption and a competitive threat in global markets.
As Chinese innovation accelerates further, American companies would do well to build capabilities to monitor and mimic product developments themselves.
The Great Decoupling: Decoupled and “non-coupled” tech markets
PRISM’s View: Hardware is the area most affected by efforts in Washington and Beijing to disentangle their tech markets; however, it is in internet services where the largest threat to American technology dominance lies.
Decoupling is continuing: Tense geopolitical competition between the world’s two largest economies started during the Trump Administration and has continued under President Joe Biden. As a result, US-China “decoupling” has become a major talking point for governments and corporations around the world. The technology sector is at the heart of the decoupling story as both the US and China look to gain an advantage in areas driving future economic prowess and national strategic interest like AI, quantum computing, critical infrastructure, cybersecurity, and supply chain security.
Much is being written about the decoupling trend, laying out the geopolitical backdrop and macro implications. We would recommend the following deep dives as illustrative and illuminating reading:
“Understanding US-China Decoupling: Macro Trends and Industry Impacts” by the US Chamber of Commerce
“US Decoupling from China and the Onshoring of Critical Supply Chains: Implications for Private Sector Businesses” from WilmerHale
“The Great Decoupling” by Keith Johnson and Robbie Gramerin in Foreign Policy
The risk to internet platforms is missing from the narrative: From a technology sector perspective, the interdependencies are clearest in hardware, where manufacturing supply chains have become highly integrated in recent decades. This is the focus of most of the analysis linked above, as well as the primary one of governments (e.g., through domestic chip manufacturing investments) and companies (e.g., through supply chain reshoring, nearshoring, and resiliency efforts) today.
In the internet services arena, however, there is less attention, but perhaps higher risk. The lack of attention is largely because this part of the technology sector was always decoupled – or at least since Google’s decision to cease operating in China in 2010. Whereas in hardware supply chains, there is interdependency between China and the US (i.e., China still to some extent relies on America’s advanced technology capabilities), in internet services, China’s ecosystem is evolving independently. There are numerous reasons why this independent evolution could soon materially threaten the position of US platforms in markets around the world.
For US internet services, the only way is down: To date, the risk for US tech companies has been hidden from view since the rapidly evolving Chinese internet services ecosystem has largely failed to expand beyond China’s borders.
With US tech companies in a dominant position in most countries around the world, the only way is down as competition intensifies. As demonstrated by the rise of TikTok, the potential for Chinese companies to compete doesn’t just exist in China’s close allies; it extends around the world and even into the US market. Beyond this example, the hypothesis that China could present strong internet services competition remains largely untested. However, given the importance of internet services to US technology leadership on the global stage, it should be considered perhaps the largest latent threat to American platforms.
A rapid shift from innovation follower to innovation leader
PRISM view: There is evidence that Chinese innovation is already starting to lead the US in internet services. There are many reasons to think this will continue or accelerate.
Chinese internet services innovation is starting to lead: Yes, Silicon Valley, or the US more broadly, is still the leader in tech innovation, with 487 unicorns created through 2021. However, China is getting closer – the country had produced 254 unicorns by the end of 2021. Some of these unicorns were Chinese versions of US services that arose years after the initial US innovation, and sometimes intentionally borrowed Western platforms’ ideas. However, the trend of Chinese services following US innovations is becoming more balanced and may even have started to reverse.
The most familiar example of Chinese innovation leadership in the US is Instagram using TikTok as the basis for its Reels format. Looking at China today, there are many other examples of innovations that have similar potential to lead the US market. For foreigners arriving in China, the most obvious case would be in the payments space. Payments in China have now moved completely online with cash and credit cards being almost entirely ditched in the process. This ecosystem is an enabler of another conspicuous example of China’s “alternate universe” in consumer tech: its “super apps” – principally WeChat and Alipay. Super apps, which can be thought of as an umbrella platform that houses many mini-programs, enable users to go about all their online and online-to-offline activities in one place. In the US, these services might span a dozen standalone apps, whereas in China, it is common for platforms to have a high degree of interoperability with WeChat and Alipay to allow users to efficiently manage their online activities.
The more consolidated app market provides advantages for users, as well as the opportunity for companies to develop innovative complementary services. Dazhong Dianping, China’s equivalent to Yelp, allows users to not only access reviews but to make reservations, order food, and hail rides. Dianping also covers beauty salons, movie theaters, hotels, and general places of interest and provides a service for discounts. TMall, the popular e-commerce subsidiary of Alibaba, is another example. TMall 2.0, which launched in 2019, offers a personally customized shopping experience for each consumer, including new augmented reality-based services and other interactive features that let users tailor and test products to their liking before purchase.
China will innovate even faster: The rate of innovation in China will likely only accelerate from here, driving increased urgency for American internet companies to monitor trends there with greater intentionality. PRISM highlights six factors that could lead to an acceleration in ways that could outpace the US:
Shielded but competitive market: China’s internet service platforms are largely shielded from outside competition. However, the lack of innovation that often comes from protection might not be a relevant consideration here, as Chinese tech platforms have not suffered from a lack of competition overall. The domestic market houses formidable competitors that force constant innovation.
Data: Chinese tech firms benefit from a massive supply of data. With the world’s largest population, China has surpassed the US as the leading producer of data. The data advantage is enhanced further by China’s super app configuration. Firms can collect more (and higher quality) data from each user than the top companies in the US can do, even though top American tech firms have the most aggregate users. An edge in data supply tilts the innovation scales, as it enables firms to improve the accuracy of the algorithms central to producing unique user-oriented services.
Culture - startups: China’s growth in technological innovation is in part a result of the feverish “996” (referring to work hours between 9 am and 9 pm, 6 days a week) work culture that characterizes the Chinese tech sector. Succinctly put by tech veteran and author Dr. Kai-Fu Lee: “Silicon Valley looks downright sluggish compared to its competitor across the Pacific.”
Culture – market: While Western populations become increasingly skeptical of the influence of tech companies, China maintains a broadly tech-optimistic culture. To some extent, this trend is illustrated by the ubiquity of mobile payments in China, a de facto requirement at point-of-sales. Credit and debit cards were never prevalent in China like they are in the US. Instead, China leapfrogged into mobile payments directly. Around 2015, firms like Tencent and Alibaba began introducing the ability to make payments by scanning a QR code. Today, it is impossible to live in China without WeChat Pay or Alipay. Everyone is online. It is how goods are purchased, businesses make deals, bills are paid, and peer-to-peer transactions are executed.
Policy: The ability of Chinese startups to lead the way in innovation is impacted by the give and pull in its domestic policy environment. Competing forces between industrial policies that support industry and the regulatory approaches that constrain it will play a critical role in differentiating China from the US. A multitude of long-term directives (e.g., Made in China 2025, Internet+ Action Plan, National IC Plan, AI Development Plan, etc.) lay the groundwork for an all-of-state approach to technological innovation. Tech entrepreneurs are showered with subsidies, and local governments use incentives to attract and support entrepreneurship in their jurisdictions. On the other hand, the forced placement of government representatives on the board of Alipay, the blocking of DiDi to go public on the New York Stock Exchange, and the exit of high-profile tech CEOs to avoid scrutiny are all examples of direct government intervention that may well dampen the success of the sector. US firms do not benefit from direct subsidies in the same way, but on the other hand operate with much less political interference, even though they may see increased regulation.
Global trends: As China’s influence abroad grows, the ability of its companies to expand services into new markets will also grow. Payments are again a leading indicator -- WeChat and AliPay have followed Chinese tourists overseas as a convenient mode of payment, thereby setting a foundation for broader adoption of Chinese tech platforms in third markets. Russia’s invasion of Ukraine also shows how global forces can sharply accelerate this trend. Western tech has either pulled out or been shut out by Roskomnadzor, Russia’s internet regulator. Countries either picking sides in a bifurcated world or trying to navigate a path between Western and Chinese ecosystems could easily look to shift toward a balance of technology platforms. As noted at the start of this paper, the level of dominance of American platforms today means any semblance of balance would be a major loss of market share for US firms.
Needed new capabilities for American tech
PRISM’s view: Today’s parallel tech universes might quickly evolve into an era of Chinese innovation leadership. US firms would benefit from developing capabilities to monitor and rapidly mimic Chinese innovation.
Chinese tech development began in earnest by taking inspiration and learning from the West. This “copying” phase is well and truly over. Today’s parallel internet services may not endure for long. For the reasons outlined above, they may quickly shift into an era in which Chinese innovation leads the US. This could happen at the same time China’s internet services companies begin to focus on international markets in a major way.
The worst-case scenario for American tech is more spectacular global adoption curves, like the case of Instagram Reels and TikTok. In this case, Instagram’s product response only came about as damage control after TikTok succeeded globally and directly threatened then Facebook and other social media players, rather than as an intentional strategy of monitoring innovations occurring in China and acting early.
The monitoring required to avoid this kind of impact from occurring again is extensive. Chinese services are making more and more forays into fast-growing emerging markets in ways that are hard to track but create a genuine threat to US platform market share in these countries but also eventually in the largest economic centers as well. Disruption theory stipulates that competition often targets lower value segments (e.g., emerging markets) to refine an offering before expanding into the incumbents’ territory (e.g., US or Europe), after which it is often too late for the incumbent to catch up in innovation.
If China is to outpace the US in innovation, even for just a short period of time, the next disruption likely won’t occur in the US and likely won’t create as clear and immediate impact as was the case with TikTok. As such, it likely won’t provide as much scope to respond with a product like Reels. To stay ahead, US tech firms would do well to develop the monitoring and mimicking capabilities that China has excelled at for the last two decades.
Authored by: Alex Kaplan