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November 28, 2004

Larger domestic IT market makes China more attractive to VCs

What is the size of the domestic market for IT products? This is one of the first questions that a General Partner at Boston and Silicon Valley based Battery Ventures posed to me, when I introduced myself to him as someone who tracks VC activity in India (at a Silicon Valley Bank event in Bangalore). The question was interesting since the popular assumption is that US VCs are primarily interested in India as a place for their portfolio companies to outsource R&D or other backend work.

Now, there's a new report saying Battery is set to invest $8-12 million in Bangalore-based optical networking technology company, Tejas Networks, most of whose customers are Indian telecom companies. Not surprising. Since telecom is indeed one sector where the Indian domestic market is large, fast growing and cutting-edge in terms of technology adoption to be very attractive to international product companies. And VCs.

Larry Cheng, an investment professonal with Battery, explains why "Huge Domestic IT Markets" is the "Reason #1" why US VCs are making a beeline for China, in a recent article for Pacific Epoch:
To appreciate China, you can’t compare it to other international investment hot spots like Israel or even India, just yet. The reason is simply that the vast size and breadth of China’s domestic market stands well above these other markets. China is one of the few countries that can support multiple billion dollar companies across several different segments of technology on the basis of its domestic market alone. The big win for many Chinese IT companies never has to entail it expanding beyond its borders. Let’s take a simple example like the semiconductor component market. Chinese companies in 2003 spent anywhere from $15B-$18B in semiconductor components. This is built ground up with local companies like Huawei and others spending $500M+ on components each. This overall number is expected to grow to $50B in the next several years. But, that isn’t even the most compelling fact which is that in 2003, ~90% of the spending was on imported components. It is anticipated that a bulk of the market spend will migrate to domestic manufacturers as capacity comes online through companies like SMIC and others. That means the import replacement market alone could grow to be tens of billions in a few short years in China. That’s a huge market. Same goes for the 350M fixed line subscribers, 350M wireless subscribers, 200M online gamers and the list goes on. Already, half of the top 25 most visited websites in the world are Chinese websites. These are all rational market numbers and form a valid reason to be enthusiastic.

Later in the article, Cheng explains how Chinese companies proceed from (doing import replacements) to becoming global IT names:
They first defeat import vendors to win the import replacement market. Then they fight and win among brutal domestic competition to maintain their leadership in China. And, once they beat domestic competition in a price sensitive market like China, they have a very strong position and cost structure to win globally. As one proud Chinese woman said at a conference, “If you can sell to smart, but poor Chinese, you can sell to the rich, dumb Americans.” This dynamic will play out in other IT markets.