Founder's Mentality Blog

Incentives vs. Insights: Responding to Turbulence in China

Chinese insurgents are shaking up their strategies, operations and reward systems. Are their multinational competitors prepared to do the same?

Par James Allen

First published on mars 27, 2015
min


We just finished a Founder’s Mentality 100 (FM100) session in Shanghai, where we had a full day with some of China’s leading founders. Turbulence remains a constant theme, but the source of turbulence is evolving. In our 2014 sessions, turbulence almost always meant “digital” as Chinese founders worked feverishly to move their businesses online. This year founders are defining turbulence more broadly—it includes not simply the online challenge, but also the need to respond to a fundamental softening of China’s growth outlook and the need to create a new value proposition for their employees. What really struck me in these meetings was that founders are far less focused on “the answer” and far more intent on changing incentive structures so the new generation would be motivated to find the answer. As one founder put it: “I have built my business to thrive in today’s China. But I won’t be the one to figure out the new business model for tomorrow’s China. The answer will come from the new generation. My job is to liberate them, empower them and reward them to come up with new answers.” While we see some danger in this (see below), it is yet another reminder of how insurgents thrive in turbulence relative to incumbents. Chinese insurgents are responding aggressively by shaking up their strategies, operations and reward systems. Are their multinational competitors prepared to do the same? There is no question there’s plenty to respond to. The Chinese market is changing rapidly and the march of digital continues in 2015. Here are a few fun facts: According to a 2014 Bain & Company analysis, China became the largest e-commerce market in 2013 and should continue to grow According to China has overtaken the US in express parcel services, shipping 14 billion packets in 2014, a 52% increase over 2013. The volume is largely attributable to the explosion in e-commerce purchases. Tencent beat Alibaba in a major “battle of the apps” when Chinese consumers used the site to send more than 1 billion (yes, billion) “red envelope” gifts to friends and family to celebrate the Chinese New Year on February 18. It is a tradition during the lunar holiday to give red envelopes stuffed with cash to friends and family. But in the digital age, the tradition is rapidly shifting online. Learn more About the Founder's Mentality The three elements of the Founder's Mentality help companies sustain performance while avoiding the inevitable crises of growth. Chinese entrepreneurs are also dealing with a new problem—a continued slowdown in projected GDP growth rates. While still the envy of most global markets, the Chinese economy has slowed fundamentally, and every meeting in Shanghai seems to start with the latest “bad news.” The most recent government forecast is for 7% annual growth and steady rates of more than 9% over the decade before 2012. Yet according to the Bain analysis, online retail is expected to grow at 25% in coming years, or three times the overall rate, which is slowing. Looked at another way, e-commerce companies are taking share from brick-and-mortar rivals even though those companies are still in the early days of building out their national footprint. Surprisingly, however, the main discussion at our FM100 meeting was not about the search for the latest e-commerce insights or the best examples of companies that have responded to the digital threat. The founders were not discussing “insights” at all. Their focus was incentives. As we’ve said, more and more Chinese founders appear to be counting on the next generation to respond to this growing turbulence and are building compensation systems to motivate them. Like most founder-led companies, the firms represented at our meeting were built on the sweat of the first generation. These people were rewarded spectacularly with equity, but as the leadership teams look for ways to similarly motivate the next generation, they find themselves constrained: There is neither the same level of equity to distribute nor the same promise of equity appreciation. The need for heroic action hasn’t changed, but the rewards available to the next generation of “heroes” have changed fundamentally. And while this is a big problem, it is hardly unique. Just walk into any breakfast spot in Palo Alto and you’ll hear plenty of grousing around the same subject. The difference is that many Chinese entrepreneurs are facing this problem at a time of extreme market turbulence, causing many to obsess about “reenergizing their teams” so they will adapt their way to the right answer. It is hard to imagine a better reflection of the themes raised in these blogs—creating the right culture for entrepreneurship and thriving in turbulence are far more important than imposing a “right answer” on a tired organization. While the Chinese entrepreneurs we met with tended to share the same view of the problem—it’s the lack of incentives, stupid!—they differed wildly on the solutions. One founder has decided to form a new company to compete directly against his old company. He’s given up on core innovation within the main businesses because he believes that team thinks too much like an incumbent. By starting a rival company with an entrepreneurial culture—and a new equity base to share—he hopes it will a) shake up the original company and b) transfer lessons back to the mother ship. Another entrepreneur is looking at turning his main business into a single “business unit” and transforming his “corporate center” into a private equity-style investment vehicle that can invest in additional start-up ideas generated by the current business. Each new business idea would be treated initially as a separate venture, with additional third-party investors and a start-up team with equity. There were as many potential new models as there were founders. The point is they were all looking for ways to radically shake up the culture of their companies to respond to the new threat. This is sobering. Last year, I observed that founder-led companies in China were already rapidly adapting their strategy and operations to respond to the threats and opportunities presented by digital, even while they were still scaling their brick-and-mortar business nationally. They were, in other words, changing the airplane’s engine while still taking off. This year, they are going much further, recognizing they need to shake up the culture and incentive structure of their businesses to create the energy necessary to thrive in turbulence. To extend the metaphor, they are still trying to take off but they are changing engines and training new pilots at the same time. I’m not sure I’d have the guts to be on that plane, but all these founders seem very comfortable with what promises to be a white-knuckle ride. Still, there are clear dangers. One of them is that these Chinese entrepreneurs will get so focused on the new equity game that they lose track of what they are actually doing in the market to respond to industry turbulence. Yes, incentives matter, but so do insights. As any venture capitalist will tell you, there are thousands of case studies of failed management teams who had all the equity incentives in the world, but also had the wrong answer to the market problem. Another danger is that the focus on rewards will dim the light on recruiting the right people. It is risky to assume that all potential second-generation leaders have the same “fire in the belly” or passion to take the business to the next level. Throwing more incentives at the wrong team will not help. These founders succeeded spectacularly because they had the right strategy and people. For lightning to strike again, they need the right strategy and team to thrive in the digital world. Incentives are not the be-all and end-all. That said, multinationals competing in China should take notice here. Their local competitors are rapidly adapting to turbulence both strategically and organizationally. They are willing to dismantle themselves to rebuild a culture with the necessary energy for the battles ahead, and it’s not clear to me the multinationals are preparing themselves with anything like the same sense of purpose. It is the difference between a founder-led company having to live or die in China and a large incumbent managing dozens of skirmishes around the globe. I’d put my money on the ones that are betting it all.

We just finished a Founder’s Mentality 100 (FM100) session in Shanghai, where we had a full day with some of China’s leading founders. Turbulence remains a constant theme, but the source of turbulence is evolving. In our 2014 sessions, turbulence almost always meant “digital” as Chinese founders worked feverishly to move their businesses online. This year founders are defining turbulence more broadly—it includes not simply the online challenge, but also the need to respond to a fundamental softening of China’s growth outlook and the need to create a new value proposition for their employees.

What really struck me in these meetings was that founders are far less focused on “the answer” and far more intent on changing incentive structures so the new generation would be motivated to find the answer. As one founder put it: “I have built my business to thrive in today’s China. But I won’t be the one to figure out the new business model for tomorrow’s China. The answer will come from the new generation. My job is to liberate them, empower them and reward them to come up with new answers.”

While we see some danger in this (see below), it is yet another reminder of how insurgents thrive in turbulence relative to incumbents. Chinese insurgents are responding aggressively by shaking up their strategies, operations and reward systems. Are their multinational competitors prepared to do the same?

There is no question there’s plenty to respond to. The Chinese market is changing rapidly and the march of digital continues in 2015. Here are a few fun facts:

According to a 2014 Bain & Company analysis, China became the largest e-commerce market in 2013 and should continue to grow
According to China has overtaken the US in express parcel services, shipping 14 billion packets in 2014, a 52% increase over 2013. The volume is largely attributable to the explosion in e-commerce purchases.
Tencent beat Alibaba in a major “battle of the apps” when Chinese consumers used the site to send more than 1 billion (yes, billion) “red envelope” gifts to friends and family to celebrate the Chinese New Year on February 18. It is a tradition during the lunar holiday to give red envelopes stuffed with cash to friends and family. But in the digital age, the tradition is rapidly shifting online.

Learn more

About the Founder's Mentality

The three elements of the Founder's Mentality help companies sustain performance while avoiding the inevitable crises of growth.

Chinese entrepreneurs are also dealing with a new problem—a continued slowdown in projected GDP growth rates. While still the envy of most global markets, the Chinese economy has slowed fundamentally, and every meeting in Shanghai seems to start with the latest “bad news.” The most recent government forecast is for 7% annual growth and steady rates of more than 9% over the decade before 2012. Yet according to the Bain analysis, online retail is expected to grow at 25% in coming years, or three times the overall rate, which is slowing. Looked at another way, e-commerce companies are taking share from brick-and-mortar rivals even though those companies are still in the early days of building out their national footprint.

Surprisingly, however, the main discussion at our FM100 meeting was not about the search for the latest e-commerce insights or the best examples of companies that have responded to the digital threat. The founders were not discussing “insights” at all. Their focus was incentives. As we’ve said, more and more Chinese founders appear to be counting on the next generation to respond to this growing turbulence and are building compensation systems to motivate them.

Like most founder-led companies, the firms represented at our meeting were built on the sweat of the first generation. These people were rewarded spectacularly with equity, but as the leadership teams look for ways to similarly motivate the next generation, they find themselves constrained: There is neither the same level of equity to distribute nor the same promise of equity appreciation. The need for heroic action hasn’t changed, but the rewards available to the next generation of “heroes” have changed fundamentally. And while this is a big problem, it is hardly unique. Just walk into any breakfast spot in Palo Alto and you’ll hear plenty of grousing around the same subject.

The difference is that many Chinese entrepreneurs are facing this problem at a time of extreme market turbulence, causing many to obsess about “reenergizing their teams” so they will adapt their way to the right answer. It is hard to imagine a better reflection of the themes raised in these blogs—creating the right culture for entrepreneurship and thriving in turbulence are far more important than imposing a “right answer” on a tired organization.

While the Chinese entrepreneurs we met with tended to share the same view of the problem—it’s the lack of incentives, stupid!—they differed wildly on the solutions. One founder has decided to form a new company to compete directly against his old company. He’s given up on core innovation within the main businesses because he believes that team thinks too much like an incumbent. By starting a rival company with an entrepreneurial culture—and a new equity base to share—he hopes it will a) shake up the original company and b) transfer lessons back to the mother ship. Another entrepreneur is looking at turning his main business into a single “business unit” and transforming his “corporate center” into a private equity-style investment vehicle that can invest in additional start-up ideas generated by the current business. Each new business idea would be treated initially as a separate venture, with additional third-party investors and a start-up team with equity. There were as many potential new models as there were founders. The point is they were all looking for ways to radically shake up the culture of their companies to respond to the new threat.

This is sobering. Last year, I observed that founder-led companies in China were already rapidly adapting their strategy and operations to respond to the threats and opportunities presented by digital, even while they were still scaling their brick-and-mortar business nationally. They were, in other words, changing the airplane’s engine while still taking off. This year, they are going much further, recognizing they need to shake up the culture and incentive structure of their businesses to create the energy necessary to thrive in turbulence. To extend the metaphor, they are still trying to take off but they are changing engines and training new pilots at the same time. I’m not sure I’d have the guts to be on that plane, but all these founders seem very comfortable with what promises to be a white-knuckle ride.

Still, there are clear dangers. One of them is that these Chinese entrepreneurs will get so focused on the new equity game that they lose track of what they are actually doing in the market to respond to industry turbulence. Yes, incentives matter, but so do insights. As any venture capitalist will tell you, there are thousands of case studies of failed management teams who had all the equity incentives in the world, but also had the wrong answer to the market problem.

Another danger is that the focus on rewards will dim the light on recruiting the right people. It is risky to assume that all potential second-generation leaders have the same “fire in the belly” or passion to take the business to the next level. Throwing more incentives at the wrong team will not help. These founders succeeded spectacularly because they had the right strategy and people. For lightning to strike again, they need the right strategy and team to thrive in the digital world. Incentives are not the be-all and end-all.

That said, multinationals competing in China should take notice here. Their local competitors are rapidly adapting to turbulence both strategically and organizationally. They are willing to dismantle themselves to rebuild a culture with the necessary energy for the battles ahead, and it’s not clear to me the multinationals are preparing themselves with anything like the same sense of purpose. It is the difference between a founder-led company having to live or die in China and a large incumbent managing dozens of skirmishes around the globe. I’d put my money on the ones that are betting it all.