Removing China’s “Startup Debt”

I’ve been struggling to come up with an elegant analogy to explain China’s regulatory crackdown on its tech industry. After observing this year’s Singles Day, I think I finally found it.

Everything that’s been happening in China Tech this year can be understood and analogized to a common practice that occurs periodically inside every successful tech company: removing startup debt.

How Does “Removing Startup Debt” Work?

Every startup accumulates a lot of “debt” during the initial years of its creation and growth. The original engineering team may have chosen the wrong stack or programming language to scale the product. The company might’ve selected the wrong HR and benefits provider that did not offer good enough health benefits to retain employees over time. The founding CEO may have hired the wrong early exec to build its go-to-market team. These are all real examples of “startup debt”, which can be technical, administrative, or organizational. They should all sound familiar to anyone who has started a tech company or worked in one.

Startups create these “debts” repeatedly, not because they are dumb, but because trying to do every aspect of company-building perfectly the first time is the wrong priority, when you don’t even know if your startup idea will work yet. Thus, moving fast, shipping features, testing out hypotheses, and running experiments is the right approach when starting something new, even though accumulating “debt” is the inevitable consequence and tradeoff.

It usually takes a tech startup 8-10 years to reach a stage of maturity where “removing startup debt” is even warranted. Most startups don't survive for that long; it’s a somewhat rarefied state to be in. When a startup gets to this stage, more experienced leaders usually get brought in, code review becomes more stringent, more investment is spent on improving infrastructure and testing capabilities, and more compliance measures get implemented across all functions. Basically, more of all the boring but essential things to “grow up”.

The most high-profile startup debt removal is Facebook (or Meta)’s transition from the controversial “Move Fast and Break Things” ethos to the decidedly more boring “Move Fast with Stable Infra”. This transition happened in 2014, exactly 10 years after Facebook's founding.

What does “removing startup debt” have to do with China’s tech crackdown? Everything!

Removing 40 Years of “Startup Debt”

When “opening and reform” began in 1978, that moment marked the beginning of China, the startup. The subsequent years of experimentation -- attracting foreign direct investment, trying out capitalism in a fishing village called Shenzhen -- was not unlike the initial years of any Silicon Valley tech startup. Deng Xiaoping was effectively a startup founder, searching for the elusive product market fit. Except the prototype was a poor country with close to 1 billion people at the time in a world market that did not understand it (and some would argue still don’t).

Fast forward 43 years later, it’s safe to say that China found its product market fit, has grown by leaps and bounds, but also accumulated a ton of “startup debt”.

Some of this debt is literally just debt (like Evergrande). Some of this debt is technical debt (like the new data governance, data privacy, and various cybersecurity rules). Some of this debt is regulatory debt (like antitrust, fintech reform, and possible change to corporate structures like VIE). Some of this debt is cultural debt (like outlawing for-profit after-school tutoring and limiting minors’ videogame playing time). Similar to a 10-year-old startup, these are all the boring but essential things to “grow up”, just implemented in the largest economy in the world (at least in GDP PPP terms).

All of these debts need to be cleaned up sooner or later, so the fact that this cleaning happened earlier this year should not be surprising. What is more surprise-worthy is the speed in which they all happened in a short period of time, under the new CEO of China Inc., Xi Jinping, who is more powerful than Deng was. (Deng had to govern mostly by consensus during his tenure and his title within the Party was never higher than “Vice Chairman”.)

There are two tricky things about removing startup debt, whether it’s a company or a country.

First, it always takes longer than you think it does. Using Facebook as our example, it’s been seven years since “Move Fast with Stable Infra”, and Instagram was down just earlier this month.

Second, while removing your startup debt, growth can’t stop! You can’t stop shipping features and improving your products or your competition will surpass you. You just have to ship a little slower than before with more code review, more testing, and more compliance. While cleaning up its infra debt (and many other forms of societal debt), Facebook is still reinventing itself by becoming Meta.

While it’s impossible (and intellectually irresponsible) to analogize Facebook to China, we can map a few concepts and experiences. Facebook is seven years into its debt removal journey and counting. We can safely assume that China, a 40-plus-year-old startup and a more complex organism, will take much longer to clean up its own startup debts. Since 2014, Facebook’s valuation and stock price has also grown at a healthy clip -- almost 6x. So we can also safely assume that China will keep growing for decades to come. Achieving this balance between removing debt and continuing growth is now the difficult terrain that China is about to face.

And that brings us to this year’s Singles Day and Alibaba.

New Singles Day, New China

The prevailing Western narrative of this year’s Singles Day is that it was a subdued, almost sad, affair. Nevertheless, the event generated an all-time high in GMV of $84.5 billion USD for Alibaba -- a 8.5% growth from last year.

Many Westerners are still discovering Singles Day. It is often used by foreign investors and analysts as a barometer to China’s consumer confidence. But it is really old news in China at this point; it’s been around as an online shopping holiday since 2009. Last year, Alibaba reframed the topline GMV number from a one-day sale to an 11-day shopping period starting from November 1st to 11th -- a clever PR trick. GMV itself is a notorious noisy and somewhat useless metric, when you account for return rate, margins after discount, etc. Singles Day has basically outlived its usefulness as a barometer.

But it can still be useful when viewed in the context of Alibaba as a whole, as Jack Ma’s creation navigates a “New China” focused on removing the country’s “startup debt” -- a lot of it was created by Alibaba under a permissive environment previously sanctioned by the government.

In startup terms, Alibaba still shipped “2021 Singles Day”, the product, and did decently well despite the circumstances. And that’s not the only thing $BABA is shipping. Alibaba Cloud shipped a custom-designed, custom-built chip as part of its proprietary server offering called Panjiu in October. The cloud unit also open sourced a bunch of software tools based on RISC-V, the open source chip design architecture, to bolster the RISC-V ecosystem. RISC-V is critically important to accelerating semiconductor design and development worldwide, but it’s boring. (Please see more of our writings on RISC-V and its strategic implications.)

China’s Big Tech like Alibaba will continue to build and ship products in this “New China” to fuel growth, they will just be more of the boring kind.

For a tech company, “removing startup debt” may slow down product improvement in the short-term, but generally creates a more sustainable foundation to grow for the long term. I see a similar possible future for China, but on a much longer time horizon. Short-term pain aside, investors who know China well, like Octahedron Capital, also believe that all these new regulations to remove China’s “startup debt” is a good thing for long-term growth.

No pain, no gain.

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