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Raphael Thys
The paths taken by Chinese companies have relevant implications for other digital and traditional players as they craft their strategies.
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The Future of Digital Innovation in China
Partners in McKinsey’s Digital Practice discuss the 6 megatrends shaping the future of China’s digital ecosystem.
In a relatively short span of time, China has transitioned from a technological backwater to become one of the world’s largest digital economies.
On the back of its base of nearly one billion internet users, China’s ecommerce sales grew to $1.7 trillion in 2020, a number that is equivalent to 30 percent of all retail sales in China.
But this is not just a story of size. It is, above all, a story of innovation and disruption. In omnichannel retail, social media, on-demand services, mobility, fintech, healthtech, and other domains, the country is developing many “China-first” innovations.
In this report, we take a close look at these innovations, and the forces, trends, and technologies that enable them. We then identify six megatrends that are shaping the future of digital innovation in China.
Finally, we pose a series of quick questions that corporate leaders should consider when crafting their digital strategies in China. By asking the right questions, executives can set their priorities and allocate their resources.
Here’s a quick snapshot of what’s inside this report:
In Chapter 1, we set the context by highlighting four interconnected factors that have created the conditions necessary to give rise to China’s digital ecosystem: A vast digital consumer base, intense pressure to quickly reach scale, a digital ecosystem that fosters innovation, and the shaping role of government.
In Chapter 2, we take a quick look at the current state of play in China’s digital economy, breaking down its components and offering insight into the major forces and technological enablers that have brought us to where we are today. We look at eight of these forces: Ecommerce and omnichannel; social commerce; the on-demand economy; shared mobility; distribution; FinTech; EdTech; and HealthTech.
In Chapter 3, we explore six megatrends driving digital innovation in China: The great retail integration; The virtualization of services; The mobility revolution; Digitization of social life; Industrial IOT / supply chain digitization; and digital urbanization.
Finally, in Chapter 4, we share a checklist of eight questions that CEOs can use to start thinking through their strategies.
Of course, these insights may be relevant to companies that already have a presence on the ground in China. But is digital innovation in China relevant to the rest of the world? And how?
Companies elsewhere, even if they don’t currently have a presence in China, might consider using the China experience as a reference point. The sheer speed and scale at which China’s digital ecosystem players are driving innovations is redefining what it means to manage a company today’s globalized, increasingly digitized economy.
There are at least four areas where Chinese players are pushing the boundaries of management: First, winning players in China exhibit the nimbleness and agility of a small startup, while cultivating the organizational and operational capabilities they need to drive initiatives at the scale of a very large company.
Second, successful companies pursue an externally-driven, internally-focused Darwinian-style process of “creative destruction” and constructive competition that funnels resources toward the right engines of growth, while quickly casting aside businesses that fail to gain traction and reach scale.
Third, this process is often enabled by the installation of “middle office” capabilities that provide the platform to rapidly incubate and scale new business models.
And finally, leading players are blurring the organizational boundaries between strategy, organization, and execution. The idea that they are discrete areas of management no longer holds. Recent moves by the government to regulate the activities of some of the largest internet players in China have cast a cloud of uncertainty over the digital ecosystem. Executives and investors around the world are closely watching this space.
As in any market, regulators in China are trying to more closely manage the activities of the internet platforms in order to strike a balance between business model innovation and societal well-being. But the changes in China have happened so quickly, they have taken many players and investors by surprise.
The scale and momentum it has built across so many digital domains will likely continue to power further growth and innovation. Companies that know how China’s digital ecosystem works, and where it is headed, will be better positioned to succeed.
The rest of this article introduces the 6 digital innovation megatrends that will matter most; download the full report to go even deeper.
6 Digital Innovation Megatrends to Watch
Having offered a snapshot of where we are in terms of digital innovation in China, we pooled the collective insights of McKinsey China’s Digital Practice to peer into the future. The list below curates their thoughts around six megatrends that will direct digital innovation in the years ahead, and provide China-facing executives with food for thought as they consider their corporate strategy.
Digital innovation megatrend #1: The great retail integration
The consolidation of previously discrete retail sectors will likely continue, integrating omnichannel retail with the on-demand economy, the social economy, and the retail supply chain. The result will be a massive and seamlessly integrated retail and social landscape. Social commerce will continue to flourish and account for an ever larger share of online GMV. This trend will be governed by improvements in consumer fulfilment; the desire for convenience and efficiency will rapidly narrow the gap between on-demand and traditional ecommerce.
Meanwhile, consumers will continue to tap trusted sources for product information, including channels extending across short videos, social media, billboards, mobile, web, and TV. Opportunities to transact will be increasingly direct, meaning that spending on social and brand-building should generate immediate positive impacts for GMV.
Content-based ecommerce is set to explode across video-sharing platforms like Douyin (the Chinese version of Tiktok) and Bilibili, as well as other content-heavy services like Toutiao. While livestreaming and broadcasting still accounts for a minority of ecommerce sales, this is set to change as China advances into the 5G and internet-ofthings (IOT) era.
The final piece of the great retail integration will be improved supply chain agility. Supply chains will have to become more agile to fulfill more frequent and diverse on-demand orders, as well as better forecast consumer trends and sources of demand.
Digital innovation megatrend #2: The virtualization of services
Just as ecommerce has taken China by storm, the provision of services online will take center stage as breakthroughs in consumer adoption, in part driven by COVID-19, are accelerating the digitization of service provision across a range of sectors. As we have seen, the virtualization of services in healthcare and education is underway, but there is enormous potential for digital innovation to continue driving efficiencies, while addressing wide imbalances in the distribution of resources.
In education, digitization will help compensate for uneven public expenditures that are 3.3 times higher in tier-one cities than in China’s smaller tier three and four urban centers. This should drive more equitable access to education resources.
Platforms like Alibaba’s DingTalk, an enterprise communication and collaboration app, will facilitate greater convergence of online and offline education delivery for schools. Now that students have become accustomed to integrated online to offline (O2O) models, the potential to expand this habit as the digital-native generation progresses along their learning journey is enormous. This will offer peace of mind to parents, some 68 percent of whom prefer the integrated online-and-offline approach, according to a survey conducted by O2O education platform Aixuexi.
Meanwhile, China will continue to experiment with AI to create personalized, interactive, and immersive learning experiences. As 5G becomes the norm, AI will enable adaptive learning, offering more personalized services based on individual patterns of learning and study preferences.
The same is true in healthcare, where digital innovation has only just begun to address wide disparities in the distribution of top-notch doctors. Almost 80 percent of medical resources are concentrated in just 20 percent of hospitals in China, so grassroots clinics and hospitals in remote and lower-tier cities lack high-quality supplies. Currently, less than 5 percent of total consultations are online, indicating a growth opportunity that should reduce the tendency for patients to travel long distances to reach general hospitals in major cities, and resolve related overcrowding issues.
Even traditionally offline experiences such as real estate viewings shifted online during the pandemic. For example, Beike, an online residential real estate platform, hosted more than 10 million virtual property showings through its virtual reality (VR) technology during the peak of lockdown, 35 times the number conducted prior to the outbreak of COVID-19.
The virtualization of services is unlikely to stop there. Government services and legal advice may follow suit, as a wave of sectors that traditionally required face-to-face interactions go digital. This should provide greater transparency of provider quality through public ratings systems, helping stoke competition and elevate standards.
Digitization will also make it possible for service providers to work anywhere, breaking down traditional regulatory and financial barriers to labor mobility, and revolutionizing the availability and quality of services. Automation will also play a larger role, with service robots debuting across the service-driven consumption market.
Digital innovation megatrend #3: The mobility revolution
China’s highly developed shared mobility network will increasingly be powered by the availability of electric vehicles (EVs) and connected “smart vehicles”, with full autonomous driving fleets on the horizon. As the hardware behind mobility solutions becomes increasingly commoditized, digital innovation will become the lynchpin in the battle for market share, driving innovation in software, solutions, and services, and spawning new opportunities for nimble and creative companies. The Chinese consumer will drive disruption, bringing their renowned adaptability and desire for new innovations into the auto arena. New entrantsare leading, evidenced by the success of local EV brands like Nio, Li Auto, and Xpeng.
Unencumbered by traditional business models and networks, they are defining the game in terms of customer experience (for example, Nio institutionalized customer operations and widened consumer interactions at experience centers and battery swap stations), and will continue to do so going forward, even as traditional automakers race to catch up.
Expect to see sustained improvements of in-vehicle technology, revolving around smart features that improve connectivity and safety, and allow vehicles to upgrade via OTA (over the air). On the macro level, China’s advantage hinges on state support for smart transportation. Further deployment of vehicle-to-everything (V2X) technology, comprising both vehicle-to- vehicle and vehicle-to-infrastructure components will likely occur. The application of AI could reduce traffic congestion by 10-20 percent, as local governments partner with ride-hailing services to analyze road user data.
AI applications in transportation and autonomous driving will also facilitate the acceleration of mobility as a service (MaaS). Notably, Beijing plans to reduce passenger car transportation usage by 30 percent by 2035. This push should promote the commercialization of MaaS services, centered around EVs. China’s pledge to reach peak carbon emissions by 2030, and carbon neutrality in 2050, may spur EV MaaS offerings to reach the next level.
The commercialization of autonomous driving will be the next stage. By 2030, China expects to reach 20 percent L4 penetration in cities. The government envisions large-scale autonomous, electric vehicle (EV) fleets on China’s streets within the next decade.
With this in mind, Didi will partner with GAC Aion, an offshoot of GAC Group, to develop a fleet of self-driving EVs, as it aims to host 1 million robotaxis on its platform between 2025 and 2030.
In 2035, the government is targeting the largescale roll-out and commercialization of robotaxis and L5 (fully automated) autonomous vehicles. Consequently, commercialization may occur faster than expected: autonomous based robotaxis could account for 22 percent of the shared mobility passenger kilometers by 2030 in tier 1 cities like
Shanghai and Beijing. (Exhibit 5) Autonomous driving will enable an entirely new mobility experience, one that is less about getting from A to B, and more about the activities and experiences passengers can enjoy during their trips. The era of cars as entertainment centers and workstations on wheels is close at hand.
EVs, drones, self-driving delivery vans, and eco-packaging will combine to improve delivery speeds, lower costs and emissions, and open up infrastructure and capacity sharing. This in turn should support the further integration of China’s retail and ecommerce ecosystem, making it smarter and more efficient.
These developments will eventually solve high cost-to-serve issues. For example, Beijing has given the greenlight for JD.com and Meituan to partner with autonomous delivery vehicle start-up Neolix to pilot driverless grocery deliveries, building on advances made during a mid-pandemic push for contactless services.
Digital innovation megatrend #4: Digitization of social life
The fictional stories of people living in virtual reality worlds as depicted in popular novels are rapidly transitioning into the “real” world. Chinese consumers are moving more and more of their social interactions and leisure activities into virtual domains. Virtual and physical social activities are also merging, as offline social interactions are increasingly orchestrated through virtual communities. Life itself is becoming O2O, where offline meet-ups more frequently spillover from communities and connections initially formed online.
This may be particularly prevalent in lower-tier cities, where opportunities to network face-to-face are more limited. In Shanghai, an app-linked bicycle community has expanded its activities into other areas of social life. On online games streaming sites such as Huya and DouYu, people brought together by the love of a particular title, genre or livestream host are taking chatroom interactions into the real world, organizing yoga classes and running clubs.
Leading digital players like Tencent are building portfolios that merge gaming, ecommerce, and social, creating a decentralized, competitive, and creator-friendly ecosystem, a “metaverse” if you will, that will have meaningful impacts in the physical world. More communities may form around social apps; respondents to our latest China Auto Consumer survey told us that lifestyle apps, including those that facilitate gatherings of owners of a particular brand, were the second-most popular value-added service overall, and the most desirable among EV owners by some margin.
Digital innovation megatrend #5: Industrial IOT / Supply chain digitization
We have explored how digital innovation is transforming distribution in consumer retail, but this is just the tip of the spear when it comes to the potential for digitization to streamline B2B operations and processes.
We view this as a frontier of China’s digital development with massive scope for efficiency gains, as the industrial internet of things (IIOT) is deployed at scale to transform digital manufacturing, digital supply chain development, and blockchainbased inventory management.
In pharmaceuticals, for example, Yaoshibang, an online B2B drug sales platform, processed 1.6 million orders in February, triple the level registered in the same month of 2020, and hinting at the potential for such platforms to thrive as more and more Chinese healthcare orders are processed and fulfilled online.
Manufacturing companies will increasingly embrace IIOT-enabled digital manufacturing to improve efficiency and sustainability. In 2020, China hosted 11 “lighthouse” manufacturing bases, exemplars of industry 4.0 advanced manufacturing processes identified by McKinsey and The World Economic Forum, the highest of any country.
White goods maker Midea deploys IIOT technologies to improve manufacturing processes and support product innovation. In Midea’s sensor-enabled “flexible automation” assembly lines, the manufacturing process is not only fully automated, but also dynamically adjustable to address differences in machine models, processing requirements, and materials. Machine vision is applied to detect errors in manufacturing processes, while IIOT-enabled machines send back customer usage data to R&D teams, providing valuable input and insights that help drive a continuous process of innovation.
SAIC, a leading automaker, has shown how committing to digital manufacturing can enable entirely new, customer-to-business (C2B) models, where digital solutions enable buyers to customize their orders via 3D digital car simulations. Car configuration and production queue information is then transmitted to suppliers to initiate justin- sequence shipment, reducing time to market by 35 percent. All the while, AI tools continuously monitor build progress to identify errors, helping lift order configuration accuracy to 99.8 percent. So far, we have seen the majority of lighthouses spring up among consumer-facing industries like autos, consumer goods, and home appliances, but the next phase will be to extend the revolution to traditional industries such as steel, machine tools, and manufacturing.
Digital innovation megatrend #6: Digital urbanization
Almost half of the world’s smart cities are in China, some 500 in total. While initially smart city applications have focused on areas like security and traffic management, 5G networks and edge computing advances are likely to usher in a new era for cities as integrated digital platforms.
Imagine the digital innovations highlighted in Chapter 2 of this report—in education, healthcare, logistics, and omnichannel ecommerce for example—being applied at massive scale across China’s cities to improve public service provision.
In Shenzhen, Tencent is building a smart city that puts people and the environment first, aiming to cut down on car usage by using AI to improve public access, while integrating green space into a huge campus for employees.
At the international AI City Challenge in March 2021, Chinese companies or research institutions took the top two places across five categories. Douyin (TikTok), for example, took second place in a challenge to identify road accidents and stalled vehicles from freeway video feeds. Alibaba’s City
Brain tool will continue to bring environmental analysis, visual search, and urban planning tools to municipal authorities nationwide. Government services are likely to be a primary beneficiary, as digitization solves pain points such as overcrowding and resource misallocation.
About the author(s)
Lambert Bu is a Partner in McKinsey & Company’s Shanghai office. Violet Chung is a Partner in Hong Kong, where Nick Leung and Kevin Wei Wang are Senior Partners. Bruce Xia and Chenan Xia are Partners in Shanghai.
The authors would like to acknowledge the contributions of Glenn Leibowitz, Jeongmin Seong, Selina Teng, Ting Wu, Lei Xu, and David Green.