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Is China’s Startup Incubator Bubble Set To Blow?
China’s startup frenzy has gripped the country in a big way. Startup incubators are popping up almost everywhere in the Middle Kingdom.
China established its first ever technology incubator back in 1987, but the market didn’t explode until 2005 when the authorities decided to weigh in. The number of domestic incubators surged from around 500 in 2005 to over 2,000 in 2015, and the figure is expected to near 5,000 by 2020, a report from research institute iiMedia shows.
Of course, there are many good reasons for the incubation boom. At the policy level, Beijing launched a series of moves to encourage startup innovation and entrepreneurship. In addition to a slew of preferential policies, the country’s state VC coffers held over US $336.4 billion earmarked for startup investment by the end of 2015.
Currently, China’s incubation programs mainly fall into six categories:
Incubators backed by big enterprises grant startups convenient access to capital and technology support. The resources are invested in exchange for new innovations in business models and technologies to boost sustainable development of the backer. (Eg: incubators run by Baidu and Tencent, Microsoft Accelerator)
Incubator + Angel Investors are organized along the Y Combinator model, which provides startups with a certain amount seed funding from private capital and mentorship. In return, they take an equity stake. Instead of generating revenue from renting and training fees, they profit when incubated startups get big and successful enough to be acquired. (Eg: Innovation Works, SusStar)
Incubating and co-working space is more similar to the WeWork model, which offers a shared incubator-like space, community, and more. (Eg: 3W Cafe, Garage Cafe)
Media-backed incubators leverage their media resources by connecting incubating projects with VCs and helping them with media coverage. (Eg: Bang Camp by Chuangyebang)
Incubator program by realtors is a new category that adopts a relatively simple model. It generates profit by collecting rental fees from incubation startups. They are run by big real estate companies that are searching for ways out from the slowing property market. (Eg: Soho 3Q, UR Work)
Incubation programs that have special added value services, whether it’s a tech specialty or access to finance or fashion. (Eg: F Camp by Trends Group)
However, with everything growing at a rocketing pace, many naturally wonder whether there’s a bubble forming. Our answer is yes, just like for China’s internet startup sector in general.
Problems Following Sprawling Growth
Generally speaking, favorable policy support and abundant capital injections are good news for the market, but these initiatives are bringing in mixed results.
The state’s support tactics for startup incubation spaces range from offering free land, lower taxes, subsidies for operational costs, and funding. Incubators have mushroomed and overcapacity problems have ensued shortly afterwards. Not only has the number of incubators risen, but also the area they cover.
A majority of the 67 incubators registered with the Shenzhen government in 2013 and 2014 take up more than 10,000 square meters each, with the biggest standing at half a million square meters. People joke that China’s incubators are outgrowing startups, and they fear there won’t be enough startups to incubate.
The lack of startups has made it easier to enroll in an incubation program, making it more difficult to guarantee quality startups. Some startups lack a clear operation plan and business model. Such projects may survive in a rising market, but as capital winter strikes, a majority of them will languish or die.
iiMedia’s report pointed out that most of China’s incubation spaces stay empty with an occupation rate of less than 40%. With the capital winter upon us, we expect this rate to plunge even lower this year.
After the sprawling growth, many of incubators and accelerators are now treading water as competition among similar startup programs intensifies.
Most Chinese incubators provide similar services, including free or low-priced workspaces, startup training, and operation management, according to iiMedia. There seems to be a disparity between what incubators offer and what startups really need.
The government’s hands-on approach is raising concerns that the state may play an inflated role in the county’s startup scene. iiMedia’s report shows that capital sources for China’s incubation spaces are primarily government (28.4%), enterprise or private (22.8%) and universities (17.7%) with the remaining mixed resources making up a third (33.1%). The government capital is taking a big share in the market, in combination with investments made through universities, which are mostly state-owned.
The Chinese government should “be careful to avoid picking winners (and losers) or crowding out private financing. Empower entrepreneurs and let markets work,” McKinsey Global Institute recommends in a report.
Lack of Sustainable Revenue Models
The most common monetization models adopted by Chinese incubation spaces are space leasing and premium services like IT maintenance and media coverage. But it is not practical to earn money from startups that are struggling with cash flow themselves.
Of course, investment in exchange for startup equity like Y Combinator’s model is another way out, but it requires a much longer timeframe. Moreover, making wise investment decisions is much more demanding and requires a deeper understanding of the market
It is difficult for independent incubators to survive the tough competition when the larger ones are backed by well-funded entities, such as the government or enterprises. It might finally be time for incubators that are eager for quick success and instant benefits to get their dues.