On May 7, 2019, Cao Yi (Charlie), Founding Partner of Source Code Capital, was invited to the “2nd Digital China Summit” as a Keynote Speaker. He delivered a keynote speech entitled, “Value Discovery and Value Creation in China’s industrial Internet.”
The theme of this year’s Digital China Summit is: “New Dynamics, New Development, New Achievements Empowered by Informatization.” It is about fostering new momentum through information technology, promoting new developments through digitization, and achieving brilliance through technological advancements. The Summit serves as both an exhibition and a platform demonstrating China’s newly found technological prowess, and showcasing China’s digital economy, related policies, e-government, smart society, and breakthroughs in the Internet of Things. It provides an experiential forum regarding digitization, and by bringing global resources together, serves as a center for practical technology and business exchange to promote the construction of a collaborative digital China platform.
Image source: The 2nd Digital China Summit
China Network Photo
The following is the full transcript of Charlie Cao’s speech:
I am honored to have this opportunity to exchange and learn together at the 2nd Digital China Summit today. Since this morning until just now, I have gotten a lot of inspiration, excitement, and new motivations – whether from the thoughtful and diverse viewpoints of academicians He Hezhen and Li Ying, or from the heads of Haier, XCMG, Inspur and Foxconn, who represent deep industry insights from four leading industrial Internet enterprises.
Today, I would like to stand from the perspective of venture capital institutions and share some thoughts on entrepreneurship in the industrial Internet, innovation, and investments, and perhaps bring a new take on the subject. Is the industrial Internet attractive? How is its value creation understood and discovered?
The “Inverted Pyramid” and the “Three Fundamental Drivers”
Over the past 15 years, I have dedicated myself to making early and growth stage investments as empowered by the Information Revolution. I can summarize the investment logic of these past 15 years with two images. The first image is an industry perspective from the “Inverted Pyramid,” which has “Moore’s Law” at its core. The economic world has been driven by digitalization, “online-isation,” and intellectualization, which create and transform businesses, thus twining the digital world from one layer to the next. The digital world constantly delivers an enormous amount of energy every day, just like how the sun spreads its energy, which by doing so, fuels photosynthesis, metabolism, species evolution, socialization, and so on.
The second image is this “Three Fundamental Drivers” (3×9) investment map, which falls on the application layer of the Pyramid. How do these three forces of “Internet+,” “AI+,” and “Global+,” promote 2C (to consumer) and 2B (to industry)? How do they create value through optimizing production and inventory, and activating incremental value-addition? In the first 10 years of that 15-years period, most of the energy was spent on consumer Internet, whereas in the past five years, industrial Internet has gradually caught-up to the level of consumer Internet. My experience is mainly based on a reference that basically reflects a change in the industry, from 2C, to 2C and 2B. I think this is also a microcosm of accurate and timely adjustment of capital. Over the past 5 years, the rapid development of this “second” Internet, as well as the evolution of the New Economy, and even the “new normal” of the national economy, are manifestations of more mature, advanced, and prosperous and development.
Figure 1 (top): An Industry Perspective through the Lens of the “Inverted Pyramid”
Figure 2 (below): Source Code’s “Three Fundamental Drivers” (3×9) Investment Map
The Second Half of the Internet: From Consumption to Circulation to Production
I divided the industrial Internet into the “circulating Internet,” and the “industrial Internet.” I think the circulating Internet is the prelude to the industrial Internet. For the time being, let’s temporarily define the “circulating Internet” as going from industry to consumption, going between industry to industry, or from industry to the distribution sequence. This covers the flow of business, logistics, capital, data, digitalization, and online “intelligentization.”
Over the past five years, this process has experienced accelerated development in various sectors, including FMCG, agricultural products, pharmaceuticals, clothing, building materials, auto parts, industrial MRO, construction machinery, 2B logistics, 2B finance, and so on. This accelerated development has led to a creation of leading enterprises that rely heavily on information technology to form large-scale and more efficient enterprises. What might have been perceived as “too large, scattered and chaotic” yesterday, has now become much more centralized and efficient. We believe that from this process, dozens of companies valued at over multi-billions (in U.S. dollar) will emerge.
With an already very developed consumer Internet and a fast-growing circulating Internet as the foundation and driving force, we believe that the budding industrial Internet will very soon take its place on the main stage.
The Circulation-driven industrial Internet will Become more Powerful
Whether a concept or a technology can be industrialized and sustained depends on the quality of the model, which directly affects whether it can achieve PMF (Product Market Fit) from 0 to 1. Therefore, in the early stage of the current industrial Internet, as an investor, we are constantly wondering: What value does the Industrial Internet create for companies of different sizes? Why do companies promote manufacturing and production online? If we look into the financial statements of those businesses, perhaps we are able to find the answer.
As we dig into their income statement, we ask: How can we help them increase their income (sales radius, sales efficiency, smart pricing, etc.), or reduce costs and expenses (purchase radius, procurement efficiency, improve human efficiency, adopt cloud services, reduce financing costs, etc.)? From their balance sheet, we look at how we can optimize their inventory (inventory turnover, virtual inventory, obsolete goods risk, etc.), optimize liabilities (funding method and cost, etc.), optimize fixed assets (cloud assets, or switch to light assets), and optimize receivables?
Based on the needs of these enterprises, we have seen models such as “cloud computing,” “cloud factory,” “cloud procurement,” and “cloud operation and maintenance” emerge. The most powerful mode of this is the circulation/business flow drive (which increases revenue, reduces costs and expenses) promotes the digitalization and online-ization of the industry. Together with the support of business flow, digital costs can be reduced and kept to a minimal level.
For example, we invested in Baibu, an industrial internet company specializing in the textiles industry. It is further strengthening its position by relying on its dominant position on the Internet. Five years ago, we made an angel investment in Baibu to help establish e-Commerce for fabrics, which facilitates purchases between garment factories and textile mills. From a GMV of only a million to a staggering 10 billion+ this year, it has become the largest channel for e-Commerce in the clothing distribution and continues to grow rapidly.
Last year, Baibu began to try a very interesting initiative, which is to entrust the capacity management of the textile mill upstream. The orders are delivered to the door, and they use IOT hardware and software systems to further improve the efficiency of the textile machines from 60% to an impressive 90%. Today, tens of thousands of textiles machines have been reprogrammed to adjust to this new online efficiency, and to achieve a very robust and efficient large-scale “cloud factory.” This helps achieve a higher operation rate (in both capacity and quality), which increases profits as well as eliminates the trouble of overcapacity.
In addition to connecting various looms through IOTs and turning them into “cloud factories,” they are also trying to achieve “cloud operation and maintenance.” Based on the fault data of the monitoring machines, they set up operation and maintenance centers accordingly to help weaving factories maintain their equipment at a lower cost. This effectively replaces the need to keep dedicated maintenance staff at every factory, but is still able to accurately assist in the purchases of spare parts.
Then there is also “cloud finance,” equipment-based GPS, and start-up data to help the factory procure raw materials based on factory orders, and based on the order full load of the factory, it can even conduct financial leasing of machinery and equipment. In fact, the essence of the business is still the same, but the machines in the network connect the entire transaction data chain, from which you can forecast your purchases, orders, and finances – actions which one seldom dared to do before when without data.
It is our goal to think about the industrial internet and its application-driven, value-creation drivers. If one tries to “go online” for the purpose of “bringing businesses online,” or if one tries to “build a platform” for the purpose of creating an “industrial Internet,” neither endeavor will last long. On the contrary, there is a blue ocean of opportunities when it comes to really solving inefficiencies around real demand and value creation for society. The industrial Internet industry is the most important and the earliest step in the construction of a digital China.
With the support of the government and collaboration among our business community, we believe we can yield an impressive growth from 1% to 10% or even 50% in industrial Internet penetration, just like what the consumer Internet did in the last 20 years. Let’s courageously and tenaciously forge on forward with this immense responsibility and grand vision. We have great prospects ahead!
Thank you all!
