Why Innovators in China Stay Close to the Market

Look at the electric shavers on offer from Philips at stores in New York, London, or Tokyo, and one will seem much like another. But go to Shanghai, or a smaller Chinese city like Yantai, and you’ll see something different. There, Philips has products that arose from local innovations and are customized for Chinese consumers.

It’s not surprising that a multinational company would be willing to adapt its offerings to serve a large market — as a Philips executive commented, a second-tier city in China might have a larger addressable market than most European countries. What is surprising is that Philips doesn’t feel the need to do this market-specific innovation in many large countries but does so in China. What is so different about competing in the Chinese market that it demands an entirely different approach than is dominant elsewhere in the world?

Over the past three years, we conducted two large representative surveys of corporate innovation. The first looked at innovation practices across eight countries, most of them highly developed. The second focused specifically on innovation practices in China, by both domestic and foreign companies operating there. We found that in China, innovation is different. Everywhere else we’ve looked, we’ve found that companies take a similar approach to corporate innovation.1 But the companies in China — be they domestic or foreign — have chosen a different path in a market where fast growth is producing a disproportionately large share of new customers for many industries, and advanced digital infrastructures, including widespread digital platforms, provide the means to access them.

Diverging Paths to Corporate Innovation

Our research shows that outside China, large companies are converging on a pattern for sourcing innovation. Internally, they are centralizing innovation. If they don’t have central R&D units, they are building them. And, increasingly, they are building centrally controlled innovation labs located in rich innovation ecosystems, such as Silicon Valley. Meanwhile, the appetite for seeking innovation from inside individual business units is decreasing, with ever fewer important innovations coming from these sources.

Externally, companies are rapidly expanding their innovation portfolios to get access to expertise, particularly for digital technologies. More businesses are turning to crowdsourcing and working with universities, startups, and third-party experts. At the same time, some external sources, like customers and suppliers, are becoming less important.

The trends we identified in China are markedly different and reflect an orientation toward generating ideas closer to customers to drive more market-led innovation. (See “Enterprise Innovation Sources in China Versus the Rest of the World.”) Chinese companies are about twice as likely as those elsewhere in the world to use customers, competitors, or business unit operational employees as a source of innovation. They are also 27% more likely to use business unit staffers who are dedicated to innovation full time (rather than those contributing to innovation alongside their day jobs). This is happening not only in manufacturing and consumer products but across many other industries as well.

Our research indicates that the choice of this approach to innovation is, in a way, itself market-driven. Even within China, companies do more market-led innovation when they produce for the internal market than when they export, on average using 46% more market-led innovation sources when they produce entirely for internal consumption than when they export all their production. So even among Chinese businesses, it is those that are trying to capture domestic customers that are focusing on market-led innovation.

How Chinese Companies Stay Close to Market Needs

Three ingredients from the Chinese recipe for corporate innovation stand out: involving customers in innovation, leveraging competitor innovation, and sourcing insights from employees in market-facing business units. Let’s take a closer look at how companies in China use these strategies.

1. Involve customers in innovation. With so many winnable customers in China, competition is fierce; foreign companies want to enter Chinese markets, and domestic companies want to defend their territory. Tailoring offerings to specific consumer niches is a way to escape the bevy of competitors. But creating new offerings that address particular niches is not easy: It requires learning about those customers and innovating alongside them. Our research indicates that in China, widespread digital platforms are key to how companies innovate with their customers. China-based multinational Haier uses the Haier Open Partnership Ecosystem platform to generate ideas from an online community of thousands of external experts and hundreds of thousands of customers.

Smartphone maker Xiaomi has taken a customer-focused approach to innovation to fuel its growth. It has extended its product range to over 100 smart consumer electronics products, ranging from smart rice cookers to air purifiers and health wearables. Xiaomi’s product development focuses on getting prototypes to market as soon as possible and actively involving users in updating the technology and design. Users, who are called “fans” at Xiaomi, can submit recommendations and questions via various online platforms, and an algorithm distributes this input to the relevant employees at Xiaomi. The result is products that are codeveloped by the community and a better fit for market needs.2

2.  Leverage competitor innovation. With rapid growth and market niches the size of many countries, competition in the Chinese economy is robust. (A common measure of market competition, the Herfindahl-Hirschman Index, pegs China as being more like developed countries than emerging markets in this regard.) As has been much discussed elsewhere, this has led to copycat products: The innovations of one company are reverse-engineered and built upon by others. But this is only one part of how businesses in China innovate with their competitors. Improvements in Chinese companies’ technological capabilities have increasingly opened the doors to direct collaboration in the innovation process.

Daimler is a case in point. China is by far the iconic German car brand’s fastest-growing market, and one where there is strong demand for innovative next-generation electric vehicles (EVs). In 2019, around 1.2 million EVs were sold in China — twice as many as in Europe, and four times more than in the United States. Daimler recognized this shift and in January 2020 announced a global joint venture with Chinese car company Geely to produce a fully electric vehicle by 2022 as part of its reinvention of the Smart car brand.

3.  Source insights from employees in market-facing business units. Many companies outside China are increasingly turning to centrally run R&D and innovation labs, and these have successfully produced important innovations. Our research shows that at the same time, companies are placing less importance on innovators whose work brings them closer to customers. In China, however, this shift has not happened. On the contrary, the practice of using internal, market-facing innovators is growing rapidly and producing some companies’ most important new offerings.

Haier, for example, gets many product ideas from repair technicians and sales representatives, who are in a position to directly observe how customers actually use, or would like to use, its products. This can mean changing washing machine characteristics in its Crystal series because of user feedback, or designing refrigerators with built-in foldout tables to target students who use them as desks in cramped dorm rooms.

Implications for Global Innovators

Many foreign businesses operating in China have adopted the local approach to innovation. In fact, our data shows that they are more similar to Chinese companies in this regard than to companies in their home countries.

Historically, Philips relied on market insights from the U.S., Germany, and Poland for global innovation. But, having committed to the Chinese market, it decided to invest in innovation specifically targeting China. For its professional health business, Philips developed a 4D strategy: design for China, decide in China, deliver at China speed, and digitize China business. From 2016 onward, Philips moved from selling equipment to selling total solutions to customers, thereby aiming to work much more closely with local customers. Since 2018, Philips has embarked on numerous local product development partnerships, such as with Digital Health China and Ping An Good Doctor, to gain insights into local preferences. The China-specific, newly launched Shinefly health care platform, which includes imaging, radiology, and PACS (picture archiving and communication system) modules at lower prices, is one innovation outcome. Philips also started to actively invest in and partner with leading local competitors, such as SinoUnited Health and Shenzhen Goldway, to co-innovate new medical imaging and patient-monitoring solutions. China is now one of Philips’s four largest innovation hubs. The company also now develops products targeted specifically for consumers in Chinese second- and third-tier cities, with the aim of leveraging those innovations to grow new markets in Southeast Asia.

Honeywell’s experience is equally telling. Since 2013, China has become Honeywell’s largest market beyond the U.S. The company’s long-term view and big bet on localizing innovation played an important role. Besides building up significant R&D muscle over the past two decades, with a large lab in Shanghai since 2003 and numerous new labs in Wuhan, Nanjing, and Xixian in the past five years, the company overhauled its innovation process for China. The aim was to build an end-to-end innovation organization, bringing innovations closer to customers. For instance, it let the whole innovation team connect with and colocate with the customer. It also became more flexible in using Chinese standards — instead of international ones — for products like hydro-purification units. Moreover, it realized that the sales team had to become more of a customer relationship team, continuously taking note of customers’ changing requirements for upgrades. “Little by little, we had this Chinese-ness in our bones,” emphasized the architect of the company’s China strategy, Shane Tedjarati, who spent two decades transforming Honeywell.3

As these examples highlight, establishing local innovation hubs or full-blown innovation centers in China is no longer unheard of for foreign companies. Our study suggests that firms innovating in China should leverage their business units’ operational and dedicated innovation staffs, even if this goes against their home-country experience.

Foreign companies must also tap the rich landscape of digital platforms in China — among the most advanced in the world. Even a newcomer in the market, U.S.-based Bissell, the world’s largest producer of floor-care products, stayed resilient during the COVID-19 pandemic by leveraging the Taobao Live livestreaming platform to stay on top of customers’ wants and needs. And through Alibaba’s Tmall Innovation Center, companies can access real-time consumer data to accelerate innovation.

Our research makes clear that most of the world is converging on a common innovation recipe — one that makes innovation easier to manage because processes can be standardized and innovation models replicated across geographies. But China is an exception. Its market is unlike that anywhere else in the world, and so is the innovation required. This means that global companies that want to capture the benefits of being in China need to accept that they have to have a dual model: one for China, and one for the rest of the world.