In March 2023, the US government announced an ambitious new course for its national bio strategy. It’s aptly named “Bold Goals for U.S. Biotechnology and Biomanufacturing” with key targets on:

1) Climate: in 20 years, convert bio-based feedstocks into polymers that can displace 90% of today’s plastics and other commercial polymers

2) Supply chain: in 20 years, more than30% of US chemical demand should be via sustainable and cost-effective biomanufacturing

3) Cross-cutting advantages: in five years, sequence the genomes of one million microbial species and understand the functions of more than 80% of newly discovered genes

As reported by Forbes in Sep 2022: “The U.S. bioeconomy is booming. Valued at nearly one trillion dollars and predicted to grow globally to over $30 trillion over the next two decades, bioproducts now include everything from the food that we eat to the vaccines we put in our arms.”

Can these bio-material goals be achieved?

The biotech space is the next big race between China, the US, and Europe. The industry must be well prepared for disruptions in the next decade or two. The goals are ambitious and the challenges are clear:

For (1), replacing 90% of today’s plastics with bioplastics, industrial and process transformations lay ahead for chemical leaders such as BASF, SABIC, and Arkema.

For (2), with at least 30% of the chemical demand in the supply chain to come from bio-manufacturing, plans to develop bio-based resources must be in place, starting now.

For (3), to sequence one million microbial species in five years, having 80% of these functions understood means the entire bio-engineering process must be accelerated through technology.

With the bio-manufacturing transition and policy changes taking place, the industry must brace for impact. Many sectors aren’t ready. Take plastics manufacturing: oil as a feedstock for plastics is cheaper than bio-engineered polymers. Oil-based plastic packaging remains a first choice for many consumer brands.

Synbio (Synthetic Biology) accelerates with tech

The key to achieving lofty biotech goals is the field of Synthetic Biology (Synbio). Synbio uses genetic engineering to alter a cell’s DNA to make target molecules for manufacturing. It plays a role in healthcare, has shown promise in energy, and is gaining traction in the consumer goods space. 

Synbio has been attracting an increasing amount of venture capital, especially in recent years. One of the reasons is the progress of computing power. Bioinformatics, with computer science, the power of AI, and machine learning, combined with chemistry, physics, molecular biology, agriculture, and engineering science, are working together to deliver bio-solutions faster than ever.

Computing power supports the Synbio development cycle, which is to Design, Build Test and Learn (DBTL). Unlike conventional chemistry, this deals with living organisms. In R&D, scientists must develop, test, and study the effect of altering genomes, microbes, and enzymes, to eventually engineer them synthetically.

In the West, synbio startups have been altering conventional products and processes, transforming the material world, and contributing to the bio-manufacturing industry, from food to cosmetics, to health and wellness – but none has been profitable.

With Synbio, supply may no longer be constrained by the availability of raw materials. Companies can engineer and manufacture an infinite quantity of things, cell by cell, from scratch. Half a gram of cattle muscle could create as much as 4.4 billion pounds of beef – more than Mexico consumes in a year.

While synbio might seem to be a magic wand to pursue a fully organic, sustainable, and low-carbon future, challenges remain in its “need for speed”.

Two methods of Synbio development: full-cell (live cells) or cell-free (synthetic cells)

(1) Full cell (in vivo/live cells)

Using live cells (full-cell) in a traditional process, scientists start with a design, then build the microbes, test them, and then record the results. The whole cycle repeats until the desired results are achieved. However, the fermentation process is complex, influenced by the control of culture and process parameters. Sometimes if the control isn’t managed well, batches may fail, affecting amplification.

Full cell processes keep cells alive in the entire development process, which limits the volume of chemicals produced on each course. There’s also a need to isolate the product from the rest of the cell (as cells have their processes to keep themselves alive) through protein purification, and is limited to products that aren’t toxic to cells. After fermentation, cells are broken down, and then purified to extract results.

It’s complex, and labor- and time-intensive.

(2) Cell-free (in vitro/synthetic cells)

The cell-free method is a new frontier, where the same process is conducted without a microbial environment (less time & complexity). Cell-free systems can be defined as platforms where biochemical reactions occur independently of living cells. Cell-free systems can be extract-based or enzyme-based.

The synthetic process replicates the basic functions of a living cell. In scientific terms, there’s no limit to the monomers to convert. Instead of a traditional 20% output, the cell-free process could allow researchers to achieve 90% output. Cell-free platforms are not restricted by limits for supporting life.

With cell-free formats, scientists can easily control and access protein synthesis with in-vitro bio systems without membranes, and achieve metabolic manipulation to enable inexpensive ATP generation or incorporate unnatural amino acids.

But there’s a catch: the cost is high.

Is there a better format?

The cell-free format is easier to manage, and results yield much quicker. The full-cell format is much slower, but the cost is lower as well – essential for startups tight on funds. To make the best of both, companies can combine the formats in their process: synthetic pathways designed, tested, and optimized in cell-free systems first, then transplanted to living cells for optimization, and then upscaled.

The Chinese synbio space

We’ve also looked at dozens of startups in the Chinese synbio industry. From the data, we zoned Chinese synbio startups across two areas: platform vs products, and those in the market for more than or less than five years.

No companies are doing just pure platforms. All Chinese synbio startups are running platforms and products, even if platforms remain their core expertise. The reason behind this? A matter of survival, since research and breakthroughs take time. Typically, it takes over five years to properly research and develop a discovery.

While there are Chinese synbio companies spanning the cell-free and full-cell formats, we haven’t encountered any startup in the cell-free space with a market product valued at more than USD 500 million.

There is great potential in the cell-free format to deliver a wider array of possibilities for the materials industry. Cost remains an obstacle. Full cell formats remain affordable for R&D, even if they’re cumbersome and time-consuming – part of the reason behind the delays in bio-material developments.

Synbio is in its own DBTL phase

So, it seems the Synbio industry itself is in the Design, Build, Test, Learn phase – cycling until it’s able to achieve breakneck efficiencies to deliver the breakthroughs needed for the bio-economy. But with constant advances in AI, computing technology, production techniques, and most importantly, embracing the cell-free format, achieving bold goals doesn’t have to be a far-fetched dream.

In the collective effort to fight climate change, CCUS (Carbon Capture, Utilization, and Storage) is one of the few frontline tools. Today, carbon dioxide (CO₂) is captured directly by power generation or industrial facilities, or even directly from the atmosphere. The captured CO₂ is then utilized or stored. If stored, it’s injected into deep geological formations for permanent storage. If utilized, carbon can be incorporated into several production processes.

But how many of us are aware of the size and scale to which CCUS is taking place in this day and age – and what happens to the carbon when it’s captured?

By capturing carbon dioxide emissions at their source, CCUS helps mitigate the overall effects of accumulated carbon in our environment. CCUS has its roots in decades of scientific exploration – back to the 1930s. Official figures from bodies like the International Energy Agency (IEA) reveal a significant increase in CCUS projects globally, with over 30 large-scale facilities in operation or under construction (as of the end of 2020).

There is an estimated global CO₂ emission of 33 billion tons per year. The global capacity for carbon capture in 2021 was 43 million tons per year, accounting for just 0.1% of the emissions. The target is for CCUS to reach 10 billion tons per year by 2050, removing a third of our annual carbon emissions. While capacities are increasing year by year (the next goalpost is 279 million tons of CO₂ captured annually by the end of 2023, according to BloombergNEF’s report), very little of that captured CO₂ has been applied in innovative, practical, or useful formats.

Most of the captured carbon at present is pumped into storage wells underground – that’s the ‘S’ in CCUS, but not enough has been done for the ‘U’. Annually, only an estimated 270 million tons per year of CO₂ have been used, mostly on fertilizers, food, metal fab, and concrete. Yet for some of these uses, the CO₂ is re-released back into the atmosphere upon use, defeating the purpose of capturing it in the first place.

This is doubly inefficient: let’s not forget that CO₂ storage facilities need to be maintained and often occupy a very large area that isn’t used for any other purpose.

With 270 million tons/year of CO2 used versus 37 billion tons/year of CO2 emitted – we have a very long way to go.

CO₂: a useful yet misunderstood element

Earth’s CO₂ issue really is about too much of a good thing. Despite the negative climate-related connotations, CO₂ primarily is a very useful element and potential resource. Aside from the need for plants to achieve photosynthesis to produce oxygen, everything on earth is carbon-based.

As the Scientific American mentions, carbon is “the most versatile, most adaptable, most useful element of all. Carbon is the element of life.” 

From the chart we can see that carbon, through conversion, can be applied into fuels, to chemicals, to building materials, and so on. Direct uses of carbon include crop yield boosting, heat transfer media, or applications in food, welding, medicines, and more. The usefulness of carbon is remarkably broad, with plenty of potential waiting to be untapped.

Carbon has the ability to form stable bonds with many elements, including itself. This property allows carbon to form a huge variety of very large and complex molecules. In fact, there are nearly 10 million carbon-based compounds in living things. 

Take for example, the Chimei Asai facility in Taiwan, a joint venture of Asahi Kasei Chemicals and Chi Mei Corp. They have been manufacturing around 150,000 tons of polycarbonates per year using CO₂ as a starting material for over a decade. 

And at the price of $15 to 100 per ton, carbon as an abundant resource isn’t expensive at all. Being so affordable, we believe more research can be done to use carbon as a resource for practical outcomes.

Carbon utilization and removal pathways

To understand what we can work with when it comes to handling carbon, we have to understand the different formats of carbon capture: Closed, Cycling, and Open Pathways.

Of the three methods, ‘Closed’ is the most conservative, practical, and commonplace. ‘Cycling’ and ‘Open’ have their uses, but both require a large investment in time and resources to make it practical.

There are three methods to utilize captured carbon:

1) CO₂ Splitting: CO₂ can be split into different components, leading to various applications.

2) Synthetic Biology (synbio): CO₂ can be absorbed by microbes/algae to produce chemicals, food, or feedstock to make products.

3) Direct Incorporation: CO₂ can be directly incorporated into products.

Splitting carbon to make chemicals and fuels

Electrochemical splitting of CO₂ can create useful chemicals, such as syngas, Formic acid, Oxalic acid, and more. However, as CO₂ is an inert molecule, the science behind splitting carbon is very complex and expensive. Efficiency rates are also very low, often ranking below 50%. The molecule-splitting process also requires plenty of water. If we consider the cost and complexity of the entire process, it’s more efficient to use electrolysis to create hydrogen, a more energy-dense fuel that’s gaining traction globally.

Converting CO₂ into liquid fuels that substitute gasoline or diesel fuel only locks in carbon until the fuel is combusted, at which point it is re-released into the atmosphere.

Synbio process to produce fuels, chemicals, food, and materials

The synbio route is an interesting one, where startups use genetically modified microorganisms to absorb carbon to create useful chemicals.

Examples include using microbes to produce useful chemicals such as bioethylene or glucose. Copious amounts of carbon can also be used to accelerate algae growth, to turn it into an abundant feedstock to make food, biofuels, plastics, or even carbon fiber. But the systems are complex, requiring AI-powered photo-bioreactors for biomass production, requiring at least a two-stage dewatering process.

Generally, the science, research, and development behind using Synbio to decarbonize our climate is extremely expensive and complex, with many companies exploring this space going under.

Direct incorporation of carbon into things we live with

Direct incorporation is a much more practical method of making use of CO₂. Today it’s part of the cement-production process, which ‘locks in’ carbon for much longer. Concrete won’t permanently keep CO₂ out of the atmosphere, but can store it for a century or more, which counts as a form of effective carbon storage. The Nature paper calls these “closed” processes.

As the Nature paper says: “Cement requires the use of lime (CaO), which is produced by the calcination of limestone in an emissions-intensive process. As such, unless calcination is paired with carbon capture and sequestration, it is difficult for building-related pathways to deliver reductions in CO₂ emissions on a life-cycle basis.”

Ironically, cement production itself emits carbon, which needs to be captured and sequestered to make it carbon-neutral. With economies and standards of living around the world improving, and real estate constantly developing, cement production is now the seventh highest emitter of carbon into the atmosphere, with energy production taking the number one spot. So that presents a paradox to the solution.

Another common use of captured CO₂ is incorporation into fertilizers. However, once the fertilizer is placed in the soil, it’s re-released into the environment within weeks.

So, all that investment and effort in carbon capture and utilization vaporizes in just weeks. Is there any point in that?

Locking carbon into a material that doesn’t degrade: plastic

It’s a challenging goal: make use of abundant captured carbon, don’t let it reintegrate with our climate, and ensure it makes no additional contribution to carbon emissions in the process.

One highly plausible solution we’ve studied over the years is to incorporate carbon in something that’s very common in our everyday living: plastics.

As the IEA puts it: “CO₂-derived products that involve permanent carbon retention, such as building materials, can offer larger emissions reductions than products that ultimately release CO₂ to the atmosphere, such as fuels and chemicals.”

More accurately, carbon can be incorporated in polyol, a raw material that’s used to make plastics/PU/surfactants. These become useful materials that we use commonly, and often for a very long time: shoe soles, car seats, insulation, beds, paints, and more. When incorporated into plastics, it keeps carbon locked away for long periods, just like carbon in concrete.

As for the production process, making traditional plastics contributes to carbon emissions (though not as much as the concrete-making process). That’s because traditional plastics rely on fossil-based feedstocks. The aim of incorporating captured carbon in plastics is to replace these fossil-based feedstocks, effectively cutting down carbon emissions in the process.

From the above chart, it is clear that the most practical and profitable use of CO₂ is incorporation into polyol, a raw material for plastics. A UK startup that’s been developing this method effectively is Econic, which uses a catalyst to incorporate carbon into the PU production process. Best of all, it doesn’t call for additional energy requirements (keeping it carbon-neutral), and it fits seamlessly into existing plastic production processes.

As mentioned in an IEA paper: “Potential climate benefits in polymer production depend on the amount of CO₂ that can be absorbed in the material, which can be up to 50% of the polymer’s mass. For example, a polymer containing 20% CO₂ by weight shows life cycle CO₂ emissions reductions of 15% relative to the conventional production process.” 

Of course, there are controversies to this: plastics are the very material the world wants to avoid, because it doesn’t degrade well, polluting our seas and environment. Yet, it’s this very fact that helps to lock the carbon away for decades. Plastic isn’t something we can live without – from fundamental living needs to medical applications, it’s a functional, durable, and waterproof material that is nearly impossible to replace.

A system in which used plastics made from carbon are responsibly collected or recycled at the end of their use will help mitigate this concern.

Economic considerations: profitability and society

Is CCUS economically viable? If the carbon is mostly stored in geological locations, most probably not. But if captured carbon can become an abundant, key resource or raw material that supports our living needs – making buildings from concrete incorporated with carbon, food from carbon, or useful plastic goods made from carbon – it would become very practical. As the human population, cities, and needs grow, so do the needs for real estate development, sustenance, and functional products made out of plastic. Wouldn’t it be great to have ‘locked-away’ carbon serving our living needs while staying out of the atmosphere?

For now, the CCUS systems in place are very expensive investments with very low or no returns. This is in part because many haven’t found a practical solution as to what to do with all that captured carbon, or how to lock it in effectively without having it re-released into the environment.

CCUS represents a multifaceted approach to managing carbon emissions. It challenges conventional perceptions of CO₂ and opens doors to innovative uses. Though still a subject of debate and development, CCUS is emerging as an indispensable tool for a sustainable future, offering untapped opportunities for more responsible use of carbon, potentially revealing paths toward both environmental protection and economic benefits.

If we can unlock the potential of captured carbon – making it useful while keeping it out of the atmosphere – the rewards for society, businesses, and mankind could be profound.

Recently, on 7 Sep 2023, Phoenix Contact celebrated its centenary globally, and its 30th anniversary in Nanjing, China. 

The multinational company is headquartered in Germany and is a manufacturer of industrial automation, interconnection, and interface solutions. It is a lead investor in Thingple digital transformation solutions, investing in more than 20 Chinese companies similar to Thingple Inc. and building an ecosystem of partners. Its Chinese headquarters boasts over 2,500 local staff with 30 billion RMB in annual revenue.

Phoenix Contact’s first 30 years in China is a picture-perfect example of how MNCs prospered in China under its early reforms. The opening up of China invited the world to come and make the best use of its resources, its people, and its potential. China quickly became the world’s factory, a manufacturing base for nearly every useful, functional product the West created (the screen on which you’re reading this article now is likely made in China).

Yet the truth is, that MNCs such as Phoenix Contact have seen slowing revenue growth in recent years. Local Chinese companies with similar offerings, highly competitive prices, and comparable quality have been stepping in, eating into what was once considered markets with no peers. So what will the next 30 years look like for companies such as Phoenix Contact?

Global brands for Chinese markets 

For many MNCs, the China business journey started in the 1990s with a ‘global for local’ strategy, which was to produce and sell Western products in China, taking advantage of its low-cost production and rapidly growing consumer market. Foreign brands held a special place in the hearts of domestic consumers and commanded premium prices. Whether it was consumer electronics, cars, or FMCG items, it was an opportunity to experience what the rest of the world was having. Back then, a long line of MNCs ventured into China, pouring billions into its economy and reaping profits.

As the years rolled by into the last decade or so, the Chinese market and its consumers matured and evolved. Consumers have become more worldly, more connected with global trends, and in many cases, have become more demanding. There has also been a notable rise in nationalist sentiment and the repositioning of ‘Made in China’ as a source of pride. Local manufacturers have picked up years of experience and lessons and applied them in their businesses and products. The level of innovation and quality has quickly caught up with the West. With a more sophisticated market, the ‘global for local’ strategy for MNCs in China was replaced with a ‘local for local’ strategy.

As Investopedia notes: “As of 2021, China has the second-largest economy in the world with a GDP of $17.7 trillion, behind the United States GDP of $22.9 trillion. If the economy were represented in purchasing power parity (PPP), China would edge out America as the largest economy with a purchasing power of more than $27.3 trillion.”

Global brands localizing for Chinese markets

The ‘local for local’ strategy calls for greater product customization since domestic competition is fervent – as in Phoenix Contact’s case. As China’s supply chain becomes more sophisticated and complete, product development and supply chains have been shifted to China, in addition to manufacturing and sales. Relying on local talents for product development helps shorten product development cycles, allowing rapid responses to the market. Local supply chain partners helped to reduce costs, making products even more competitive. With the ‘local for local’ strategy, MNCs today – hanging on the hope that their foreign brand value holds a premium – are exposed to never-ending price wars, cutting profit margins thin.

Yet most MNCs working with the ‘local for local’ strategy continue to keep their core technology research, branding, and strategy outside of China. This approach is mired in the traditional smile chart, where the market believes China’s strength lies only in low-cost manufacturing. That’s no longer the case.

Chinese brands for global markets

In the last 30 years, MNCs possessed strong positions in technology, product, quality, brand, and pricing, while Chinese companies held the lower end of the market with copycats. Over time, Chinese companies also started innovating, becoming increasingly competitive in mid- to high-end markets locally, and overseas.

Today, there are many examples of Chinese brands claiming significant overseas market share with breakthroughs in innovation and quality, not just cost. Chinese brands are seeing success in consumer electronics (Huawei, Vivo, Xiaomi), new energy vehicles (BYD, Nio, Xpeng), and even FMCGs such as affordable fashion (Shein) and consumables (Luckin Coffee).

As mentioned in Harvard Business Review’s article on China’s New Innovation Advantage, “To understand what’s powering the global rise of Chinese companies, we need to recognize that China now has at its disposal a resource that no other country has: a vast population that has lived through unprecedented amounts of change and, consequently, has developed an astonishing propensity for adopting and adapting to innovations, at a speed and scale that is unmatched elsewhere on earth.”

There is a well-known Chinese phrase: 三十年河东 三十年河西 (30 years a river flows east, 30 years a river flows west). This translates to how fortunes can change course over time, emphasizing a cyclical or impermanence of life. It suggests success and failure can alternate, and one should remain adaptable and not be overly complacent.

Well, now that the first 30 years have passed for Phoenix Contact – and many other MNCs from that era – what will the next 30 look like? How can MNCs today continue to grow in a disruptive Chinese market? 

With the evolution of the industry, ability, talent, innovation, and even demands, here are four key suggestions for MNCs with a Chinese footprint to tackle the next three decades:

1. Replace the mindset ‘local for local’ with ‘local for global’

‘Local for local’ implies that local talents and local supply chains are only good enough for the Chinese domestic market, which implies low- to medium-quality use cases. ‘Local for global’ means treating domestic vendors as partners, leveraging innovation and product development capabilities for global markets. MNCs need to integrate the teams and make decisions by looking at and comparing strengths on a global scale.

2. Always include the Chinese market in global strategies

“When China sneezes, the world catches a cold” is a well-known adage to abide by. As China is now the world’s second-largest economy, global strategies must integrate what’s happening in the Chinese market. No ‘global strategy’ can succeed without considering strategic input from China

3. Chinese innovation is influencing global tech

Increasingly, high-quality use cases are growing in China. China is a leader in many fields today, such as internet and mobile applications, EVs and electrification, solar and wind, and digitization and IoT. These high-quality examples foster many advanced technologies and products, with innovations that can be applied to the global market. Many Chinese-innovated technologies are patented and leased to well-known multinational brands such as Apple, Samsung, VW, Audi, and more. 

4. Co-create, not compete

Make a bigger pie instead of trying to cut it up. Rather than fighting in the same, limited market, it’s better to collaborate and co-create. Geo-political tensions and supply chain security issues are forcing continents to build independent manufacturing capacities, with little concern for demand. When manufacturing has over-capacity and margins are slashed, this inevitably creates a negative spiral. It’s more important than ever to co-create new applications and new products for new industries so that the added manufacturing capacity can be profitably and sensibly utilized.

In the 1997 book ‘The Innovator’s Dilemma’, author Clayton Christensen explains how even the most successful companies today can still lose their market leadership or even fail, as unexpected competitors step in and take over market share. The term ‘disruptive technologies’ was first mentioned, which is a disruptive innovation that potentially creates a new market and value network that will disrupt an existing market and replace existing products.

Which is what is happening right now with the Chinese marketplace and industry. Large, firm-footed MNCs such as Phoenix Contact are feeling the tremors, but there is a great opportunity to resolve the competition and build market share. The rise of Chinese innovation and its intentions to succeed cannot be ignored, and the best strategy forward is to embrace its progress to help achieve its ambitions – and yours.

As China reopens and relaxes Covid restrictions, we’re taking a dive into interpreting China’s latest economic objectives and goals and putting them into the wider context of China’s relation to the global economy.

One of the indicators we examined is China’s ranking in the Global Value Chain (GVC). GVCs are part and parcel of today’s finished goods, and is a powerful driver of productivity growth, job creation, and increased living standards.

The GVC Position Index assesses a nation’s upstream or downstream positions on the value chain. Russia exports mostly minerals, ie. oil or gas, so it is upstream. Japan and US are upstream because they export research and development, intellectual property, and half-finished goods. China is downstream because it exports mostly goods in a highly-finished state.

What’s more interesting is the bubble size, which represents the volume of domestic value-adds absorbed for its total exports. China and US are the two biggest bubbles, but the exports as a percentage of their GDPs are ~ 10% for the US vs ~ 20% for China. Furthermore, the US exports mostly IP and high-value components, while China exports more assembled goods with less value-add.

For China to grow its bubble, it needs to add more value to its end products through innovation and making higher-value goods. Otherwise, it’s unable to do much more, as China does not have raw material advantages. We also see that the US can grow its bubble by moving manufacturing back onshore, delivering more finished goods.

The GVC Position Index is deeply related to the latest policy direction revealed in the 20th Chinese National Congress, an upmost important political meeting held in October 2022. With a newly elected Politburo Standing Committee, General Secretary Xi Jinping gave a speech that outlined key goals for the country for the next 5 years.

The cornerstone of his speech undeniably focused on the pursuit of innovation. It was declared that China should “use technology as a primary productive force and innovation as a primary engine.”

This was anchored by 3 points: (1) focus national resources on strategic areas (2) build a globally competitive and open innovation ecosystem, and (3) develop original and cutting-edge innovation.

Other highlights drawn out from the week-long political meeting include China’s aims to achieve modern socialism by 2035. This is done through the modernization of its population, achieving common prosperity through a reduction of wealth gaps. Prosperity is defined to include material and spiritual wealth. Two other points also stand out: achieving harmony with nature through green development, and peaceful development.

The Chinese economy emphasizes on high-quality development through:

• A strong manufacturing sector (not just size, but also strength)
• High-quality outputs, innovation-driven, productivity growth
• Strong consideration for the environment/climate

The key message on environmental responsibility is interesting. Xi’s speech suggested to “Xian li hou po” – meaning to “rise above and break through,” but omitted the mention of specific years for carbon-peaking and carbon-neutrality goals. Our take on this is that China wants to establish sufficient clean energy resources before shutting down traditional energy sources. It is abandoning its earlier hard commitments to carbon-peaking in 2030 and carbon neutrality in 2060, for a more pragmatic and flexible path.

Xi has also set three main themes to support China’s goals for the next half-decade.

Three main themes to support Chinese growth:

• Theme 1: The state-owned economy will be the core economic theme.
• Theme 2: To earn one’s fair share of wealth through labor, not just wealth creation from capitalism.
• Theme 3: Focus on domestic circulation, with higher-quality and reliable goods & services for its domestic population.

An unusual standout keyword from his speech was “dou zheng” — meaning struggle, targeted at foreign influences. This alludes to how China should stand up against opposition with confidence and indicates that China is willing to face confrontation with the West over what it considers its core interests and values.

Overall, we believe that the 20th CCP congress provided clarity on what matters to China’s leadership. There has never been more clear, strong and firm policy support for Chinese hard tech, innovation, and manufacturing upgrades – the golden time is here and now.

The article was first published on Global Corporate Venturing.

Politicians in the White House and Europe want to bring tech manufacturing back to its home turf. But while tech companies like Apple are slowly moving manufacturing operations away from China, they’re shifting them over to India, Vietnam, and Mexico – not the US.

The reality is that bringing manufacturing back to the US or Europe is more complex than it seems because of the deeply embedded chains built over decades of East-West collaboration.

We believe that Western re-shoring will be a long struggle and that Chinese hardware businesses will continue to make excellent investment targets in the meantime.

Rebuilding industrial value chains will take time

The US offshored a significant amount of production, such as electronics, in the 70s, which extended into IT and communications in the 90s. Restoring these abilities requires significant time, investment, and effort. Even the most basic of necessities – the humble N95 face mask – required navigating a complex maze of obstacles to have it manufactured back in the US. The irony was US companies had to import materials and production equipment from China to make it possible to manufacture the masks locally. Building a resilient supply chain is expensive as well, just to ensure there are alternative sources and resources. And knowing the bureaucracies of US politics, there’s the challenge of getting all regulatory agencies to work together.

Capital markets aren’t supporting manufacturing

Known as the smile curve and the ‘Manufacturing Gap,’ where the return on capital is too low for capital markets to invest in, the smile curve hypothesis shows that the manufacturing stage is the least valuable in the entire industrial value chain.

This is very much true: chip designers enjoy gross margins as high as 60%, while companies that produce and assemble the chips average just 17%, according to Bloomberg Intelligence. Currently, chip design is dominated by the US market at 68% of the market share. But the US possesses just 3% of the outsourced semiconductor assembly and testing market.

In the West, labor is expensive, energy is costly, and companies struggle to find banks to finance their new factories, especially if it takes up to two decades to pay off.

If we look at NASDAQ to see where capital flows, less than a quarter goes to hard tech. Assuming most of it is R&D, design, and marketing, we can expect even less going into the actual manufacturing of the product. However, more than half of all the market capital is invested in software, and the rest is laid across a broad variety of services and fundamentals.

The Chips Act and the Inflation Reduction Act will not benefit smaller startups

The Chips Act and the Inflation Reduction Act were passed to encourage bringing manufacturing back to the US, creating more jobs, and protecting intellectual property. Subsidies and tax cuts are in place, but we see these mostly benefiting the large conglomerates such as Intel or Texas Instruments. From a WACC (weighted average cost of capital) standpoint, expected returns range from 10% to 15%. For smaller startups backed by venture capital funds, that only makes sense at a 30% internal rate of return. Yet small companies make up the bulk of the market.

And as S&P Global Market Intelligence reports, “there are also plenty of challenges that the Chips Act can’t directly address — a complex brew of economic factors, logistical bottlenecks and disruptions, trade wars, shifting geopolitics and (not least) technical barriers — that could mitigate any positive impacts attributable to the Act.”

Learnings from the clean tech bust a decade ago

The 2011 Solyndra bankruptcy was a valuable lesson for many tech investors, a spectacular failure in the clean tech bust at the beginning of the 2010s. In total, government grants worth $1 billion went up in smoke — it was quite exceptional that a single clean tech company could receive so much in grants. The concept of solar energy drawn from a revolving tube of alternative solar-sensitive materials was interesting, but the delivery and execution left much to be desired. This can be attributed to 3 primary reasons:

(a) Extremely high cost

From R&D to manufacturing to distribution, several teething issues weren’t resolved. Solyndra invested in a costly custom machine that couldn’t reach its expected output. In the end, a Solyndra module’s production cost 30% more than a traditional solar panel.

(b) Slow ramp-up

Poor timing. In 2008, polysilicon prices, a key element for solar panel production, was $300/kg. By the time the federal government approved Solyndra’s loan, the prices fell to $50/kg. Natural gas prices fell as well, contributing to lower energy prices. At the same time, a flood of Chinese-made solar panels became a much more viable option.

(c) Slow revenue

Private venture capital funds typically work on three to five-year horizons. Energy and environmental technology initial offerings on traditional exchanges take an average of 8.3 years.

As TechCrunch reports, “Solyndra had the innovations, but it didn’t get to the price point where it could compete, not only with other energy sources but even with the conventional solar panels it was trying to disrupt.” 

The combination of factors – the 2008 financial crisis, cheaper natural gas, and China’s affordable quality solar panels – formed the perfect storm for Solyndra to fall.

We’re starting to see the same thing happening today. Remember Nikola, touted as the global leader in zero-emissions transportation, energy supply, and infrastructure solutions? The stock (NKLA) price is down 70% today. And chip plants aren’t cheap or easy. Building a chip plant in the US is several times what it costs in Taiwan and Asia. Just an entry-level plant in the US will cost $10 billion to $20 billion, and up to five years to build. Let’s not forget operational costs. A chip plant requires an average of 4.7 million gallons of water daily – unable to meet today’s ESG requirements. A semiconductor engineer’s salary in the US is $118,300 a year, while the same engineer in the Taiwan region is paid $32,500 a year. If we do the math, many of these costs will be passed on to our pockets: the consumers.

“One of the big reasons for this is that the cost of labor is lower, and it’s just far cheaper to produce at a very massive scale, integrated circuits and chips, in those parts of the world (Asia),” says Columbia Business School professor Dan Wang. 

Morris Chang, the founder of TSMC, said that it costs 50% more to manufacture chips in the U.S. than in the Taiwan region.

Difficult to replicate Tesla’s success 

Of course, many will cite Tesla as the most obvious, successful, hard tech company out of the US. It is worth noting that aside from the US, Tesla has built factories globally in markets where they are popular: Germany and China. Two crucial points stand behind its success:

(a) Tesla is a direct-to-consumer company. There are no middlemen costs in between. Even more so with their factories located in customer countries.

(b) The founder, wealthy from his sale of Paypal and eBay, assumed Tesla’s earliest startup risks heavily with his personal funds.

We can safely assume that most startups in materials or hard tech don’t have, or can, afford that model.

When bringing tech manufacturing back to shore is motivated by politics, it inevitably increases costs for everyone, due to the lack of consideration for economic fundamentals. Even with a substantial investment of capital and resources, a clear and present risk of failure remains. While there is a resurgence of hard-tech startups in the market, we prefer to remain cautious – as we, like all capital investors – must look at the hard economics first.

We believe in this because our investment philosophy centers around not just the science behind the tech, but also the macro and microeconomics behind it. It is one of the reasons our investments regularly deliver positive results.

In conclusion, we can expect this to be a long value chain struggle. While there are plans and steps in place to close that manufacturing gap in the West, it will be years, possibly decades, before that becomes a common reality. Until Western manufacturing costs fall to a level that can beat Chinese manufacturing outputs, the advantage of Chinese manufacturing cost, quality and experience remain our preferred reality for now.

China has become a huge magnet for foreign capital. In 2020, despite the COVID-19 pandemic, China passed the United States as the world’s largest recipient of foreign direct investment, while its exchanges hosted half of the world’s 10 largest IPOs and four of the top five. Meanwhile, US pension funds continue to pour money into big Chinese private equity deals—$13 billion between 2010 and 2019—despite geopolitical tensions and disappointment over the sudden halt of the IPO of fintech juggernaut Ant Group.

But for all the inflow of capital, very little of it has gone into Chinese science- and engineering-based startups, especially those working in advanced materials and manufacturing, industrial digitization, AI and IoT innovations, and climate tech. Such companies, often referred to collectively as those in the “deep tech” space (or, more commonly in China, “hard technology”), are where some of the most intriguing developments are underway.

While global private investment in Chinese deep-tech companies totaled $14.6 billion from 2015-2018, according to BCG and Hello Tomorrow, it represented less than 2% of the total private equity funds raised for the China market in that period, based on data from CVInfo.

I see the same lack of interest as a venture capital investor. It’s surprising. The hard-tech space is on a roll: Hard-tech investments in China have had a compound annual growth rate of more than 20% in recent years, with companies benefiting from government policy, an educated workforce, and sheer market size. And the outlook is bright. China’s spending on research and development jumped more than 10% last year, to a record $378 billion. Last month the government announced, as a key new target in the five-year plan, to increase by 7% or more a year its R&D expenditures for 5G, quantum computing, and other initiatives.

There are other reasons the hard-tech space should be attractive to foreign investors. Previously, when foreign interests expanded to China, they brought their own goods and methods. Today’s Chinese market is more dynamic and competent, bringing homegrown innovation to both the domestic market and overseas partners. Tech startups in this space have both the talent and government support to make innovative leaps more quickly than other countries. The size of the Chinese market alone suggests that, if these startups can scale, they will produce returns consistent with those sought by venture capitalists.

That China has both the means and determination to innovate and compete globally in technology and other sectors is increasingly clear—not that it comes without complications. Yes, geopolitical tensions complicate the picture, but there is still opportunity for savvy investors.

Consider the climate space: A recent Goldman Sachs report regarding China’s goal of becoming carbon neutral by 2060 projects $16 trillion in Chinese investment in that sector, creating 40 million new jobs. Plans for IT and cloud infrastructure are similarly ambitious. The technology for much of that is being developed in China and represents a huge opportunity for Chinese industrial startups and foreign investors who choose to back them. Advances in medical devices and solutions are of interest to many investors as well.

READ MORE: Tech in the five-year plan

China’s entrepreneurial climate is strong. The profile of CEOs for industrial startups is increasingly one of experience and sophistication. An earlier generation of young B2C entrepreneurs, such as Jack Ma, who started companies based on little more than a vision. Many of today’s entrepreneurs in hard tech are seasoned business leaders with technical expertise and, in some cases, experience working for multinational corporations. Some have even led public companies. These executives and their companies are geared to a venture-capital model and built for public listing or an M&A exit. In fact, a 2019 survey by Silicon Valley Bank found that more than half of Chinese startups expected their next source of funding to come from venture capital.

Also, the Chinese workforce is (as we have seen earlier in countries such as the United States) increasingly drawn to the startup world, where there is less bureaucracy and things move faster. China has made a huge bet on education. More than 10% of Chinese citizens are now considered scientifically literate by internationally accepted metrics, according to a survey conducted by the China Association for Science and Technology. All of these factors point to an era of rapid innovation and industrialization.

It’s difficult to predict what’s next concerning international trade relations, yet it’s worth noting that tensions tend to reinforce China’s commitment to developing its own hard-tech solutions. The “In China, for China” mindset, fueled by policy and enabled by educational strides, is producing hard-tech innovation that is increasingly competitive globally. China offers an entrepreneurial opportunity that foreign venture-capital investors would do well to explore.