Dr. Kai-Fu Lee is a name that is increasingly associated with the Chinese technology sector, having worked with companies like Apple, Microsoft, and most recently, with Google, to make their debuts in the Asian/Chinese markets.  His blog, hosted at the popular Chinese Internet portal Sina.com, is one of the site’s most popular, with more than 18 million hits at the writing of this entry.

After a rather public transition from Microsoft to Google, and an even more exit from Google China, the Carnegie Mellon-educated computer scientist is onto his next venture with Innovation Works, an incubator which aims to nurture and support the next generation of Chinese entrepreneurs.

While the Chinese Internet space has grown significantly in the last five years, regulatory challenges, a lack of know-how in bringing concepts and technical tools to market, and a general ecosystem to promote innovation has hindered the entrepreneurial growth of the Chinese tech sector.  Lee hopes Innovation Works will be the bridge to take China’s tech sector to the next level, and help create the same environment for innovation that has historically defined Silicon Valley.

In a discussion with members of the Asian-American Investment Managers community, Lee shared some of his thoughts on the current and future state of the Chinese tech space, particularly in online services.

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Talent and Scalability. Regardless of industry, one of China’s greatest opportunities (and challenges) is the size of its population. With 1.3 billion people focused on education, Lee highlighted the opportunities in scalability inherent in the number of skilled engineers in the country, who have also won their fair share of global programming accolades.  In a marketplace where the average salary for an engineer is 18,000 USD — compared with nearly ten times that amount in Silicon Valley — there are more opportunities to explore projects and ideas that may have been otherwise passed up.

While Lee admits that like in any other start-up environment where not all ideas may pan out in the end, the lower costs of testing out different business models and products will result in greater overall success.

Gap between actual and achievable potential of the Internet. I know that this is such vague and self-evident statement, but when you look at the numbers, it’s an important concept to keep in mind.  Currently, China has 390 million internet users, representing roughly a quarter of the country’s total population. Lee explained that since most online activity is still concentrated purely around entertainment and gaming services, the full potential of the Internet is yet to be fully explored, from online advertising, to e-commerce, to business services.  Below, I’ve highlighted some of the key opportunities that Lee raised:

• Cloud computing software will spearhead innovation in China’s software sector. Due to piracy and lack of IP protection, growth in software development has been stalled.  By forcing users online to run all processes, and in turn paying for these services, Lee predicts that cloud computing will change the way software is developed and distributed in China. He correlates this to the Chinese gaming industry, where 12 years ago, students were swapping CDs in dorm rooms, where today, they are paying spending their allowances on virtual goods.
• E-commerce will grow by at least 200 times in the next five to ten years. According to Lee’s estimates, China’s e-commerce environment is at least five years behind that of the US and Japan.  The average spending per capita online is 1/16 of the US, the Chinese online connectivity is 1/3 that of the US, and most of that has been C2C.   Roughly half of all e-commerce transactions currently take place on Taobao, the C2C selling arm of Alibaba.com.
• Mobile. Lee sees the greatest potential in the mobile sector, which currently has 800 million users (the number of cell phones).  Of those, Lee estimates that approximately 160 million are already on the mobile Internet.  However, most people are using their phones only for texting or reading, because that’s what’s most readily available now. What will happen when a device like the iPhone launches in China?

Google’s withdrawl from China: Of course, the topic of withdrawl of Google China came up — regardless of whether or not you agree with the company’s decision, Lee argued that it has also sent a signal to global companies like Facebook and Zynga who will be more hesitant in making significant headway/investment into the China market.

This, added with strict filtering mechanisms instituted by the government, has created an environment of two Internets — China and the rest of the world. What this means is that companies who choose to go directly to China will only be competing with local companies — for the time being.

As Professor Peter Yu, a legal scholar at Drake University once said, “The question is no longer how the Internet will affect China. It is how China will affect the Internet.”

Final thoughts: As always, Lee delivered an engaging, thought-provoking discussion that was able to break down something as abstract as “opportunities in technology in China” into bite-sized, actionable thought/action items.  As Lee himself said, “I really was not leaving Google, but rather going to Innovation Works.” With a system like Innovation Works in place, it will be interesting to see some of the developments coming out of the Chinese marketplace in the next couple years, especially in its development of not only entrepreneurs, but product managers who can combine technical know-how with business savvy to bring concepts to market.