The Uber-Didi deal is more about China than about Uber and Didi

[Photograph by kaboompics under Creative Commons]

Let’s lift the veil for a moment. On July 28, China announces new regulations for cab-hailing services. Barely 48 working hours later, Uber decides to sell out its Chinese business to Didi to create a cab-hailing company with over 90% marketshare. Is it a mere coincidence?

Not likely. If these events are connected, and I suspect they are, then a government/regulator has just facilitated the creation of a monopoly in China, with the Party’s blessings. 

China has demonstrated again and again that it will not allow foreigners to control its vital assets—and what’s more vital than its entire digital ecosystem? Almost every Western tech giant has learnt it the hard way—that China has its oligopolies (the trio of Alibaba, Baidu, and Tencent) and the government protects them fiercely.

And why not? What China has essentially done is that it has created a giant utility out of Didi-Uber, a near monopoly, highly regulated—yet driven by the profit motive—unlike an inefficient bureaucracy-laden utility.

Now, it wasn't as if Didi was given all of this on a platter.

This state-led economic model allowed Didi to merge with its local rival Kuaidi. The new merged entity had to then clearly demonstrate that it had the capability to compete with the world’s best. Only then was it anointed a monopoly and allowed to buy Uber. In a sense, the fittest has been rewarded, provided that it eventually plays by the rules that were set for it.

The logic behind this economic model is simple: the government knows that a state-controlled enterprise will not be able to harness the energy of its entrepreneurs, so it carves out markets for them to play in, provides a cushion of state debt and benign regulations and allows them to build scale rapidly.

Here’s an excerpt from The Economist:

“A third group of firms appears to be fully private, in that the government owns no direct stake in them. Their bosses are not political appointees, and they are rewarded for commercial success rather than meeting political goals. But they are still subject to frequent meddling. If they are favoured, state-controlled banks will provide them with cheap loans and bureaucrats will nobble their foreign competitors. Such meddling is common in areas such as energy and the internet.”

This schema has been used in company after company—allowing the build-up of the three giants who rule the roost in their respective “core” segments. Alibaba for e-commerce and payments, Baidu for search and Tencent for social media. Of course, these companies compete, but they do collaborate when they get a gentle nudge from the powers-that-be at the Party office. An example of this is Alipay—which was allowed to grow despite there being no regulatory framework for online payments. Today, Alipay has over 450 million users and has almost 70% market share in mobile payments and has created a frictionless escrow and payment system which has been the bedrock of China’s internet boom. (For those interested, here’s a useful primer on Alipay.)

This is the reason that no Western internet company has been able to make any headway into China. Google and Facebook have been effectively kept outside the market. Amazon lost the battle and gave up. Only Apple—which has a huge manufacturing base in China and has created jobs there, and has agreed to comply with demands of the Chinese government regarding storage of Chinese users’ data, has been able to craft a working arrangement to build its China business.

Here’s a bit more perspective from the WSJ:

“President Xi Jinping—with the help of conservatives in government, academia, military and the technology industry—is moving to exert influence over virtually every part of the digital world in China, from semiconductors to social media. In doing so, Mr. Xi is trying to fracture the international system that makes the internet basically the same everywhere, and is pressuring foreign companies to help.”

The context in this piece may be internet censorship, but the broad principles drive the Party’s agenda of “Internet Sovereignty” and putting its internet businesses behind the “Great Firewall”. Uber’s case is another example of success—ironically, Didi-Uber is now a monopoly whose significant shareholders are the Chinese trio of Alibaba, Tencent and to some extent Baidu. If anything, these three shareholders will strengthen Didi’s monopoly by blocking any local player. Between the three—they control over 70% of China’s internet traffic.

In the case of Alibaba, the unprecedented state support initially was evident, as this story from Forbes points out:

“Since the early days, Alibaba, has been supported by the Chinese government which used Alibaba’s Taobao and Tmall sites to do billions of dollars of transactions between various government agencies which allowed Alibaba to post eye-popping revenues and growth in the early days.

“The Chinese government still conducts a lot of trade between its various agencies using Alibaba platforms so as to ensure the continued scorching growth rates that Alibaba has been able to post year in and year out.

“In almost every single line of its various businesses, Alibaba is by and large protected by the government from foreign competitors. I have been saying for almost a year that between the government related intra-trade and the sale of fake goods that occur on Alibaba’s various B2B, C2C and B2C trading platforms, there is not a whole lot of actual business occurring when looked at on a percentage of overall revenue basis. A large portion of Alibaba’s revenues on its various auction sites continue to be various Chinese government entities doing business with other Chinese government entities.”

If you pull back, you have to simply marvel at the ingenuity of the Chinese. After all, it is remarkably clear about the objectives of its strategy: protect a few domestic players, allow them to build efficient near-monopolies and in fact, actively encourage it and then govern them with a benign eye to ensure that they don’t abuse their power. You get the best of both worlds—a bunch of entrepreneurs who are driven to compete and make billions and an efficient utility for your consumers that cuts down transactions costs and friction in your economy.

The Chinese don’t see the fact that a few billionaires get created along the way as a large social cost, particularly because those billionaires are beholden to them to do their bidding—and will not abuse their firms’ monopolistic powers against Chinese consumers. This allows the creation of large, scalable cash-rich companies, which have the economies of scale to compete in international markets and buy the best technology assets.

Also, the fact that the Chinese government has serious global ambitions for its local giants is self-evident. In 2014, a report in Bloomberg pointed out how the Chinese government had supported Alibaba in every which way:

“Chinese government officials are eager for a local company to break into the ranks of tech’s global elite, and the huge payoff for Alibaba will highlight just how valuable official Chinese support can be.”

We’ve yet to see a global success story—but I think we are at the cusp of ownership of a global tech company by the Chinese.

This is not to say that we can or should follow the same system in India. We are vitally different at the core. The government or a political party does not “run” our businesses or our lives. In effect, our regulations are designed to avoid the creation of monopolies. There are structures that create oligopolies which are “natural monopolies”—i.e., public goods are auctioned out, like for instance in telecom, the regulators work hard to ensure that monopoly power is not abused. Unfortunately, this leaves Ola to fend for itself—the large marquee investors in Ola have already hedged their bets by investing in Uber—so in the betting game of venture capital, they are a bit indifferent to Ola surviving as a standalone company.

Now, coming back to Didi, it is entirely possible that the 20% stake in the combined entity for Uber China (Uber gets a 17.7% stake but only 5.9% of the voting rights in the new entity; investors in Uber China, including Baidu, will get a 2.3% stake) is not born of any economic rationale, but more of a negotiated settlement accorded by the powers-that-be in exchange for perpetual licence and access to the technology Uber creates—a way for China to secure the best technology for its urban transportation and autonomous travel sector. Of course, the way Uber will portray it is that it gave up a battle to fight the war.

It isn’t just Uber CEO and co-founder Travis Kalanick, who deserves kudos for his strategic retreat from the Chinese market. We also need to reserve some for the Party bureaucrat who stitched up this deal.

Updates

August 5, 2016:
An earlier version of the article said that Uber will have a 20% stake in the combined entity. This has been corrected to Uber China, which includes Baidu as an investor.

August 6, 2016,
The article was updated to include details of Uber's stake in the new combined entity.The Author's Note was updated to include the two possible outcomes for Uber following its deal with Didi.