China tech: new frontiers

How is China innovating and developing cutting edge technology?

von UBS AM 09. Jan 2020

China tech: new frontiers – in 60 seconds

  • China's successful landing on the far side of the moon represented a 'moonshot,' but we see many other cases of tech-driven moonshots happening domestically in China;
  • AI-driven 'city brains,' foldable smartphone screens, and robotics are just three of many areas where Chinese companies are taking the lead;
  • China's commitment to R&D is a key driving force here and one which will continue to differentiate it from global competitors in the coming years;
  • We believe this wave of innovation is positive for long-term economic growth prospects and will likely be the source of attractive long-term opportunities for investors for many years to come.

Cotton, potatoes, moon landings

The 'Space Race' between the US and Russia began in 1955 and saw billions of dollars spent on developing spacecraft, launching satellites, and putting men on the moon.

But landing on the far side of the moon remained elusive because neither the US or Russia had the capacity to maintain communications with space probes on the far side of the moon.

However, that all changed in early 2019 when China launched its own communications satellite to maintain contact and then followed up with a manned mission (Chang'e 4) to the far side of the moon that landed on January 3, 2019.

China's mission didn't just stretch boundaries by landing on the far side of the moon; it also redefined space exploration because it featured experiments to grow cotton and potatoes on the moon.

China's growing space ambitions

Source: Space Launch Report, 2019

Why cotton and potatoes?

Cotton and potatoes have been around for years, but growing them on the moon was all about preparing for the future.

Successfully growing crops could help astronauts grow their own food, and that could support longer-term and more wide-ranging exploration of the solar system.

More than that, it could point to redefining how we think about the moon in the first place, less as a goal in itself for exploration, but more of a staging post with a permanent presence from which to launch missions to other planets. Indeed, China's ambitions are far-reaching and the government has announced plans for a Mars mission in 2020.

So expect lots of excitement both in China and globally about a potential Mars mission in 2020. If so, it truly would add further weight to China's space exploration credentials. That said, such a mission may not rely on space-grown cotton, since the seeds on the moon died within two days of planting.

More than the moon

But China's progress is remarkable. It only launched its first manned space mission in 2003 and is now overtaking established powers like the US and Russia in space exploration.

But as much as it is remarkable, it is also typical of China's rapid advances in recent years, particularly in the world of tech and innovation.

That's because Chinese companies have rapidly increased their spending on R&D in recent years.

In part, that's because of government support, but it's also because of fierce competition in domestic markets which means companies have to constantly innovate to maintain a competitive edge.

Global Comparison: R&D Spending (as % of GDP) and GDP per Capita (USD), 2017

Source: OCED, Morgan Stanley Research, May 2019

And this R&D spending is feeding through into rapid growth in patent registrations. After starting from low levels in 2008, Chinese entities have ramped up patent applications and are on course to soon overtake the United States.

Patents are an important indicator because they measure how innovative a country is becoming and, crucially, that it is protecting its intellectual assets.

Global Comparison: International Patent Applications ('000s), 2002-2018

Source: OECD, Morgan Stanley Research, May 2019

While China's innovation progress that can be seen as a threat for China's strategic competitors, its good news for investors, for two principal reasons:

  1. Increased innovation is positive for China's growth prospects: Innovations help drive productivity, and productivity drives long-term economic growth, according to the IMF.
  2. Companies leading these innovations have the potential to grow over the long term: China has already produced a whole range of innovative, investible companies, and it's likely that more are on the way.

The right conditions

Looking at China's corporate universe, we feel the conditions in China are ripe for innovation, for four main reasons:

Firstly, the size of the market offers opportunities to run localized product innovations (at scale) which can generate rich feedback. It's this factor which has helped Chinese companies test ideas locally, build rich datasets and rapidly innovate product.

Secondly, China has a wealth of tech prowess at hand. An estimated 4.7 million graduates in STEM fields, as well as well-established tech platforms, allow for rapid product development;

Thirdly, having access to a well-established manufacturing ecosystem that allows product prototypes to be developed quickly, and then brought to market quickly.

Finally, China doesn't have the same data restrictions as the US or Europe, and that give China tech companies a big advantage in terms of data collection and manipulation.

You find in China the intersection of craftsman kind of skill, and sophisticated robotics and the computer science world. That intersection, which is very rare to find anywhere, that kind of skill, is very important to our business because of the precision and quality level that we like

Tim Cook, Apple CEO

Moonshot

A project that addresses a huge problem, proposes a radical solution and uses break-through technology

(Google)

Against this backdrop, we're seeing a series of what we call moonshots, which - like the moon landings - could be major tech breakthroughs that change the way we both see and function in the world.

Moonshot #1: The city brain

For anyone who has struggled through dense inner-city traffic, the cost in terms of time (and tempers) lost can be huge.

Indeed, the costs are high for economies, with some estimates putting the cost of traffic congestion in the US alone at USD 305bn , according to INRIX, a transport consulting firm.

While the causes of congestion differ between countries, two key factors are largely consistent across the world: rapid urbanization and increased car ownership – two areas where China's challenges are severe:

  • 187 million people have moved into China's cities since 2010, and 144 million more are estimated to move into urban areas by 2030, according to estimates by the United Nations;
  • Car ownership in China has quadrupled from 59 million in 2007 to 240 million in 2018, putting untold pressure on China's roads and environment and exacting a huge cost on local economies, with congestion costs in Beijing estimated at USD 11.3bn per year;

But one leading tech company has come up with a solution – the city brain.

In simple terms, the city brain is an AI-driven supercomputer linked to a vast network of sensors, cameras, traffic data sources, and on-board computers within public transport.

The supercomputer processes traffic data, feeds it through an algorithm, and then produces a range of solutions ranging from lengthening/shortening traffic signal cycles, directing services to road accidents, highlighting illegal parking, and clearing the roadpath for emergency services like fire and hospital responders.

The first city brain was put to work in Hangzhou in 2016, and has been credited with increasing traffic speed by 15% and improving traffic flow to such a degree that the city slipped from 5th place to 57th place in the rankings of most congested city in China.

Moonshot #2: A new breed of screens

While we all might spend time in traffic jams, we definitely spend more time looking at smartphones.

Three hours and fifteen minutes per day on average, in fact, according to research by Rescuetime , a US-based tech company whose apps measure screentime use globally.

But the demands we are placing on our smartphones are changing.

Data service improvements means smartphones are becoming the main place where we watch films, play games, and work – so smartphones are increasingly becoming like tablets.

And Chinese companies are delivering new innovations in foldable smartphone screens. That's why Huawei sold out the first batch of its new Mate X on its release on November 15th, as consumers lapped up the new technology, despite the high price tag (USD 2,419.70).

The phone features lots of innovations that Huawei is famous for – high-speed processors, advanced camera functions, but it uses the latest foldable screen technology, which is supplied by a Chinese company.

Suppliers from outside China are coming up against fierce competition and innovation from domestic Chinese companies, particularly in the foldable screen segment.

And now China's prowess is being recognized by Apple, which is trialing the technology for a major domestic supplier as it looks to launch its own foldable screen iPhone model in 2020.

It remains to be seen whether Chinese companies will unseat dominant players like Samsung, but news that the world's biggest companies are adopting China tech because of its prowess, not only confirms the progress Chinese companies have made in a short period of time, but also indicates where the future lies for the smartphone industry, and that's a development that will affect us all.

Moonshot #3 Robots

As with smartphones, Chinese manufactured goods are part of everyday life, but where you may be familiar with Made in China, you'll likely have to get used to Made (by Robots) in China.

That's because robot installations are spreading widely in China's manufacturing sector, with an estimated 154,000 systems installed in 2018 alone, roughly equivalent to the combined total installed in the US, Japan, Germany and Korea.

Annual installations of industrial robots ('000s)

Source: UBS Asset Management

The push factors are obvious: labor costs have been on the rise for some time now, and the after-effects of China's one-child policy mean that the supply of labor to the manufacturing sector has declined dramatically.

Most of the industries adopting robots on production lines are well known: auto companies have lead the charge, as have electronics manufacturers, and more traditional parts of the manufacturing sector.

But robots and automation are becoming much more widespread - And the applications being dreamt up for robot applications are increasingly wide-ranging:

  • Hotpot service: Hotpot is a traditional favorite both in China and across Asia and one growing hotpot chain, Hai Di Lao, has employed waiter robots to serve customers, as well as robotized soup mixers to precisely mix the broth that constitutes the key ingredient of the hotpot dish;
  • Package sorters: Competition is cut-throat in China's e-commerce industry and major players are filling their warehouses with automated guided vehicles to pick, load, and package deliveries to boost efficiency and reduce customer waiting time;
  • Reception staff: Called FlyZoo Hotel, the structure hosts a robot at the reception that through the facial recognition deals with the registration of guests while various routine operations are automated for an experience with the least possible human interference. The robotic intelligence is called Space Egg and combines AGV technology with communication and facial recognition abilities.

Companies that are taking the lead with automation are taking the benefit by boosting efficiency, cutting delivery times, improving customer service, and reducing costs for many Chinese companies, but the take-up of robot systems is also a boon for domestic robot manufacturers in China, who are ideally placed to capitalize on this growing market. 

A note of caution

But as much as China's tech achievements are accelerating, it's important to remember that the companies behind them are operating in a unique environment.

And that may be a limiting factor because many new innovations in China rely on data capture methods and management that would not be allowed in say Europe or the United States.

Additionally, government restrictions in both inside and outside China and may prevent companies - like the one behind the City Brain - from expanding and transferring technology.

That said, we maintain that as the moon landings of 1969 changed the way we saw the world and opened up a whole range of new possibilities, China's rapid progress in the world of tech and innovation is a similar force.

And that's something we believe will outlive the short-term vagaries of the US-China trade relationship. China's fundamentals and domestic conditions are too strong to be held back by tariffs on selected industries.

And we note that Chinese companies have responded to recent tariffs by doubling their efforts to develop domestically-produced technology, for example Huawei's base stations now have no US-produced parts.

Put together, we believe China's commitment to innovation is something that all investors should bear in mind because it not only bodes well for China's long-term growth prospects, but will also create a range of investible ideas in China's tech sector.

UBS Asset Management - Deutschland

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