City Spotlight: Innovation in Shenzhen

November 3, 2016 Posted by China Briefing Reading Time: 6 minutes

By Mike Vinkenborg

Formerly a fishing village, Shenzhen has rapidly emerged into the thriving metropolis it is today. Since the city’s designation as a Special Economic Zone (SEZ) in 1980, Shenzhen has continuously been growing at a high speed. The population has increased from 30,000 in 1979 to over 10 million today, and Shenzhen’s property prices are growing at the highest rate not only in China, but also globally, hitting a growth rate of 62.5 percent in 2015 with no signs of slowing down.

The city is rapidly replacing low-end labor-intensive factories with emerging sectors, having cleared up over 17,000 of these factories since 2011. According to Shenzhen’s 13^th Five Year Plan, the city will spend more than RMB 110 billion on research and development by 2020, representing over 4.25 percent of its annual GDP – numbers only met by high-tech hubs such as Israel and South Korea.

Chinese companies such as Tencent and Huawei have their roots in Shenzhen, and foreign enterprises are increasingly finding their way to the city as well. On October 11, 2016, Apple announced that it will be opening a new R&D center in Shenzhen, hoping to tap the local innovation talent pool. In 2014, 82,254 patents were filed in Shenzhen, amounting to 65 per 10,000 citizens – 13.9 times the national average. In the same year, 11,639 international patents were applied for, accounting for almost half of the total applications in China.

This can largely be attributed to the city’s early establishment as an innovation center. Shenzhen has often been referred to as Shanzhai, with most of the innovation coming from copy-catting Western innovations. However, China’s emerging middle class, who are able to afford genuine and high quality products, have fueled Shenzhen’s transformation into an innovation hotspot, earning the new nickname The Silicon Valley of Hardware.

Preferential policies

Since its designation as an SEZ, Shenzhen has received preferential policies to stimulate technological innovation. At the time of its establishment, the Shenzhen Special Economic Zone (SSEZ) was the country’s largest of its kind. It became an experimentation area for China and its window to the outside world, strategically placed alongside Hong Kong to promote a stable relationship with its prosperous neighbor. As such, the government incorporated several preferential policies to attract foreign investment.

For 36 years, foreign enterprises in Shenzhen have enjoyed significant income tax cuts, longer periods for land use at lowered fees, and simplified application processes. This has proven to be a very successful strategy and continues to be implemented.

In the coming five year period the government is encouraging mass entrepreneurship and innovation as the new engine for China’s growth. Consequently, FIEs in the high-tech sector continue to enjoy such incentives when situated in one of the SEZs. With the entire city of Shenzhen being designated as an SEZ since July 2010, when the Bao’an and Longguang districts were incorporated for the purpose of offering space to enhance Shenzhen’s scientific innovative capacity, Shenzhen was already an attractive investment area. Exclusive to Shenzhen, however, come additional benefits not found elsewhere in the country.

With the recent establishment of the Qianhai Free Trade Zone in a 15 km² area of mostly reclaimed land, Beijing hopes to improve interaction between the mainland and Hong Kong in the financial, logistics, and IT sectors. In the zone, additional preferential finance policies are made available to foreign investors. For firms in the high-tech sector, this includes CIT exemptions for the first two profit yielding years and tax deductions for R&D investments. Besides these preferential policies, more benefits to investing in Shenzhen exist.

Epicenter of innovation

What makes Shenzhen unique is its bustling innovation scene and the available source of talent. The number of incubators has gone up from a dozen to over 1,000 over the past two years, with most of the innovators focusing on hardware. Whereas electronics markets such as Huaqiangbei used to be full of knockoff products, the latest inventions can now be found in the city before anywhere else in the world. Many of the latest inventions can be found in the market, such as a microphone that rates karaoke skills through a smartphone app, computers the size of a USB stick, and mini robot friends.

The startup scene in Shenzhen is attracting young entrepreneurs from all over the country, as well as from abroad. Due to optimized connectivity, ordering hardware parts for prototypes often only takes a few days in Shenzhen, whereas this would take about a month in a country like the UK, and due to the vast amount of competition, acquiring essential parts can be done at lower costs. As such, the speed at which ideas can be turned into products is barely matched anywhere else in the world.

Inventors are able to showcase their prototypes in one of the electronics markets quickly afterwards, gaining customer feedback at a quicker pace before releasing to the general public. These are all benefits that attract new talent to the city every day. However, this open system poses problems as well.

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The Shanzhai culture is still embedded in China. As a result, intellectual property (IP) infringement is still common and once an idea hits off successfully, there will be many manufacturers waiting to join the hype by creating fresh knockoffs. The recent success story of the hoverboard in China is one famous example. Introduced at a premium price of US$ 1,000 in the U.S., Shenzhen-based manufacturers quickly managed to make their own versions for much lower prices before the hype even started. It is therefore essential for any investor to file IP registrations. Just international IP filing is not enough, as these are often not acknowledged in China. When operating in China, it is essential to file domestic IP registrations as well, which can be a lengthy process.

Made in China 2025

With GDP growth slowing down, China is hoping to complete the transition from an economy driven by investment and exports to one driven by innovation and local consumption. It wants to move up the value chain, with the Made in China 2025 initiative being one of the main pillars in the latest Five Year Plan. To encourage innovation, the country will continue to offer incentives to investors in high-tech industries. Importing foreign knowledge is essential in this process, thus creating opportunities for FIEs. And when it comes to hardware, Shenzhen is the epicenter of innovation in China and offers a huge pool of talent to tap into.

When asked about Apple’s decision to open an R&D center in the city, CEO Tim Cook mentioned that Apple “realized the skill level of Shenzhen’s factories was gradually leading other places in the world”. Apple is just one of the firms to notice this. With China aiming to innovate and produce higher value goods, the government strives to attract more and more foreign expertise to reach its goals. The combination of preferential policies, the city’s strategic location, and its huge talent pool makes Shenzhen a highly attractive place for innovative high-tech firms.

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Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email china@dezshira.com or visit www.dezshira.com.

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