Zhu Shi'an walks quickly as he leads a visitor toward a building being remodeled to house part of one of Beijing's newest high-technology business incubators. "In this older entry portion of the building, we are in many ways in the 1960s," he says. But opening a connecting door to the refurbished incubator section, he declares, "Now we are moving into the new century." The incubator's goal: to help transform the rundown facilities of state-owned conglomerate Beinei Group into a productive part of the nation's economy.

China's high-technology incubators are providing crucial assistance to young and old companies alike, but government involvement is limiting their potential

China has founded more than 130 high-tech business incubators since opening its first in 1987, according to statistics from the Torch High-Technology Industry Development Center, under the Ministry of Science and Technology (MOST). The ventures are sprinkled among office buildings, universities, and established state-owned enterprises (SOEs), such as Beinei, that are in dire need of new business models.

Most incubators provide companies with low-cost office space and strategic advice on issues such as management and financing, and most are government-owned. Some target rapidly growing industries such as biotechnology, microelectronics, software, and telecommunications and seek to attract Chinese students returning from overseas and international investors. But how effective are these institutions--can they be a tool to energize Chinese entrepreneurship with vitally needed managerial guidance, capital, and institutional support?

The Western experience

In contrast to the American model, in which some 25 percent of incubators are for-profit, most Chinese incubators, organized under MOST's umbrella Torch Program, are nonprofit. Only a handful of Chinese incubators are privately owned, though most incubated companies are in private hands. Indeed, Chinese incubators face the difficult task of assisting and guiding private entrepreneurs in a society that until a decade ago looked with great suspicion on those trying to build their own company.

Characteristics and roles of incubators

The primary attraction to many tenants is the low rent, which can be 50 percent or more below market rates. Rents for admitted companies usually rise over a three-to-four year period, to encourage companies to become self-sufficient and eventually graduate. Tenants receive other infrastructure discounts, such as subsidized telecommunication network access and use of community meeting rooms.

Other features found in incubators reflect a Western model: staff provide companies with advice on management practices and loan applications and give low-cost or free legal and accounting aid. Perhaps most important for the fledgling companies is potential--though limited--access to venture capital (VC) funding. As discussed below, this part of the equation has become the most vital--and yet most nettlesome--for new companies.

Table 1 summarizes some of the key national statistics for incubators. As of 2000, about 37 percent of China's 21,000 high-tech companies in development areas were housed in incubators. The average size of an incubated company--about 17 employees working in about 350 square meters (m2) of office space--has remained fairly stable over the past seven years. Total income for tenant companies has risen more than tenfold, and the average revenue per company has gone from about 1 million RMB ($120,000) to 2.3 million RMB (nearly $280,000). According to Chinese officials, however, few of these companies actually earn profits during the incubation phase, and only one-third or fewer of them graduate after the flexible and often non-contractually binding limit of three or four years. Others either terminate their business or linger on in the incubator. Claimed failure rates range from as low as 10 percent for electronics equipment manufacturers to as high as 90 percent for Internet or biotechnology-related startups.

Table 1 Growth of High-Technology Incubators, 1994-2000
	1994	1995	1996	1997	1998	1999	2000
Number of Incubators in China	73	73	80	100	100	110	131
Number of Tenant Companies	1,390	1,854	2,476	2,670	4,138	5,293	7,693
Average Number of Tenant Companies per Incubator	19	25	31	27	41	48	59
Total Employees in Tenant Companies	NA	NA	NA	45,600	68,975	91,600	128,776
Average Number of Employees per Tenant Company	NA	NA	NA	17.1	16.7	17.3	16.7
Total Income of Tenant Companies (billion)	1.48	2.42	3.63	4.08	6.07	9.58	17.88
Average Income per Tenant Company (million)	1.06	1.31	1.47	1.53	1.47	1.81	2.32
Number of Companies Graduating	NA	174	284	177	491	618	836

In the past seven years, the total number of incubators in China has doubled, but the average number of tenant companies per incubator has risen from 19 to about 59. This has posed problems for some incubators that cannot meet the demand for management support. For example, at Jinghai Hi-tech Business Incubator Co., Ltd. in Beijing (one of the country's few incubators in private hands), manager (and Qinghua University MBA graduate) Yang Yanqiu has only enough time to devote her full attention to helping the five most promising--and potentially profitable--of her incubator's 32 companies. Jinghai has taken up to 50 percent equity stakes in some of these chosen companies. Most of the incubator's other enterprises, however, receive little targeted aid from Yang and her handful of assistants. Yet even this minimal level of attention surpasses that devoted to tenants of the typical state-owned incubator. Most managers of these outfits have backgrounds in government work, so they can offer little practical management advice.

The typical ownership structure of China's incubators gives rise to other problems. Government incubators often take little or no equity stake in the incubated companies and thus have little motivation to generate profits by helping their tenants succeed. Nevertheless, they do excel at providing mainly non-financial aid to small, high-tech enterprises that can find little other administrative support. Moreover, as discussed below, some government incubators have started to take financial interests in hosted companies on an experimental basis, indicating some movement toward greater profit incentives for incubator managers.

Types of incubators

University incubators

The Beinei Group's incubator has become a model of sorts for other SOE incubators. As of late 2001, it hosted some 15 companies that employed about 400 workers, and occupied nearly 10 percent of Beinei's old internal combustion engine plant.

Many of China's major universities have used incubators to channel academic and scientific talent into the business world. Beijing's Qinghua University and Shanghai's Fudan University provide useful cases of such interaction.

Qinghua founded its incubator, dubbed "Pioneer Park," in August 1999. With nearly 40 companies as of late 2001, the innovation center is part of a larger university science park. Because of space limitations, the incubator was selective, accepting only 20 to 30 percent of applicant companies. Fudan University founded its Yangpu incubator, which now has some 150 companies, in an area bordering its Shanghai campus in 1997.

The university incubators' obvious advantages include ready sources of faculty and students. Professors in specialized fields, such as those in the university's business school faculty, regularly hold sessions for the tenant companies and lecture on accounting, tax rules, and management practices.

Qinghua's incubator typically recruits recent graduates--several companies interviewed in 2001 claimed each employee had a Qinghua degree. Former students founded most of the companies, with two or three companies led by returned overseas students.

Qinghua's faculty used to act as consultants, rather than company employees. In late 2001, however, the university began to discourage faculty members from taking too much time from their teaching duties to participate in company activities. Fudan's policy was that faculty members should spend at least 80 percent of their time in education efforts, but one computer science professor at the Shanghai incubator said he spent 95 percent of his time doing company work. With typical university salaries at Fudan ranging from about 2,000 to 3,000 RMB ($240 to $360) per month, the higher-paying work at private companies is tempting.

Returned overseas student incubators

In Beijing, the Haidian Pioneer Park's returned student facility, founded in 1997, houses 140 companies, most of which focus on information technology. Returned students average 30 to 40 years old, and most have a PhD and 6 to 12 months of overseas work experience. Up to 80 percent of returned students possess either foreign passports or foreign resident rights, mainly in the United States, Canada, or Australia.

Returned students are attracted primarily by the opportunity to found their own companies, a prospect many find difficult abroad. Language and lifestyle issues also attract students back to the PRC. The Pioneer Park offers free rent for 60 m2 of office space during a company's first year and discounts on rent for the next two years; provides standard legal, loan, and managerial advice and assistance with photocopying, faxing, and other clerical work; and helps resolve housing and childcare-related issues.

The biggest barrier, even for returned students at the Haidian facility, is generating sufficient startup capital. Pioneer Park officials complain that they could not offer financial assistance or take a financial stake in any of the promising companies under their purview. They pointed out, however, that returned students bring back as much as 300,000-400,000 RMB ($36,000-$48,000) of their own seed money and can use this to cover many startup costs. Few of the companies, however, are able to attract overseas VC funding.

SOE incubators

Incubators focusing on, or even operating within, SOEs represent a novel way to tackle this most difficult institution in China's economy. Though SOE incubators are found in only about a dozen enterprises nationwide, they are based in key corporations such as Capital Iron and Steel Co. and Beijing Chemical Plant. Beijing's Biomedical Hi-Tech Incubator Co., Ltd. provides in-house laboratory equipment for scientists from SOE pharmaceutical companies as far away as Guangdong.

The Beinei Group's incubator has become a model of sorts for other SOE incubators. As of late 2001, it hosted some 15 companies that employed about 400 workers, and occupied nearly 10 percent of Beinei's old internal combustion engine plant.

As production at Beinei fell in the late 1990s, plant space, equipment, and workers became available to new, private companies. Most of the incubated enterprises, such as those making medical equipment or automated road-toll collection machines, are well suited for the buildings formerly used by abandoned Beinei production lines. Of the 400 workers, about 200 are former Beinei employees.

For SOEs, then, incubators can solve several problems: they absorb excess labor, use dormant space, and, in the case of Beinei, potentially provide revenue to the host SOE, which can take an ownership stake in the incubator. Beinei Group owns about half of its resident incubator, and the incubator in turn has equity stakes in several enterprises. Unlike the traditional model, however, companies are not encouraged to graduate--rather, they are encouraged to stay and generate revenues for the for-profit incubator. New companies come in as the incubator renovates dilapidated buildings, allowing managers such as Zhu Shi'an to boast about his innovation center's achievements.

Despite this success, the incubator's impact on Beinei's operations remains minimal to date compared to the SOE's engine plant, which currently employs several thousand workers and staff. Zhu's goal is to have 50 to 60 companies in his incubator by 2007.

Venture capital and profit motivation

One manager said that conservative Chinese government venture funds cannot accept the Western idea of only 10 to 20 percent of VC-funded companies succeeding.

Because most VC funds are linked to government coffers, incubators or private companies able to obtain funds felt a distinct obligation to avoid "losing" the resources; one Withub manager noted that an incubator that misuses government money could become a target of official criticism. As a result, such VC funding lacks the air of risk it possesses in the West, and, according to one incubator manager, is scarcely more than a loan in many cases. One manager said that conservative Chinese government venture funds cannot accept the Western idea of only 10 to 20 percent of VC-funded companies succeeding.

Private and overseas VC has managed to infiltrate China's entrepreneurial system through some of the more innovative incubators. Beijing's private Jinghai Group, owner of the Jinghai incubator, supplies VC directly to the best of its enterprises, based primarily on growth of company revenue and profit projections. Shanghai's China Internet Incubation Center (CIIC), a largely privately backed incubator that takes larger-than-normal equity positions of 30 to 60 percent in incubatees, encourages small companies to seek overseas funding. During the Internet boom of early 2000, CIIC claims that one of its companies, an Internet auction site called auctiondown.com, raised $500,000 from an American VC firm. The start-up company, however, operated for less than one year.

Qinghua University's incubator has also opened itself to foreign investment, and as of late 2001, had attracted 40 million-50 million RMB ($4.8 million-$6.0 million) from Taiwan and Singapore investors. These funds gave the overseas investors a 25 percent equity stake in the incubator itself, but the money was targeted at four of the most promising companies at the innovation center. The incubator itself holds as much as a 10 percent equity stake in these select four enterprises.

Struggling for independence

The profit motive may yet become a strong incentive, not just for the tenant startups but also for the incubators themselves. With incubators like Jinghai, CIIC, Qinghua, and even Beinei taking greater financial stakes in their enterprises, successful incubators may eventually attract ever stronger management teams and help small companies grow more quickly. As long as the state takes a major role in operating and financing incubators, though, the enterprises will lack the full risk and reward benefits that private capital flows can offer.