News analysis: Internet startups reinvent offline services

When Cheng Wei knocked on the doors of several venture capitals three years ago to fund his smartphone app helping people to hail a taxi, few thought it was a good idea.

Three years later, Didi, the application Cheng developed at Xiaoju Technology, dominates China's taxi hailing market and has expanded its offerings to ride-on-demand services similar to that of Uber.

Cheng's vision has grown from simply connecting passengers with taxis to offering transportation solutions based on traffic conditions and what's available on the street, be it a cab or a private vehicle heading toward the same destinations.

That vision is now worth 16.5 billion U.S. dollars, compared to 51 billion for Uber, Didi's closest equivalent in the world. Its latest round of funding even attracted China's sovereign wealth fund China Investment Corporation.

Didi's success came as China has became the world's largest smartphone market, with more than 500 million people logging onto the Internet via smartphones.

Smartphones are affordable, with many budget brands produced by Chinese firms like Xiaomi, Huawei and Lenovo selling for less than 160 dollars.

"This is probably the largest consumer market where the consuming class has emerged at the same time as everyone got a smartphone," said Jeff Walters, partner at the Boston Consulting Group. "Consumption is still growing quite strongly, and if I can identify one area, it's obviously online."

Though a slowing economy has weighed on retail sales, they still grew by 10 percent in the first half this year. Online retail grew by 40 percent in the same period, accounting for 10 percent of total retail sales.

"If a company manages to consolidate both online and offline, it has the potential to become the next Alibaba," said Han Weiwen, partner at Bain & Company.

That's what Alibaba did earlier this year when it invested in Suning, a brick-and-mortar retailer, just days after its rival JD.com bought a stake in supermarket chain Yonghui for better logistics and delivery.

Integration between online and offline are also helping the underdeveloped offline service sector drastically improve by using the Internet and data analytics to offer everything from dining, travelling, house-renting to home cleaning and even getting a manicure.

Venture capitalists from both China and abroad have invested hundreds of billions in startups.

The picture, however, is not that rosy. Startups are finding some of their offerings at odds with existing regulations. Companies like Didi and Uber have been repeatedly warned by local transportation authorities that their ride-on-demand services are illegal because private automobiles are not allowed to drive passengers for profit under existing rules. Some drivers were fined.

"The regulator is not right in all cases and the company is not right in all cases. It's not black and white," Walters said. "Frankly it takes time and friction to work it out."

Though online represents the future of China's consumption, the playground is getting overly crowded, with numerous strikingly similar ventures vying for consumers' attention. Most of them, analysts say, will die out.

Investors are pulling out of some less promising startups that they see as unlikely to survive the fierce competition. Even Didi merged with another firm, Kuaidi, in February after a year of expensive battling to convince customers to use their services.

"I'd always tell my staff, for every dollar we get from our investors today, we'll just have to pay back some day," Cheng said. Endi