11 min read

How Airbnb Manages to do Business in China

How Airbnb Manages to do Business in China

Facebook is banned in China. Google is also banned. But Airbnb isn’t. I wanted to know why China allows Airbnb to operate when it’s banned so many large American tech companies, so I dug into the history of Airbnb and their operations in China to figure out what it takes to grow a truly global tech company in the 21st century. What I found really surprised me.

Airbnb is a great lens to view US-China relations and in this video I’m going to show you the China loophole, how it relates to Airbnb’s history, and what it means for the future of American technology companies in China. The Chinese economy is expected to be the biggest in the world in a few years after all, so this is important stuff.

If you’re traveling to China, you’d probably need a VPN just to read this post. That’s because most websites are blocked by the Great Firewall, which prevents anyone in China from accessing basically any website or app that the government doesn’t have control over. Instagram, Pinterest, and Snapchat are all blocked, but Airbnb isn’t. Which struck me as odd, since Airbnb is a very typical American tech company. They were founded in the Bay Area, are listed on the NASDAQ, and all three founders are American citizens.

But Airbnb has employed a few key strategies to allow them to succeed in China where so many tech startups have failed before, and understanding the choices Airbnb has made shines a light on how the Chinese Communist Party views relations with American companies as a whole. Let’s figure this out together.

Part 1: The China Loophole

China has an entirely unique set of rules and regulations when it comes to internet businesses. Taking a business model that’s working in the United States and expanding internationally is often alluring because of how many new customers you could gain. If you have product-market fit domestically, launching that same product in a foreign country seems like an easy way to grow your business. But China is unlike any other country in the world.

See, China is a one-party state led by the Chinese Communist Party, and the government enforces strict rules around what can be done on the internet. In America, you can spin up a new startup with little more than a landing page, but expanding your venture into China is a lot more complicated.

Airbnb has taken three key steps to maintain compliance with the Chinese government and each one showcases the benefits and costs of expanding into China.

The first hurdle in any American company’s way is the Internet Content Provider or “ICP” license.

“The ICP is kind of the golden key, that opens the gate and allows you inside.” - Ziyang David Fan, Senior Legal Counsel at Airbnb 2015-2017

That’s Airbnb's former Senior Legal Counsel stressing the importance of this license. Without it, you literally can’t put up a single website in China, and it’s far from a simple process. You need a local law firm in China to help you with the filings and have your web hosting provider vetted by Chinese authorities.

“This is not just any business license you can do within 21 days, this takes all teams” - Ziyang David Fan, Senior Legal Counsel at Airbnb 2015-2017

Airbnb is a big company though, so they clearly have the resources to set up a team in China to handle this, but the specific structure they used to build their Chinese division is unlike any normal corporate structure.  And here’s where it gets really weird.

Under Chinese law, foreign ownership in most Chinese industries is prohibited. Companies like Alibaba aren't allowed to have non-Chinese shareholders, but there’s a work around. It’s called the Variable Interest Entity or VIE, and this is really the heart of the China loophole.

A Variable Interest Entity is essentially just a shell company. The entity is set up to hold all the assets the company owns in China, but because of Chinese law, the entity isn’t technically owned by the controlling company.

So Airbnb created one of these variable interest entities to operate in China, but it doesn’t own a single share of it. Instead, there is a complex web of legal agreements between Airbnb and their Chinese counterpart that gives Airbnb a claim on the profits belonging to the shell entity, but there is no recognition of any actual ownership.

This model was actually first developed by Enron to perpetuate a massive fraud at the turn of the millennium and it has major risks. If you’ve seen the recent volatility of Chinese stocks on American exchanges, it’s all because of the VIE structure. Because Airbnb lacks clear control over their China operations, there’s a chance that laws could change and they could have to forfeit everything very quickly.

But this is essentially the cost of doing business in China. When you can’t own shares in a Chinese company, it’s basically impossible to set up a proper subsidiary, like you would in Canada or Mexico.

These laws make rapid expansion into China extremely risky, and as we’ve seen, most American tech companies fail to gain traction in China. Airbnb was willing to undertake the challenge of getting an ICP license and setting up a Variable Interest Entity, but that doesn’t explain why China let them advance through these stages undeterred.

The reason is that China cares a lot more about censoring information on social media than restricting commerce, and Airbnb isn’t really used for spreading information like Facebook and Twitter are. One of Airbnb's investors put it really well:

“Media and commerce are two separate categories, and as you know media is a lot more regulated and there’s a lot more oversight in that part of the internet value chain. Whereas cross border commerce is being promoted by Chinese government.” -  Hans Tung

Essentially, if you’re going to do business in China, you’re going to have to hand over your data and censor information that the Chinese Communist Party doesn’t want spreading. This requirement has proven to be insurmountable by many American tech companies. Google famously pulled out of China entirely after refusing to censor search results.

But Airbnb's business isn’t built on data and censorship isn’t as much of an issue, so these Chinese rules are much less harmful to their core business. In order to understand how Airbnb operates and the real reason why they actually stand a chance at launching a successful China operation, we have to go back to the company’s founding.

Part 2: AirBnB History

In 2015, Brian Chesky, the founder of Airbnb stood on stage with Xi Jinping at a US-China technology summit. But just 8 years earlier, he was a broke entrepreneur looking for a way to pay his rent.

It was 2007, and Brian was living with his future Airbnb co-founders although he didn’t know that at the time. He had graduated from the Rhode Island Institute of Design and recently decided to move to San Francisco to pursue the dream of building a startup.

This is October 2007, I get to San Francisco and Joe tells me the rent is $1,150. I didn’t have enough money for rent. That weekend, this international design conference was coming to San Francisco. We went to this conference website, and we noticed on this conference website, they had a hotels tab. And we clicked on the hotels tab. And in the hotels tab, there are always hotels and next to every hotel, it said, “sold out”, “sold out”, “sold out”. And at that point, we just had this idea. We said, “well, designers need a place to stay, we literally have no money, in fact I don’t know how I’m gonna make rent.” So we thought, what if we just created a bed and breakfast for the design conference? - Brian Chesky

So they created the first Airbnb ever in their own apartment. The idea didn’t take off immediately, but after testing the idea again at a few other conferences, they began to think the idea had traction.

Beyond saving money on hotels and being able to find a place to stay on short notice, Airbnb created really strong relationships between hosts and guests. When most people travel, they want to get to know the city they are staying in and have an authentic experience. By staying in an Airbnb, a tourist would have a local contact and get recommendations about what to do in town.

And it’s this idea of building a community and sharing culture that really drives Airbnb to expand globally. Airbnb’s mission is to “create a world where anyone can belong anywhere” and in order to achieve that mission, Airbnb has to be available in every part of the world, even if that expansion comes at a very significant cost.

But it’s also in Airbnb's financial interest to expand globally, even more so than other tech companies. This is because the short-term vacation rental market has a global network effect. It’s a winner take all market because people who use Airbnb while traveling from New York to San Francisco will also want to use the service while traveling abroad. And this became a really critical strategy for the company early on in their journey.

The first few funding rounds for Airbnb were pretty small by Silicon Valley standards. They joined Y-Combinator in 2009 and received $20 thousand dollars in exchange for 6% of the company. The entire global financial system had just collapsed and America was still recovering from the great recession, so startup valuations were definitely depressed.

As Brian went out to raise money for Airbnb after demo day, he wasn’t getting a lot of attention. It was still difficult for venture capitalists to wrap their minds around the idea of staying on an airbed in a strangers house. But one venture capitalist knew there was something special here. Greg McAdoo at Sequoia Capital saw something unique in Brian and his team: they had grit.

One of the biggest concepts Paul Graham, and really the entire Y-Combinator team tries to instill in the startups they fund is the idea of “staying alive.” Far too many entrepreneurs raise money and then spend it all over a few months, expecting that they will be able to raise more. It’s critical to instead focus on keeping your startup alive for as long as possible, by any means necessary.

The Airbnb team had scraped by for years doing whatever it took to make ends meet. They just refused to call it quits. During one particularly rough stretch, they decided to capitalize on all the hype around the 2008 election between Barack Obama and John McCain.

Leveraging their design backgrounds, the team put together custom cereal boxes with each candidate's name on them and sold them as collectors items at the conventions. Even though this wasn’t a scalable business and really had nothing to do with Airbnb directly, they made $25 thousand dollars and were able to keep the company alive for a few months longer.

This story resonated with Paul Graham, who accepted Airbnb into the 2009 YC cohort, and when Greg McAdoo asked PG what team had the most grit, it was an easy answer.

That willingness to grind it out when times were tough allowed Airbnb to survive long enough to raise more money, and I think this determination is a big reason why Airbnb has been able to overcome so many challenges in China.

Brian and the Airbnb team were able to raise a $600 thousand dollar seed round after demo day and quickly followed that with a $7 million dollar series A in 2010. These are pretty typical figures for young startups, and are even a little low by present day standards, but Airbnb's Series B round was where things really changed. They raised a massive $112 million dollars from Andreessen Horowitz, and the reason was clear: Airbnb had to go global.

A group called Rocket Internet had launched an Airbnb clone in Europe called Wimdu and this was a major threat to Airbnb's long term plans. Within 3 months of closing the Series B, Airbnb had opened its first international office in London. Airbnb wound up beating Wimdu and establishing a strong foothold in Europe, but Asia would be another matter entirely.

Airbnb wanted to create a flywheel of guests becoming hosts and vice versa. People would start by using Airbnb while traveling for work, like what happened at that first design conference, but then they would start using it for vacations. The more they traveled using Airbnb, the more likely they were to list their own home on Airbnb when they had free space.

Leaving international markets up for grabs was extremely risky. If American travelers wound up using a different app while traveling abroad, they could easily wind up using that app while traveling domestically as well. If one country stops using Airbnb, there could be a domino effect in other countries.

China is the final frontier in Airbnb's plan to become a truly global company and in order to win, Airbnb has to be a great experience for both Chinese hosts, and Chinese travelers abroad. Here’s Airbnb's co-founder explaining their full rationale:

“Why China? So, Chinese travelers are the biggest spender on international tourism. It’s at this point double or triple that of the United States or Germany which is number 2 or 3 respectively. So it’s a huge outbound market. So that alone is a reason to prioritize it.” - Nate Blecharczyk

That’s Nate Blecharczyk. He’s a co-founder of Airbnb and the Chairman of Airbnb China, and he’s a really critical part of this story. When he says “outbound market” what he means is Chinese tourists staying at Airbnb’s while abroad.

But there’s a second critical piece to Airbnb's China strategy:

“The second part though is, you know, this is a marketplace networks effects business and so actually more than 50% of our travelers going to destinations in Asia are coming from China. And so by attracting Chinese guests from China, we’re actually helping to grow our business in Japan, in Thailand, throughout Asia.“ - Nate Blecharczyk

Other tech companies can afford to cut ties with China if they don’t have as strong of a global network effect. But losing China may cause Airbnb hosts in Japan or Thailand to switch to a competing service, which could cause a domino effect. When a user decides to list their home on Airbnb, they want to be sure that any traveler, no matter what country they're coming from, can book a reservation without any issues. And that’s why China is so critical.

Part 3: The Future of China

Airbnb clearly needs to maintain operations in China. Their entire Asia business depends on it, but sharing customer data with foreign governments is a tricky issue that is starting to play a bigger role in the national dialogue.

Chinese apps like TikTok have come under fire for collecting data on US consumers while ultimately answering to the Chinese government. As AirBnB has grown their operations in China, they have had to make compromises to the way they handle customer data.

Since 2016, Airbnb has told users that it shares information with Chinese authorities. Phone numbers, email addresses, and in-app messages are all made available to the government when you check into a Chinese Airbnb, but this doesn’t really surprise me.

I was in China a few years ago and just assumed that the government could see anything I was doing on my phone, and I expect most Airbnb guests traveling in China would assume the same.

While I would never want to live in a place that restricted personal freedom and privacy to such an extent, I don’t think there’s much that a company like Airbnb can do about it.

Nate Blecharczyk actually made headlines last year when the Wall Street Journal reported that he had said “We’re not here to promote American values” - that can seem callus, like he’s someone that doesn’t see privacy as a universal right, but I think he’s just doing what’s best for Airbnb.

Ultimately, pulling out of China would mean sacrificing not just their Chinese business, but much of their Asia business more broadly, and it wouldn’t do anything to change how privacy is handled in China. Local competitors would just step up to fill the void while gladly giving full access to their data.

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