Burning cash has become alarmingly fashionable among Chinese internet companies, many of whom have taken to paying customers massive subsidies to use their services in hopes that their competitors go out of business before they run out of money.

One start-up, Emao.com, which aims to be an online platform for car dealerships, has based its entire marketing strategy around losing money. “We burn cash from our investors to win the hearts of car shoppers,” a recent ad says.

Travis Kalanick, chief executive of Uber, boasted earlier this year that the ride-sharing app’s China affiliate was losing more than $1bn a year, in part because of the subsidies it was paying to grab market share. A local car hailing app, Didi Kuaidi, is waging a fierce price war against Uber in several cities.

Uber’s competitors have made it clear they will not be outspent. Jean Liu, Didi’s president, said in September that “we wouldn’t be here today if it wasn’t for burning cash”. The company’s chairman, Cheng Wei, said the company spent $4bn last year in what he called “market fostering”.

Executives from another rival carhailing app, Yidao Yongche, said last month that they are “entrapped in a cash burning vortex”. Zhou Hang, the chief executive, said recently: “We have prepared at least Rmb3bn-Rmb5bn of ammunition for the year.”

“Burning cash” may not sound like a viable business model, but these young companies argue that paying customers to use their services is necessary to build their brands and achieve the scale needed to compete. This is especially true in China, where a shift from an investment-driven to a consumption-led economy, which the government insists is under way, makes the goal of buying Chinese consumers — in hopes that one day they will buy your wares — look appealing.

At least some see it this way. Others claim the Chinese internet fad for burning cash heralds the top of an internet bubble. Just as Silicon Valley companies convinced investors that profits no longer mattered during the 1990s dotcom bubble, China’s internet companies have made a fetish out of losing money.

“A lot of these companies will be forgotten when the money runs out,” said Ma Jihua, founder of Datareal consulting, who estimates that as much as Rmb50bn a year is being poured into subsidies aimed at connecting Chinese consumers via their smartphones to taxis, massages and car washes.

But he concedes that companies have little choice. “In this market, if you don’t burn cash you won’t get market share which means you won’t get funding, consequently meaning you won’t stand a chance against competitors that do burn.”

‘A big party for consumers’

Funded largely by venture capital and private equity firms, along with larger — and profitable — internet companies like Tencent and Alibaba, most of the subsidies are going into apps that aim to be the Uber of massages or the Airbnb of car washes. These “online to offline” services, or O2O, are the hottest investment theme in China’s internet sector.

The potential benefits to the market leaders help explain why they are so willing to spend: according to HSBC, China’s O2O sector is a Rmb10tn market that is only 4 per cent penetrated, and grew 80 per cent year on year in the first half of 2015. HSBC estimates that in five years the “profit pie” in the industry would be worth Rmb26bn.

“O2O right now is a big party for consumers,” said Meng Xing, CEO of Helijia, a health and beauty app, in an interview last month. “We have no plans to make profit in the near future, because the VCs are still offering money.”

Over the past year, his company has “burnt several hundred million renminbi,” he said, though he has cut back on subsidies after his main competitor went out of business. “That’s just how the Chinese internet is, it’s too popular. There are so many VC and [private equity] companies that are willing to fund these wars.”

Start-ups are busy raising funds from investors at ever more dizzying valuations, only to plough them back into subsidies. Recent funding rounds have valued Didi Kuaidi at $20bn, up from $15bn last July. Uber China was valued at $7bn in a January funding round, while the merger of Meituan and Dianping, the two largest food delivery and group discount sites, was valued at $15bn-$17bn in November.

Many of these companies do not publish financial statements, so it is impossible to see what the true scale of cash burn is. Mr Zhou estimates that Rmb20bn was burnt by car-hailing apps like Yidao, Uber and Didi Kuaidi on rider subsidies in 2015, while Meituan Dianping, the biggest seller of restaurant reservations and cinema tickets in China, put out a cryptic press statement in February that said it had “saved food lovers Rmb58bn” in 2015.

Last year, 84 O2O companies went bankrupt, but the sector also attracted huge headline investments. Alibaba and its payment affiliate, Ant Financial, announced they will each invest Rmb3bn to develop a food delivery service called Koubei, while search engine Baidu has said it would invest Rmb20bn in Nuomi, a group discount and food delivery app.

JP Gan of Qiming, a venture firm that is funding the Helijia app, says there is method to the subsidy madness. “Most sophisticated venture capitalists are looking at the same model — you buy users, you buy service providers, you scale up the platform to 100 cities or 200 cities, and you build up a concentrated workforce to provide services to the parts of the cities where there are customers,” he says.

But the pitfalls are obvious in a sector where the providers are fragmented and the services closely resemble each other. Ken Xu of Gobi Capital, a VC firm in Shanghai, says the problem is that “the user has no loyalty to anybody in these sectors; they only go for the apps that have the subsidies. In car-hailing apps, everybody is starting to realise they are subsiding the same group of people who either use Uber or Didi Kuaidi, depending on who is paying them more.”

‘Last man standing wins’

The O2O model has been subjected to scrutiny elsewhere, especially in the US, where many apps that form the basis of the “gig economy” have failed after venture funding dried up. That experience has spawned worries in China about whether the same will happen once the era of “VC welfare” ends.

One difference between the US and China, however, is that the offline shopping and services are so much farther developed in the US that “business is not desperate for the internet to make it more efficient or attractive”, says Duncan Clark, head of Beijing technology consultancy BDA and author of a forthcoming book on Alibaba. In China, bricks-and-mortar commerce is often overpriced or simply dismal, he says, so investors are betting that the internet will be the primary way that Chinese connect to services in the future.

“In the west, we’ve had efficient retail for a long time,” Clark adds. “In a sense China is leapfrogging the west.”

Another advantage for China’s high tech economy is a distinctly low-tech factor: labour costs. Couriers are 10 to 20 per cent the cost of what they are in the US.

Hans Tung, a managing partner at GGV Capital, said that cheap labour and urban population density in China are among the main reasons why the O2O services are economic, compared with the US, where the sector has struggled. “In the US there has been uneven uptake of this so-called gig economy because consumers are more spread out, delivery cost is higher, usage frequency is lower,” he says. “It is harder, besides Uber and Airbnb, for start-ups in this category.”

In China these factors are all flipped in favour of the industry. “The costs of delivering O2O services are lower, urban population is denser, and therefore, the fundamentals of the sector can be better once there is consolidation around category leaders,” he says.

But it is clear that subsidies still play a defining role.

Companies are giving massive discounts to tempt consumers. At Rmb99 on the app goodchef.com, it is cheaper to invite a chef over to your house to cook a five-course Sichuan meal than to go to a restaurant, where the same meal might set you back Rmb200. Taking an Uber ride a short distance for Rmb8 is two-thirds the price of a ride in a licensed taxi, whose fares are already held low by government fiat.

A driver for both Uber and Didi, who gave his name only as Mr Guo, says both companies pay subsidies that often amount to two to three times the cost of the ride.

“Subsidies are an essential part of the income. Because of the competition, the fare is very low,” says Mr Gou. “Without subsidies, the fare is not enough to cover the gas — it wouldn’t pay off.”

The ultimate viability of this business model depends on what happens when the money stops, as it inevitably will, say analysts.

Last year, there were already signs that investors have had enough of “cash burn”. Pressure from investors was thought to be behind the merger last year of Didi Dache and Kuaidi Dache, two reigning taxi apps, who no sooner had solved their cash burn problem than Uber appeared on the scene. Later in the year, Meituan and Dianping merged, only to be confronted with search engine Baidu’s competing platform Nuomi.

“That’s the story of the Chinese internet — the last man standing always wins. And sometimes when there are two last men standing they will merge,” says Mr Gan of Qiming.

Brian Viard, an economist who teaches at the Cheung Kong Graduate School of Business in Beijing, says platforms like Uber and Airbnb depend on large numbers of customers and sellers to achieve a critical mass, which drives down costs. But he said the fundamental model of “burning cash” is more about optimism than economics.

“A lot of these companies have one thing in common — their perceptions of the odds of success are higher than they actually are,” he says.