China’s Consumption Growth Engine
China is the largest eCommerce market globally…
Global eCommerce sales reached US$889bn in 2013, and China was the largest market, at US$314bn, our global teams estimate. The eCommerce mega-growth trend is still in its initial phase in many countries, including China. Broadly speaking, we expect multiple phases in China’s eCommerce growth, with the current phase (up to 2016) driven by more new online shoppers (194mn added in 2013-16, we project). As online consumers become more sophisticated, we expect online spending per user to reach US$1,880 by 2018, from US$1,040 in 2013. We estimate China’s eCommerce industry in 2018 will account for 18% of the country’s retail sales, up from 8% in 2013. We expect it to contribute 30-40% of incremental retail sales annually in the same period, becoming one of the key drivers in China’s US$3trn consumption market.
… and eCommerce is one of the major ways to address China’s 21st century challenges…
China is faced with slowing growth, an aging population and overcapacity in multiple sectors. Until now, China’s ambition to be a consumption-led economy has been impeded by lack of a social safety net, fragmentation and uneven quality of its physical infrastructure, and regional imbalances in economic development.
China is also in the midst of a digital revolution, with the internet embraced by major sectors, not only those that are consumer-focused. We think that technological innovations and data-centric solutions will help the consolidation process that is required to ensure sustainable growth.
… and it is still growing, driven by key enablers
Over the next decade, greater mobile adoption, increased participation and improved infrastructure are key enablers:
Mobile penetration – On average, 26% of online purchases were made on mobile devices in China in 1H14. Of China’s 780mn active mobile devices in 1H14, 58% are registered in lower-tier cities, where users’ first internet experience is likely through mobile. As illustrated in Exhibit 3, there has been a strong correlation between online shopping and smartphone penetration since 2011. Faster and cheaper 4G network connections should help accelerate mobile usage.
Infrastructure support – Outlined in China’s 12th Five-Year Plan, the government seeks to help construct 200 logistics industrial parks in major economic zones. Investments in highways, railways and waterways are key initiatives.
Opportunities that could drive change:
• The move to eCommerce becoming a key driver of a consumption-led economy, contributing 33-40% of incremental retail sales annually in 2014-17.
• Promotion of mass consumption amid rising affordability. The Alibaba Shopping Price Index has shown declining prices online, suggesting increased affordability.
• Greater SMEs and rural participation. As of end-2013, SMEs accounted for 70% of China’s GDP, and rural areas housed 46% of China’s 1.4bn population. We expect lower barriers to participate in online commerce versus offline, as well as rising incomes, to ensure greater participation from these underserved markets.
• Streamlining and improvement of supply chain and distribution value chains. A more sophisticated C2B (Consumer-To-Business) business model would streamline the supply chain and flatten distribution layers in key consumer categories.
• An accelerated crackdown on counterfeit goods, illegal parallel imports and fictitious transactions are long-term positive, but they could be near-term headwinds for selected industry players.
• Digitization and connection of online and offline commerce, leveraging existing resources and reduce wastage
Threats that could impede growth:
• Regional imbalance = logistics inefficiencies. Income and supply hub imbalances could result in a “full truck in and empty truck out” phenomenon.
• Slower delivery and uneven service quality due to the multi-layer franchised model of 3PL logistics companies.
• Higher costs and greater competition among sellers and participants in the eCommerce ecosystem.
• Taxes (VAT) positive for B2C but negative for C2C
• Extended period of macro slowdown
Key Industry Debates / Issues
Global investors are grappling with many uncertainties when investing in the internet sector given the rapid changes of the industry and technological advancements. We believe the following are the key questions that investors are examining:
1. Is Social Commerce an opportunity or a threat?
2. Verticalization – will verticals take material market share from platforms and be the dominant eCommerce force in China?
3. Which eCommerce Model works for China long term – the 1P principal (direct sales / consignment) or 3P marketplace (commission / advertisement)?
4. Should eCommerce platforms build their own warehouse infrastructure?
5. Should eCommerce platforms operate the last mile delivery network?
Global investors and the Street’s opinions remain split on many of these questions; and admittedly it is still too early in the industry’s development to have the right answers. As such, throughout this report, we seek to enhance the debates by providing incremental insights that the Street has yet to discount and examine how the China model will evolve. Ultimately, we recommend investors to compare the eCommerce companies’ absolute gross profits earned over time and, more important, the level of returns and value created from the profits reinvested.
eCommerce is a global trend but the right business model needs to be localized…
To address the above questions, we believe investors should also be aware of the structural differences between China and the US – they are different in many ways. Unlike other internet sub-sectors with similar business models replicated globally, the right eCommerce business model for any country needs to be tweaked for the local market, similar to physical goods retailing offline.
A one-size-fits-all approach is unlikely to work. Specifically, consumption habits, the maturity of offline retailing and the complexity / fragmentation of wholesale and retail distribution are critical factors shaping online digital commerce dynamics. Additionally, China’s internet sector is regulated, enabling domestic incumbents to grow without much foreign competition. Potential deregulation of the internet industry long term could also change the competitive dynamic over time, we believe.
… and China is primarily a DIY market for sellers and retailers operating inside the leading 3P marketplaces
The dominance of Alibaba’s 3P marketplaces (i.e. Taobao and Tmall) have shaped China’s eCommerce industry to be a primarily DIY (Do-It-Yourself) market in which C2C sellers and B2C retailers handle most parts of a transaction value chain, as illustrated below. This is different from the primarily DIFM (Do-It-For-Me) approach that Amazon uses to dominate in the US.
Over the long term, we think alternative platforms to Alibaba’s could add value in some parts of the transaction value chain, especially in warehousing management. Nonetheless, the DIY method for traffic generation and customer service will continue to be the standard that sellers, distributors and retailers use to conduct business in the leading 3P marketplaces (such as Taobao, Tmall, and JD).
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