China roars along e-tailing superhighway
Mass consumption is coming of age in the internet era, write Richard Cooper and Richard Dobbs.
When you think about centres of technological innovation, Silicon Valley, Seattle and Seoul are probably the first places that come to mind. After all, they are the homes of Amazon, Apple, Facebook, Google, Intel, Microsoft and Samsung - companies whose innovations transform the way other sectors, from financial services and telecoms to the media, do business.
Now, however, the rise of "e-tail" (consumer-facing e-commerce) in China is enabling Hangzhou - the base of Alibaba, China's largest online retailer - to join their ranks. Indeed, on April 29, Alibaba signalled its ambitions by buying an 18 per cent stake in Sina Weibo, China's version of Twitter. And, as with technology hubs elsewhere, innovations born in Hangzhou are determining the development path of related industries.
China's e-tail market is the world's second largest (after the US), with an estimated $US210 billion in revenue last year. Since 2003, the market has posted a compound annual growth rate of more than 110 per cent. By 2020, China's e-tail market could be as large as today's markets in the US, Japan, Britain, Germany, and France combined.
Despite a broadband penetration rate of only 30 per cent, e-tail commanded between 5 per cent and 6 per cent of total retail sales in China last year, on par with the US. And the sector is already profitable: Chinese e-tailers are logging margins of 8 per cent to 10 per cent of earnings before interest, taxes, and amortisation, which is slightly larger than the average margin for physical retailers.
Two features of Chinese e-commerce stand out. First, roughly 90 per cent of Chinese e-tail is conducted on ad-funded virtual marketplaces. On these platforms - which resemble eBay and Amazon Marketplace - manufacturers, retailers and individuals offer products and services to consumers through online shopfronts. By contrast, in the US, Europe, and Japan, roughly 70 per cent of the market is composed of e-tailers running their own websites, whether online-only merchants such as Amazon or traditional bricks-and-mortar retailers such as Carrefour, Dixons and Walmart. Moreover, a study by the McKinsey Global Institute shows online purchases in China do not simply replace offline purchases. Rather, e-tail supports incremental consumption: $US1 of online consumption seems to generate roughly US40¢ of additional sales. And incremental spending as a share of total spending is even higher in China's less-developed cities, where a shortage of bricks-and-mortar retailers means that online shopping provides access to otherwise unavailable products and brands.
Mass consumption in China and other emerging economies is coming of age in the internet era. Given that industry structures are still developing in many of these countries, e-tail is set to shape
not only the retail landscape, but
also the manufacturing and financial services industries - and even the urban landscape itself.
In most countries, the retail sector has typically developed in three stages: first, local or regional players dominate, before a smaller number of national companies takes over, with e-tailers ultimately challenging traditional businesses. But China lacks national leaders, with the top five Chinese retailers in different product categories commanding less than 20 per cent of the market, compared with up to 60 per cent in the US. And establishing a strong physical presence throughout the country will be time consuming and expensive.
By contrast, Alibaba (which owns marketplaces such as Taobao) and 360buy.com (which focuses on electronics) rank among China's top 10 retailers, and already provide national coverage through the reach of express delivery companies. As a result, China's retail sector seems more likely to follow a two-stage development path, with e-tailers emerging as the nation's big sellers.
The ability afforded by online marketplaces to new players to attain national - and international - prominence without huge upfront investment will profoundly affect how retailers and manufacturers approach new consumer markets. Japanese retailer Uniqlo, for example, used such marketplaces to expand into China in 2009.
Likewise, by removing some of the benefits of scale and specialisation that characterise the consumer-goods industry elsewhere, e-tail enables new manufacturers to join the market, selling goods such as apparel and cosmetics directly from workshops and factories to consumers. Such businesses are also leveraging their broad access and widely recognised brands to expand their role in financial services.
Finally, e-tail could shape China's urban development and transform leisure activities. Urban centres worldwide revolve around shops, whether on main streets or at the shopping centres, with many consumers viewing shopping as a leisure activity. China's evolution will probably entail smaller main streets and shopping centres, with large distribution centres near city limits. Citizens will spend more free time engaging in other activities, such as dining out. These changes could alter the use and pricing of real estate.
Other emerging markets are likely to follow a similar course. Chinese e-tailers are already using their advantages in exporting products from the country's factories to expand internationally. And enterprises in other countries are adopting a similar online business model.
China may have largely missed the Industrial Revolution in the 19th century. But its approach to e-tail is poised to be one of the forces shaping the emerging-market internet revolution of the 21st century.