CHINA: A Hotspot for Online Retail

Transcription

1 June 2015 CHINA: A Hotspot for Online Retail China s economic slowdown has worried many investors around the world, but one market segment continues to outshine most others: e-commerce. Here s why and what s driving the winners in the space. Julianne D. McHugh Director, Senior Research Analyst

2 Concerns still abound for China s slowing economy, but the country has enjoyed one continued bright spot: online sales. According to a recent report from Forrester Research, online retail spending totaled $307 billion in 2013 and is expected to top $1 trillion by Last year, Chinese e-commerce behemoth Alibaba Group raised $25 billion in the world s largest initial public offering in history. 2 Although this IPO shattered records and made headlines on its own accord, it also brought global attention to the rapid growth of Chinese online consumption and the competitive advantage that some players have developed. In this paper, we will examine why China offers such substantial opportunity and what has enabled some participants to succeed in a market that is evolving differently than the U.S. A Changing Climate for the Old Guard Unquestionably, China s retail market is a sizable one, representing about US$4.2 trillion in 2014, according to the National Bureau of Statistics. 3 In 2014, total retail sales in China grew 11.9% year over year, continuing a pace of double-digit growth, 4 although representing a slight decline from 13% a year earlier. While the anti-corruption campaign, which started in 2013, and the slowing economy have impacted overall retail growth, forecasts from the country s central-bank officials for 12.2% growth in retail sales for 2015 still outpace GDP growth. 5 Exhibit 1: Shopping on the Go Share of China Online Shopping Via PC & Mobile Device by GMV Q Q E-commerce is fueling much of that growth. According to iresearch, e-commerce transactions grew over 48% year over year in 2014 to US$453.6 billion. Online shopping now represents approximately 10.7% of China s retail market, 6 up from 8% in 2013, surpassing the levels achieved in the U.S. Within e-commerce, iresearch shows that mobile shopping is growing exponentially, accounting for almost 48% of online shopping in the first quarter of 2015, up from 26% a year earlier. 7 (See Exhibit 1.) We believe mobile could represent more than 60% of online shopping in the next few years, given the market s rapid development and mobile Internet adoption. Shoppers Shift Online Consumers have enthusiastically embraced e-commerce in China for a variety of reasons that extend beyond what we witnessed in the U.S. and other developed countries. First, there is a relative lack of access to brick-and-mortar stores in China s lower-tier cities, as retailers have been unable to open enough locations to gain a national presence, given the country s size and shorter history in focusing on consumption growth. In addition, lower-tier cities have relatively low carownership penetration rates, while the higher-tier cities are plagued with traffic congestion, making it difficult to get to a store even if one exists. Source: iresearch Global Inc. The data were calculated and estimated based on the financial results published by enterprises and interviews with experts by iresearch statistical model. 2

3 At the same time, government-backed telcos have been investing in expanding broadband and 3G access to drive higher penetration rates. In many cases, the average Chinese consumer s first PC was a smartphone. Therefore, the country s rising middle class whose disposable income is growing but whose access to physical stores is limited is flocking online, as shown in Exhibit 2. Another structural reason for why online shopping is growing faster than offline is the wide price difference between traditional stores and their online counterparts. Department stores in China do not take ownership of the inventory that they sell but rather act more as a real estate provider to brands selling on consignment. As such, there are a number of intermediaries, such as agents and distributors, in the offline chain, each taking a share of profit before a product is ultimately bought by the end consumer. Add to this any taxes and/or import duties, and the extra charges for consumers quickly mount. In the online marketplace, by contrast, manufacturers can sell directly to consumers without additional commissions or fees. Finally, there is the convenience factor. Similar to what we have seen in the U.S. and elsewhere, many online sites are evolving into information platforms, a source for shoppers to gather data before making purchases. Online retailers also offer consumers incredibly convenient delivery services, some providing items to buyers within as little as two hours. (That s not a typo!) Exhibit 2: Measuring the Share of Online Shopping Online spending in sample of Chinese cities, Lower operating and physical costs and the ability to reach more customers are driving businesses to invest more online than in traditional distribution channels. Businesses can sell goods either to an online player such as JD.com, which sells to end customers, or to end customers directly through marketplace sites such as Alibaba s Tmall. These online players can offer small and medium-sized enterprises some logistics support, traffic and brand credibility that could otherwise be too costly to do on their own. Can Traditional Retailers Respond? In From Bricks to Clicks: A Retail Evolution, The Boston Compnay s Leigh Todd outlined how traditional retailers in the U.S. have stepped up their e-commerce efforts to respond to online competition. Companies have invested in technology and distribution to ensure a smooth shopping experience through linking store inventory with online offerings and creating a seamless shopping experience. Unfortunately, it is not as easy for Chinese counterparts to do the same. As mentioned earlier, a notable difference is that Chinese department stores often do not own their inventory; they are essentially mall operators that offer inventory on consignment. Under this model, they have not been responsible for understanding pricing strategies, nor have they had to build logistics and distribution talent and capabilities. As a result, it is a much bigger challenge for these players to develop e-commerce solutions. Therefore, Source: McKinsey Global Institute analysis; cities analyzed, representing > 70% of online retail sales. 2 Cities in China are grouped into four tiers based on their economic development and political importance. Tier 1 cities have the highest urban GDP, while Tier 4 cities have the lowest. 3

4 the strategies that are emerging in China look different from those that we have seen in the past. Rather than investing in technology and distribution, Chinese retailers are investing in partnerships and product offerings. First, mutually beneficial partnerships are being developed. In 2014, Alibaba acquired a 9.9% equity interest in Chinese department store, Intime Retail, with the potential to increase it to 26% on conversion of convertible bonds. 8 Both firms will benefit from shared consumer data and the ability to target a wider range of customers. In addition, Intime gains traffic as Alibaba will enable its customers to buy online and pick up purchases in the stores, and Alibaba will add leverage to the online payments infrastructure. In this solution, each player continues to focus on its own area of expertise, real estate or e-commerce, while leveraging the infrastructure investments of the other. developed by China s more traditional retailers, given their shorter operating histories and structural differences from U.S. counterparts. Instead, Chinese department stores and malls may be better served by partnering with firms that have already built these capabilities and instead leverage their real estate expertise. The winners will be those with access to customer data and behaviors, access to the goods and services demanded, the ability to drive traffic to gain the sale, and the ability deliver these products on the customer s terms. Others are adapting their inventory strategy in order to minimize the overlap with less expensive and commoditized products sold on line. Consumer-electronics chain Gome is increasing the amount of differentiated products it carries, such as private-label merchandise, licensed brands and exclusive products. In 2014, 33% of Gome s sales were differentiated products, 9 for which Gome owns the inventory, and it is targeting 50% by Still others, such as Golden Eagle, are adding entertainment features such as restaurants, cinemas, spas/salons, and children s play areas in order to drive traffic. These investments may pull down returns up front, with hopes that they will attract more sales in the future. China s Evolving Retail Landscape We expect Chinese consumers to also shop both online and offline in the future, so traditional bricks-and-mortar stores will not become extinct anytime soon. The online marketplaces that dominate China s e-commerce industry today will evolve to include both online and offline storefronts. It is not just the traditional offline retailer that is rushing to adapt. We are also seeing online players, such as search engine Baidu, invest heavily to partner with offline merchants in order to educate consumers about offline goods and services. We expect the most successful strategies to be those that can promote products to consumers when and where the customer wants them. Strong logistics and infrastructure capabilities will be required to succeed in retailing, but this competency is unlikely to be 4

5 End Notes 1. Vanessa Zeng, China Online Retail Forecast, 2014 to 2019, Forrester Research, February 4, China+Online+Retail+Forecast+2014+To+2019/fulltext/-/E-RES Liyan Chen, Ryan Mac and Brian Solomon, Alibaba Claims Title for Largest Global IPO Ever With Extra Share Sales, Forbes.com, Sept. 22, China s Economy Realized a New Normal of Stable Growth in 2014, National Bureau of Statistics of China, Jan. 20, gov.cn/english/pressrelease/201501/t _ html 4. Cecilia, China to Become World s Largest Retail Market by 2018, China Internet Watch, March 19, com/12782/become-worlds-largest-retail-market-2018/ 5. Li Ran and Kevin Yao, China economic growth may slow to 7.1 percent in 2015: central bank report, Reuters, Dec. 13, reuters.com/article/2014/12/14/us-china-economy-growth-iduskbn0js02f China Online Shopping Market Reaches Over 10% Penetration, iresearch, February 10, html?bcsi_scan_de2e b6=gr+yq8c6oe3zbtvrxec+y77g068raaaaxvpkua==&bcsi_scan_filename=6236.html 7. Q China Mobile Shopping Market Surges 168.3%, iresearch, May 26, Elzio Barreto, Alibaba invests $692 million in Chinese department store operator, Reuters, March 31, article/2014/03/31/us-intime-alibaba-group-idusbrea2u01k Gome Achieves Excellent Results under Omni-Channel Strategy, Gome press release, March 23, attachment/ _en.pdf As Mentioned In This Paper, You May Also Be Interested In: FROM BRICKS TO CLICKS: A RETAIL EVOLUTION Traditional retailers are stepping up their e-commerce efforts, in part by investing in better online systems and distribution networks, to make shopping more convenient for their consumers. However, they re also benefiting from technological innovation. In this paper, Leigh N. Todd, CFA, senior retail analyst at The Boston Company, outlines the ways in which the Web has changed the retail landscape. Download Paper >> 5

6 Disclosure Any statements of opinion constitute only current opinions of The Boston Company Asset Management, LLC (TBCAM), which are subject to change and which TBCAM does not undertake to update. Due to, among other things, the volatile nature of the markets and the investment areas discussed herein, they may only be suitable for certain investors. This publication or any portion thereof may not be copied or distributed without prior written approval from TBCAM. Statements are correct as of the date of the material only. This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorised. The information in this publication is for general information only and is not intended to provide specific investment advice or recommendations for any purchase or sale of any specific security. Some information contained herein has been obtained from third party sources that are believed to be reliable, but the information has not been independently verified by TBCAM. TBCAM makes no representations as to the accuracy or the completeness of such information. Listed securities are being present for illustrative purposes only. This is not a recommendation to buy, sell, or hold these securities. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. CFA and Chartered Financial Analyst are registered trademarks owned by CFA Institute. 6

7 About the Author Julianne D. McHugh Director, Senior Research Analyst Julianne is a senior research analyst on The Boston Company s Global Research team, covering the emerging-markets consumer discretionary sector and the global property industry. Before joining the firm in 2004, Julianne was an equity analyst at State Street Research & Management, where she focused on the financials and retail sectors. Before that, she served as a research analyst at Dalbar Inc., covering the financial industry. Julianne holds a B.S. with a concentration in finance from Lehigh University and an M.B.A. with a financial management track from MIT Sloan School of Management. For more market perspectives and insights from our teams, please visit