The period of China’s most robust growth has corresponded with the global rise of the internet and the digital economy. This convergence is placing China in the forefront of e-commerce growth worldwide. Some of the same disruptive processes we’ve observed in the U.S. with the rise of companies such as Amazon, Netflix, Priceline, and eBay are also playing out in China. The difference is that this disruptive force is hitting China just as the country is stepping into the limelight as a consumer powerhouse. The evolution of retailing in China will look nothing like other developed nations.
In the third quarter of 2013, Chinese online retail sales were up 42 percent from the third quarter of 2012 — indicating that online retail is growing at three times the pace of Chinese brick-and-mortar retail. At current growth rates, Chinese online retail will overtake the U.S. in absolute size by 2015.
[See Related: Retail Analyst: Recession Driving Consumers Online; Predicts "Terrible" Christmas Shopping Season
Online Retail in the U.S. and China: Similarities and Differences
Expansion of online retail in the U.S. has been dramatic, as the above graph shows (we were reminded of this trend this past weekend, as a shopping trip to buy shoes began with visits to brick-and-mortar retailers, and Vertical Axiz = Billions of USD Source: McKinsey & Company Growth of Online Retail Worldwide ended at Zappos.com). Chinese online retail growth has been even steeper — and steeper than other fast growers such as Japan.
Several factors give particular power to this trend in China.
First, China’s brick-and-mortar retail sector is underdeveloped, so online retailers aren’t facing the same kind of competition that they have in the U.S. There are regional differences, with more remote areas and smaller 3rd tier and 4th tier cities being particularly poorly served. As yet, robust and dominant national retail chains have not emerged — and given current online retail developments, they may never emerge.
Second, while U.S. online retail was born during the PC era, Chinese online retail is emerging in the era of mobile devices. Morgan Stanley research observes that 40 percent of new users accessing mobile internet in China have never accessed the web via a personal computer. Falling smartphone prices are helping penetration, but there is still huge scope for growth. Total broadband penetration in China is estimated at only 30 percent.
Third, while U.S. online retail is developing in the context of a mature consumer economy with slower growth prospects, China’s is occurring in the midst of the emergence of the largest consumer cadre on the planet. Again, especially in smaller cities and further-flung regions, these emerging Chinese consumers have felt their spending power increase with relatively few outlets for it. Online retail seems to be leap-frogging the widescale development of brick-and-mortar retail to meet their needs. In China’s 4th tier cities, the average online shopper spends more than a quarter of their disposable income on internet retail.
Fourth, Chinese online retail is taking a different structural path — one that sharply decreases the upfront costs for merchants establishing their businesses. While online retail in the U.S. is dominated by large business-to-consumer sites such as Amazon and the online storefronts for large brick-and-mortar retailers like WalMart and Target, China’s online retail space is overwhelmingly oriented to marketplace sites such as those run by Alibaba — Chinese equivalents of eBay. Taobao, run by Alibaba, has 6 million merchants listing on it.
Fifth, evidence shows that since Chinese online retail is meeting significant unmet needs among underserved consumers, there is little cannibalization of brick-and-mortar sales. Analysts estimate that slightly more than half of each yuan spent online is taking away from a brickand-mortar seller — and slightly less than half is a new incremental sale that would not have occurred offline.
Analysts estimate that online retailing could lift overall private consumption by 4 to 7 percent by 2020.
Sixth, online retail has some attractive cost-saving features for retailers and therefore for the consumers to
China E-commerce Comes of Age in the Mobile Era whom the savings are passed — notably relief from China’s high and fast-rising rental costs, as well as easy ways to work in a gray area where tax avoidance is facilitated. That second one may not last forever, but it is certainly a factor that’s presently in play.
And last, the Chinese government has so far taken a rather friendly, laissez-faire attitude towards e-commerce — perhaps keeping in mind the employment and labor efficiency it will generate.
U.S. and Chinese Online Retail: Similarities and Differences
Source: McKinsey & Company
The Future Face of Chinese Retail
Among the more interesting aspects of online retail development in China, is the parallel to a process seen elsewhere in the developing world. The wide availability of wireless phones obviated the need in much of the developing world to build out a large, expensive, traditional land-line phone infrastructure. This permitted telecom systems that had missed out on the development of such infrastructure to skip it, leap-frogging directly into wireless. This leap-frogging allowed many emerging countries to offer better, more robust wireless access than was available in parts of the developed world.
With China hitting its transition from industrial-led to consumer-led economics at this exact technological junction, the same thing may happen in retail. Rather than have to build-out a brick-and-mortar retail sector, China might show us what a consumer economy looks like when it bypasses that stage and jumps straight into dominant online retail.
Online retail growth is surely the writing on the wall globally, but the process will likely be even more ferocious in China than in the developed world. Chinese online retail, and e-commerce generally, presents a host of investment opportunities beyond the actual retail marketplaces and storefronts themselves — in sectors as diverse as marketing, IT, warehousing and distribution infrastructure, and payment services.
Here are some Chinese online retail organizations: Soufun Holdings ADR (SFUN), Qunar Cayman Islands Ltd. ADR (QUNR), E- Commerce China ADR (DANG). We are not recommending any of them for purchase.
This is because their shares sell at very high valuations. and we are uncertain about the accuracy of the financial information for a couple of them. At this stage this is only a list of some of the names we are monitoring. Should they fall dramatically in valuation, we might recommend some of them — but not yet.
For more commentary or information on Guild Investment Management, please go to guildinvestment.com.
