The growth of e-commerce in China is one of the country’s biggest success stories. Chinese e-commerce accounted for almost US$630 billion in sales in 2015, 80% higher than in the US.
Currently 13.5% of all spending, e-commerce in China surpasses all major economies (except the UK1). What is notable to investors today is that the software and services industry, wherein a large percentage of e-commerce transactions take place, has an MSCI China weighting of 30% and annualized returns of 40.6% over the past five years2.
As bottom-up investors in Chinese equity markets, we utilize a selective approach to identify companies with sustainable leadership and growth. Given the importance of China’s e-commerce, we will explore the key unique driving forces behind the sustainability of this growth. These include the near-monopoly status of industry leaders, a strong and widespread rural population with a trajectory in online spending, and creative logistics solutions to tackle the vast geography and fluctuating demand.
How did e-commerce gain prominence in China
China’s combination of an underpenetrated retail market, large geography and widespread Internet availability, has enabled the rapid growth of e-commerce. China has very little physical retail infrastructure compared to other markets - its top 100 retailers make up less than 8% of total retail spend compared with the top US 100 comprising 57%3. This means decreased reach across the nation due to the country’s vast area and number of small cities. Developing a physical presence is both difficult and costly and this has paved the way for an abundance of ‘Mom & Pop’ stores. Access to internet infrastructure however has made it easier and more economical to set up online stores.
Near-monopoly status of industry giants spurs growth
Many Western e-commerce giants struggle to penetrate the Chinese market - not only due to the firewall and other restrictions, but also their business models cannot be easily embedded. Industry domination comes from a few domestic firms who have adapted to the market’s unique demands.
Alibaba, one of the world’s largest e-commerce players, owns Taobao - a shopping marketplace for individual consumers and retailers. Similar to eBay but without the bidding, where sellers are able to post goods for sale, there are no fees for listing items, and revenue is generated by the sale of ads. Unlike eBay China and Amazon, Taobao doesn’t charge for transactions or retain a portion of sales as commission thereby attracting loyal customers in the process. Its large number of merchants offers a wide range of products to users making it a destination for shoppers.
Taobao is a consumer to consumer (C2C) model and just one of Alibaba’s core businesses. Tmall and Juhuasuan are two notable parts of the Alibaba family. Tmall is a business to consumer (B2C) sales platform for high-quality products and established brands while Juhuasuan is a group-buying platform for SMEs wanting to launch promotional sales. In our view, Alibaba’s core businesses coupled with advanced logistics, cloud-computing, and product search services represents a complete and unique e-commerce ecosystem. Its seamless logistics operations, payment system, and near 24-hour online communication between buyers and sellers makes the firm a ‘one-stop shop’ for C2C, B2C, and group buys. Alibaba now holds approximately 80% of the e-commerce market share in China. Comparatively, Amazon has approximately 30% market share in the US due to online competition from independent merchants4.
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1 McKinsey iConsumer China 2016 Survey, April 2016.
2 Invesco, Factset. Performance of MSCI China’s Internet Software & Service Index, annualized over 5 years ended Dec 2016.
3 Ecommerce Worldwide, as at May 10, 2016.
4 CNBC, May 5, 2016.