31 May - 6 June 2013 #658

China’s e-tail revolution

Mass consumption in China is coming of age in the Internet era

SHANGHAI – When you think about centers 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 to telecoms and 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 29 April, Alibaba signaled 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 that of the United States) with an estimated $210 billion in revenue last year. Since 2003, the market has posted a compound annual growth rate of over 110 per cent. By 2020, China’s e-tail market could be as large as today’s markets in the US, Japan, the United Kingdom, Germany, and France combined.

Despite a broadband penetration rate of only 30 per cent, e-tail commanded six per cent of total retail sales in China in 2012, on par with the US. And the sector is already profitable: Chinese e-tailers are logging margins of ten per cent of earnings before interest, taxes, and amortization, which is slightly larger than the average margin for physical retailers.

Roughly 90 per cent of Chinese e-tail is conducted on ad-funded virtual marketplaces. On these platforms manufacturers, retailers, and individuals offer products and services to consumers through online storefronts. By contrast, in the US, Europe, and Japan, roughly 70 per cent of the market is composed of e-tailers running their own Web sites, whether online-only merchants like Amazon or traditional brick-and-mortar retailers such as Carrefour, Dixons, and Walmart.

Online purchases in China do not simply replace offline purchases. Rather, e-tail supports incremental consumption: $1 of online consumption seems to generate roughly $0.40 of additional sales. 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.

Alibaba (which owns marketplaces such as Taobao) and 360buy.com (which focuses on electronics) rank among China’s top ten 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 major national players.

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 like 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 the financial-services sector.

China may have largely missed the Industrial Revolution in the nineteenth century. But its approach to e-tail is poised to be one of the forces shaping the emerging-market Internet revolution of the twenty-first century.

© Project Syndicate

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