China: the world’s largest E-tailing battlefield by

Yi Gao Vice President, Estin & Co

1 - Rise of China’s E-tailing market and its new developments While China was a late comer in the nineteenth-century-industrial revolution, the same cannot be said about China’s Internet era in the twenty-first century. Even though China’s Internet penetration rate, proportion of consumers who shop online and average online spending still lag behind developed countries, China’s large population base indicates an unbalanced market with huge potentials. With significantly higher growth than developed economies, China surpassed the U.S. to become the world's largest E-tailing market in 2013. Its online good sales as a percentage of total goods sales had grown from 1.2% in 2008 to 7.7% in 2013, higher than the 5.8% in the U.S. China's E-tailing market is expected to reach 5,5 trillion RMB in 2017 (around $900 billion), more than double the size of that of U.S. - Chart 1 - Market size of E-tailing in China and U.S. CAGR!

1,000!

893!

2008-2013! 2013-2017!

900! 800!

 ! China!  ! U.S.!

700!

Market size 2008-2017
 (in Bn $)!

600!

30%!

15%!

13%!

434!

500! 400! 300! 200! 134! 100!

76%!

135!

18!

37!

2008!

2009!

194! 167! 123! 79!

226!202!

306! 263!

0! 2010!

2011!

2012!

2013! 2017E!

Source: CNNIC, U.S. CommerceSource: Department, Estin&Co analysis and estimates CNNIC, U.S. Commerce Department, Estin&Co analysis and estimates!

The rapid rise of China’s E-tailing market can be attributed to: improved Internet infrastructure (high broadband penetration and increasing adaption of mobile Internet technologies), rising disposable income, urbanisation and lifestyle changes, as well as active promotion, technology upgrading and continuous innovation by leading Chinese Internet conglomerates. The Chinese Internet market is dominated by several leading Chinese IT conglomerates with strong technical and financial capabilities. They are trying to consolidate the E-commerce industry with presence in all related fields. The current competitive landscape is characterised by intensive rivalries between Alibaba and Tencent.

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- Chart 2 - Two Chinese conglomerates compete in every field of E-commerce

M&A!

Internal Division!

Internal Division! !

M&A!

C2C E-tail!

B2C E-tail!

Online Payment! Instant Message! Group buying!

Map!

Group buying!

Location Based Service!

Taxi!

Map!

Taxi! Logistic/ Warehousing!

Source: Estin&Co research and analysis

Source: Estin&Co research and analysis!

The Taobao under Alibaba group is currently the largest online retail platform for small C2C businesses, with up to 17 million registered sellers offering a variety of merchandises. In 2009, Alibaba launched its B2C platform Tmall to attract established offline brands. Taobao’s promotional “11.11” sales event has been widely adapted by Chinese e-retailers, even extending to offline promotional sales activities. Around 240 million Chinese online shoppers participated in the “11.11" event in 2013 with 45 billion RMB revenue generated (nearly $ 7.4 billion), far higher than the 2013 Cyber Monday day sales in the U.S. which attracted 130 million U.S. shoppers and generated $ 2.29 billion in sales revenue. Emerged during 2010, Group-buying websites swept through catering, hairdressing and entertainment industries. Group buying rocketed from a 2.5 billion RMB market in 2010 to a massive 41 billion RMB market in 2013, of which, Alibaba holds around 60% of the market through its group-buying subsidiaries. Started off as an instant messaging software company, Tencent group has cultivated a huge customer base over the years, and with its new mobile application Wechat introduced in 2011 and other strategic acquisitions, Tencent has successfully introduced an integrated one-stop solution with service offering ranging from instant messaging, location based service to online shopping, payment and finance. Mobile-internet is expected to drive the future E-commerce growth. Mobile retail accounted for 9% of total E-tailing sales in 2013 and is expected to reach 18% in 2017. Future of the Internet conglomerates also depends on their strategy in Mobile-commerce.

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- Chart 3 - Mobile-commerce in China 1,400!

1,200! CAGR 21%!

CAGR 330%!

11%!

994! 750!

800!

Mobile Int. users 600! 2009-2017
 (in M)! 400! 200!

55%!

1,200!

1,000!

300!

360!

420!

500!

Mobile 1,000! retail 800! market size 600! 2009-2017
 400! (in Bn RMB )!

171!

200!

23!

0!

2!

1!

12!

63!

0!

2009! 2010! 2011! 2012! 2013E!2017E!

2009! 2010! 2011! 2012! 2013E! 2017E!

In % of total ! E-tail sales! 0.2%

0.4% !

1.6%!

5.2% !

9.2% !

18% !

Source: iResearch, Estin&Co analysis and estimates

Source: iResearch, Estin&Co analysis and estimates!

2 - E-tailing’s impact on its related industries Standardized products such as electric appliances, books and household essentials and a part of service activities can be distributed through online retailing channel. The top three online product categories in China are clothing (26%), 3C and household appliances (18%) and cosmetics (5%). As a result, leading Chinese e-retailers mainly started their ventures in: clothing (Vancl, Moonbasa), cosmetics (Jumei, Lefeng), household appliances (Jingdong, 51buy), books (Dangdang, Joyo acquired by Amazon), Yihaodian (Groceries and general merchandisers, acquired by Wal-Mart). Most of these e-retailers have expanded beyond their traditional product range and diversified into full-fledged e-retailers, offering a wide selection of products. - Chart 4 - E-tail impact on several industries Clothing!

Beauty!

Publications!

Household Appliances!

3C products!

100%! 80%!

Share of Online and Offline sales! (in M RMB)!

66%! 60%!

71%!

95%!

72%! 87%!

91%!

96%!

88%!

90%!

78%!

40%! 20%! 0%!

34%!

2009!

29%!

2012!

2009!

28%! 14%!

9%!

6%!

2012!

2009!

2012!

4%! 2009!

12%!

10%!

2012!

2009!

22%!

Share of online sales share! Share of offline sales!

2012!

Source : China Statistic Bureau, iResearch, Eguan, Aliresearch, Geome, Estin&Co analysis and estimates

The first ones to feel the impact of E-tailing are traditional retailers. Challenged by online home-appliance specialists such as Jingdong and 51buy, Gome and Suning, the once dominating players in home appliance retailing market, experienced severe profit decline in recent years: Gome’s revenue fell by 20 percent in 2012 with a net loss of 600 million RMB, during 2012, Gome opened 107 new stores and closed 137 of its old stores. In 2012, Suning’s turnover grow by 5 % but net profit fell by 44%, during 2012, Suning opened 163 new stores (398 new stores in 2011), while closed 182 of its existing ones store (25 closed stores in 2011). Recognizing the threat of e-retailers, the duo has taken initiatives to address the online market, with Suning establishing Suning Yigou in 2009 and introducing uniform-pricing between its online and offline merchandises. Its online sales revenue currently represents above 20% of its total revenue with a full-range product offer, not only on home-appliance.

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However, most B2C e-retailers are fighting with low price strategy to gain market share, which make them in general not profitable yet. E-tailing has provided a low-cost trading platform for small businesses. Some small businesses managed to attract a huge customer base and even established their own label solely through Taobao platform. The growth trajectory of such “Taobao brands” vastly exceeds that of traditional brands. For example, the top two female clothing “Taobao brands”: “Hstyle" (set up in 2008) and "Liebo" (in 2006) doubled their revenue each year, and within 4-5 years their sales have exceeded 500 million RMB, and in 2013 through the successful acquisitions of other Taobao brands, they achieved over one billion RMB in sales revenue. Hstyle expects to realize nearly two billion RMB sales in 2014 and is currently preparing for IPO. In contrast, it took Etam, whom entered China in 1994, a whole decade to achieve 10 billion RMB in sales revenue. It experienced significant slowdowns over the following 10 years, even though it managed to triple its revenue: its annual compounded growth was significantly lower than apparel industry average and in 2012, it closed 272 of its stores. - Chart 5 - Development of Etam and “Taobao brands” 1,600! 4000! 1,400! 3000!

3,329!

3,653! 1,850!

1,200! 2000! 2,078!

Annual 1000! 1,000! revenue 2009-2017
 800! 800! (in M RMB)!

1,706!

1,261!

600! 600!

560! 550!

400! 400! 200! 200! 0! 0! 1994!

2004!

0.2!

1.3!15!

2006!

2008!

90! 80! 2010!

2012! 2014E!

4000! 3000! Etam! Hstyle! 2000! LIEBO! 1000! 0! -1000! -2000! -3000! -4000!

CAGR! 2008-2012! 15%! 356%! 146%!

Source: Ebrun, Etam, Estin&Co analysis and estimates!

Source: Ebrun, Etam, Estin&Co analysis and estimates

For established offline brands, online retailing provides a relatively low cost channel of accessing a larger consumer base in different geographic locations, such as to access consumers looking for very specific product types or consumers in tier-3 and tier-4 cities where established brands do not yet have physical presence. Therefore it is extremely important for these businesses to adjust their product mix, marketing methods and distribution model and to integrate their online-offline resources. For example, Uniqlo, the Japanese apparel brand, was able to enhance its brand visibility by combining its physical store operations with its mobile application and “Tmall” stores. Uniqlo combined its brick & mortar with online operations to create a multi-channel network (such as distribution coupons to be used at offline stores) in high-tier cities where they already have a physical presence. Its online websites could cover low-tier cities where they can cultivate a loyal customer group in preparation of physical expansion. Uniqlo aligned online and offline prices and established a coordinated online/offline operation that offers complementary products range, which in effect could minimise sales cannibalisation and reduce conflicts of interest. Uniqlo’s success led to a 30% increase in number of planned new stores in 2014. In addition to independent e-retailers, E-tailing platform operators, platform users, upstream and downstream of merchandise, the rise of E-tailing also led to the rapid development of other industries in China such as: IT, logistics, warehousing, advertising and finance.

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- Chart 6 - Development of local players and industry consolidation of express delivery 120!

100!

Market size and share of express delivery! (in Bn RMB, %)!

16%!

Others!

-8%!

6%! 8%!

ZTO! YUNDA!

26%! 22%!

12%!

YTO!

28%!

52 !

12%!

STO!

27%!

47%!

20%!

SF!

33%!

27%!

EMS!

23%!

2012!

Total!

23%!

80!

60!

40!

20!

CAGR! 2007-2012!

146 !

4%! 6%!

7%! 8%! 10%! 19%!

0! 2007!

Source: Express Delivery Industry Annual Report，SF-Express, Estin&Co analysis and estimates

- Chart 7 - Development of online payment industry 40,000!

CAGR! 2007-2012!

3659 !

35,000! 21%!

Others!

103%!

12%!

Unionpay!

75%!

21%!

Tenpay!

86%!

47%!

Alipay!

81%!

Total!

85%!

30,000!

Market size and share of online payment! (in Bn RMB, %)!

25,000! 20,000! 15,000! 10,000!

577 ! 5,000! 0!0!

15%! 14%!

21%! 50%!

2009!

2012!

Source: iResearch, Estin&Co analysis and estimates

3 – Implications for European brand developments in China For those European brands hoping to grow in the Chinese market: except for B2B industrial products and a part of service industry, it is inevitable that they felt the impact of E-tailing in China. First and foremost, western companies should change their perception that “China is a backward market comparing to developed economies." In the field of E-tailing, China is a massive market with huge potentials; and sheer intensity of competition and constant innovation indicate that China is an advanced market, especially in mobile Internet. Secondly, it is wrong to think that you can take a proven European E-tailing model and introduce it directly to China. As mentioned earlier, China's E-tailing market has its own characteristics. Different from the brand driven B2C model in Europe, China relies heavily on E-tailing platforms which have a high penetration rate among internet users and have ESTIN & CO

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developed a huge customer base. Therefore it is essential to have a localised E-tailing model, as demonstrated by the failure of Newegg and Groupon as well as Ebay’s exit from the Chinese market. - Chart 8 - Market share of B2B and B2C E-tailing platforms 100%! 90%! 80%! 70%! 60%!

Market share! (in %)!

5%!

14%! 3%! 5%! 5%!

1%! 2%!

17%!

50%!

Others! 95%!

Dangdang!

40%! 30%!

VIPS! Amazon! Tencent!

54%!

20%!

Suning Yigou!

10%!

JD! Alibaba(1)!

0%! B2C!

Market Size! 387 Bn RMB!

C2C!

873 Bn RMB!

Note：(1) Alibaba owns B2C platform Tmall and Taobao docused on C2C Source: iResearch, Estin&Co analysis and estimates

In this large and rapidly evolving E-tailing market, European brands wanting to develop an online business should: - Set an ambitious objective: the weight of E-tailing varies greatly between different industries and each market participants possesses different level of E-tailing know-how. But one should not constraint itself with conservative targets. With closing window of opportunities, timing and speed are of fundamental importance to a successful strategy. - Establish efficient resource allocation (human capital, financial resources, supply chain etc.): even though the Chinese market represents only a fraction of European companies’ current revenue mix, the market is growing fast and has great potentials. China is no longer a low-cost country, so it is necessary for European to anticipate changes and make appropriate investment preparations. However, it is more difficult to address the lack of experienced E-tailing talents, as it is very time consuming to develop a team that understands a firm’s capabilities and is familiar with Chinese E-tailing market. - Be open-minded and adapt a flexible business model: China’s large and innovative market presents great opportunities, but to grasp the scale of changes and to develop responsive business model is a delicate issue. New problems present themselves at every corner, such as: should one enter the market as an independent e-retailer or relying on existing E-tailing platform to establish a customer base (e.g. Zara has its own online platform, Puma has its own websites and is actively participating in the market through Amazon and Tmall etc.), how to integrate online/offline businesses or resources (Uniqlo has complementary online and offline discount offering), whether to sell directly or rely on distributors (the leading Chinese sunglass brand Bolon, has its own Tmall store, but is also distributing through other online distributors) and how to use internet to achieve precision marketing. Unlike traditional market where 3-5 years advance planning is required, the secret to a successful E-tailing business is about finding the right business model and ensuring promote responsiveness. For Western service providers, the field of web advertising, payment services and courier services are already consolidated with strong local leaders. What China needs are innovation in Internet technology, integrated services, advance logistics, warehousing etc. However, local Internet conglomerates are accelerating their efforts in establishing a vertically integrated business, one example would be Taobao’s newly established logistic business. Therefore, ESTIN & CO

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western companies need to be able to provide differentiated products, technology innovation and better quality experience in order to be competitive in China. In addition, timing and entry strategies are very important in gaining a foothold in this market (joint ventures and strategic cooperation to achieve fast market penetration). For western E-tailing platform providers and independent e-retailers, apart from some specialised product (e.g. overseas luxury products sales, such as NET-A-PORTER) it is very difficult to enter the fiercely contested and gradually consolidating Chinese E-tailing market. But it is more feasible to acquire local leaders, such as Amazon’s $75 million acquisition of Joyo in 2004, which helped Amazon to successfully establish a foothold in the Chinese market. However eBay’s $150 million acquisition of Eachnet failed to produce the desired results, leading to eBay’s eventual exit from China. Moreover, the current valuation of Chinese websites is quite high: VipShop.com acquired 75% of the cosmetic website “Lefeng” for $ 112.5 million, while Tencent spent $400 million to take 20% stake in the review and group-buying website “Dianping”. If western E-tailing platform operator or independent eretailer wants to grow organically in China, they must be willing to take initial losses, but more importantly, they must adapt their business model to suit Chinese demands. In addition, western companies must be conscious of the fact that Chinese internet conglomerates are very good at replicating business models, supported by large customer base and capable of engaging in price wars with abundant financial resources. As for western department stores and supermarkets, it is better to think about how to leverage on the rise of E-tailing. For supermarkets, as there is no much room for product and service differentiation, it is more effective to focus on promoting on-line sales, e.g. Wal-Mart’s acquisition of “Yihaodian” grocery websites, Auchan and RT-Mart’s joint introduction of their own "Feiniu” sites. For department stores, apart from developing online operations (e.g. precision marketing using big-data collected on its websites or leverage on Tmall to access additional customers and resources), it is more important to provide consumers with differentiated products and service experience in their stores: for example, the art themed shopping mall “Parkview Green” and the “Fast fashion and limited edition” themed Shin Kong department store in Beijing, have successfully attracted their specific customer groups. In summary, the Internet era has brought about an E-tailing market with tremendous opportunities as well as challenges. For company executives, the fortune of your company will depend on your reaction to such challenges, having an effective strategy and ensuring its timely implementation are essential. March 2014 Estin & Co is an international strategy consulting firm based in Paris, London, Zürich and Shanghai. The firm assists CEOs and senior executives of European, North American and Asian groups in formulating and implementing growth strategies, and private equity funds in analysing and improving the value of their investments.

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