Go East! How China is disrupting global consumer retailing

GO EAST! HOW CHINA IS DISRUPTING GLOBAL CONSUMER RETAILING

GAM Investments’ Swetha Ramachandran and Amanda Lyons combine their expertise in luxury brands and technology respectively to examine how global consumer brands are responding to China’s innovative technology landscape.

Around 20% of the world’s population are celebrating Chinese New Year this year. It marks the transition from the Year of the Pig, said to symbolize effort and persistence, to the Year of the Rat, which represents adaptability and innovative problem solving.

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This shift seems to mirror the evolution of the USD 2 trillion Chinese e-commerce landscape itself – with the scale of domestic Chinese demand combining with rapid-fire innovation to deliver market-specific solutions, as well as new channels for global brands targeting Chinese consumers.

We examine some of the key trends currently under way in Chinese e-commerce and consider their potential implications for technology and luxury investing.

Do BATs have FAANGs?

E-commerce in mainland China is projected to have grown by over 30% in 2019 alone, to reach a total size of almost USD 2 trillion – eclipsing the circa USD 725 billion e-commerce spend across the US, UK, Germany and Japan combined. That said, internet penetration in China is still a modest 60%, compared with levels of 85% and 90% (in the EU and the US respectively). Even at such levels, the sheer scale of the market in its entirety means there are nearly three times as many internet users in China as in the US. In the mobile payments space, the gap is even wider; more people pay with their phones in China than live in the US.

Rising online penetration should underpin the long runway for growth for Chinese e-commerce which the Chinese government views as an effective tool to catalyze the country’s continuing transition away from dependence on manufacturing and towards a consumer-led economy. Yet, while China has enthusiastically embraced e-commerce and also social media, and is now increasingly adopting social commerce, the country’s digital ecosystem has developed in ways that make it quite distinct from its counterparts in the West. In place of the West’s so-called ‘FAANG’ stocks (Facebook, Apple, Amazon, Netflix and Google), the ‘BATs’ (Baidu, Alibaba and Tencent) have dominated in China. Unlike the FAANGs, which have remained in the ascendant and have been growing their market share, China’s technology leaders are more dynamic because the landscape is ever evolving.

Baidu, for example, has steadily been in decline after failing to transition successfully from desktop to mobile and ignoring the rise of the so-called ‘walled garden’ (or closed platform) model. By the time Baidu realized its strategy was failing, it was too late for the company to catch up. China’s internet is now dominated by four sectors: e-commerce, led by Alibaba; online entertainment, led by Tencent; online services, led by Meituan; and digital advertising led by ByteDance (which owns TikTok). The latter two companies are mobile only. The mobile-first behavior of Chinese consumers has required global brands targeting them to substantially modify their approach to the Chinese market.

Converging consumption across city tiers

Only 37% of China’s lower tier city populations are currently estimated to have internet access. This highlights both the disparity in e-commerce spending levels across China itself and also the significant room for domestic catch up as lower tier cities continue to grow economically. ‘Lower tier’ cities are those classified in Tiers 3 and below, ie with populations below three million. In combination, these cities house more than 50% of China’s population (around 650 million people in total), which perhaps goes amiss in their characterisation as ‘lower’ tier. After all, that is roughly equivalent to 75 New York Cities in total scope.

E-commerce in China remains primarily platform-driven – Alibaba has a circa 62% share of the e-commerce market and JD a 24% share. Combined with high mobile wallet penetration (3.5% of all transactions in 2011 were mobile versus 83% in 2018), we see this phenomenon as a potent force for further unleashing the growing spending power of lower tier city consumers, from a currently low base. Various companies in China have highlighted this ‘consumption upgrade’ effect from consumers in lower tier cities. And it was a prominent feature of last year’s ’Singles’ Day’ festival, which saw multiple e-commerce spending records broken. Alibaba saw gross merchandise volumes worth USD 38 billion (+26% year-on-year) transacted on its platform over a 24-hour period, while international brands such as Estée Lauder, Nike and L’Oréal grossed more than RMB 1 billion (USD 143 million) in sales on Alibaba’s platform during the festival.

‘Heaven is high and the emperor is far away’

This Chinese proverb could well be used to explain not only the decentralized nature of economic growth in China following reforms, but also the decentralized nature of internet / social media expansion itself. Niche platforms catering to broad sections of Chinese society are thriving thanks to their market scalability. These platforms range from Kuaishou – a short-form video app that draws its users overwhelmingly from lower tier cities – to Wanwuxinxuan, a social e-commerce community focusing on ‘post-1990s’ new mothers, offering advice and enabling them to buy recommended baby products. China’s socially-oriented digital ecosystem has lent itself well to influencer (or KOL – Key Opinion Leader) marketing. Indeed, KOL marketing has fast become an indispensable way to win over Chinese consumers. A further wave of social-led growth is being driven by KOCs – or Key Opinion Consumers, ordinary consumers whose product reviews are trusted by a niche audience. These KOCs have been one of the driving forces behind the success of the ’Red’ (Xiaohongshu) app, which has developed into a recommendation-based social e-commerce platform. Two-thirds of Red’s users are estimated to be under 30, with 57% living in Tier 1 cities – making it a target platform for luxury brands seeking to gain traction with young, wealthy women. At the same time, new brands have found it possible to find their market as social commerce in China becomes more and more segmented; for example, Perfect Diary, a local Chinese cosmetics brand that launched in 2015, operates purely on social commerce.

Blurring the online / offline divide

Since its launch in 2017, Tencent’s WeChat’s ‘mini-programme’ functionality – or apps within its super-app – have grown significantly to more than two million today, with the messaging and social media app attracting more than 300 million daily active users. Several luxury brands have been quick to recognise mini-programmes’ potential to bridge the online-offline experience. For example, LVMH brand Celine’s mini-programme incorporates the ability to browse Celine’s latest runway collections and to virtually experience its international flagship stores as well as, crucially, enabling consumers to make digital appointments to visit offline stores.

Omnichannel strategies, where online and offline presences combine, are the buzz word in retailing and here China is setting the pace for the rest of the world. Back in 2016, Alibaba coined the phrase ‘new retail’ and it has subsequently been transitioning its business model so that the lines between online and offline are increasingly blurred. In China, the omnichannel experience is all about providing a seamless, fast and convenient service where the customer is at the forefront of the solution. Technology is embedded into the entire experience, rather than being a late addition to an existing solution. Facial recognition software, digital payments, big data analytics-driven personalisation and self service are all increasingly standard in Chinese stores.

Most recently, we have been seeing increased use of augmented reality and virtual reality technologies as brands experiment with ways to harness them in order to woo consumers.

For example, JD.com has launched a ‘beauty mirror’ that allows customers to experiment with different lipstick shades without physically trying them in a store. Although most companies in China are embracing technology and this is changing the way people shop, Tencent and Alibaba’s dominant payment solutions – TenPay and AliPay (which is expected to go public this year) – mean that they can lead the way. These payment solutions not only allow for a faster and enhanced customer experience in store, but also provide their parent companies with a treasure trove of data that they utilize to personalize and strengthen the user experience.

Implications for technology and luxury investing

While China remains the key growth engine for brands in the global luxury sector, the sources of growth appear to be widening outside the Tier 1 and 2 cities where these brands have set up flagship stores. The growing spending power of Tiers 3-5, and even rural, consumers means that the brands must continue investing in both physical distribution and e-commerce infrastructures if they are to effectively capture growth from this increasingly large consumer base.

Given the growth in omnichannel approaches, it is essential that brands innovate if their physical retail space is to remain relevant in future. Burberry, for example, is launching a ’social retail’ store in Shenzhen in 2020 that will be powered by Tencent technology seeking to engage consumers both on and offline. The store is likely to showcase new technologies and to pioneer new ways to engage with would-be customers and, ultimately, encourage sales conversion.

The challenges facing global luxury brands may be further heightened by the rise of social commerce, which could level the playing field for domestic brands in several categories. This will require international players to step up their efforts to win over Chinese consumers; we believe it will prove crucial to monitor which brands are doing so most effectively if we are to identify potential outperformers. In our data-driven world, we believe that it will be those companies that hold the most data that are likely to remain firmly in the ascendant. Currently, Alibaba and Tencent have the lead and are seeking ways to use their data intelligence to keep their market-leading positions. Those global brands that seek to reach consumers via China’s third-party platforms will need to have careful controls in place to safeguard ownership of their customer data – there is a risk that these platforms could gain the upper hand given their dominance.

What stands out from the emerging trends outlined above is that, as investors, we believe it is those companies that are innovating and disrupting traditional retail models that are best placed to thrive in China in the years ahead. In our view, it requires active management and extensive research to identify those companies with the potential to become these successful innovators and disruptors.