Chinese Consumption Goes Digital; In the U.S., e-commerce is the icing for retailers. In China it is the cake

July 24, 2013, 12:46 p.m. ET

Chinese Consumption Goes Digital

In the U.S., e-commerce is the icing for retailers. In China it is the cake.

FRANK LAVIN

Speculation over when Chinese online giant Alibaba will launch its initial public offering is again drawing attention to the country’s burgeoning e-commerce industry. Alibaba’s sales are larger than Amazon’s and eBay‘s EBAY +0.89% combined, and its retailing site Tmall boasts more than 500 million registered customers. If China is going to rebalance its economy toward domestic consumption, clearly the Internet will play a big role. This poses a challenge for foreign firms: How can they get in on this act, too? In important respects, e-commerce will fuel China’s greater opening to foreign consumer products. There is no simpler, faster or less expensive way for foreign firms to establish a national retail presence in this sprawling continental market. But online retailing can also be a trap for the unwary.The biggest pitfall foreign companies need to avoid is the belief that they can merely translate a product or marketing strategy that succeeded back home. Adherents of this “fallacy of nothing” change nothing—not their product slate, not their brand positioning, not their market segmentation, not their distribution, not even their financing methods. While Internet commerce requires fewer adjustments than a bricks-and-mortar store would, companies still need to recognize five surprising ways in which China is unique.

First, in the U.S. e-commerce is the icing. In China it is the cake. In the U.S., e-commerce constitutes some 7% of total retail sales, meaning it can give a respectable lift to already strong sales. But in China, e-commerce constitutes 20% to 30% of retail sales, and among young shoppers it can spike to 50%.

This requires a reversal in strategy from what companies pursue back in America. Foreign businesses might traditionally devise a China market-entry strategy and then a China e-commerce strategy. But increasingly it makes sense to turn the e-commerce strategy into the entry strategy. Later, the company can pursue offline sales as necessary. Youth-oriented brands such as Quiksilver and Uniqlo have become adept at this, launching a product or a theme on-line before pursuing it in traditional stores.

Second, the disaggregation of production and sales structures, such that the parent company does not necessarily directly own either activity, is giving rise to a new distribution model, especially a business-to-business-to-consumer model. A foreign company wanting to set up online retailing in Britain, for instance, would need to rent a warehouse, hire a fulfillment team, and work through customs and tax issues. These are often stiff barriers for small companies.

In China, in contrast, you can hire a service provider to act as a middleman between your manufacturer and your customer. My company is one such service provider, and there are others. This model allows well-known American groups such as the National Football League and upscale children’s boutique Little Giraffe (both of which are our clients) to offer their merchandise without any physical presence in China.

Third, foreign e-tailers need to understand how they will fit into the market. Chinese firms tend to dominate the price-sensitive mass end where their lower cost structure will usually give them a pricing advantage. But foreign firms do extremely well in the premium space, where quality-oriented companies such as Levi’s and NikeNKE -0.89% can appeal to the more affluent consumer. Similarly, foreign firms do well in niche areas, from cooking equipment to automotive accessories when their products are specialized or their brands are strong.

Fourth, foreigners should take full advantage of the opportunities Internet commerce offers for experimentation. The cost of building a physical presence is so high that it would ordinarily make sense to spend the money on market research. But the relatively low upfront investment required for an online shop frees firms to jump in. It makes little sense to pay $25,000 for a rudimentary market survey when you can spend $10,000 on an ad campaign and see how it goes. The NFL did not conduct market research before selling footballs, it just started selling.

Finally, foreigners need to understand the social nature of China’s Internet. Chinese Internet consumers are fanatical reviewers and communicators. Your products will undergo a series of ratings, reviews and scoring systems. All of these help the consumer, and thereby help the seller, but the velocity of opinions might surprise foreign companies.

Social activity feeds commercial decisions and commercial activity feeds social discussion, leaving traditional channels out of the mix and requiring companies to devise new strategies. The U.S. specialty apparel company Totes, another of my clients, offers membership cards to Chinese consumers for a frequent purchaser program, something they do not do in the U.S. In the U.S. you are a consumer, but in China you are joining a club.

Those rumors of big opportunities in China for foreign retailers are true, and the opportunities will only grow bigger as the economy rebalances, domestic consumption increases, and technology moves society to e-commerce. But foreigners should not assume this process will be easy. Those who avoid the fallacy of nothing and start adapting the soonest stand to gain the most.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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