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The World’s Next E-Commerce Superpower Navigating China’s Unique Online-Shopping Ecosystem R The Boston Consulting Group (BCG) is a global manage- ment consulting fi rm and the world’s leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep in sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet- itive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 74 offi ces in 42 countries. For more infor- mation, please visit www.bcg.com. The World’s Next E-Commerce Superpower Navigating China’s Unique Online-Shopping Ecosystem bcg.com Jeff Walters Youchi Kuo Waldemar Jap Hubert Hsu November 2011 © The Boston Consulting Group, Inc. 2011. All rights reserved. For information or permission to reprint, please contact BCG at: E-mail: bcg-info@bcg.com Fax: +1 617 850 3901, attention BCG/Permissions Mail: BCG/Permissions The Boston Consulting Group, Inc. One Beacon Street Boston, MA 02108 USA T W’ N E-C S  Contents Introduction 5 An Internet Giant 6 E-Shopping on the Rise 6 Managing Early Obstacles 7 The Weight of Superheavy Spenders 8 A Winning Proposition 9 What Makes China Different 11 The Dominance of Taobao 11 Delivery and Logistics Challenges 11 Distinctive Online Behavior 13 A Unique Online-Shopping Ecosystem 13 Catching the E-Commerce Wave 14 Fast Penetration into All Categories 14 The Dynamics of Superheavy Spenders 14 Winning Customers Through Quality and Service 16 Shopping by Mobile Phone 18 Key Implications for Different Companies 19 Strategies for Brand Companies 19 Strategies for Retailers 20 Strategies for E-tailers 21 For Further Reading 22 Note to the Reader 23  T B C G T W’ N E-C S  China, already known to have the largest In-ternet population in the world, can now also claim the distinction of having the second-largest population of online shoppers—145 million people (versus 170 million in the United States). This is more than double the number in Japan and fi ve times that of the United Kingdom. More- over, online shopping will see exponential growth through 2015, with spending that could make China’s e- commerce market worth more than RMB 2 trillion and possibly surpass the size of the U.S. market. Research conducted by The Boston Consulting Group of- fers an in-depth look at the underlying dynamics behind this exciting time of growth. Drawing from surveys of more than 4,000 online shoppers across tier 1 through tier 5 cities, this report illuminates the conditions that make China’s e-commerce environment unique com- pared with other markets and points out the crucial trends companies must be aware of to achieve success. It is clear that Chinese consumers, especially the coveted urban dwellers and those in the middle and affl uent classes (MACs), are quickly adopting “multichannel” shopping behaviors, creating both opportunities and chal- lenges for brand companies, retailers, and e-commerce companies alike. Organizations that have been quick to capture the attention of these consumers are already reaping signifi cant benefi ts. Vancl.com, for example, has become one of China’s top-ten casual apparel brands (ex- cluding sportswear) while selling exclusively online, with expected 2011 sales of RMB 8 billion (four times 2010 sales). Many companies, however, have been slow to respond, leaving signifi cant growth opportunities on the table and allowing other merchants—such as those that sell on Taobao.com, a Chinese shopping portal in the vein of Amazon.com—to shape consumer perceptions of brands. Companies that do not have an active e-commerce strat- egy are allowing a fast-growing channel to develop with- out exerting any control or infl uence over the process. Companies wishing to benefi t from the rise of online shopping in China need to understand the circumstances that make the e-commerce environment there unique, as well as the trends and consumer behaviors that will di- rect future progress. At the moment, a very small propor- tion of overall category shoppers do their shopping on- line, leaving much room for growth. Usage and spending levels will increase in every e-commerce category, but cer- tain categories are poised for more dramatic change. Con- sumers will become increasingly demanding as their needs alter, especially the heavy spenders, who will rep- resent an outsize share of growth. Websites able to meet the need for better quality and service will win in an in- creasingly competitive online environment. And those that focus on the high profi t potential of multichannel shoppers will also be at an advantage. Companies wish- ing to capture opportunities online must customize their strategies to account for the unique behaviors, demands, and challenges of the online ecosystem in China. Introduction  T B C G An Internet Giant China’s status as home to the largest popula-tion of Internet users is widely known and touted (457 million in 2010, more than in the United States and Japan combined). As Internet usage ramps up, so too does adop- tion of online shopping, aided by a number of circum- stances that set the stage for a coming e-commerce ex- plosion. (For a breakdown of China’s e-commerce numbers, see the sidebar below.) E-Shopping on the Rise Consumerism is already big in China—people simply love to shop. Beyond this, the Internet is aff ordable, and thus widely available, thanks to government eff orts to modernize the country’s telecommunications infrastruc- ture. Broadband Internet costs just $10 per month (against an average urban household income of $830), compared with $30 per month in India and $27 per month in Brazil, and it is accessible to approximately 90 percent of China’s population.1 The years 2007 through 2010 saw rapid growth in the number of consumers going online. In each of those years, China gained between 73 million and 88 million new Internet users—a volume exceeding the population of France. (See Exhibit 1.) As new e-commerce off erings coincided with this growth, consumers went from having In 2010, the e-commerce market in China was worth ◊ RMB 476 billion as transaction value (actual value of sales, including all fees), nearly double that of Japan or the United Kingdom and a drastic increase from RMB 128 billion in 2008. E-commerce penetration has grown rapidly from a low ◊ level. Less than 10 percent of China’s urban population shopped online in 2006. That fi gure jumped to 23 per- cent by 2010, and will nearly double to 44 percent by 2015, quickly narrowing the gap with the United States and other developed markets. By 2010, China had 457 million Internet users, with pen- ◊ etration of 52 percent in urban areas and 18 percent in rural areas. The number of e-commerce shoppers will take off through 2015, growing from 145 million people to 329 million. An astounding 30 million consumers are expected to ◊ shop online for the fi rst time every year until 2015. That’s a population nearly the size of Canada’s begin- ning to shop online every single year. BCG forecasts that e-commerce will go from represent- ◊ ing 3.3 percent of total retail value today to 7.4 percent in 2015. In the United States, it took ten years to achieve that growth. Our projection means that China will sur- pass the United States to become the largest e-com- merce market in the world, achieving a compound an- nual growth rate of 33 percent, to reach more than RMB 2 trillion. China’s Growing Online Market 1. See China’s Digital Generations 2.0: Digital Media and Commerce Go Mainstream, BCG report, 2010. T W’ N E-C S  a little familiarity with online shopping to a relatively high level of comfort and adaptation. In addition, the e- commerce industry has benefi ted from China’s low cost of shipping—$1 on average to ship a 1-kilogram parcel, versus $6 in the United States. (For more on the indus- try’s delivery and logistics challenges, see the next chap- ter.) All of these characteristics will make the coming years, from 2011 to 2013, a period of rapid e-commerce penetration. Managing Early Obstacles A few years ago, one of the most commonly cited barri- ers to e-commerce adoption in China was the lack of a satisfactory method for payment, especially given that credit-card usage is not prevalent. The shopping portal Taobao has resolved this problem for most shoppers through its innovative Alipay escrow accounts, intro- duced in 2003. Alipay has won consumer confi dence through a protective structure whereby payments from consumers are held in escrow until the consumer re- ceives his or her order. (Paypal, by contrast, transfers money to the merchant when the consumer places an order, and merchants do not send out orders until their money is received.) Alipay has become the most com- mon payment method for e-commerce in China, with more than 60 percent of consumers using it on Taobao, and approximately 20 percent using it on business-to- consumer sites. Business-to-consumer companies also off er the simplest solution, cash on delivery (COD), which has been widely accepted by shoppers. Among the biggest of these web- sites, COD is rated the most frequently used payment method for nearly half of online shoppers. The other most-cited obstacle to e-commerce adoption has been a low level of trust in a consumer population wary of fake or inferior goods. Taobao has eff ectively 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 100 80 Millions of people New Internet users New e-shoppers Era of fast connectivity growth... Population of France Population of South Korea Population of Canada 60 40 20 0 17 11 26 10 73 12 88 25 86 29 73 36 61 43 48 38 50 38 47 34 40 31 ...leading to an era of rapidly growing e-commerce Exhibit 1. China’s Rapidly Expanding E-Commerce Market Follows an Era of Exponential Growth in New Internet Users Source: BCG analysis.  T B C G addressed this issue, as well. The site features an exten- sive seller-rating system that enables potential shop- pers to read up on the reliability of vendors and then make what they feel are dependable judgments about them. The Weight of Superheavy Spenders New Internet users will certainly push e- commerce forward in the coming years, but so will the individual consumer’s lev- el of familiarity with online shopping. The more experience people have with Internet shopping, the more they spend online. Consumers can be divided into four segments according to how much they spend on the Internet, ranging from light to moderate to heavy to super- heavy. Crucially, superheavy spenders make up just 7 percent of online shoppers but account for 40 percent of total online spending. Meanwhile, a long tail of light spenders—nearly 60 percent of total shoppers— accounts for less than 15 percent of spending. (See Ex- hibit 2.) Experience remains a major driver of online spending, even when shoppers’ income levels are factored in. Affl u- ent shoppers with little e-shopping experience might, in fact, spend 60 percent less than emerging- middle-class shoppers who have accrued more experience shopping online. It typi- cally takes affl uent online consumers four or more years before they become super- heavy spenders.2 By 2015, the majority of today’s 145 mil- lion online shoppers will be “experi- enced,” and more consumers overall will have entered Total online spending (%) 100 10 20 30 40 50 60 70 80 90 100 Online spending distribution E-shopper segmentation Nearly half of the total spending is contributed by the top spenders <2,000Lightspenders 2,000– 5,000 Moderate spenders 5,000– 10,000 Heavy spenders >10,000Superheavyspenders 90 80 70 60 50 40 30 20 10 0 Total e-shoppers (%) A long tail of light spenders Segment 2010 distribution Annual online spending (RMB) Percentage of e-shoppers Percentage of spending 57 24 12 7 14 21 24 40 Exhibit 2. Seven Percent of E-Shoppers Are Responsible for 40 Percent of Total Online Spending Source: BCG analysis. Consumer familiarity with e-shopping will drive online spending in the coming years. 2. Affluent shoppers are those who earn more than RMB 10,000 in monthly household income; emerging-middle-class shoppers are those who earn RMB 4,000 to RMB 6,500 in monthly household income. T W’ N E-C S  the ranks of the middle and affl uent classes (MACs)—re- sulting in a sharp increase in the amount of money that each shopper spends online. Average annual online spending will have nearly doubled to RMB 6,220 per shopper, close to the $1,000 (RMB 6,500) average in the United States today. A Winning Proposition There are a number of conditions particular to China’s consumer market that make e-commerce an attractive option for companies and that will help drive the coming years of growth. The Limited Reach of Brick and Mortar. China’s mas- sive geography hampers the eff ectiveness of physical retailing. The country’s coveted MACs are quickly expanding beyond the biggest cities, meaning that fi rms must constantly broaden their reach. There will be 365 cities with 100,000 or more MAC consumers by 2015. Today even the largest retailers in China, GOME and Suning, have stores in only about 260 cities.3 And well-known multinational retailers cover even less ground. Wal-Mart, for example, has stores in fewer than 120 cities.4 This limited reach results in the fragmentation of retailers. The country’s top 20 retail- ers account for only 13 percent of total urban retail sales. China is unusual in that Internet access has far outpaced the reach of the top physical retailers, which could mean that its e-commerce development will not necessarily mirror the pattern in other countries. (See Exhibit 3.) It could progress much as the country’s mobile-phone in- dustry has. China has more or less bypassed the landline phone system, leapfrogging from one phone per village to nearly one phone per person—and most of these are mobile phones. As of June 2010, China had 306 million fi xed-line phone subscribers and 796 million mobile- phone customers. 3. As of the end of 2009. 4. As of the end of 2010. Retail consolidation (top 20 retailers’ share of total retail sales, %) Internet reach (% of population) 3 13 26 27 30 44 49 51 52 United Kingdom France Germany South Korea United States Japan Brazil China (urban) India 7 51 33 81 87 78 80 76 81 Urban China is nearing a developed country’s Internet reach... ...while having a developing country’s level of physical retail consolidation. E-commerce in China benefits from the ability to get more goods to more consumers. Exhibit 3. Internet Access Has Far Outpaced the Reach of the Top Physical Retailers— a Dynamic Unique to China Source: BCG analysis. Note: 2010 Internet reach calculated using 333 million Internet users within an urban population of 654 million. Top 20 retailers account for 10 percent of all retail sales in China. We assume that 76 percent of retail sales in China come from urban areas (based on urban versus rural ratio of total disposable income in 2010), and all top retailers’ sales come from urban areas.  T B C G Many consumers, especially in lower-tier cities and rural areas, began using mobile phones before landlines, thereby building up the habit of turning to their phones not just for communication but also for entertainment and other activities that previously would have required a dial-up connection on a personal computer. Consumer- ism in China could develop similarly, skipping the usual stages of retail development and arriving directly at a heavy reliance on e-com- merce—a pattern completely different from the experience of other developed countries. The High Cost of Brick and Mortar. Phys- ical retailing is pricey for companies. Sky- rocketing real-estate prices eat up a much larger proportion of operating costs for modern physical retailers in China than in more developed markets. More- over, China’s distribution structure is still ineffi cient and o en involves multiple layers of middlemen and whole- salers, resulting in a loss of profi t margins. Selling directly to consumers on the Internet circumvents both of these costly outlays. A number of factors make e-commerce attractive on the consumer side, as well. A Better Selection. E-commerce sites enable easier ac- cess to a wider range of goods. The majority of consum- ers in China are not looking for fake products online. Less than 5 percent of our respondents claimed to seek out fakes—though more than that may purchase them un- knowingly. Up to a quarter of e-commerce demand in China is, in fact, for products that consumers cannot fi nd in physical stores—a circumstance rather unique to Chi- na, where, as noted above, the country’s immensity limits the coverage of many physical retailers. This is particularly notable in the case of skin care and cosmetics products; 25 to 35 percent of the consumers we polled said that they shop online for items in this catego- ry that they cannot fi nd in brick-and-mortar shops. In top- tier cities, more cosmopolitan (and o en more well-trav- eled) consumers are seeking out brands that have not yet entered China. In low-tier cities, e-shoppers are more of- ten searching for brands with limited coverage that are not yet available in any physical stores in their city. Better Bargains. Chinese consumers are price sensitive, and for a number of reasons, online channels are able to off er them the best deals. There is a large amount of ex- cess inventory along the supply chain in China, due to the many layers of middle- men. In addition, lack of data transparen- cy and the diffi culty of accurately predict- ing demand mean that stores o en have a lot of excess inventory at the end of the season. This is especially true in catego- ries such as apparel, which has a short product life cycle and relies overwhelm- ingly on a franchise model. It becomes convenient, then, to liquidate excess and dated inventory through online channels at a discounted price, which, of course, attracts consumers. We estimate that apparel inventory accounts for approx- imately 50 percent of total market value. By contrast, in developed markets such as that of the United States, the United Kingdom, and South Korea, this fi gure is only 20 percent or less. That’s why apparel has been the fi rst e-commerce category to take off in China, and it is still the biggest. Greater Consumer Trust. E-commerce sites offer a number of features that help increase the trust of con- sumers. The prevalence of low-quality and fake products in China has created a skeptical consumer mentality. Physical retailers are sometimes able to overcome this wariness through a trusted retail brand name or a per- sonal relationship with the customer, but neither of these is common. The faceless nature of online shopping can make for even greater skepticism, but there are mecha- nisms unique to e-commerce that allow consumers to judge a potential purchase. These include extensive re- view and rating systems, word-of-mouth endorsements via online forums and message boards, and escrow ser- vice guarantees that go beyond what most physical re- tailers provide. E-commerce sites ena