O'Brien and Gruetzner -- China's internet old guard face a new era
As global investors obsess over the health of China's economy and fret about slowing growth, there is one facet of the country's "new normal" economy that is racing ahead: retail and wholesale e-commerce.
Until recently, the fastest-growing, most innovative segment of China's consumer economy has been controlled by a small cohort of large, powerful and insulated internet companies. Political and consumer shifts are rapidly changing China's e-commerce landscape, however, and a newer guard of internet companies which operate with more globally minded business practices is beginning not only to take market share, but also help the domestic economy thrive.
Chinese internet commerce grew 28% in the first five months of 2016, and at $270 billion, e-commerce sales now make up 14% of total consumer sales, nearly twice the proportion they represent in the U.S. Moreover, like most of Asia, China's massive e-commerce ecosystem is smartphone- and social media-centric. This has spurred innovative mobile commerce and consumer engagement platforms, making China one of the world's biggest mobile payment and peer-to-peer lending markets.
Internet commerce is thus a key driver for China's consumption economy and its chief catalyst for technical innovation as the country seeks to turn from labor-intensive production to knowledge-intensive activity.
China's internet space has long been dominated by a trio of giants -- Baidu, Alibaba Group Holding and Tencent Holdings -- often known collectively by the acronym BAT. Alibaba is a towering presence in China's e-commerce markets, with more than 3 trillion yuan ($450 billion) transacted across its internet platforms during its last fiscal year. Tencent was recently ranked the second-most valuable brand in China. Its WeChat social messaging platform has become China's omnichannel, combining social and broadcast media as well as mobile commerce peer-to-peer payments.
But concerns remain about the ability of China's e-commerce markets to prop up the rest of the domestic economy. This is because these new economy leaders are ironically seen as products of the country's economy as it was before China's accession to the World Trade Organization in 2001. Greatly protected from foreign competition by government policy and beneficiaries of the so-called "Great Firewall of China," the BAT companies have used favoritism and influence to run the country's internet economy as a de facto oligopoly.
This sheltered privilege has, in turn, made them prone to unorthodox and often opaque business practices. Consider here Alibaba's cavalier treatment of major shareholder Yahoo or the complicated governance of assets in its initial public offering. All of this is underpinned by a persistent market perception that Alibaba shopping platform Taobao has been a haven for peddlers of counterfeit goods despite the company's publicly stated antipathy to fakes.
A broad characterization of China's internet old guard as unscrupulous puppets of the state is, however, untenable. Doubtless, the BAT trio have benefited from state patronage and protected positions in the domestic online economy. Yet they contend with the state as well as cozy up to it. Alibaba and its peers are both innovative technology companies and coddled insiders who push regulatory boundaries to maintain their market advantages.
The general market environment is changing amid national pressure to increase corporate and government transparency, driven by President Xi Jinping. The firm grip of China's internet old guard over the country's e-commerce market appears to be loosening. Maturing consumer preferences are a big part of the reason. As online shopping becomes the norm, consumers are also growing wealthier and more discerning. As a result, their requirements for quality and customer service grow.
Premium e-tailers like JD.com have benefited from this shift. The company, which saw sales transactions on its site rise over 55% in the first quarter of this year to 129.3 billion yuan, has generated a reputation for selling authentic brands. It also has been willing to collaborate with recognized international retailers to help them expand their China presence.
This shift in China's consumer markets has clearly been a driver of Alibaba's recent attempts to promote itself as a champion of intellectual property and brand protection for consumer goods. The company held a "Rights Holders Collaboration Summit" in Hangzhou in June, Chairman Jack Ma has penned opinion pieces in the international press announcing zero tolerance for fakes and Alibaba claims it has removed millions of fakes from its sites in just the past year.
While still largely state-favored, BAT companies are not categorically underhanded in their business dealings, no more than the new guard are uniformly driven by purely ethical business practices. It is clear that the old guard, which has grown powerful in a market environment protected by vested interests, is no longer able to control access to China's internet market in the same ways as before.
Rather than beat the new guard, the BAT companies have decided to join them. JD.com joined Tencent and Baidu to invest Aug. 2 in a $550 million fundraising by automotive internet content company Bitauto Holdings. Tuniu, backed by Hainan Airlines, is taking on Ctrip.com International's dominant position in online travel bookings, which stemmed from early backing the company received from TravelSky Technology, China's domestic airline reservation system.
Tencent has been a major shareholder of JD.com since 2014. This relationship gives JD.com a strategic advantage in mobile payments via WeChat Pay. Wal-Mart also recently acquired 5% of JD.com in a deal in which the American retailer ceded operational control of its own local online platforms to its new Chinese partner. If trends continue, JD.com's online sales might surpass Alibaba's by next year.
Historically the BAT companies maintained their success through some degree of political leverage, but these advantages are decreasing in commercial importance. Foreign internet players are supposed to be granted wider access as part of the WTO services agreement schedule and the U.S. Trade Representative has flagged China's internet firewall as a restrictive trade practice, as well as a political barrier.
International pressure will only increase, particularly from the U.S., as both leading presidential candidates are China sceptics. Facebook recently hired a senior executive from WeChat as it positions itself outside the gates of China's firewall. Yet while China's internet oligopoly can no longer have the run of China's internet economy, domestic companies still have home field advantages. The decision by U.S. ride service Uber Technologies on Aug. 1 to effectively merge its China operations with Didi Chuxin, part owned by Alibaba and Tencent, is evidence that local political influence is still a necessary component for market success.
JD.com and its fellow vanguard of new internet companies appear more attuned and receptive to the emerging shifts in Chinese consumer sentiments to a market less obsessed with bargains and availability and more concerned about quality and corporate reputations. This may mean that BAT companies will need to play catch-up to a new, more globally collaborative reality rather than rely on their ubiquitous presence and market legacy to succeed. China's e-commerce economy will be the better for it, as will the economy overall.
Ross O'Brien and John Gruetzner are principals with Intercedent, an Asian-focused business advisory company.