online shopping

Alibaba grabs the IPO money but the future belongs to Jeff Bezos and Amazon China

Amazon China & Alibaba

Alibaba Group should next week collect the big money from its NYSE IPO. But, Seattle’s Amazon owns the future of China’s $400 billion online shopping industry. Amazon’s China business is better in just about every crucial respect: customer service, delivery, product quality even price when compared to Alibaba’s towering Taobao business. Hand it to Jeff Bezos. While few have been watching, he is building in China what looks to me to be a better, more long-term sustainable business than Alibaba’s Jack Ma.

Amazon’s China business fits a familiar pattern. The company is often mocked for keeping too much secret, investing too much and earning too little. In China, far away from the Wall Street spotlight, Amazon has invested hugely, with a long-term aim perhaps to overtake Alibaba and become a dominant online retailer in the country. But, it has zero interest in letting its shareholders, competitors, or the world at large know what it’s doing in China. Open the company’s most recent SEC 10-K filing and there are three passing mentions of China, and nothing about the size of its business there, the strategy.

Amazon shareholders may well wake up one day and suddenly find Bezos has built for them one of the most valuable online businesses in the world’s largest e-commerce market, the only one not owned and managed by a Chinese corporation. No rickety and risky VIE structure, unlike Alibaba and virtually all the other Chinese online companies quoted in the US.  (Read damning report by US Congress investigators on these Chinese VIE companies here. )

Jeff Bezos has been in the online shopping business from its genesis, in 1994. He first got serious in China ten years later, by buying a small online shopping business called Joyo in 2004. Taobao was founded by Jack Ma a year earlier. Within three years Taobao had demolished eBay’s then-lucrative China online auction business, by making it free for sellers to list their products on Taobao. Buyers and sellers both pay Taobao zero commission. It earns most of its money from advertising. EBay China closed its doors in 2006. Since then, Alibaba has grown from about $170mn in revenues to over $6 billion in 2013. Approximately three out of every four dollars spent online shopping in China goes through Alibaba’s hands. Overall, online shopping transaction value is on track to exceed $1 trillion by the end of this decade.

online shopping China

The champagne and baijiu will flow at Alibaba next week. Meantime, Bezos will continue executing on his plan, begun in earnest around 2012, to first gain on Taobao, and one day outduel it in China. How? To buy from Amazon China is to see Bezos’s mind at work. He has clearly assessed Taobao’s pivotal weaknesses, and is targeting them with precision.

Taobao has done phenomenally well. But, it is much the same business today as a decade ago. It is mainly a raucous collection of individual sellers where counterfeit, used-sold-as-new or substandard goods are rife. Everything is ad hoc. Sellers can appear and disappear overnight. They charge whatever they like to ship you your merchandise. Try to return things and it can be anything from complicated to impossible. Most payments are processed by Alipay, a business with similar ownership to Alibaba, but not fully consolidated as part of the IPO. Alipay tries to act like an impartial escrow service between Chinese buyers and sellers who too often seem to be out to try to cheat one another.

Taobao is a product of its time, a China where getting stuff cheap, of whatever origin, authenticity and quality, was paramount. It’s also been a great way to create an army of small entrepreneurs in China, eight million in total, with their own shops selling merchandise to over 200 million different individual customers on Taobao. But, Chinese are much richer and more discriminating today than ten years ago. They are getting richer by the day. The larger trends all point in Amazon’s favor.

Here’s why. When you buy things on Amazon China, you mainly purchase direct from Amazon, not from individual sellers. As in the US, Amazon China sells a full range of merchandise not just books. While it has far fewer items for sale than Taobao, it does many things that Taobao cannot. First, it has its own nationwide delivery service. Where I am in Shenzhen, I get delivery the next morning from a guy in an Amazon shirt with his electric motorcycle parked on the sidewalk in front of my building. You can either pay online by credit card, or pay the delivery guy in cash, COD. Delivery is free and reliable. Parcels are professionally packaged in Amazon boxes and generally arrive in mint condition. It’s a limousine service compared to Taobao.

Stuff ordered on Taobao can take days to arrive, and is sent using any of a group of different independently-owned parcel delivery companies. They don’t accept returns, or cash, and often in my experience as a Taobao customer for the last five years the parcels arrive pretty badly roughed up. The Taobao sellers do their own packaging, sometimes good and sometimes no, usually with boxes rescued from the trash, then call whichever parcel company offers them the cheapest rate. The seller usually takes a mark-up since delivery on Taobao is generally not included.

Amazon China is putting its brand and reputation behind everything it sells. This provides a quality guarantee that no individual seller on Taobao can match. I’ve also found over the course of the last year that prices for similar items are often now cheaper on Amazon than on Taobao. How so? For one thing, unlike the Taobao army, Amazon can use its buying power to extract lower prices and better payment terms from its suppliers. Taobao has a subsidiary business called TMall, where major brands directly sell their products. Here at least there should be no worries about the quality and authenticity of what’s being sold. But since each brand manages its own store on TMall, the prices are often higher than on Amazon China. Delivery is also less efficient, in my experience.

What does Taobao still do better than Amazon China? Its website seems a bit easier for Chinese to navigate than Amazon China’s, which looks and acts a lot like the main Amazon website designed and managed in Seattle.

As Bezos’s shareholders know well and occasionally grumble about, he loves spending money on warehouses, shipping technology and other expensive infrastructure. The China business is a marvel of its kind, a kind of “Bezosian” tour de force. The scale and complexity of what Amazon China are doing is formidable. Bezos started and prospered originally with a no inventory business model, letting outside wholesalers hold and so finance the inventory of books he was selling online.

In China, Amazon must stock huge inventories to get products delivered to customers overnight. Where these facilities are and how much Amazon has spent is beyond knowing. Anything I buy on Amazon China — most recently three books, an electronic garlic-mincer and some ceramic carving knives — is delivered to me next day, within about 15 hours of when I ordered it. In a country China’s size, where moving things around long-distance by truck as UPS and Fedex do in the US is difficult and expensive, Amazon has apparently invested in a large nationwide distributed network of warehouses to hold all this inventory. Whether these are owned by Amazon or third parties is also not disclosed. But, it all works smoothly. I get what I order quickly and efficiently, direct from Amazon’s own liveried delivery team, at prices Taobao can’t match.

Every delivered package drives home the message how much faster, cheaper and more reliable Amazon China is compared to Taobao. Try us once, Bezos seems to be saying here in China, and you’ll try us again.

Amazon China delivery guyCan Amazon China be making any money here? My guess is No, that the current operation in China is a big money sink. How big? China’s other big online shopping business, JD.com, which went public earlier this year and has a business model more like Amazon China than Alibaba’s, is losing money every quarter. (Nonetheless, it has a current market cap of $40bn.)

Alibaba, by contrast, is making money hand-over-fist, Rmb8 billion ($1.3bn) in net income the last quarter of 2013. To get noticed, those eight million individual Taobao sellers, as well as TMall brands, need to pay more and more to Taobao for ads and preferential placement.

Longer term, though, the Taobao ad-supported model looks ill-adapted to where China is headed. Traditional store retailers in China are getting slaughtered by online competitors. Among those online players, it seems likely business will shift to those that can guarantee quality, authenticity, easy product returns and efficient next-day-delivery. That describes Amazon.

One reason it’s crazy to bet against Bezos is he has shown no compunction about using shareholder money to build a business that can only start to make real money in ten maybe fifteen years. Jack Ma has no such luxury, especially now that Alibaba will be quoted on the NYSE. Alibaba is not likely to attract the kind of patient shareholders drawn to Amazon.

This is perhaps one reason why Ma has been out spending a huge pile of Alibaba money buying into all kinds of businesses to tack onto Alibaba. These include US car service Lyft, messaging business Tango, and all sorts of domestic Chinese businesses, including a big slice of China’s Twitter, Weibo, the digital mapping company AutoNavi,  16.5% of China’s YouTube knockoff, NYSE-quoted Youku and a Hong Kong-quoted film studio that seems to have been cooking its books. He also bought control of a professional soccer team in China, hoping to upgrade the much-maligned image of the domestic game. Add it up and it looks like even Ma isn’t fully convinced Taobao will be able to keep spinning money for years to come.

His most successful recent venture begun last year is an online money management business called Yuebao that pays Chinese savers about 4% on deposits, compared to the less than 0.5% offered by local Chinese banks. As of early September, it had Rmb574 billion, nearly $100 billion, under management. This business is not included in the Alibaba entity going public in New York. That points up another worrying aspect of Jack Ma’s business style. He has shown a proclivity to put some of the more valuable assets into vehicles that only he, rather than the shareholder-owned company, controls. Yahoo! and Japan’s SoftBank have some bitter direct experience with this.

How far can Bezos go in China? After all, he doesn’t speak Chinese and doesn’t seem to visit China all that often. Can a kid from a Miami high school really build a better China business than scrappy Hangzhou-native Jack Ma? One pointer is that the most successful traditional retailers are now mainly foreign-owned and managed. Domestic retailers couldn’t adapt to this new era of rampant low-price online competition. But, Zara, H&M and Sephora are all thriving here. They, too, focused on details often overlooked here, like good customer service, no-questions-asked return policy, competitive prices and great merchandising.

Alibaba’s market cap next week, after its biggest-of-all-time IPO, may temporarily overtake Amazon’s, at $160 billion. But, make no mistake, Amazon will likely prove the more valuable business over time, both in China and globally.

 

Alibaba’s Taobao and Other Online Shopping Sites are Pushing Traditional Retailers in China Toward Extinction

Welcome to the desolate future of mall retailing in China.

China shopping mall

This seven-story skylit shopping mall occupies a premier spot in a high-rent commercial district in booming Shenzhen’s main shopping street, with a huge underground parking lot and entrances that link it directly with a busy Metro stop. And yet,  everywhere you walk, floor after floor, retail shop fronts are boarded up, with most stores closed down. Only the ground floor supermarket, top floor Multiplex movie theater, basement chain restaurants and a large Starbucks are thriving. Thousands of square meters of retail space, fully rented as recently as twelve months ago at some of the highest commercial rents in the world, are silent and vacant. No customers, no tenants, no rent income.

Malls are starting to empty out in China, but Chinese are richer, and spending like never before. Overall, retail sales rose 13% in 2013. The paradox can be explained by a single word: Taobao.  It is China’s largest online shopping business, and the anchor asset of Alibaba Group, now preparing for one of the world’s richest-ever IPOs on the US stock market. Taobao, along with its sister site TMall, and a host of smaller online retailers including Jingdong, Amazon China and Wal-Mart-controlled Yihaodian, have landed like an asteroid, and are wiping out the ecosystem supporting traditional retail in China, especially brand-name clothing shops.

The impact of online shopping in China is already far more wide-ranging than anything seen in the US or elsewhere. The reason is price. Taobao and others sell the same brand-name products available in shopping malls, but at prices often 30%-50% cheaper.  More even than rising incomes, online shopping is the most powerful force in China for raising ordinary Chinese living standards and purchasing power.

Online shopping is everywhere in the world, at its heart, a price discovery tool. And Chinese are now discovering, in their hundreds of millions, they have been getting seriously ripped off by traditional stores, especially those selling foreign and domestic brand-name clothing and consumer electronics. They usually occupy 70% or more of a mall’s retail floor space.

Alibaba and other online merchants are joyously surfing a tidal wave of dissatisfaction with the high price of store shopping in China. Not only are brick-and-mortar stores’ prices much higher than buying online, they are also often more expensive, in dollar-terms, than the same or similar Made-in-China products sold at Wal-Mart or Target in the US.

Those two giant chains have fought back against online retailers in the US by using their buying power to offer brand name products at low prices. No retailer in China is really attempting this. Retailing in China is both fragmented and uncreative. As dynamic and innovative as China is in many industries, I’ve yet to see even one great home-grown retailing business here in China.

There’s also a big problem in the way Chinese shopping malls, especially high-end ones, are operated. Chinese mall owners are mainly a motley assortment of one-off developers who used government contacts to nab a valuable piece of commercially-zoned downtown land at a fraction of its market value. They then mortgaged the property, built a fancy shopping palace, and now take a cut of sales, along with a baseline rent. This revenue-sharing discourages retailers from cutting prices. If they do, they will fail to meet the landlord’s minimum monthly turnover figure.

Compounding the pressure on traditional retailers, mall owners often give the best ground-floor locations to global brands like Louis Vuitton or Prada, who pay little or no rent, but are meant to give the mall a high-class ambiance. The big luxury brands’ China outlets seem to have rather anemic sales, but use their China stores as a form of brand promotion richly subsidized by mall owners. Domestic brands are shunted to higher floors. Fewer shoppers venture up there, and so the stores will often end up failing.

The result, as in the photo above taken on a recent Sunday, floor after floor of vacant space. China is creating an entire new retail landscape – a glamorously-appointed mall in a nice part of town whose upper floors resemble downtown Detroit after a riot, with boarded-up shop fronts and scarcely a soul.

Anywhere else in the world, a mall with so much vacant space would either need to cut rents drastically or hand the property over to the banks that lent the money. Neither is happening. For now, the banks can often afford to be patient. Malls that have been around for a few years have probably already paid off the loan principal. Newer loans look far shakier. There are hundreds of bank-financed high-end malls now under construction or opening this year across China.

The stampede away from malls is only just beginning. Though China has already overtaken the US in dollar terms as largest online shopping market, there is every sign that the shift to buying online is accelerating and irreversible. Online sales in China should reach 10% of total retail sales this year, well above the US level of 6%. We project this percentage will rise to over 15% within the next decade. That’s because more Chinese will shop online, especially using their mobile phones, and because the range of items that are cheaper to buy online is so much larger in China than anywhere else.

For that, online merchants must also thank the country’s parcel delivery businesses, led by Shunfeng Express. They charge so little (about one-tenth the price of Fedex or UPS) and are so efficient in getting your parcel into your hands quickly that it makes economic sense not only to buy higher-priced apparel and consumer electronics, but also packaged food, soap, personal care items, even knickknacks that sell for less than $1.

The retail stores that remain in shopping malls are increasingly being used as free showrooms to facilitate sales by online competitors. Chinese shoppers go to stores to find what they like, try it on, check the price, then go home and buy direct from Taobao. That’s one reason malls are still drawing crowds.

Online shopping is not only cheaper, customer service is usually much better. Most merchants selling on Taobao manage and run their own online shops. Taobao is nothing more than an aggregation of millions of motivated individual entrepreneurs. They are available just about any time, day or night, by phone or online chat to answer questions, or even, when asked, offer an additional discount. They are, in my experience, smart, self-confident, friendly, competent.

Sales help in stores are often poorly-paid younger women who cling together behind the cash register. They clearly don’t much enjoy what they are doing, nor are they there to enhance the shopping experience. Often just the opposite.

So what’s going to happen to all the malls in China? There are over 2,500 across the country, already more than double the number of enclosed malls in the US. More are opening around China every week. Who will fill up all the space? There’s serious money to be made by investors or operators who can take advantage of the large disruptions now underway in traditional retailing.

Restaurants in malls are still doing well, and they don’t have anything to fear from Taobao. But, food outlets generally pay lower rent, per square foot, than retail stores and occupy either the top or basement floors. Premium office space is also still in demand in the downtown areas where many malls are located. Should malls be turned into food and entertainment centers? Or converted to commercial offices? Neither path looks easy.

The US went through a large wave of shopping mall bankruptcies in the 1990s, as large operators like DeBartolo and Campeau failed, and better ones like Simon Property Group and Westfield Group thrived. The good operators lowered costs, improved the economics and did well as newer retailers like Victoria’s Secret, Abercrombie & Fitch, Hollister, Juicy Couture, H&M, Apple, Papyruys, Teavana, Nordstrom honed retail formulas that could withstand online competition.

Retailers in China are in such peril because they charge too much, never innovate and do so little to win the loyalty of their customers. Alibaba and other online sellers are hastening them towards extinction.

 

 

 

Better and Worse Investment Ideas For China’s Future

tablescreen Where is China headed and how to make money by getting there first? If you were to ask professional China investors, almost without exception you’ll be offered an identical vision of the China of 2020 and beyond:  retired Chinese in their tens of millions living in assisted-living housing spending their days on their smartphones buying clothes, playing games and booking European vacations.

It follows, the pros will tell you, that the best places to put your money today are with Chinese companies building retirement and assisted living housing, mobile apps and online shopping websites. Indeed, these are the sectors getting by far the most attention and seeing the most substantial flows of new investment capital these days.

I happen to think the “smart money” is wrong and here’s why. First, in my experience across 30 years of business life, whenever you get so much agreement about where the future is headed and where money should be staked, the predictions usually prove wrong and the money usually lost.

In this case, the basic analysis is fine. Yes, China is getting older and yes it needs more places to house and care for the elderly. And, yes, Chinese will buy more stuff online since prices are often much lower than in shops. But, only a fraction of the projects now receiving funding will be successes.

The assisted living, online shopping and mobile services businesses already seem over-invested. And yet the money keeps pouring in. It reminds me very much of the last “can’t miss” investment idea in China: group shopping. Two years ago, PE and VC firms poured billions into at least a dozen different group shopping sites in China Most, if not all of that, will be lost.

There are formidable hurdles in the way of all three of the currently-favored business models. For assisted living and retirement housing, it’s not clear Chinese retirees in significant numbers will want to move into these kinds of places, even if their kids are paying. Nor is it clear how these projects will make equity investors money, since Chinese banks remain loathe to lend money to any kind of real estate project.

Online shopping? Great business, but all the companies getting investment have to compete with a few powerhouses with huge market shares. The list includes Alibaba’s Taobao business, Yihaodian (part-owned by Wal-Mart), Amazon China, 360buy.com. I see little reason to believe these newer PE-backed entrants will make any serious dent against these competitors.

As for mobile services, yes Chinese have all switched en masse to smartphones. And, yes, they use the mobiles to do lots of stuff online, including shopping, chat, games. Problem is, in the overwhelming number of cases, Chinese don’t pay for any of it. In my view, they never will. Any investment predicated on the theory that eventually Chinese will start paying fees to mobile service-providers is usually based on not much more than a hope and a prayer. Nothing solid.

So, where else to put money now to be best-positioned for the China of 2020? I can think of two places. One is organic foods and the other is health supplements and what are called “functional foods” in the US.

As of now, both are tiny industries in China, a fraction of their size in the US and Europe. My guess is that the market in China will eventually dwarf those two other places. I’ve read about a few PE investments in these industries. But, in general, the so-called “smart money”  has stayed out.

So, why do I think organic, “functional foods” and supplements will become huge businesses in China? In general, the same forces will prevail in China that have propelled the growth of these industries in the US and Europe: a wealthier population, more interested in their health, more distrustful of traditional commercially-prepared foods, and also more interested to improve their health, fitness and life expectancy by exercising, eating well (including vitamins and supplements) while keeping away from doctors.

In China, this distrust of commercial foods and commitment to a more healthful lifestyle, though still in a comparatively early stage,  is already strong, deep and widespread. So is the lack of trust in the quality of medical care received from doctors.

As anyone who lives in China can attest, there are very good reasons for all of this. Food scandals are common. There seems to be a lot of unhealthy and unhygienic food circulating.  Doctors don’t enjoy a very high standing any longer. They are often seen as fee-grubbing predators, ever willing to make phony diagnoses as a way to put more money in their pockets from their share of fees paid for tests, medicines, surgery, hospital care.

In short, the conditions couldn’t be riper for the development of organic foods, and health supplements of all kinds. Chinese traditional medicine shares quite a few principles in common with the OTC health supplements sold in the US. Chinese, in a way Westerners generally do not, have always accepted that Western pharmaceuticals should often be taken as a last resort. They worry greatly about side effects. If there’s a more “holistic” way to treat a condition, Chinese will often prefer it.

China, as of today, has no vitamin and supplement shops like GNC in the US, nor do mainstream pharmacies give such products any shelf space. When you can find them, vitamins are sold at very high prices in China, usually at least double the US level. There are no good domestic brands, no winning products or packaging formulated specifically for Chinese consumers.

One data point: it’s more and more widely known in China that fish oil is beneficial for digestion and circulation. And yet, it’s hard to find the product anywhere in China. When you do, it is usually stuff imported from the US, in old-looking packaging, with English-language  labels, and prices three to four times higher than in America.

Whether the world has enough cod livers to meet future Chinese demand for fish oil is another story. But, I’m confident the China market should eventually rival the US’s in size.

As for organic and healthy foods, China has lots of conventional supermarkets. But, so far no one has tried to follow the path blazed by Whole Foods Market in the US. Nor are there large, established organic food brands like Organic Valley, Applegate.

It will all happen. When, and which investors will make the big money is hard to say. Even now, the demand for genuine organic fruits, vegetables and dairy outstrips the available supply. There’s yet no real standard in China for what can be called organic, and so Chinese consumers often view products labeled that way with suspicion. That too represents a business opportunity in China — providing standards and credentials for the organic farming industry.

The lesson here: in China, the best business opportunities are often hiding in plain sight, often unseen by professional investors. Nowhere is contrarian investing more warranted and more potentially profitable.