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China’s e-commerce bubble

Dec 23 2011 07:00 Reuters

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Dongfeng Village - It was a Cinderella story: a pig-rearing and vegetable-growing hamlet in China’s eastern Jiangsu province that transformed itself into a village boasting millionaires and expensive cars, all through plywood, ingenuity and the internet.
 
In 2007 Sun Han, the 30-year-old de facto e-commerce chief in Dongfeng Village, fell in love with the designs of Swedish furniture giant Ikea and decided to make similar furniture of his own to sell on the internet.
 
Others in his village soon followed suit and the fairytale of wealth was born.

What were once vegetable plots have been converted into workshops and storefronts. Sun’s factory, sitting on just over an acre of land, now churns out knock-off Ikea shelves and beds to fill the 200 orders he gets a day on his two online shops.
 
But the story may not have a happy ending for everyone.

Intense competition has fuelled price wars among furniture vendors. That, combined with fee hikes from China’s leading online e-commerce platform, Taobao Mall, this year forced the closure of some of fledgling businesses in this dusty village that is home to more than 1 000 Taobao furniture sellers.

“There is more competition now, but we need to continue to innovate and meet customer needs,” said Sun, who looks more like a professor than a village business chief, in his black leather loafers, grey tweed jacket and half-rimmed spectacles.
 
Another furniture maker in the village, Wang Le, is more blunt about the situtation. As others have rushed to imitate those making the copycat furniture, he says, profit margins have been undermined for all.

“With everyone making similar things and prices dropping, the competition is vicious,” Wang, 29, said.
 
“You see that baby crib?” he said, pointing to an unfinished plywood crib on the floor of a decrepit brick room in his factory. “A few years ago, I could have sold it for 600 to 800 yuan ($95-$125). Now I can only sell it for 300 yuan.”

Fall from grace

Dongfeng village’s fall from grace is reminiscent of what is happening in China’s wider e-commerce market. Once the darling of private equity and venture capital firms, it is now set for a period of intense competition and shake-out.

Money entering the sector and the relatively low barriers to entry have spawned a multitude of e-commerce companies that are jostling for consumers’ attention.

From shoes to junk food, there are an estimated 25 000 online stores in China.

“Every private investor, most of them with more money than sense, tends to think they can replicate the Amazon model in China. And so that is what really created the competition, this flood of capital,” said Michael Clendenin, managing director at Shanghai-based consultancy RedTech Advisors.

With 173 million Chinese people shopping online, China’s e-commerce industry is expected to surpass 750 billion yuan ($118bn) in gross merchandise value this year, more than the gross domestic product of Vietnam.

It is expected to become the world’s largest e-commerce market in 2015, Boston Consulting Group said in a report recently.

Though the waters for this market look promising, analysts warn that they are shark-infested.
 
“It’s very competitive and the margins are quite low, so it’s hard to make money in it... When we think about books, how much are books in China? It’s so low, but you still have to give free delivery for 29 yuan,” said Hong Kong-based Samsung Securities analyst Paul Wuh.

Amazon.com, the largest online retailer in the United States, usually reports operating margins of 3-5%. By comparison, Chinese online book retailer Dangdang reported negative operating margins in the third quarter.
 
Heavy spending on logistics, waging price wars, holding steep discount promotions and splurging on massive offline advertising are what it now takes to be an e-commerce player in China and to stay at the forefront of consumers’ minds.

“It’s going to be the guys with the most to lose who are going to win in the end. And what do they win? They win a business that is low margin. It’s just so tough,” RedTech Advisors’ Clendenin said.

Who are the big players?

Alibaba Group, founded by former tour guide Jack Ma, is the biggest e-commerce player in China. Its Taobao unit is now the single largest e-commerce platform in China, dominating more than 70% of all transactions made online and half of all parcels sent in China.
 
Taobao paved the way for other e-commerce players to compete, first by creating e-payment system Alipay and also by pioneering an overall e-commerce ecosystem that caters specifically to Chinese consumers.

For example, Chinese customers have a high trust barrier, so they frequently pay with cash when their goods arrive.

By using the Taobao platform, they are also able to chat directly with sellers via instant messaging to ask about items on sale.

But Taobao is not spared the intense competition. Dangdang, Tencent Holdings, Wal-Mart Stores and 360buy, backed by Russian internet investment group Digital Sky Technologies, are battling for a share of the pie.

Bricks and mortar appliance retailers such as Suning Appliance and Gome Electrical Appliances Holdings are also beefing up their online presence.

“When you compare online retail compared with offline retail, the growth rate cannot be compared. One is 100 percent year-on-year growth and the other is 15 to 20 percent,” said Marie Jiang, a Shanghai-based analyst with Pacific Epoch.

Some analysts expect platform players such as Taobao, who have the least monetary outlay, and the traditional retail players such as Gome and Suning, who have superior logistics, to be the ones to thrive in the end.

“This isn’t the old days of the Chinese internet of higher margins. It’s a whole new phase of the internet where it’s much, much, more competitive,” Clendenin said, adding that the time when firms like search engine Baidu and Tencent, which operates social networking and online gaming sites, could build their businesses into monopolies are essentially over.
 
Wang Bing, a pig farmer turned logistics company boss back in Dongfeng Village, has mixed feelings about the sudden competitive turn in his industry. There are at least a dozen logistics companies operating out of Dongfeng village to support the e-commerce trade.

“When I first entered the business, I knew absolutely nothing about it. Now that I’m in it, I can see just how hard it is to compete,” said Wang, whose newfound wealth has meant he can afford the gleaming white Hyundai that sits incongruously along Dongfeng’s dusty main road as logistics trucks trundle by.

“But life now is so much better. Not just a little better, way better.”
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