E-commerce in China: Changing the face of retail
August 8, 2013
As we wrote here in the fall of 2012, domestic consumption is expected to become a steadily growing component of China’s economy.
Indeed, consumption is on the rise and the transformation is seemingly under way. It’s not by any means complete, however; there is a long way to go, and it will take time. But China’s new economic patterns are being established during a particularly heady time: the Internet era. The effectiveness and ease of online commerce will help digital providers proliferate, unhindered by the limitations of traditional brick-and-mortal retail.
The dominant role of e-commerce
Already, China houses the second-largest online shopping marketplace, behind only the United States. Even residents of China’s remote areas now have a chance to shop, and they are now being exposed to a growing array of products that were once distributed only in (or near) major metropolitan areas. This growing consumer base has helped China’s e-tailing industry reach a compounded annual growth rate of 120% since 2003 (data: McKinsey & Company, March 2013).
At the front of the pack: Alibaba
One of China’s leading e-tailers is Alibaba1, a company that by some measures has become the world’s largest e-commerce hub. With a staff of 24,000, it operates platforms that facilitate transactions for at least three major market segments:
For a better idea of Alibaba’s scale and market leadership, let’s look at its business volume versus established online leaders below.
Alibaba’s merchandise pipeline: Surpassing Amazon and eBay
|For financial year 2012, in billions ($)
||Gross value of merchandise
*Through September 2012 | Data: Company reports and Morgan Stanley, via The Economist
The Alibaba phenomenon is worth noting because it embodies the power and the promise of Internet commerce in China. As the company continues latching on to more growth opportunities, it should likely continue its role as an emblem of Chinese e-commerce.
1Alibaba is a private, unlisted company. We reference it solely as an example of e-commerce’s potential in China. This should not be read as an endorsement of Alibaba, its prospects, or its business model.
Despite the huge potential, maintaining a conservative focus on quality
Based on research, by 2020, China’s e-tail marketplace is projected to be bigger than existing markets in the U.S., Britain, Japan, Germany, and France combined. China’s online leaders are expected to dominate retailing not just locally, but more broadly at the national level. Given that e-tailing will be an important factor in China’s growth, companies that serve the industry are among those that we are monitoring as we seek opportunities in the coming quarters. All along, however, we are maintaining our traditional focus on bottom-up, stock-by-stock research, investing only in companies that we believe exhibit:
- strong franchise sustainability;
- long-term earnings power; and
- valuations that are at significant discounts to our estimates of their intrinsic value.
At this writing, the Chinese allocation within the fund the we manage, Delaware Emerging Markets Fund remains slightly below the its benchmark index, where it has been for some time. In absolute terms, however, China remains among the significant weights within the Fund’s portfolio, but our approach to Chinese equities remains selective.
Indeed, our focus in China has been largely on internet companies; given the volatility within such sectors as materials and real estate. We have found success within this unique segment of the information technology sector.
The growth of Chinese e-tailing will come with its share of opportunities as well as challenges. Any adjustments to holdings will be based on the criteria mentioned above. As we consider China-based Internet companies, any new position will have to earn its way into the portfolio, exhibiting what we view as considerable potential before we initiate a transaction.
The primacy of franchise quality
As important as it is to identify big trends, it’s even more important to find business models that we believe will sustainably benefit from those trends. The companies that we pursue are first and foremost good franchises. Alibaba, for example, is an e-commerce hub that benefits from so-called network effects — sellers are attracted to its large user traffic, and users are in turn attracted by the wide variety of products available on Alibaba’s sites.
We also invest in other companies that benefit indirectly from the e-commerce boom. Their search engines are a gateway to China’s e-commerce websites. Online search is a highly scalable, capital-light business that benefits from any type of Internet traffic, especially traffic with a commercial intent (such as e-commerce). E-commerce is therefore one of the fastest growing segments, and we expect this to continue.
The views expressed represent the Manager’s assessment of the market environment as of August 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
Diversification may not protect against market risk.
Past performance does not guarantee future results.