China Is Establishing the Future of Retail
Today, China is ground zero for the future of retail. It’s highly likely the West will have to learn from, and adopt, the experiments in retail that are happening today in the East.

Consider Alibaba, the Chinese Internet giant whose wide-ranging businesses span e-commerce, offline retail, fintech, online video, digital maps and browsers, and artificial intelligence. By the third quarter of 2017, Alibaba’s business model appeared to have reached peak fruition, as the company took pole position as the world’s largest e-commerce platform, but was also third in digital advertising, just behind Google and Facebook. What could possibly change? A lot, as we have seen in the past 12 months.

Experiments in Retail

Alibaba’s experiments in what it calls “new retail” have gained a scale and urgency scarcely imagined a year ago. Over 1 million of China’s 6 million small locally owned stores have signed up for the company’s Lingshoutong initiative.1 Lingshoutong refits the shops and supplies them directly using Alibaba’s logistics channel.

Alibaba’s high-tech food/grocery retail store concept, known as Hema, is expanding quickly. These outlets serve as walk-in restaurants, food and grocery purchase points, and warehouses for online delivery – all at the same time. There are now 64 Hema stores in operation, with two being added each week. Already, Hema stores in operation for over 18 months are reporting revenues up to five times those of traditional offline stores. Sixty per cent of Hema’s sales are through the online delivery channel, making the stores far more productive, for far more hours of the day, than pure offline stores.1

Unsurprisingly, China seems uniquely ready to adopt the Hema concept. Organised channels for grocery are currently underdeveloped compared with the United States, where over 90% of grocery already passes through established super/hypermarkets. In China, wet markets, the Asian equivalent of farmers’ markets that sell fresh meat and produce, still account for more than 70% of the country’s grocery sector. This signifies the boundless potential for Hema as it keeps on driving the new retail experience involving online and offline integration.

There is more. Alibaba’s online shopping Taobao platform is no longer content with making ad-based recommendations, which were driven by keyword bidding by merchants. Recommendation feeds driven by consumer opinions have gained priority, as have sharing, short-form videos, and live streams, which improves conversion rates.

Ambitions are also rising at the recently acquired Ele.me, an online food delivery platform. Not content with its 167 million user base, Ele.me is now eyeing the nearly 600 million e-commerce user base of Taobao and Tmall, another Alibaba e-commerce platform, and the 870 million users of Alipay, Alibaba’s digital payments platform, to substantially expand its reach.1

Retail space owned by Intime Retail – now a part of Alibaba – is being used for experimental “Tmall pop-up stores,” which allow consumers to walk in, sample inventory, access a large apparel collection on giant touch screens within the store, pay with Alipay, and choose self-pickup or home delivery. Alibaba also has a furniture store that uses augmented and virtual reality to show consumers how an item will look in their homes. Retail stores owned by Sun Art Retail, in which Alibaba has a 31% stake, are dedicating space to products directly sourced from Tmall. These products can be sampled with an eye to the online purchasing habits of people in the immediate vicinity of the store – tastes the offline store may not have been aware of before, but known to Alibaba via its ecommerce operations.

The Need for a Retail Transformation

Is there a method to this cornucopia of initiatives? Alibaba’s new long-term target to transition from working with 10 million small and medium enterprises (SMEs) to 10 million profitable SMEs provides a clue1. As e-commerce penetration rises to nearly 20% in China, the existing silos of offline and online retail raise vital questions, are brands and merchants more profitable, or less, as e-commerce grows larger? Does Alibaba’s success come at the expense of its merchants’ profitability, or is everyone truly better off?

Analysis suggests that between 2011 and 2016, when e-commerce grew dramatically in China, costs rose significantly for several retail categories as they tried to keep up, particularly consumer appliances, apparel, and personal care. These rising costs reflect the parallel universes that exist today; offline retail channels, demand management, space planning and supply chains, and consumer analytics have little in common with e-commerce. Also, the analytics that can be garnered from in-store customer transactions have little in common with what can be drawn from e-commerce engagements. Increasingly, brands and merchants seem to be running two businesses for the same product, which unsurprisingly leads to cost inflation.

The true promise of omnichannel retail, or new retail, is a more profitable merchant. The future economics of giant e-commerce platforms will likely emerge from this promise, and the hope that these platforms will not simply maintain their share of a shrinking pie but maintain or increase their share of an expanding one. Not content to be appropriators or gatekeepers of consumer demand, these platforms increasingly aim to help fundamentally change the way consumers shop.

Points of Friction Are Likely

Not all will be smooth, of course. The real world possesses far more points of friction than online businesses traditionally encounter. Offline or omnichannel initiatives address a target market that is five times larger than online retail, but one-fifth as profitable, or even less so in the initial years. Even as the strategic rationale for ongoing initiatives is inescapable, it may decrease profitability.

Elsewhere, the expectations of consumers and merchants will remain fluid, exposing new threats and opportunities. There are still unmet consumer needs, despite everything we have already seen in China. Merchants need more too — more analytics, higher returns on their ad spends, and more handholding with their supply chain and information technology systems. There are companies seeking to address these needs: Meituan, for example, is not just China’s largest food delivery and restaurant booking platform, it also provides restaurant management software that is helping to cement its lead.

And thus, to the future of retail. What drives shopping? Needs, of course, but also habits, impulses and, increasingly, fun. Shoppers seek convenience, price, and experience, but also identity and social connection. In the future, will it really matter where we notice a product, where we try it, pay for it, or how it is delivered to us? These ideas are not new, but as e-commerce platforms and offline retail move into each other’s turf, they have acquired an immediacy not seen before.

Explore More in Each Section

Our equity and fixed-income investments, who spend considerable time in these markets, share their insights on where they believe the greatest opportunities lie. Our Innovation Index also demonstrates emerging markets may lead the next wave of technological breakthroughs.

1. Emerging Markets Are Poised for Transformational Growth

2. The Big Picture

3. Regions in Depth

4. View from the Ground

5. Innovations in Emerging Markets

6. China's Tech Revolution

 
  1. a, b, c, dSource: Alibaba presentations, 2018 Investor Day, Sep 17-18, 2018. https://www.oppenheimerfunds.com/advisors/article/the-future-of-ecommerce-and-retail-will-be-written-in-china