Making of China’s consumer society

Andrew Sheng & Xiao Geng

China’s transformation from a manufacturing-driven and export-led economy to one underpinned by services and domestic consumption is firmly underway. And that’s good news not just for China, but also for the future of the global economy.

The 2016-17 edition of the Blue Book of China’s Commercial Sector by Fung Business Intelligence and the Chinese Academy of Social Sciences maps the change. China’s retail markets reached CN¥30 trillion ($4.6 trillion) in 2015, after more than a decade of double-digit growth. Household consumption has begun to climb, even as the pace of investment has fallen, and now exceeds 60 per cent of GDP. Though the consumption growth rate has slowed to 10.7 per cent, the Blue Book projects that China’s domestic market may reach CN¥50 trillion by 2020.

A key driver of this transformation has been Internet technology. Building on heavy investments in public infrastructure, such as ports, airports, roads, rail, and telecommunications, the Internet is now expanding rapidly the range of choices available to Chinese consumers, while lowering costs and accelerating delivery.

As a result, China’s online retail sales have surged in recent years, from 6.3 per cent of total retail sales in 2012 to 12.9 per cent by 2015. By 2020, 40 per cent of all retail transactions in China may be conducted online. Online sales via mobile phones have jumped from only 1.5 per cent in 2011 to 55.5 per cent in 2015, and may reach 73.8 per cent by 2018.

China has now overtaken the United States to build the world’s largest online retail market. With a growth rate of some 33 per cent, it is also the fastest-growing such market. And despite growth in Internet use – the number of connected Chinese has risen from 253 million in 2008 to 688 million last year – there is plenty of room for further expansion.

This progress reflects innovations that enable broad-based consumption without the construction and maintenance of expensive brick-andmortar outlets.

In fact, growth in mobile sales has been driven by lower-income consumers, particularly in rural areas, where more than 81 per cent of Internet use occurs via mobile devices.

One key innovation has been multi-sided platforms like Alibaba, which, by providing access to production, logistics, distribution, and payments, challenge traditional business models – and with considerable success. In the second quarter of 2016, Alibaba announced that its revenue from China’s retail market had increased by 49 per cent year on year; another online platform, Tencent, reported a 52 per cent increase.

By connecting small and medium-size enterprises (which account for 80 per cent of employment in China) with the consumer base, such platforms erode some of the competitive advantage of large state-owned enterprises (SOEs). Indeed, while the returns from China’s Internet retailing revolution have been highly concentrated, for once this concentration has not been in the state sector.

In online retailing via mobile devices, Alibaba held an 84.2 per cent share of the market last year, with the next largest online retailer, JD.com, capturing just 5.7 per cent.

In the business-to-consumer market, Alibaba’s Tmall claimed a 58 per cent market share in the third quarter of 2015, with JD.com taking just 22.9 per cent. In third-party online payment services, Alipay held 47.5 per cent of the market, while Tenpay captured 20 per cent, and UnionPay, the only service developed by the banking community, had 10.9 per cent.

As a result, SOEs, which have long specialised in single markets or products, have now begun to recognise that they need to re-tool to compete both in China and in global markets. Given that SOE reform has long been on China’s agenda, this extra impetus may prove beneficial. But the challenge of determining how to create a level playing field for healthy competition and improve capital allocation in the Internet age remains.

It is not just China’s large companies that need to rethink their business models. As China’s ecommerce platforms become increasingly global, they may erode the dominance of giant multinationals in international trade.