Six reasons China is winning at e-commerce

Why has China’s e-commerce industry developed so fast? I get asked this in almost every country I visit, usually closely followed by the question: “Could the same happen here?” To try to answer, I focus on the following six points:

1. First and foremost, China manufactures too much of almost everything

This has created an enormous supply of product that manufacturers, distributors and retailers are looking to get rid of at a marginal price, ideally into a part of China that they are not focused on. Chinese mom and pop retailers, distributors and the millions of contract manufacturers have seized this opportunity gratefully.

E-commerce potentially enabled this, with a consumer to consumer model with almost no barriers to entry that allowed anyone with as little as a box of T-shirts, legitimate or fake, to set up as an online supplier.

2. There was never a shortage of capital

China’s investing community has been only too willing to fund e-commerce start-ups. Take group purchasing, à la Groupon, with Chinese characteristics. At one point there were 5,000 start-ups playing in this space. This enabled Chinese e-commerce players to focus on growth, not profitability, and to wait for a long time before they had to go to the public markets for capital.

3. The consumer had to be ready to spend and in China they were

By the mid-2000s, China’s middle class was rich enough to be shifting its spending from necessities to optional spend, but still value-driven enough to want to look for a bargain. These consumers had often bought their home and were now looking to purchase items to fill it. Their spending was enhanced from 2008 on by the strategy of the government to push up wages by more than 10% annually. Spending and incomes are highly correlated in China.

4. The internet and physical infrastructure to join these sellers and buyers needed to be in place

Thanks to China’s state-owned telcos’ responsiveness to the performance goals set by the government to bring broadband to tens of millions of new homes every year, internet coverage grew quickly, allowing the middle class to browse online from their homes, rather than having to go to the internet cafes. E-commerce logistics benefited significantly from the physical infrastructure that China had built over the last 20 years to bring products from factories to ports for export. Much could easily be leveraged to bring product from factory to China’s middle class consumers who were overwhelmingly based in coastal cities.

China had many “subsistence” logistics providers in addition to the state-owned China Post parcel service. These owner-operated truck drivers drove inter-city carriage prices down to almost marginal levels, and an entire new industry of last mile scooter-based delivery agents grew up in cities, earning only a few hundred RMB a month. So costs of getting product to buyers was very low, and even that low cost was absorbed by e-commerce players focused on growth, not profits.

The lack of readiness of several key players meant they neither recognized nor responded to the threat for several years. Large retailers were focused on their own land grab of physical locations and simply didn’t see what was happening. Even if they had, most were more real estate managers than sophisticated retailers, renting space to brand owners. They had no capabilities to move quickly online.

Brand owners themselves had relied on distributors and franchise stores to maximize their China coverage. Their control of the channel was modest. When hundreds of vendors popped up online selling their product, they had limited levers to control. They had perhaps even less control of the factories to which they had outsourced production. If overruns ended up online, what recourse did they have? Private and state-owned mall owners, focused on the expansionist behavior of large retailers, continued their breakneck expansion also, not seeing that some of their key sectors such as electronics and clothing would soon be reducing, not growing, their store footprint.

5. Banks were also unable to anticipate where e-commerce was heading

They missed the opportunity to move into the online payments space, to capture the trading and financial information on millions of retailers that would have enabled them to better assess risk in lending to China’s SMEs. Instead, the online players were allowed, in a regulatory grey zone, to create their own payment systems. From this, they have built lending and investment businesses, credibly moving now into full service online banking.

6. Sometimes passivity is a key enabler, and it was here

The government had no grand plan for or against e-commerce, and in its early days, largely stood back and observed whether or not this would turn out to be a positive. As it seemed to be allowing millions of small scale businesses to get established and flourish, the experiment was seen to be a success, even if players had not always sought licenses they might have required, or had ownership structures that may not fully align with regulations.

Will any other country put together this mix of ingredients in the same way? Unlikely.

Published in collaboration with LinkedIn

Author: Gordon Orr, Chairman, Asia at McKinsey & Company

Image: Richard Liu, CEO and founder of China’s e-commerce company JD.com, crosses a street on an electric tricycle as he delivers goods for customers to celebrate the anniversary of the founding of the company, in Beijing, June 16, 2014. REUTERS/Jason Lee