CLSA 8.2011 Blue Book On China E-Commerce

Blue Books
Experts’ views for expert investors

China
Internet

26 August 2011

Elinor Leung, CFA
Head of Asia Telecom &
Internet Research
elinor.leung@clsa.com
(852) 26008632

Guest author
Professor He Xia
Deputy Chief Engineer,
Institute of Policy and
Economics, China Academy of
Telecommunication Research
of the Ministry of Industry
and Information Technology

Buying into e-commerce
Transforming China into an online market
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Blue Books

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Professor He Xia
Professor He Xia is Deputy Chief Engineer at the Institute of Policy and
Economics in the China Academy of Telecommunication Research of the
Ministry of Industry and Information Technology (MIIT). She also serves as
Chairman of China Information Economics Society and an expert member on
two MIIT committees. She is a guest professor at BUPT School of Economics
& Management and Xi’an University of Post & Telecommunications.

She graduated from the economics school at Capital University of Economics
and Business, and received her Master’s degree from the school of
economics at Renmin University of China. She also spent some time
studying at the University of Maryland, USA in 1995.

Professor He has conducted economics and policy research in
telecommunications for 25 years. She has published more than 100 research
papers domestically, including Investment and Financing in Information
Industry, The development of the Mobile Communications Industry and its
social influence, and Telecommunications Regulation of the Internet Age.
One of her new works - Information Industry and System Innovation - will
be published soon.

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2 www.clsau.com 26 August 2011


Blue Books

Foreword
Beijing is a big supporter of e-commerce as the industry can provide solutions
for many of the challenges that China now faces. It is the first internet
application that the government has determined to be a worthy use of large
network investment. The authorities value e-commerce much more than
online games and social networking, which are pure entertainment.
Successful development of the industry could transform China into the largest
e-commerce market in the world.

Advancing e-commerce in China is one of the key elements of the 12th Five-
Year Plan and will be crucial in developing a domestic-driven economy and
migrating up the value chain. It should also help boost the health of small and
medium-sized enterprises, which are the backbone of the mainland economy,
as well as sustain economic growth.

The government aims to develop an IT-driven society to drive the country’s
education, productivity and competitiveness. The telecoms regulator studied a
national broadband strategy last year but had to put it on hold as it struggled
to justify the large investment to support entertainment businesses such as
online games. E-commerce is different, however, as it will have profound
economic benefits. China also wants to be a leader in new technologies such
as ‘internet of things’ - a network of everyday objects that can interact via
web services - and cloud computing. It has identified these as key strategic
industries in the 12th Five-Year Plan. To accomplish this, the country plans to
build one of the best telecom networks in the world.

Professor He Xia, Deputy Chief Engineer at the Institute of Policy and Economics
in the China Academy of Telecommunication Research of the Ministry of
Information Industry Technology, shares her insights on China’s internet policy
and how the country is going to build an e-consumption economy. She has more
than 20 years of experience in the telecoms and internet industry.

Regulatory risk for the internet sector has been overstated. This is obvious
given the explosive growth of the industry. The government’s goal is to
cooperate with the internet companies to promote growth. There are obvious
contradictions with self-censorship and other issues, but China has found a
middle road that has allowed the sector to flourish. The internet is one of the
most successful private industries and is critical in helping China move up the
value chain.

Elinor Leung
Head of Asia Telecom & Internet Research

26 August 2011 www.clsau.com 3


Blue Books

Contents

Executive summary ............................................................................ 5

Building an e-consumption economy .................................................. 6

Uncharted territory with hurdles, opportunities ............................... 23

Growth is inevitable ......................................................................... 28

Conclusion........................................................................................ 37

Appendix: Shanghai Provisions ........................................................ 39

China moving online



Executive summary Blue Books

Buying into e-commerce
Shifting to a consumption- The global credit crisis has forced China to re-evaluate its export and investment-
driven economy driven model. It was a wake-up call that may have prevented Beijing from
pushing the economy from overinvestment into a hard landing. According to the
Chinese Academy of Social Science (CASS), economic restructuring with a focus
on boosting consumption is needed to sustain growth. Domestic growth,
especially consumption, is vital to maintain fast economic expansion over the
next 10 years. The stakes are high for Beijing to get this right.

E-commerce a key part of E-commerce is a key part of the government’s next five-year plan. The
the next five-year plan biggest advantage of developing e-commerce in China is that it is a relatively
new industry with a large multiplier effect over the entire economy. It is
mainly software driven and leverages on all the hard infrastructure that was
invested over the last decade. E-commerce will benefit from strong demand
as incomes rise. Over the next five years, the government aims to build an
IT-driven society, improve the support system for e-commerce and build it up
to help SMEs compete against the big companies. It is also a critical factor in
developing the service sector, which will be a key engine for job creation. The
government plans to develop B2B and facilitate expansion into B2C. It will
enforce light regulation on e-commerce, as it is a payback for all the
infrastructure investment.

E-commerce faces many However, there are still many hurdles such as privacy issues, user information
challenges, but growth protection, implementation of real-name registration, online taxation policy,
is inevitable
inefficient logistics network and new online-payment and anti-laundering
regulations. Nevertheless, Beijing will continue to invest in the infrastructure
to support e-commerce growth. China has one of the world’s best telecom
networks and the internet industry has been the main beneficiary. It will build
on this success and plans to accelerate broadband growth, even in rural areas.
With the move to 4G and greater smartphone usage, the internet industry will
thrive. The risk is that the government will impose a centralised agency to
manage the sector, which could stifle development of internet services by
adding more approval processes and imposing strict censorship guidelines.
We believe this is unlikely. Internet policies will continue to support growth.

E-commerce transactions E-commerce to double in China over next three years
to double
25 (Rmbtn) (%) 50
e-commerce transaction value (B2C, C2C & B2C)
47
Growth rate (RHS) 46
20 40
41 41

15 34 30

10 23 20

5 10

2.9 3.6 4.8 6.8 9.5 13.9 20.4
0 0
2008 2009 2010 11F 12F 13F 14F

Source: iResearch



Section 1: Building an e-consumption economy Blue Books

Building an e-consumption economy
Shifting to a consumption- The 2009 credit crisis provided a wake-up call for the Chinese government to
driven economy re-evaluate its export and investment-driven model. It prevented Beijing from
pushing the economy into an inevitable hard landing. The country had to
restructure its policy and focus on boosting consumption to sustain economic
growth. Domestic consumption is vital to maintaining rapid economic growth
over the next decade.

E-commerce easiest There are large structural barriers to boost consumption in China such as high
way to lift domestic logistic costs, imbalanced taxation structure and safety scandals that all serve
consumption
to keep prices high and depress consumption. One of the easiest ways to tear
down these barriers is to develop a new industry and infrastructure. This is
why e-commerce is important as it is the easiest way for the government to
not only boost domestic consumption, but also push China up the value chain.

A key part of the next E-commerce is a major focus of China’s five-year plan. The biggest advantage
five-year plan of developing e-commerce in China is that it is a relatively new industry with
a large multiplier effect over the whole economy. It is mainly software driven
and an extension of all the hard infrastructure that was invested over the last
decade. E-commerce will benefit from strong demand as incomes rise.

China has a large China has two major advantages to build a world-class e-commerce industry: It
consumer market and has a huge consumer market, which will likely become the largest in the world,
internet user base
as well as a massive internet user base that is already the largest globally. Sale
of retail consumer goods rose 14.8% YoY in 2010 and CASS expects growth to
maintain at an annual rate of 17% for the next five years. CASS expects China
to overtake the USA as the biggest market of consumer goods by 2015.

Over the next five years, the Chinese government aims to:
 Build an IT-driven society.
 Improve e-commerce support systems.
 Build up e-commerce to help SMEs compete against big corporates. It is
also a critical factor in developing the service sector, which will be a key
engine for job creation.
 Build upon B2B and facilitate expansion into B2C, which will replace C2C.
 Enforce light ex-post regulation on e-commerce, as it is a payback for all
the infrastructure investment.
 Avoid centrally planned e-commerce regulation.

World’s largest consumer-goods market
China could become the China could become the world’s largest market for consumer goods by 2015
world’s largest market for according to CASS. The country contributed 5% of the world’s consumption of
consumer goods by 2015
US$37tn in 2010, from less than 3% a decade ago. China’s private consumption
grew 14% to US$2tn in 2010 and will likely continue at a 17% Cagr for next five
years. Private consumption contribution to GDP will likely increase 2-3% to 35-
36% by 2015. More than half of China’s private consumption is on consumer
goods, compared with about 30% of the USA’s consumption of US$10bn (70%
on service). China’s private consumption could reach Rmb4.6bn by 2015,
overtaking America as the world’s largest consumer-goods market.




Catching up to the world’s China has stepped up its efforts to shift from an export-oriented and investment-
rich countries led economy to a consumption-driven one after the 2008 global financial crisis. It
is catching up to the world’s rich countries by investing in new manufacturing and
retail capacity, improving its banking system and consumer-credit market,
adopting modern technology and increasing workers’ productivity.

Figure 1 Figure 2

China’s private consumption China’s private consumption as a share of GDP

5 (US$tn) 4.6 40 (%)

38
4 17% Cagr 38

36 36 36
3 36 + 2-3%
35

2.0
1.8
2 1.6 34
33
1.3
1.1
0.8 0.9
1 0.6 0.6 0.6 0.7 32

0 30
11CL

12CL

13CL

14CL

15CL

11CL

12CL

13CL

14CL

15CL
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2006

2007

2008

2009

2010
Source: CEIC, CASS

Figure 3

China is the world’s third- China accounts for 5% of the world’s consumption
largest consumer market
Country Private consumption (US$tn) % of world consumption
1 USA 10.4 28.0
2 Japan 3.2 8.7
3 China 2.0 5.3
4 Germany 1.9 5.1
5 France 1.5 4.1
6 UK 1.5 4.0
7 Brazil 1.3 3.4
8 Italy 1.2 3.3
9 India 1.0 2.6
10 Canada 0.9 2.5
World 37.1 100.0
Source: Euromonitor

World’s largest internet market
China is the world’s China is the world’s largest internet market. The number of Chinese netizens
largest internet market increased by 19% YoY to 457 million in 2010, almost double that of the USA.
However, internet penetration remains low at 34%. China’s internet users are
likely to double to 800 million with about 60% penetration by 2015, according
to MIIT. This will be driven by increased investment in fixed-broadband as
well as the rollout of 4G (wireless broadband). At the end of 2010, China had
303 million mobile netizens.




Figure 4 Figure 5

Top-10 largest internet markets by users China internet users

China 457 900 (m) (%) 70
USA 248
800 Internet users 60
Japan 101
700 Penetration (RHS)
Brazil 84 50
600
India 75

500 34 40
Russia 66
29
Germany 66 400 30
22
Nigeria 53
300 16
UK 53 20
200 8
10
France 47
10
100
S Korea 41

111

137

210

298

384

457

800
(m)
Mexico 32 0 0

11CL

12CL

13CL

14CL

15CL
2005

2006

2007

2008

2009

2010
0 100 200 300 400 500

Source: Euromonitor Source: CNNIC, MIIT

E-commerce to double in next three years
E-commerce services have E-commerce-driven services are gaining traction and have become the
become fastest-growing fastest-growing online business in China. About 92.7% of SMEs have internet
online business in China
access, and the figure is close to 100% among large companies. About 43%
of Chinese companies have their own dedicated websites or online stores on
third-party e-commerce platforms like Taobao.

E-commerce transaction The overall transaction value of China’s e-commerce market (B2B, C2C and
value will exceed B2C) in 2010 amounted to Rmb4.8tn, up 33.5% YoY. The market is likely to
Rmb10tn by 2013
maintain a high growth rate for the next three to five years and exceed
Rmb10tn by 2013, according to iResearch. China currently has 25,000
domestic e-commerce (B2C) firms and 1,880 online group-buying companies.

Figure 6

Transaction value to Transaction value of China’s e-commerce market
double in next three years
25 (Rmbtn) (%) 50
e-commerce transaction value (B2C, C2C & B2C)
47
Growth rate (RHS) 46
20 40
41 41

15 34 30

10 23 20

5 10

2.9 3.6 4.8 6.8 9.5 13.9 20.4
0 0
2008 2009 2010 11F 12F 13F 14F

Source: iResearch

B2B is China’s largest B2B is the largest e-commerce market in China with a transaction value of
e-commerce market Rmb4.2tn in 2010, accounting for 88% of the nation’s total e-commerce
business. However, online shopping (C2C and B2C) has grown rapidly. The
market expanded at a more than 100% Cagr over 2007-10, more than six
times that of retail sales in the same period. About 148 million Chinese
people or 30.8% of netizens shopped online last year. Online-shopping




transaction value was up about 90% YoY to Rmb498bn in 2010, accounting
for 3.2% of total retail sales and is expected by iResearch to exceed 5% by
2012. Traditional companies are beginning to embrace the online business, to
offer consumers more choice. Consumers, on the other hand, are becoming
increasingly dependent on online shopping given cheaper prices, wider
selection and free delivery service.

Figure 7

B2B accounts for 36% of China’s e-commerce transaction value breakdown (2010)
online transaction value
Air ticket & hotel
1.3%
Online shopping
10.4%
Companies
above
designated size
B2B 35.5%

SME B2B 52.8%

Source: iResearch

Building an IT-driven society
China wants to develop China’s ambition is to accomplish an IT-driven industrialisation, marketisation,
an IT-driven society urbanisation and internationalisation. This will come with a change in social
and economic structures and e-commerce will play a role. Both central and
local governments have made the deployment of IT infrastructure,
broadband/fibre backbone network, the internet of things and cloud
computing applications a top priority.

Heavy IT investment continues
Government has outlined The government has outlined IT as a strategic emerging industry in its 12th
IT as a strategic Five-Year Plan. China will continue to invest heavily on IT and reform traditional
emerging industry
industry with high-tech and international advanced technology and thus boost
the nation’s competitiveness. It will further push broadband and home
appliances into the countryside, e-government and public cultural service
systems, education levels in rural areas and healthcare informatisation projects.

Accelerate broadband and fibre growth
Government to accelerate The government has plans to accelerate broadband rollout in the next five
broadband rollout years. China could introduce new competition and drive network convergence.
It may also launch a national broadband strategy to encourage local
governments to subsidise rural rollout. The government expects to provide
FTTx broadband connections to 100 million users by 2015. All urban internet
users will enjoy a minimum 50-100Mbps broadband service. Meanwhile,
wireless broadband 4G will extend China’s internet coverage.

Getting ready for 4G
China is a strong Beijing is a strong supporter of Time Division-Long Term Evolution (TD-LTE)
supporter of TD-LTE technology, the next-generation 4G standard. China Mobile has started TD-
LTE trials in 6+1 cities, including Beijing as a showcase, with 83 million




people since the beginning of the year. Seven leading domestic and
international equipment vendors have participated in the trials, namely
Huawei (Shenzhen), Alcatel-Lucent (Shanghai), Nokia Siemens Networks
(Hangzhou), ZTE (Guangzhou), Datang (Nanjing), Ericsson (Shenzhen) and
Motorola (Xiaman). Motorola has completed Phase 1 of the trials (network
plan and optimisation, key technology and network performance) earlier than
the original schedule of 3Q11. The next phase will involve networking tests,
Inter-RATE reliability tests, e2e services (full voice and data services) and
user experience and will be completed by mid-2012. Qualcomm plans to
launch a TD-LTE/TD-SCDMA chipset by year-end. Licensing for 4G will not be
a problem as soon as the technology is ready. China has charged minimal
spectrum fees on 2G and 3G services and 4G will likely be the same.

Internet of things - A key new strategic industry
Internet of things is a The internet of things (IOT) is a new strategic industry for China. IOT is a
new strategic industry network of real-world objects that can interact via web services, using
technologies such as radio frequency identification (RFID) and sensors.
China’s IOT industry reached close to Rmb200bn in 2010 given the strong
push by local and central governments. The market size could reach
Rmb750bn by 2015. IOT can be used in a wide range of areas including home
safety, electric power safety, public security, health monitoring and
environmental protection. In 2009, the MIIT set up a working group on
sensor network standardisation. Premier Wen Jiabao also delivered his ‘Let
Science and Technology Lead China’s Sustainable Development’ speech,
stressing the importance of selecting emerging strategic industries and calling
for consistent efforts to make breakthroughs in key technologies such as IOT.
Many local governments have already set out plans to promote IOT. Wuxi, in
Jiangsu province, has led IOT investment and was first to test smart buses in
the city. It has set up China’s first IOT industry fund of Rmb5bn. The Nanjing
government has also prepared Rmb1bn to fund emerging industries and
technology innovation, including IOT. Projects include a smart power grid,
smart transportation network and smart medical network.

Beijing to lead cloud-computing development
Cloud computing is China has identified cloud computing as a key area for rapid development. With
also a key focus a large number of SMEs, it can use cloud computing to improve investment
returns as it negates the need to build new data centres. Cloud computing is
still in its early stage in China with the development of ‘private clouds’ and
‘public clouds’. Hybrid clouds and the industry value chain will be formed during
the 12th Five-Year Plan. Beijing will likely lead the development of cloud
computing as it is the headquarters for most big corporates and many IT
purchase decisions are made in Beijing. Cloud computing is included in Beijing’s
development plan for the IT industry in the five-year plan. These projects will
receive priority support from the Beijing municipal government. The Beijing
government expects revenue from the cloud computing industry to reach
Rmb200bn by 2015.

Policy support for e-commerce
Promoting e-commerce by In the 12th Five-Year Plan on national economic and social development,
improving support systems China will speed up IT development and actively promote e-commerce,
especially for SMEs, by improving support systems such as credit service,
online payment and logistics. Premier Wen Jiabao proposed in the
Government Work Report to strengthen China’s logistics and distribution
network and actively promote the development of e-commerce.




Six authorities drafting Six leading authorities, including the Ministry of Commerce, Ministry of
plans for e-commerce Industry and Information Technology (MIIT) and People’s Bank of China
(PBOC), are drafting the 12th Five-Year Plan on e-commerce, which puts e-
payment as a core development for e-commerce, making online stores a
100% e-business. Many online shoppers still pay by cash on delivery.

Shanghai has introduced the Provisions of Shanghai Municipality on Promoting E-
commerce Development (see Appendix 1) to support the development of e-
commerce at the local level. The policy has it as a priority although efforts are
needed to improve the legal system and regulatory mechanisms.

Improving e-commerce infrastructure
Online payment core to The government has improved e-commerce supporting systems to propel
e-commerce development growth. Online payment is at the core of e-commerce development. The
PBOC issued third-party payment regulations in 2010 and granted third-party
payment licenses to 27 companies in June. This will legitimate the online
payment industry and encourage growth. The central bank has no plans to
limit the number of licenses. Logistics is still a major bottleneck for e-
commerce development in China. However, the strong demand has attracted
heavy investment in the sector. China’s push in e-government, e-ID cards and
technology evolution has also laid a solid foundation for e-commerce growth.

New third-party payment policy opens up new opportunities
Online-payment policy Last year was critical for the development of third-party payment service in
is clearing up China, due to the exponential growth in the sector, but also PBOC’s issuance
of new licenses and regulatory policies. The new policy will legitimate the
online payment service in China and open up the market to attract more
investment as well as product and application development. The third-party
payment sector will likely experience another big leg-up with increasing
internet penetration, clearer government rules and expanding applications.

Online transaction China’s third-party online payment sector recorded phenomenal 100% YoY
doubling per year growth in 2010, with transaction value exceeding Rmb1tn. The market is
expected to top Rmb1.7tn in 2011 and surpass Rmb4tn in 2014. Alipay is the
largest online-payment operator in China with a large 50% share, significantly
ahead of the second and third-largest operators TenPay and 99bill.

Figure 8

Online payment Online-payment transaction value
transaction will likely
reach Rmb4tn by 2014 4,500 (Rmbbn) (%) 120
100
4,000 96
100
3,500

3,000 70 80

2,500
Transaction value 60
2,000 Growth rate (RHS) 44

1,500 30 40
27
1,000
20
258

500
1,011

1,720

2,480

3,230

4,100
505

0 0
2008 2009 2010 11F 12F 13F 14F

Source: iResearch




Figure 9

Alipay has led with Online-payment operator market share
a 50% market share

Guangzhou
Chinapay 3.8%
Others 2.1% Yeepay 3.9%
iPS 3.6% Shanghai
Chinapay 4.1%
ChinaPnR 6.1%

99bill 6.2%

Alipay 50.0%
Tenpay 20.3%

Source: iResearch

More sectors are adopting Third-party online-payment services are already widely used on C2C and
third-party online payment online-travel booking sites. The service has also extended to other payments
such as utility bills, funds and insurance sales. Most shoppers on independent
B2C online retailers still pay upon delivery, but all B2C online retailers support
third-party online-payment services. More sectors will electronise their
payment with the clearly defined policies. Online payment will become a
crucial part of the internet economy.

Third-party payment-service providers generate revenue by charging a
transaction fee to retailers and additional fee for value-added services.
Competition centres on pricing, value-added services and product
differentiation. Market segmentation and mobile payment will become more
important as more traditional businesses move online.

Trojans and fraud have Trojan horses (programs that steal information) and fraud have been an
been a growing concern increasing concern in the third-party online-payment sector as its popularity
grows. However, the risk can be effectively mitigated by the implementation
of website registration, mobile real-name system and tightening cooperation
among payment operators, banks and virus prevention and control companies.

Private couriers gather steam
Revenue of China’s online-shopping courier industry in 2010 was Rmb50bn,
up 100% YoY. This figure was close to zero a decade ago. About four billion
parcels were delivered in 2010, of which about 60%, or 2.5 billion, were from
Taobao. Private courier companies accounted for 60% market share,
compared with almost zero 10 years ago. However, the growth is still not
enough to feed the insatiable maw of e-commerce.

Strong demand from The strong demand from e-commerce has attracted more investment in the
e-commerce has attracted sector. Both leading B2C companies like 360Buy and traditional retail stores
more investment
like Suning have significantly raised their logistics investment to capture the
e-commerce opportunity. Private logistics companies such as SF Express have
been doubling their size every year. China Post has partnered with Tom Group
to tap the e-commerce market.




Government has issued China has for the first time set out clear development guidelines for the postal
guidelines to promote industry in the 12th Five-Year Plan. It is targeting:
express-delivery industry
1) Over 90% of the express delivery in urban cities within 72 hours

2) Delivery delay rate within 0.8%

3) Damage rate within 0.01%

4) Loss rate within 0.005%

5) Express-delivery satisfaction rate over 70%

The plan also expects postal revenue to double in the next five years, express
delivery revenue to increase by 150% and total delivery packages to reach
6.1 billion.

Constructing an e-government and issuing e-ID cards
China has spurred on e- Beijing has spurred on e-government construction to reduce corruption and
government construction improve efficiency. China started its “government online project” 10 years ago
to reduce corruption
and now all provinces and state bureaus are online. The projects included:
online electronic information exchange; online government procurement
bidding; online welfare payment; electronic delivery; information centre;
electronic documents; electronic tax and digital ID. A wide range of e-
government services can be accessed online.

Introducing electronic China introduced its first electronic ID card in 2004 and expects to issue more
ID card than 1.3 million second-generation resident electronic ID cards based on
radio frequency identification (RFID) chips. RFID tags can send and receive
data over short distances. The new ID cards can be read by a reader within
20-30 centimetres of the card. The electronic ID cards can reduce the
expensive and time-consuming paper process, enhance privacy protection
and better prevent identity fraud. Electronic ID cards can also provide a fast,
inexpensive and secure solution for online transactions.

Technology evolution supports e-commerce growth
IT infrastructure has China’s IT infrastructure has developed rapidly given the country’s large
developed rapidly given network and growing connectivity. Mobile internet has promoted the
large network size
innovation in online shopping. Mobile e-commerce has entered a fast-growing
period with the popularity of 3G, falling tariffs, the launch of mobile-phone
identification policy and the breakthrough of mobile payment solutions.

E-commerce service could E-commerce services could further improve with the use of video and 3D
further improve with technology. Technologies in internet of things such as RFID have supported
video and 3D technology
the real-time tracking of moving trucks and delivery status of goods, hence
reducing inventory cost and optimising inventory control. This will also help
improve customer satisfaction as they can now check the delivery status of
their orders any time and any where.

Cloud computing helps Cloud computing provides three important services for small businesses and
support SMEs’ IT needs entrepreneurs:

1) Data storage - Minimising the configuration for SME’s own servers.




2) IT services - Reducing SMEs’ need for an in-house IT team. SMEs can
also easily access the most advanced technology.

3) Open-platform data processing services - Providing direct access and
convenient tools to market information and data analysis, lowering the cost
of product innovation. With the increasing public data and resources shared
by suppliers and consumers, this has encouraged more cooperation
between e-commerce operators and internet application developers.

In the past, these services could only be afforded by a few major companies.
However, SMEs can now also enjoy the advanced data process solutions for
their e-commerce operations with cloud computing. E-commerce is entering
an explosive growth phase in China and a nationwide e-commerce era will
come soon.

E-commerce helps SMEs compete against big corporates
SMEs first to embrace SMEs are the first to embrace the online platform as they face increasing
the online platform competition from multinationals and big domestic corporates. SMEs have
been a key economic driver for China, contributing more than 60% of the
nation’s GDP, 40% of profit tax and 75% of employees. However, SMEs have
faced difficulties in competing with the big companies, which have greater
manpower, material resources, finance, technology management and
information technology. The trend has become more obvious after China
joined the WTO and the global financial crisis. Many SMEs have been
struggling to survive. E-commerce has opened up new opportunities for SMEs
and enhanced their competence. SMEs can now promote their products and
services to domestic and international customers, source raw materials in a
larger area and lower operating costs. Online contact can also shorten trade
cycle and enhance client management. SMEs can set up an online storefront
on B2B and C2C platforms at affordable prices. About 50% of big corporates
have established e-commerce system and over 30% of SMEs source their
product suppliers online while 24% are engaged in online marketing.

B2B has provided a great B2B has provided a great platform for SMEs that do not even have a website
platform for SMEs that and IT team to reach international buyers and source raw materials. B2B
don’t have a website
transaction value of Chinese SMEs increased 36.4% YoY to Rmb2.53tn last
year, driven by economic growth, government's support of e-commerce and
expansion of B2B operators’ businesses and services.

Alibaba.com a strong Alibaba.com remains the indisputable leader in China’s B2B market, taking
leader in the B2B market 57.2% share of total industry revenue. Global Sources, HC360, Made-in-
China and GlobalMarket accounted for 9.9%, 3.8%, 3.3% and 3.2% share
respectively. Other players also enjoyed stable growth.

Dominators have decisive B2B dominant operators have decisive advantages given their large online
advantages community. High-quality and extensive services are the key success factors.
Currently, most B2B companies mainly provide listing and advertising services
for SMEs on an annual membership fee basis. However, online transaction
services such as logistic and payment could present a new opportunity for the
B2B operators.




Figure 10 Figure 11

B2B e-commerce transaction value B2B market share (2010)

16 (Rmbtn) (%) 60
Mysteel 2.4% Globalmarket 3.2%
SME B2B e-commerce transaction value
14 53
Made-in-China
Growth rate (RHS) 50 Netsun 1.5%
12
51 3.3%
Others 19.0%
46
40 HC360 3.3%
10 42
Global Sources
36
8 30 9.9%

6
20
4 18

10 Alibaba 57.3%
2
1.9 2.5 3.6 5.3 7.8 12.2
0 0
2009 2010 11F 12F 13F 14F

Source: iResearch

E-commerce a critical E-commerce is also a critical factor in developing the service sector, a key
factor in developing the engine for job creation. China’s service sector is still one of the least
service sector
developed in the world. The service sector represents only a 40% share of
China’s GDP, compared with 70-80% in the developed market. Being ‘the
world’s factory’ has taken its toll on China’s environment. It has faced more
challenges in expanding its share of the world’s manufactured goods and the
manufacturing sector can no longer create new jobs.

Government has stressed The government has stressed the importance of the service sector in its 12th
importance of the Five-Year Plan and expects this industry to exceed 50% of GDP by 2020. The
service industry
service industry can ease labour supply pressure, strengthen the non-SOE
business sector, increase economic efficiency and accelerate trade and
technology progress. E-commerce has helped propel growth. B2C and C2C
have made wholesale and retail trades more efficient. The increasing demand
for e-commerce has attracted big investment in the logistics sector from B2C
companies as well as foreign firms. The growth of online-travel services has
gained paced. About 35% of travellers now buy tickets or book hotel rooms
online. Sofun and CRIC, China’s largest real-estate sites, provide extensive
property-transaction information online. Banks and security firms have also
set up their online platforms to enhance their services.

Figure 12 Figure 13

China’s service industry as a percentage of GDP Services share of GDP - China vs developed markets

44.0 (%) 43.7 China 43

43.5
43.1 S Korea 58

43.0
Australia 71
42.5
42.1
Germany 71
42.0 41.8

41.5 41.2 Japan 76

41.0 USA 77

40.5
UK 77 (%)
40.0
2006 2007 2008 2009 2010 0 20 40 60 80 100

Source: Euromonitor




C2C has set the stage for B2C to shine
B2C will replace C2C and B2C will replace C2C and become the mainstream of online shopping as B2C
become the mainstream sites offer better credibility and service quality. C2C accounted for a large
of online shopping
87% share of China’s total online shopping transaction value in 2010. It has
paved the way for e-commerce growth in China, but its inherent simple and
low-end features have limited future growth. Most of the sellers on C2C are
small companies. Fraud and consumer complaints are common on C2C
platforms. Operators normally offer limited guarantee for products purchased
online as they are just platform operators.

With M18 and Dangdang going public, China’s B2C market has gained strong
awareness domestically and internationally. All major independent B2C online
retailers have aggressively scaled up their business and attracted fresh capital.
More than 40 Chinese e-commerce companies raised over US$1bn in 55 deals
last year.

Leading C2C operators Even leading C2C operators such as Taobao and Paipai have started shifting
have started shifting their their focus to B2C. Alibaba Group has spun off its B2C platform TMall. Small
focus to B2C market
individual online stores have also started to standardise their online operation.
Baidu and Tencent are finding their way into the B2C market. Baidu has
partnered with Rekuten to launch a B2C platform in China. Tencent has
partnered with Groupon to offer a group-buying service. It has also acquired a
stake in various vertical B2C sites such as Okbuy, a leading online shoe retailer.
There could be more M&As to come. Leading B2C operators will face more
direct competition for adspend, user growth, product sourcing and talents.

B2C should continue to B2C should continue to gain market share. Transaction value reached
gain market share Rmb63bn in 2010 with a 12.7% online shopping share, up 3% YoY. There are
two types of B2C operators. Independent B2C retailers such as 360buy and
Joyo Amazon, which source and sell products, account for a 6.6% share of
online shopping transaction value while B2C platform operators like TMall
(Alibaba Group) took up 6.0%.

Figure 14

B2C gaining momentum China’s online-shopping market (C2C and B2C)

(%) B2C C2C B2B
100

80

71.3 69.4
74.8
60 81.3
87.3
93.2 91.5

40

12.5 13.2
20 11.5
9.0
6.6 16.2 17.4
3.5 9.7 13.7
5.4 1.4 3.0 6.1
0
2008 2009 2010 11F 12F 13F 14F

Source: iResearch




Figure 15 Figure 16

C2C market share (including TMall) (2010) B2C market share (2010)

Eachnet
3%
360buy 32% Others 31%

Paipai
11%

M18 2%
Dangdang icson 5% Taobao
9% 86%
Redbaby 3%
JoyoAmazon
9% New egg VANCL 4%
5%

Source: iResearch

E-commerce operators China's online-shopping operators are likely to expand with more diversified,
will expand with more standardised and branded products. Many have also launched open platforms to
products offerings
extend their product offerings. China’s online-shopping market as a percentage
of retail sales was only 2% in 2009, much lower than the 13% in Korea and 6%
in the USA. This implies strong growth potential in the next few years.

Figure 17

China online retail sales Online retail sales as a share of total (2009)
has lagged developed
markets 14 (%) 13

12

10

8
6
6

4
2
2

0
China USA Korea

Source: Alibaba

Consumers are accustomed to online shopping
Chinese consumers are Chinese consumers are accustomed to online shopping after the multiyear
accustomed to online cultivation by early entrants like Dangdang, Joyo, Taobao and 360buy. More
shopping
than 200 million consumers (or 44% of internet users) already shop online.
They use the web to check out product information, compare prices and place
orders. Online payment adoption has also been growing. Government and e-
commerce operators have put in a lot of effort to improve the internet credit
system and created a healthy social environment for e-commerce. China also
needs to strengthen its talent and application training to ensure sustainable
growth in this market.




Healthy economic growth spurs internet economy
Healthy growth of China China’s healthy expansion will lay a solid foundation for the internet economy,
will lay solid ground for ensuring continuous investments in the sector and robust growth in consumer
the internet economy
spending. Rising wages will also spur consumption and online spending. The
financial crisis and inflation have helped drive online-shopping growth while
large venture-capital inflows enable e-commerce firms to expand faster.

More specific and detailed policies have driven the development of online-
payment services. This is reflected in the continuous extension of third-party
payment applications and stable growth in online transaction value.

E-commerce a crucial E-commerce has become a crucial business for internet companies with more
business for internet and more people spending their social life online. The B2B platform has
companies
transformed from information-based to transaction-based. Many traditional
retailers have set up their online stores through self-owned B2C portals, M&A,
joint ventures or a third-party e-commerce platform. The internet has
become an important distribution channel.

However, a poor logistics system has been a major obstacle. E-commerce’s
cost advantage is fading with rising online ad rates and delivery costs. The
migration of traditional businesses online may pose increasing challenges to
online SMEs.

Most economic factors are Most economic factors are positive for e-commerce development except
positive for e-commerce logistics, which should be the key investment area for major operators in the
except logistics
near term.

Using a light-touch regulatory approach
China has adopted light- China has adopted a light-touch ex-post regulation approach for the e-
touch regulation approach commerce industry. The sector’s fast growth has been mainly driven by the
market and the private sector. Regulations will only be introduced when
needed and policies will focus on promoting the industry. China has no tax
rule for online transactions yet. However, any regulations will likely favour
online operators such as preferential tax rate.

E-commerce will help pay E-commerce will help pay back the infrastructure investment made by the
back the infrastructure government. The government was struggling to justify the heavy telecoms
investment
infrastructure investment with only online gaming and social networking
businesses. E-commerce can bring direct economic benefits to consumers as
well as enterprises. It can also create new jobs and improve productivity and
competitiveness of the country. The vast benefits of e-commerce enable the
government to further accelerate their telecoms and IT investment.

Avoid centrally planned e-commerce regulation
Industry is supervised by China’s e-commerce industry is supervised by five government departments.
five government Regulatory areas focus on taxation, user rights protection, credit safety and
departments
market order, financial security and network and information security. The
evaluation of the transaction legitimacy may also involve medical, audio-
visual cultural and religious regulatory authorities. All platform-service
providers, online-payment-service providers and related parties in the
transactions are under the regulatory jurisdiction (figure 14). The structure
will avoid centrally planned e-commerce regulation, which could hinder
industry development. Each department will focus on its own area to promote
e-commerce growth.




Figure 18

Government departments supervising e-commerce industry

Management
Management MIIT
MIIT PBOC
PBOC MOFCOM
MOFCOM SAIC
SAIC SAT
SAT
main bodies
main bodies

Managing
Managing Platform service provider
Platform service provider E-payment provider
E-payment provider Transaction parties
Transaction parties
target
target (Alibaba, Taobao)
(Alibaba, Taobao) (Alipay, eBay)
(Alipay, eBay) (corporate/individual)
(corporate/individual)

Network and
Network and Financial
Financial Market order, credit security,
Market order, credit security,
Managed area
Managed area Tax guarantee
Tax guarantee
information security
information security security
security consumer rights protection
consumer rights protection

Source: MIIT
Responsibilities of each government department are as follows:
MOFCOM responsible for  The Ministry of Commerce (MOFCOM) is responsible for sector
sector development development, formulating guidelines and supportive policies. It
focuses on upgrading industry infrastructure, promoting the advent of an
information society and creating a favourable operating environment. It
doesn’t have specific management duties.
MIIT in charge of  The Ministry of Industry and Information Technology (MIIT) is in
network access charge of network access, equipment authentication, network and
information security management. Platform services and electronic
payments, which are part of online data processing and transaction, have
been included in MIIT’s management of value-added telecoms services.
The regulation is based on The Telecommunication Regulations guidelines.
PBOC supervises online  The People’s Bank of China (PBOC) supervises online financial
financial services services. Online payment has been classified as a payment service
provided by non-financial institutions. Licenses for third-party payment
service will be issued and relevant regulatory measures will be introduced.
SAIC responsible for  The State Administration of Industry & Commerce (SAIC) is
credit mechanism and responsible for managing credit mechanism and market competition.
competition B2B and B2C have been identified as online platforms which require real-
name registration. C2C real-name registration system has been enforced.
SAT responsible for  The State Administration of Taxation (SAT) is mainly responsible
collecting tax for collecting tax from related parties of the online transaction. B2B
and B2C platforms have been under the taxation system. Currently, the
SAT is trying to implement sales tax on C2C platforms.

Under the current regulatory structure, the MOFCOM is responsible for
development and regulatory policies, but does not have full authoritative
power. The SAIC, PBOC, SAT and MIIT are responsible for promoting China’s
e-commerce development, but they are struggling to balance the
development and interests of online and traditional businesses in the industry
transformation. They will likely face a bumpy ride ahead when it comes to the
enforcement of new taxation and user registration policies.

China’s e-commerce policies, laws and regulations
Government has The National People’s Congress (NPC), the State Council and all ministries and
introduced many policies commissions and the provincial/municipal governments have introduced or
to promote e-commerce enacted a multitude of e-commerce policies, laws and regulations to promote
sector development, credit and authentication, and online payment since
2010. This has played an important role in the development and supervision
of the e-commerce sector. The government has stepped up its new policy
introduction given the explosive growth in 2010.



CLSA 8.2011 Blue Book On China E-Commerce

CLSA 8.2011 Blue Book On China E-Commerce

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CLSA 8.2011 Blue Book On China E-Commerce