THE EVOLVING PROFILE OF E-COMMERCE IN CHINA

At approximately $630 billion of sales in 2015, China’s online retailmarket is the world’slargest, nearly 80 percent bigger than the United States’s, which it overtook some two yearsago. E-commerce in China accounts for 13.5 percent of all retail spending, a higher sharethan that of all large economies but the United Kingdom. Although Chinese e-commerce isforecast to grow strongly in the near term, our survey shows that companies need to prepare for new customer segments, product categories, and sales channels to emerge as dominantsources of future growth.

Catering to users across devices has become essential for consumer-facing businesses.This year’s survey confirms that China’s digital consumers still overwhelmingly use mobiledevices to access the Internet, as they have for years. While mobile-first marketing strategiesare important, PC-basedofferings should not be neglected. We found that multidevice owners (those who use two or three connected devices, such as smartphones, tablets,and computers) are more intense digital consumers. They spend 17 percent more on e-commerce than their mobile-only peers. They also shop online in 29 percent morecategories and interact 14 percent more with businesses through social networks, using such interfaces as brands’ public WeChat accounts (Exhibit 1).

Among China’s digital consumers, certain product categories have caught on more thanothers (Exhibit 2). Consumer electronics and small appliances are two well-established onlinecategories, with e-commerce reaching around 30 percent of total retail sales. Apparel hashistorically led other categories in online adoption; our survey found that nearly 60 percent of consumers bought apparel online at least once in the past three months. For the apparel sector to increase its online-value-share percentage above its current level in the low 20s, allelements of the e-commerce experience—including merchandise selection, style advice, and returns and exchanges—need to become as appealing as shopping in physical stores.

Food (including packaged and fresh food), a category that faces more challenges in building sustainable online business models, has also reached a high level of adoption, with nearly 50 percent of consumers making some purchases online, according to our survey. But those online purchases account for only 5 percent of consumers’ total food spending. The small size of the average online food basket, at less than $15, suggests that consumers are not yet going online to make food purchases as large as those they make at supermarkets.Companies that can entice consumers to do routine grocery shopping online stand tocapture a lot of business.

Within this large and active e-commerce market, we see three trends that have important implications for how consumer-facing businesses can continue pursuing revenue and profit growth in China.

Consumers in low-tier cities are outspending those in high-tier cities online—and the gap is likely to get wide

By several measures in our survey, the e-commerce activity of low-tier cities (Tier 3 andbelow) now rivals or surpasses that of high-tier cities (Tiers 1 and 2). Low-tier cities’ total spending on e-commerce caught up with that of high-tier cities for the first time in 2015 (Exhibit 3). And low-tier cities are now home to 74 million more online shoppers than high-tier cities.

Even with these gains, low-tier cities still have tremendous potential for e-commerce growth. Some 160 million people in low-tier cities who use online services have yet to begin shopping online. That’s nearly as many people as the number of online shoppers in high-tier cities today. Major e-commerce platforms are investing heavily to acquire customers and build logistics networks in low-tier cities. Brands that have historically focused on high-tier cities may benefit from revisiting their geographic strategies and making adjustments to take advantage of opportunities in low-tier cities, where physical retail needs time to mature.

In high-tier cities, by contrast, our survey shows limited potential for e-commerce growth driven by user penetration. Nearly everyone living in high-tier cities is online: 83 percent of people 13 and older. Among those Internet users, 89 percent already shop online. Further e-commerce growth in high-tier cities may therefore need to come from increased shopping frequency, expansion of online shopping categories, and larger purchases. To increase e-commerce sales to existing shoppers, companies will need to use data analytics to better understand the needs of different customer segments and engage them with tailored upselling and cross-selling efforts.

Social media has become a powerful channel for initiating online purchases

Half of the digital consumers we surveyed use social media to do product research or get recommendations. More recently, consumers have used social media as a significant channel not just for deciding what to buy, but also for acting on those decisions. Of the WeChat users we surveyed, 31 percent initiated purchases on the platform—double the proportion of the previous year. These purchases begin in a range of places on the social platform, from official channels (such as JD.com entrances and brands’ public accounts) to user-generated content (such as Moments and chat groups) to links to other apps.

Impulse-driven categories like apparel and personal care are most popular among the WeChat shoppers we surveyed, with WeChat-initiated purchases accounting for about 25 to 30 percent of online spending in those categories (Exhibit 4). We see considerable opportunity for brands and retailers to reach customers on social platforms, using tactics like contextual targeting to display information about products at moments when consumers are reading about them.

Consumers are buying goods from cross-border vendors to supplement what they buy domestically

E-commerce has given China’s digital consumers access to products from overseas, and a notable share of consumers appears to be taking advantage. Nearly one-fifth of the digital consumers we surveyed now buy some goods from vendors outside China (Exhibit 5). We also found that cross-border shoppers prefer items that are either too expensive or too scarce at domestic vendors. For example, shoppers in Tier 1 cities use overseas sellers most often for premium healthcare products (for example, dietary supplements, medicines, and medical instruments) that supplement the offerings of local retailers. For consumers in Tier 2 cities, luxury goods account for the highest proportion of purchases from foreign vendors.

Chinese authorities recently announced the formalization of import and value-added taxes on cross-border commerce. As these changes take effect, we believe China’s consumers will increasingly use foreign e-commerce vendors to buy products that domestic sources do not offer, rather than to get better prices on goods that are available from domestic vendors. For foreign brands that have limited reach but proven appeal in China, e-commerce offers a way to serve Chinese consumers without adding local distribution capabilities.

NEW DYNAMICS IN O2O SERVICES

O2O services companies have attracted huge streams of capital from investors who see the category as the next big thing in digital China. Some observers believe O2O businesses have used investors’ money to lure customers with prices that are too low to generate profits—and they predict that O2O companies will eventually go out of business or burn through their capital reserves and raise prices enough to send consumers back to offline-only vendors. O2O services have put considerable pricing pressure on traditional vendors in sectors such as travel but less in sectors such as dining and mobility. In all these sectors, quality and convenience matter just as much as price, if not more.

Among the consumers we surveyed, 77 percent reported that their total spending on travel increased after they began buying from O2O vendors (Exhibit 6). Similarly, using O2O services led 65 percent of consumers to increase their total spending on dining and 42 percent to spend more on mobility. This suggests that O2O services offering a unique value proposition could power additional growth in China’s online market over the years to come.

Chinese consumers are embracing O2O travel services

Nearly 80 percent of the digital consumers we surveyed have traveled in the past 12 months. These consumers are relying more and more on O2O travel services. According to our survey, travel is one of the most popular O2O categories, used by 36 percent of O2O consumers nationwide and 56 percent in Tier 1 cities (Exhibit 7).

Travel also demonstrates the pricing and spending dynamics of O2O services. Nearly 60 percent of the people we surveyed expect to pay O2O travel providers less than they would pay traditional providers. The survey also showed that online channels stimulate significant travel spend: 77 percent of O2O travel users indicate that their total travel spend increased after they began using O2O travel services. Many hotels and airlines are strengthening their own e-channels to avoid pricing pressure from O2O services.

To capture opportunities in O2O travel, businesses also need to address consumers’ stated concerns, which include ticket guarantees and doubts about product and service quality.

O2O dining services are growing rapidly thanks to price stimulation, but consumers’ expectations for quality and experience are rising

Our survey results suggest that O2O dining services are poised for strong growth. Convenience and discounts stand out as the most important reasons why consumers choose to use O2O dining services. Diners in high-tier cities are leading the way: 67 percent of O2O consumers in Tier 1 and 2 cities are using O2O dining services, compared with 33 percent of O2O consumers in cities at Tier 3 and below (Exhibit 8). As O2O dining services continue expanding their city coverage, we expect adoption rates in low-tier cities to catch up to rates in high-tier cities.

Although consumers expect O2O travel services to cost less, many express a willingness to pay a premium for O2O dining services: 36 percent for Tier 1 and 2 cities, 39 percent for cities in Tier 3 or lower. Notably, though, significant numbers of O2O dining users say they are willing to pay for value-added services such as food-quality control (68 percent of those surveyed), faster delivery (52 percent), and better packaging (49 percent). Those who do not use O2O dining services indicate that food safety is their top concern, followed by a preference for restaurant dining.

As people use O2O mobility services like Uber and Didi more, they drive less

Didi, Uber, and other O2O mobility services have caught on with 31 percent of digital consumers (Exhibit 9). These services are especially popular in high-tier cities, with 54 percent penetration in Tier 1 cities and 43 percent penetration in Tier 2 cities.

Consumers seem to be less sensitive to the price of O2O mobility services than to the price of other O2O services. Just 35 percent of O2O users in our survey said they expect lower prices from O2O mobility services (compared with 59 percent who expect lower prices from O2O travel services), and 42 percent of users said their total spending on mobility services increased after they began using O2O options.

The use of O2O mobility services is also changing consumers’ driving behavior. Survey respondents reported that the average number of days they drive per week dropped by nearly one full day, from 4.04 days per week to 3.26 days, after they began using O2O mobility services. Carmakers and dealers may need to look for ways to adjust their offerings as consumers shift to using O2O mobility services. Given the possibility that some consumers will buy fewer cars as they rely more on mobility services, automakers should explore new opportunities to market vehicles through mobility services, such as targeting their drivers as frequent car buyers or using them to showcase new car models to the public.

In an e-commerce market as large and fast-growing as China’s, retailers and consumer-facing businesses will have no shortage of opportunities: in low-tier cities where online and e-commerce penetration remain relatively low, and in categories of goods and services that have yet to become major ecommerce propositions. Even in high-tier cities and in categories such as apparel and food with high e-commerce adoption rates, there is significant room for online spending to make up a bigger share of consumers’ overall spending, as consumer-facing companies improve their offerings and user experiences, and leverage social channels to influence consumers’ decisions.

O2O services have shown that convenience and experience (in addition to low prices) can win consumers and even convince them to spend more than they might otherwise. For businesses in the O2O market, overcoming shoppers’ concerns and offering new levels of value may be the keys to achieving mass-market acceptance and establishing business models that will thrive over the long term.

Our survey of China’s digital consumers indicates that growth in e-commerce and O2O is shifting to new areas. Succeeding in this market is a matter of keeping pace with changes that are playing out across geographies, product categories, and channels. Consumer-facing companies must look closely within these parts of the market to uncover opportunities and move quickly to take advantage of them before their competitors do.