‘Explosive’ growth in internet penetration
China is already the largest internet market in the world, with more than 800 million users. It is only likely to get bigger, because the internet penetration rate is just 58%. Most of the remaining unconnected live in the countryside. All in all, two-thirds of the rural population remain unconnected. But that is changing quickly. Between 2007 and 2017 the rural internet penetration rate rose from 7% to 35%.
The word ‘explosive’ is overused. Nevertheless, the main consequence of the rise in internet penetration has been truly explosive growth of e-commerce. That was true in urban China from the late noughties, and it is now happening in rural China. In recent years, online retail sales in rural areas have grown much faster than the national average.
In the four years to 2018, online retail sales in rural China increased by a compounded annual growth rate of 66%, compared to 34% nationally.1 As a proportion of total e-commerce sales, online gross merchandise value (GMV) for rural areas accounted for 20% of total online retail sales in 2017, up from just 6% in 2014.2 Meanwhile, the percentage of rural internet users that engaged in online shopping has tripled to half since 2008.3
The main consequence of the rise in internet penetration has been the explosive growth of e-commerce
No wonder that McKinsey puts rising e-commerce penetration in rural areas and lower-tier cities as one of the four main drivers of Chinese e-commerce.4
Given the lack of offline retail options in rural China, rural e-commerce penetration has a good chance of catching up to that in urban areas. E-commerce penetration is highest in China’s largest cities such as Beijing, Shanghai, and Shenzhen, at 75-85% vs 55-60% in tier-three and tier-four cities and just 40% for rural areas.5 All of this implies an impressive growth trajectory over the coming years.
What is driving this rise in rural e-commerce?
There are three factors:
Transport network improvement
First, policy momentum from the Chinese government has boosted rural e-commerce.
Online shopping in rural areas is aligned with China’s rural revitalisation effort. It boosts consumer spending and therefore is part of economic rebalancing; it narrows the income gap between urban and periphery; it augments productivity because e-commerce is ultimately of higher value than smallscale farming.
The potential impact of the internet has been succinctly captured by Chinese Premier Li Keqiang:
Different from previous industrial revolutions, the new round of industrial revolution is enabled by online platforms in a ubiquitously networked environment. Lower thresholds of entry have presented all with an equal and accessible opportunity to participate and benefit. Empowered by the internet, anyone, no matter in urban or rural areas, can easily start his own business, make innovations and create wealth.”6
What sort of policy support has the government given? In addition to providing space for new logistics centres and funds for warehouses for preferred providers like Alibaba (discussed later), in 2014, the Ministry of Agriculture launched a pilot program to boost internet access in villages. Subsequently, in March 2015, this was bundled into Li Keqiang’s “Internet Plus” initiative, one of the four primary goals of which was expanding access to the internet. For rural areas, the plan identified two specific policies to boost e-commerce areas:
- Incentivising internet firms to create platforms to help farmers boost marketing channels and connect with consumers.
- Creating pilot programs aimed at connecting more villages and rural enterprises to the internet.
The result of all this was the Rural E-commerce Demonstration Program. This launched in 2014 to establish and improve the provision of e-commerce in rural areas, foster rural e-commerce supply chains, promote connectivity between agriculture and commerce, and enhance e-commerce training.
By 2018, the program had grown to 1,016 ‘demonstration counties’, covering 737 poor counties including 137 counties with extreme poverty. The share of poverty-stricken counties among demonstration counties increased from 27% in 2014 to 90% in 2018.7
Online shopping in rural areas is aligned with China’s rural revitalisation effort
Second, increasing smartphone penetration is the key reason why rural consumption has seen an upward inflection in the last 3-5 years. As Eric Zhao, JD.com’s Vice President of Technology put it, “in some of the rural, underdeveloped provinces, the percentage of orders from smartphones is more than 90%.”8 This has only been possible in recent years.9 While boosting broadband provision in rural areas has been a Chinese policy priority since at least 2013, the rise of smartphone penetration has superseded it in importance. Cellular networks now cover even remote, sparsely populated regions.
According to one major ten-year longitudinal survey of 121,000 residents of rural areas in China conducted by Shanghai University of Finance and Economics, mobile phone usage in the countryside far exceeds that of landline telephones. Only around 29% of households still use landline telephones at home, while over 90% own mobile phones.10
Growing smartphone usage has enabled a rapid increase in the use of mobile payments. The proportion of rural internet users using mobile payments increased to 47% by end 2017 from 32% at end-2016.11
Smartphone penetration has been underpinned by the rapid development of China’s 4G network, which took place between 2013-2017. 4G coverage across China is now well above 95%, with over one billion users. Given the near-universal penetration of 4G in higher tier cities, every increase can be attributed to lower-tier cities or rural areas. In the first quarter of 2018, eight million people were added to China’s 4G networks, just under the population of Sweden.12
The number of 4G base stations from the three major telecommunications providers quadrupled in the three years to December 2017.13 In a sense, it is entirely predictable that rural e-commerce took off during this period.
Figure 1: China broadband and smartphone penetration
4G smartphone users
Source: Chinese telcos, CLSA
Transport network improvements
Finally, the development of transport networks connecting isolated rural areas in China has been crucial for e-commerce.
China now has excellent road networks, which have enabled urban residents to consume fresh agricultural products more easily at less expensive prices while consumer goods can now be delivered to lower-tier cities and rural areas more efficiently. Car ownership has risen from 9.9 per 100 rural households in 2013 to 19.3 in 2017. These cars are no doubt used for transporting goods, as well as people. The road network has increased by 534,000 km, while inland waterways have also continued to improve.
The country’s high-speed rail network has grown like a weed thanks to the spending after the global financial crisis in 2009, and it continues to grow. In the five years to 2017, railway mileage increased by 27,000 km. Moreover, the State Council plans to expand it to 45,000 km by 2030.14
Figure 2: China high-speed rail planning map: 2030
Besides the high-speed rail networks, the launch of more direct flights linking lower-tier cities will further enhance their connectivity to the main urban centres and to the world.15
As rural areas prosper, freight networks will also benefit. Logistics costs in rural China can run up to five times higher compared to urban areas, with many of these areas out of deliverable range for logistics companies.16 The growing intensity of e-commerce usage in these areas is therefore self-reinforcing and will bring down transport costs.17
Drones will improve rural connectivity further. JD.com is notable in trying to bring down the cost of transporting goods to rural areas using drones, primarily for last-mile fulfilment. The first drone delivery was two years ago, JD has since completed 20,000 drone trips to customers in two Chinese provinces: Jiangsu and Shaanxi. CEO Richard Liu has said that drone deliveries would ultimately reduce the costs of shipping freight by 70% compared to conventional truck delivery.18
Drones will improve rural connectivity further
Case Study: Alibaba
Alibaba is by far the most dominant player in rural e-commerce. Astonishingly, four-fifths of Chinese rural e-commerce sales goes through Alibaba.19 Rural development began as a quasi-philanthropic enterprise, but it has grown to become an important commercial pillar for the company.20 "From the beginning, the goal of the initiative has been to 'create social good through a commercial approach.' Of course, we are a business, and we can certainly make money if we do well. But the core issue is still about helping the countryside," said Bill Wang, vice president of Alibaba Group and general manager of the Rural Taobao initiative.21 In the fourth quarter of 2018, the growth rate of digital spending on Alibaba’s e-commerce platforms reached 24%, or 4.5% higher than that in first-tier cities.22
Recently, the company has said that it is looking to make its rural strategy one of its three core strategic development plans over the next two decades, after global and cloud, to achieve its goal of serving two billion consumers and supporting ten million businesses worldwide.23
Figure 3: Rural e-commerce market share 2016
Source: MOFCOM, Companies, CLSA estimates.
Alibaba has described its strategy in rural areas as “2 Cores + N,” with the cores being Rural Taobao and Taobao Villages. “N” relates to other products in the Alibaba ecosystem.
Launched in 2014, Rural Taobao (cun.taobao.com) is the key platform for rural residents to shop on Alibaba. There is a special Rural Taobao app and a special website, both of which have different product designs to the regular Taobao platform.
Rural Taobao includes an extensive distribution network at both the county and the village level. Typically, Alibaba will set up a service centre at the county level with an Alibaba employee. That employee will then recruit and train different representatives in different villages. The representatives then return to their villages to set up village-level service centres, build relations with village residents, promote the products and teach villagers how to order online. Village representatives run the store as an Alibaba franchise, pocketing the sales commissions but bearing all the costs. Alibaba expects to generate revenue from advertising or revenue sharing in the future. This has greatly incentivised the local partners to boost transactions. Daily gross merchandise volume (GMV) has increased to Rmb2,000 per village, compared to Rmb500 a year ago.
Rural Taobao has been expanding rapidly, from service stations in 212 villages in 2014 to more than 30,000 villages in 2018. In 2018, Alibaba said that it was aiming to reach 150,000 country villages within the next three years.24 China has 600,000 villages, so this is just scratching the surface. By contrast with rural Taobao, ‘Taobao Villages’ are only expected to cover the most advanced of China’s villages in terms of e-commerce activity.
These are accelerator programmes for clusters of rural Taobao merchants. The first Taobao Village appeared in 2009.25 In Alibaba’s official documents, these are defined as villages where:
- Taobao is the primary e-commerce platform
- Total annual e-commerce transaction volumes are at least RMB 10 million
- At least 10% of village households are engaged in e-commerce.26
There were 3,302 Taobao Villages in 2018, from just 20 five years before that.
While over 95% of the Taobao Villages cluster in the eastern region, particularly in Zhejiang, Guangdong, and Jiangsu, they have started to spread to the inland region, going from four villages in 2014 to over a hundred in 2018.27
Figure 4: Alibaba Rural GMV
Figure 5: Rural GMV % of Total GMV
Source: Aliresearch, CLSA
There are three reasons why Alibaba dominates rural areas and will continue to do so:
- Alibaba has a first mover advantage in winning the trust of rural businesses.
- Delayering provides real value to Chinese consumers and retailers.
- Alibaba’s efforts in rural China have the characteristics of a deep public private partnership.
First mover advantage
A key part of Alibaba’s distribution model in rural areas is strong partnerships with mom-and-pop stores through Ling Shou Tong, a platform that, according to Alibaba, "digitises the inventory management of each store and integrates these businesses into a central warehousing and logistics system."28 Ling Shou Tong offers mom-and-pop stores the opportunity for an extreme tech makeover, injecting modern analytics to improve, streamline and automate operations that have long relied on elbow grease and intuition.
In exchange, Alibaba extracts data that enables its brand partners to distribute their products to mom-and-pop stores in rural areas, thereby reducing brand partners’ upfront investments to distribute in lower-tier cities.
An outside consultant, called a 'City Partner,' helps install the back-end technology and shows the corner-shop proprietor how to use Ling Shou Tong and fine-tune their merchandising, product display and in-store promotion through the mobile app. The partners get a commission on what the merchants order from Ling Shou Tong. The merchants get the convenience of buying and negotiating with single distributors with less chance of supply disruptions.
Alibaba feeds back the data from these transactions to its own partner companies. For instance, Mondelez used data insights from Ling Shou Tong to come up with individual-serving Oreo cookies in China.
Delayering provides real value
Typically, rural businesses and consumers participate in multi-layered distribution networks – national, regional, and local – with increasing prices each step along the way. Since each intermediary charges a little more to make a profit, the final price of goods in rural areas is high, despite the lower incomes. This has curbed price-sensitive rural consumer demand relative to what it might have been. Moreover, there is a quality issue at work. As Bill Wang put it, "people in the countryside have no way of getting products of the same quality at the same price as in the cities. Urban consumers don't need to know how to distinguish the quality of goods or determine whether or not something is fake, because there are developed monitoring systems in place and everyone knows how to play by the rules. Rural areas lack this. Every businessman is out for himself. This is the current state of China."29
Alibaba’s presence has effectively cut out the middlemen. Mom-and-pop stores registered to Taobao gain access to a national network of products. Meanwhile, consumers have access both to Rural Taobao and those same mom-and-pop stores, while enjoying 2-3-day delivery optionality.
Deep public-private partnership
The development of e-commerce has provided a new income stream for rural villages and is greatly welcomed by local governments. But government is not a passive bystander in this process. Instead, exactly as the State Council’s 2015 Internet Plus plan proclaimed, e-commerce is being encouraged to facilitate “mass entrepreneurship and mass innovation” and “the provision of public goods and services by the government”.
Alibaba has effectively become a corporatist arm of the state
In some rural areas, Alibaba has effectively become a corporatist arm of the state, or in its more familiar term, a ‘public-private partnership’. As Khanna et al put it, "rural Taobao was part of a larger effort to explicitly align Alibaba's goals with those of the central government, namely using e-commerce as a tool for alleviating poverty in rural China."30 The Ministry of Commerce has helped Alibaba to promote and spread its Rural Taobao program, providing space for new logistics centres and helping to educate farmers on using the internet. The Ministries of Commerce and Finance have allocated $300 million to 200 rural counties to spend on warehouses and training. In 2016, Alibaba Group signed a strategic cooperation agreement with China’s National Development and Reform Commission, creating entrepreneurship pilot projects for rural e-commerce development.
Meanwhile, “local governments participated in the construction of basic infrastructure, e-commerce industrial parks and service centres, low-interest loans, tax concessions, administrative convenience, liaison with universities for training provision, re-designing villages' spatial planning to better accommodate the growth of e-commerce, and so on”.31
In some cases, the Communist Party of China has even become an active organiser of e-commerce. CPC members have been encouraged to open online shops on Taobao, with their CPC membership explicitly shown to customers as a mark of quality goods. This initiative has been dubbed 'Red Taobao' and is said to echo the call for party-building with the economy and the task of poverty alleviation in mind.
*Other contributing authors
Greg Kuhnert, Co-Head of 4Factor | Mark Evans, China Analyst | Mike Hugman, Portfolio Manager, Emerging Market Fixed Income