Asia e-commerce: The next generation

"My partner and I had one delivery van, and we had to do deliveries ourselves every night, and go to [supermarket chains] FairPrice and Cold Storage when we ran out of stock," RedMart co-founder Roger Egan told the AVCJ Singapore Forum in July. "Having to do it ourselves was probably the best thing that happened to us, because we built a core competency in the grocery business."

The Singapore-based online grocer has come a long way from its humble beginnings, having raised $54 million since its inception in 2011, including a $26.7 million bridge round that closed last week. RedMart developed an inventory-led grocery business and is now in the process of building a marketplace through which customers can purchase a wider variety of products from third-party retailers.

But its ability to do this hinges on a delivery network devised in those tough early days. "You have to have the vertically integrated supply chain and keep the cold chain," Egan says. "No third-party logistics companies can do that well, and we've built it into a competitive advantage."

RedMart's story is indicative of the explosive growth potential of e-commerce in Asia and the challenges that come with it. The company has combined the marketplace model followed by Alibaba Group's B2C Tmall platform in China with the inventory-led approach displayed by Tmall rival JD.com. It is a sign of what the future could hold as the sector moves into the next stage after the consolidation of the current reigning giants, but finding a balance between scale and service quality is difficult.

The existence of both models is a boon to investors, since it means they have a number of options they can draw on rather than being limited to just one. However, they still need to pick the right approach for the right market.

Spending on steroids

Rising disposable incomes and rising mobile internet use has turned e-commerce into a powerhouse in emerging Asia in recent years, with all three principal regions showing consistent strong growth. China has seen gross merchandise volume (GMV) rise from just under $1 trillion in 2011 to nearly $2 trillion last year, and GMV is projected to increase to $3.3 trillion by 2017.

India has shown similarly impressive growth, though an order of magnitude lower, with the estimated e-commerce market size rising from $3 billion in 2009 to $10 billion in 2013; projections have it reaching $86 billion by 2018. While figures for Southeast Asia as a whole are harder to come by, in Indonesia, the largest country in the region, transaction value has risen from $67 million in 2010 to $776 million in 2014.

Along with the growth in market size has come a torrent of growth capital. AVCJ Research data indicate that since 2010, VC and PE investors have committed more than $17 billion to e-commerce companies in China, nearly $6 billion in India, and $1.5 billion in Southeast Asia.

The investment figures represent some huge transactions, including two separate deals for India's Snapdeal that netted the company more than $1 billion. Snapdeal's rival Flipkart has benefited even more from the surge in investor interest, raising $1 billion in a single round in 2014. That round was both bigger than all of the company's previous funding rounds combined, and was the single largest investment for an Indian internet company.

Each market can boast a few major successes. China has Alibaba Group and JD.com, both of which are now listed in the US; Southeast Asia, though more fragmented than the other two regions, still has Lazada and the rest of the Rocket Internet stable. However, e-commerce encompasses more than a few established giants. There is plenty of activity outside of those few record-breaking rounds - between 2010 and 2014 there were an average of 81 deals per year in China, 40 in India, and 20 in Southeast Asia.

We find for a lot of companies coming in, the founders think they'll build out an e-commerce brand, but the level of understanding surrounding how you take care of every single cross item is lacking - Tarun Davda

Tarun Davda, a Mumbai-based director at Matrix Partners, sees the investor interest in e-commerce as having reached a kind of critical mass - but care is needed to ensure that investor support is not wasted. "I'm sure that today, anyone in their right mind has a stake in an e-commerce company," he says. "But we find for a lot of companies coming in, the founders think they'll build out an e-commerce brand, but the level of understanding surrounding how you take care of every single cross item is lacking."

Wide or deep?

The rivalry of Snapdeal and Flipkart in India, along with that of Alibaba and JD.com in China, spotlights the attractions of the two competing e-commerce business models, marketplace and retail. Each has its proponents, and there are plenty of examples of successful businesses using either one. However, a start-up has to weigh the advantages and disadvantages and ultimately decide which one to pursue.

The retail model - most readily attached to US-headquartered Amazon.com - is perhaps the most easily grasped, because it is in many ways an adaptation of the traditional offline approach. A company stocks goods in its own warehouses, takes money from consumers and handles shipping and logistics itself.

Several advantages of the retail model relate to the ability of a company to build a solid reputation. The more control it has over the overall customer experience, the better able it is to make that experience a positive one. "The Amazon model is an upgraded Wal-Mart model. It still sells globally, and offers limited choice," says David Wei, founding partner and chairman of Vision Knight Capital. Customers who are familiar with traditional offline shopping will find the retail model easy to adopt.

But the control offered by retail comes at a high price. The model is highly cash-intensive, requiring significant investment not just in maintaining a stock of inventory, but also in storage space and fulfillment costs. It is often also low-margin, since suppliers have to take their cut as well.

The alternative, then, is the marketplace approach, in which the company is simply an intermediary, providing a platform for buyers and sellers to connect to each other. The most prominent examples of this model are Tmall and Snapdeal, but many firms can be found that pursue the approach, due to its lower barriers to entry. The marketplace model in its most fundamental form does not require any investment in physical storage space or in logistics.

"If you look at history, barring eBay, in many cases marketplaces have evolved from inventory-led models," says Nikunj Jinsi, global head of venture capital at the International Finance Corporation (IFC). "And so, when anyone wants to get involved in a vertical, let's say, furniture or shoes, people start off collecting some inventory, but eventually move into a marketplace."

In addition to the relatively light investment requirements, the marketplace model allows for much higher variety in the units offered for sale. Whereas retailers can only offer as many goods as they can afford to buy themselves, marketplaces face no such barrier. Inventory is restricted by the capacity of the sellers on the platform.

There are some ways for retail operators to shore up their margins. One common approach is to launch self-owned private label brands. Just as offline retail stores sell generic, non-name brand merchandise, online merchants will often contract with manufacturers to produce less expensive products for their customers.

BigBasket, one of India's largest online grocery retailers, is one example of this approach: the company has three private brands, for which it claims it earns four times the profits of resale brands. Another example is India's online pet supply store DogSpot, which carries more than 400 items under its own brand. Even Chinese retail giant JD.com also offers electronics under its private dostyle label. The move offers clear benefits; however, it does require significant initial investment as well.

"If you're a reseller, you're probably a 15-20% margin business. If you're in electronics, you're probably a 1-5% margin business. Whereas if you're doing private label, you can be a 60-70% margin business," says David Gowdey, managing partner at Jungle Ventures. "But out of that 60-70%, you have to go out and build not only the marketing for your site but also your private label brands. So in the short term, most of the expense is acquiring customers and building brand recognition around your private label."

Geographical obstacles

Regional differences also play a role in start-ups' preference for one model over another. In India, the country's relatively undeveloped warehouse sector makes it difficult for companies to get access to storage space. This, in turn, makes business models that do not require storage and shipping more attractive to entrepreneurs.

In China, one advantage for the marketplace model is the proximity of sellers to the country's large manufacturing base. Goods can be acquired quickly, and shipped cheaply, particularly since import tariffs and duties do not need to be paid. Of course, those same suppliers can also sell their goods to retailers and get their cut that way.

"If you look at the supply side, China is still the world's largest factory for almost everything. So, in other words, every factory is a supplier, and the merchants are looking for different channels to connect to consumers directly," says Vision Knight's Wei. "That offers the chance to have millions of merchants, while if you look at the US or Europe, they have to import most of the products they sell to consumers."

Southeast Asia presents special challenges for e-commerce start-ups, no matter what approach they use. While some market watchers point to increasing smart phone penetration and internet connectivity as an indicator of future positive development, the low revenue and investment figures clearly indicate wariness about the possibility of achieving region-wide scale.

One difficulty that seems unlikely to be overcome quickly is the fragmentation of the region. Unlike China and India, each of which is a single land mass with a unified political system, Southeast Asia is split on a geographical, political and cultural level.

"I think that if I was going to build an e-commerce business, I would much rather do it in China or India today," says Jungle Ventures' Gowdey. "In Southeast Asia, Lazada, which is the biggest e-commerce player in the region, has a warehouse in every single country, a website in the language of that country, and its selling products and transacting in the local currency, which makes that business so much more complex than a business that's just operating in China, in a single language, in a single currency."

With the many arguments for and against each model, investors may have a hard time deciding which model to support. Understandably, industry professionals see many other factors at play as well. A particular model may be better suited for one region or industry over another.

The worse the experience, the greater the pain a user is willing to put up with initially to let a start-up try something in this space - Hans Tung

Start-up founders must be intimately familiar with the market in which they will be operating. They need to know what frustrates consumers about the current offline shopping options, and how to take advantage of that when appealing to potential users - what Hans Tung, managing partner at GGV Capital, calls "the lousiness of the offline shopping experience."

"In Hong Kong, it's hard for e-commerce to really dominate, because shopping overall is much easier in a very concentrated, dense area," he says. "The worse the experience, the greater the pain a user is willing to put up with initially to let a start-up try something in this space."

When it comes to retail outlets, management must also have a plan to take advantage of the supply side of the equation. Each industry follows different rules, and a business model that worked for one industry will need adjustments to work in others. For instance, Meilele - a furniture retailer from which several venture capital investors recently secured an exit as a strategic investor bought in - sells its goods online, but also manages a chain of shops that customers can visit to try out the wares themselves.

Favoring flexibility

As for the future of the sector, the current dominant players seem unlikely to go anywhere. IFC's Jinsi says that in e-commerce, early success provides a useful buffer that can insulate a company from later pitfalls. "This is very much a first-mover kind of business, unlike many other businesses," he explains. "As long as the first mover can execute decently and grab enough land, then its relative advantage of being so much ahead will cover up for the fact that the number two and number three guys are executing in a better way."

If there is an established order at the top of the food chain, investors will look for opportunities that are part of this ecosystem without copying it. These start-ups can still take business from the major players, but by identifying areas in which they fall short rather than copying their approach.

As a result, some companies have found success participating in the e-commerce ecosystem in a tangential way, rather than buying and selling items directly. Mogujie, a Chinese start-up that created a social network around Taobao, Alibaba's C2C platform, is one such company. It raised a $200 million Series D round last year at a valuation of $1 billion.

"A lot of time, when you go shopping, even if it's offline, really you're just browsing and you don't know what you're looking for," says Andrew Teoh, founder and managing partner at Ameba Capital, which backed Mogujie in a 2011 seed round. "Mogujie solved that problem. It had a recommendation engine behind it whereby you help the young ladies on the platform to find the styles, the trends, what people are buying, and help them to filter through that and close the transaction on Taobao."

With the number of players in the market, and the variety in their models, it is not clear whether the retail or the marketplace approach will achieve preeminence in the long term. Indeed, the question itself may be flawed - certainly, the lesson from the last generation seems to be that flexibility pays off. Amazon, for instance, has offered a marketplace for second-hand goods for years, while Alibaba recently bought a 20% stake in Suning, a predominantly offline electronics retailer that wants to build its business online.

RedMart is also pursuing both strategies, albeit on a smaller scale. The test is can it size up, given the obstacles presented by different industry, geographic and competitive dynamics. For Egan, though, presenting the two models as being in competition is to miss the point. What matters is that the company provides the best possible experience for its customers.

"The customer doesn't care. They just want the best products at the cheapest price," he says. "And if you are able to offer that - the best selection, the cheapest price, the most convenience - whether you're doing it or a marketplace partner is, if you offer all of those choices to them, they're going to come right to your platform."

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• Topics
• Technology
• Consumer
• Venture
• Greater China
• South Asia
• Southeast Asia
• TMT
• Consumer
• Southeast Asia
• India
• Venture
• GGV Capital
• Vision Knight Capital
• Matrix Partners
• IFC