Japan e-commerce: Shopping for fun

Mercari isn't Japan's first e-commerce app to focus on the consumer-to-consumer (C2C) space. When the company launched in 2013, the likes of Fril, which targets female consumers, were already in operation, allowing independent sellers to trade goods without paying substantial fees to merchants.

"We came after them [Fril], and we had a better UI UX [user interface, user experience], so we grew much faster. Rakuten and Line were in the C2C space too. Rakuten has Rakama, and Line has Line Mall which actually suspended operations several days ago," says Kei Nagasawa, CFO of Mercari. "I think we have a quite clear position in Japan."

Consumers have voted with their fingers, downloading the Mercari app 25 million times. Investors have now also given the company their seal of approval, with a Series D round worth JPY8.4 billion ($74 million). It features a host of new investors including Mitsui & Co, Development Bank of Japan and Sumitomo Mitsui Trust Bank's Japan Co-Invest, along with existing backers Globis Capital Partners, World Innovation Lab (WiL) and Global Brains.

Most notable of all is the valuation - Mercari is now worth more than $1 billion, making it Japan's first pre-IPO tech unicorn.
Japan is the world's fourth-largest internet market by user numbers and has produced numerous innovative start-ups, but due to limited scale and entrenched competition, none apart from Mercari have made it big in e-commerce. Investors say the company has a competitive edge - can it be sustained, domestically and overseas?

"We invested in Mercari's prior round when it was still small. I think they can win the domestic market, but to become a unicorn or dragon [a single investment that returns an investor's entire fund on its own], they have to enter the US and perhaps Europe. The domestic market isn't big enough. That's Mercari's ambition," says Gen Isayama, co-founder and CEO of WiL.

Flea market model

About 80% of Japanese consumers shop online and the B2C e-commerce market was worth JPY12.8 trillion in 2014, up from JPY11.2 trillion the previous year, according to the Ministry of Economy, Trade & Industry (METI). There are three dominant players - namely Rakuten, Amazon Japan and Yahoo Japan - that account for about half of overall e-commerce sales. Rakuten and Amazon have a stranglehold on the larger B2C space, while the preeminent C2C players are eBay and Yahoo Auction.

Mercari positions itself as only C2C and only mobile. Vendors take pictures of the items they want to put up for sale and list them on the platform within two minutes. They then receive a barcode, afix it to their package, and drop it off at a Yamato, Mercari's logistics partner. It is said to be a more streamlined process than that of the more PC-oriented eBay and Yahoo Auction.

As a result, VC investors say consumers visit the platforms with different purposes. Most of the vendors on eBay and Yahoo Auction are small business sellers and so these services essentially operate as classifieds sites - users come to the platform to find the products they want at the cheapest possible price. Mercari monitors its vendors to ensure they are individual sellers, leading to a "flea market" environment populated by consumers who are primarily there for the joy of shopping.

"The seller and buyer enjoy communicating and this enhances impulse buying. Also the seller is not a professional merchant so they are looking for additional pocket money from the things they don't need any more, so sometimes the buyer is able to find an extremely good bargain, which makes them come back to the app," says Shinichi Takamiya, general partner and chief strategy officer at Globis.

This kind of "sharing economy" didn't exist two years ago, but people are getting used to it, Nagasawa says. The stickiness of the app allows Mercari to charge a 10% commission per transition, and its monthly gross merchandise value (GMV) is currently about JPY10 billion.

"That means they receive monthly income of about $10 million, and their profit margin should be at least $2-3 million. If that is the case, considering their growth potential in the future, I think $1 billion is reasonable. They are profitable even from the Japan business," says Nobuaki Kitagawa, managing director at CyberAgent Ventures.

Going overseas

As WiL's Isayama noted, the limited size of the domestic market has prompted Mercari to follow in the footsteps of other Japanese giants, such as Rakuten and DnA, and expand overseas. A US operation was launched in 2014 and the app has so far been downloaded seven million times. Monetization will not become a priority until Mercari achieves meaningful scale, but is unlikely to come easily. Amazon and eBay are already there, while there are numerous pure-play mobile e-commerce start-ups such as Wish, Poshmark and OfferUp. Having said that, there is no single dominant player in the C2C space.

"Mobile technology is the biggest opportunity in the US. If other players are already good at C2C mobile tech, there is no way Mercari can come in," says Hans Tung, managing partner at Sino-US firm GGV Capital, an investor in Wish. "Meanwhile, some local players like OfferUp already have a lot of experience in international expansion. Mercari is late to the game outside of Japan and I'm not saying they can't do it, but the company has yet to prove itself."

With eBay still to build a dominant position in mobile and OfferUp and Craigslist serving as classifieds platforms that don't manage payment and logistics, Mercari could find itself a niche in the US, and to this end it already has partnerships with UPS and FedEx for shipments and Braintree for payments. But the challenge facing the company should not be underestimated, with Rakuten and China's Alibaba Group yet to find their feet in the US. Indeed, Southeast Asia might seem a stronger near-term bet.

Nevertheless, the company's path into new markets could be smoothed by some of its new investors leveraging their strategic capabilities. In Mitsui, for example, Mercari has an ally with considerable experience in Southeast Asia and a connection to Indonesian telecom giant Internux.

"We believe that the company has the talent and experience to be successful in other markets," says Hitoshi Saishu, general manager of e-payment and internet business in Mitsui. "We hope we can add some value to the company and contribute to its success overseas."

SIDEBAR: Building momentum

Japan's economic strength and technological sophistication are at odds with a domestic venture capital market that seems to consistently punch below its weight. Investment in start-ups reached $644 million last year, recording a third consecutive annual decline, according to AVCJ Research. Meanwhile, VC firms deployed $854 million in South Korea in 2015.

The fundamental issue is a lack of talented entrepreneurs willing to take risks and launch their own companies. Many prefer the comparative security of a Panasonic or a Toyota, and so a lot of innovation happens within those companies' product development departments.

"The larger corporates are the ones starting new businesses," says Kei Nagasawa, CFO of Japan-based e-commerce platform Mercari. "The system is changing, but traditionally it hasn't been that encouraging for start-ups. Japanese culture has not been open to independent entrepreneurship."

As a result, several Japanese venture capital firms, including CyberAngent Ventures, Global Brain Corporation and B Dash Ventures are increased their activities in Southeast Asia, China and South Korea. Meawhile, few international VC players have made big bets in Japan.

Gen Isayama, a former partner at DCM, co-founded Silicon Valley-based World Innovation Laboratories (WiL) with a view to bringing Japanese start-ups to the US and increasing global awareness of Japan. "The lack of information about the Japanese start-up ecosystem makes foreign investors think twice before investing. They haven't seen Japan as a place to invest in unicorns, which is something I hope to change in the next few years," says Isayama. "When the next Mercari comes along, you might see a different trend. But Japan as a country isn't there yet."

Nevertheless, there is evidence that the market is maturing. Domestic VC investors are increasingly bullish about their pipelines and both large corporations and pension funds are starting to invest in the new economy. For example, Globis Capital Partners brought in several unnamed LPs as co-investors in Mercari's recent $74 million round.

"The Japanese VC ecosystem is developing," says Shinichi Takamiya, a partner from Globis. "Three years ago, if a start-up could raise $3 million, it was a big round. Nowadays we often see $10 million rounds and the recent Mercari round is a big leap forward for Japanese start-ups. We're seeing more companies raising larger sums at higher valuations, and looking to expand globally."

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• Topics
• North Asia
• Consumer
• Technology
• Venture
• Japan
• TMT
• World Innovation Lab (WiL)
• Globis Capital Partners
• CyberAgent Ventures
• GGV Capital