Editor's note: This month's episode of "On China" examines its burgeoning e-commerce, premiering on Wednesday, September 18 at 5:30 pm HKT. Click here for airtimes.
(CNN) -- This episode's guests include Yu Gang, chairman of Yihaodian.com, one of China's biggest online grocery stores, David Wei, former CEO of Alibaba.com and Oliver Rust, senior vice president of Nielsen.
Kristie Lu Stout: Yu Gang, Oliver Rust, David Wei, welcome to "On China". I'm not going to ask you how big the e-commerce market is in China. We know that it is the biggest and the fastest growing e-commerce market in the world, but why is that the case? What are the drivers behind it?
David Wei: Well first I think the traditional retail business in China is underdeveloped which has given e-commerce opportunity to pass the traditional retailer faster. So in US and other developed countries the traditional retail business is well established, penetrated everywhere and e-commerce becomes the niche, the complimentary business. But in China...I was running a retail business for seven years in China and it's well underdeveloped, giving e-commerce a chance to be the mainstream for retail formats in the future.
Kristie Lu Stout: So you have this leapfrogging effect because of the lack of the traditional brick and mortar stores. Who's buying online in China? Is it an audience that skews young?
Oliver Rust: Well historically obviously it's going to skew younger than we see elsewhere. But it's changing, right? The internet penetration in China is getting bigger, and it's going more deeper into the Chinese market, so it's going to change over time but obviously at the moment and in history it's going to be younger orientated.
Yu Gang: We saw a transition of people buying online as a fashion now to buying online as a daily life. You know people in the past just buy online for the things they couldn't find in physical stores, the ones that are special. And now they're buying for daily life.
David Wei: Yep.
Yu Gang: The fast moving consumables and they buy toothpaste, drinks, everything online.
David Wei: I normally divide the development stages of China's consumer e-commerce into four stages. Stage one is non-core customer buying non-core products online. As Mr. Yu said earlier they are complementary products, fancy products. And stage two is the non-core customer buying core products, so this relatively younger generation starting to buy mainstream products. Stage three is core customers, like us, buying non-core products so you can figure out what the fourth stage is the core customer buying the core product range. So what's the stage now? Are we are in stage three or four? I believe we are almost finishing stage three, getting into stage four: core customer group buying core products categories.
Yu Gang: Also you see the penetration started from the major cities, now to the second, third or fourth tier cities.
David Wei: It's all about the penetration. I still remember the story about how we advised P&G to open a shop in Taobao, TMall, to sell their very expensive men's shaver under the brand of Braun, it's a very expensive one. So when they put the shop online, the biggest sales, doesn't go to a first tier city, it goes to the third and fourth tier city, in Shanxi.
Kristie Lu Stout: Oh, cause they couldn't find the goods on the ground.
David Wei: Exactly! Those people who made a lot of money from mining they just buy hundreds of them, thousands of them over night. And for that city we asked P&G what's their plan to open a shop there, they say not even in the next ten years so. In other words, people who live in third and fourth tier cities with internet can enjoy the same quality of life at least from the product sales point of view compared to a first tier city.
Kristie Lu Stout: Let's talk more about what people are buying online in China. For example, Yihaodian, what is your fastest growing product segment?
Yu Gang: Still fast moving consumables, this for daily life everyone needs. They started probably with apparel and books and now they buy for their daily life.
Kristie Lu Stout: So it's like toothpaste, shaving foam...
Yu Gang: Toothpaste, shaving foams, shampoo... You know. Everything.
Oliver Rust: And I think somewhere the apparel industry is the one that's got the biggest number of people that are buying online right, but the frequency of things like more daily needs are increasing, so we're seeing things like basic household product needs. The frequency of online purchasing is getting more than what we are seeing in any other category, and that's just going to show the growth potential that sits in front of us on the category.
Yu Gang: Also, people are very sticky. I think for fast moving consumables, they buy every week. The cameras, the computers, they buy it probably every two years.
Kristie Lu Stout: What about luxury products? How well do they sell online in China?
Yu Gang: I think still behind. I think that's developing, we see the trend. I think it's still behind.
Oliver Rust: We tend to see in luxury products there's more direct selling from the luxury provider, the sort of brick and mortar retailer selling directly, rather than going through a mall or an e-commerce or e-tailer.
David Wei: Luxury products, I think this the most difficult category to do e-commerce. The reason is, again, the sourcing side. The luxury brands don't want to give up their price advantage offline to online. None of them want to. They want to keep very high margin and as the e-commerce solution, you need the consumer, but you also need the supply to work with it. And on the supply side, luxury brands are the least willing to do it online, so you don't have the proper stable product supply.
Kristie Lu Stout: Another question I have is, when you look at the front page of all of the leading e-commerce sites in China, and I'm an American, but I have read Chinese, so it's not gobbledygook to me, but it's very chaotic. It's messy. There are all of these images, animated gifts. Why is the user interface designed that way?
Yu Gang: In fact, we had an experience. Our first website simulated what Amazon did, very clean using the navigation bars to search and so on, but we found that our customers didn't like it.
Kristie Lu Stout: It was too clean?
Yu Gang: They want to see a page, very crowded...
David Wei: When I worked for Alibaba, I cleaned the homepage to the international standards, it doesn't work.
Yu Gang: Yeah, that doesn't work. Our consumers like a page very crowded, busy with lots of links, at the same time you opening many windows at the same time.
David Wei: Not surprising to me if you take a picture in Wal-Mart offline stores in China compared to the Wal-Mart offline stories in the states, they're different. In China: very busy, very colorful, lots of promotion, ads, whatever coupons, free gifts. That's in the Wal-Mart China store. In the Wal-Mart US store: very clean, very disciplined, cleaned back merchandising. So I think it's not a big difference between online offline. So the offline experience has been mirrored to the online experience.
Kristie Lu Stout: So when you go into the Chinese consumer psyche, they want to have a chaotic bazaar type experience.
Yu Gang: They want to create this shopping atmosphere.
Kristie Lu Stout: Yeah, very interesting! How does the shopping experience compare when you shop at a dominant China e-commerce website vs. Amazon or something in the west? Is it something that's more tailored to the user experience? Are you finding products you can't find anywhere else? Would one argue it's a superior shopping experience?
David Wei: Well first, when you shop on Amazon or any... eBay... in any US... you don't chat with the merchants that much. But in China, this merchants and the consumers chatting is huge and people enjoy chatting with the merchants. And that's very, very different. The instant messenger is embedded in almost every e-commerce platform or e-tailers. That's the lesson eBay should learn. In China, also people talk to the shop assistants a lot when they're shopping. Because a lot of consumers are still relatively new to these products, they need to learn from the shop assistants. So again there's an experience mirrored from offline to online. That's the huge difference. In US you cannot find all the customer service people online all the time, but in China when you get to the shop, the shop assistants talk to you first.
Yu Gang: We found that the consumers in China are more price-sensitive, you know. It's very promotion-driven. Big promotion events, you can track a lot of traffic. That's one. The other is, unlike in Europe or US, there the philosophy of "Time is Money", in China it's not recognized as valuable. Certainly, for example, people are reluctant to pay delivery fees.
Kristie Lu Stout: And delivering goods that you purchase online in China, how is that working out?
Yu Gang: Well, largely through mopeds and motorcycles. In the past it used to be bicycles, unlike in the US, you know, through trucks. I think that still, logistics in China is very fragmented. But it's very cost effective though.
Kristie Lu Stout: It's cost effective, but is it going to change any time soon? And do you see this as one of the biggest challenges?
Yu Gang: I think China... this is probably an advantage in China. You know, the logistics cost is lower. Because China is very densely populated and very suitable for e-commerce and you know delivery associate can go door by door to deliver goods. I think that's the advantage to China.
David Wei: Yes, agree!
Kristie Lu Stout: And if you were to advise a multinational brand, who want to sell their product online in China what would you tell him or her?
David Wei: Well, my question first start with, does this multinational high end, does this brand have offline presence in China or not?
Kristie Lu Stout: What if you don't have an offline presence in China, do you need to set one up, before you start selling online?
David Wei: My advice: yes.
Kristie Lu Stout: OK.
David Wei: Put up a flagship store, mark up your price and great shopping experience, but you don't need to roll out hundreds of stores to do that, but you still need a physical presence but very limited number premium locations to start with. It's easier.
Oliver Rust: I think it also depends on what kind of product you're selling right? We've advised clients to go straight to online and go straight to the e-commerce world. Depending where you are, where your target audience is, a lot of that depends on what your price points are, who you're trying to engage, what geographical reach you're trying to get so that has a massive impact on what we advise our clients both local and also international.
Yu Gang: My advice would be to find a solution provider for you. In China, lots of platforms. For example, we provide a service by Yihaodian, SBY model, helping offline or international brands launch not only on our website, but also other websites, other platforms. We handle logistics; post sale services, all the services so I think it's better to go through solution providers.
Kristie Lu Stout: Now the scale and the promise of the e-commerce market in China are tantalizing, but how many companies are actually making a profit right now?
David Wei: If we look at who is making a lot of profit now is the e-mall is making profit, huge profit. They're like a virtual profit developer and e-tailer is improving their profitability and also you find a lot of e-brands starting to make money. And the hybrid of online offline combined is improving profitability but not become very profitable yet.
Kristie Lu Stout: At this stage, Yihaodian, are you making profit?
Yu Gang: We're not making profit yet. As David mentioned, e-commerce needs scale. Our business model needs to be scalable, so as we grow in scope and scale, we start to reduce our overhead, and improve our sourcing and eventually we will start to make profit.
Kristie Lu Stout: And you need scale because it's a margin business.
Yu Gang: It's not only a margin business but also your logistics, your sourcing, all need scale.
David Wei: Yihaodian's retail price needs to be very competitive compared to offline retailers, but if their scale is smaller than offline retailers, how can they take advantage on their sourcing volume? So they need to build the sourcing volume to reduce the cost of products they are sourcing. But they are competing with the offline retailer now on retail price.
Kristie Lu Stout: You have to fend off your competitors both in the real world and the virtual world. That's another challenge for you isn't it?
Oliver Rust: We're seeing consumers now start to shop online and replacing it with the offline. That replacement of the offline to online is a dramatic shift.
David Wei: It's not reversible, it will not shift back.
Oliver Rust: No! That's the thing, exactly as Mr. Yu said...
David Wei: It's a matter of time!
Oliver Rust: ...If you become sticky with a brand and you're buying the usual products then you will.
Yu Gang: For example last year's November 11th, right? They call it China's singles day.
Kristie Lu Stout: It's China's Cyber Monday, Single's Day.
Yu Gang: The total e-commerce sales were about 30%, of total national sales. I think, you know, in the future that will be a norm.
Oliver Rust: And that's three times what it was in the US on The Black Monday.
Kristie Lu Stout: It's a market so tough, that you have someone or a company like eBay back out of China entirely. What went wrong with eBay in China?
Yu Gang: Not only the e-commerce companies. If you count all of the internet companies, you rarely find a great success, you know. You count, eBay, Google, Groupon, Yahoo etc. you know. I think there are several reasons. One is that it's probably a lack of understanding of Chinese culture and trying to copy their global business model to Chinese market. I think that's probably one reason. The other reason is that the management scheme. The e-commerce or the total internet world, the decisions need to be made very dynamically, very locally, very quick, but their global organization structure do not allow them to do so. That slowed down the decision process.
David Wei: When Taobao fought against eBay, we listed all of the top ten things eBay was doing in China, we do 100% different. For example, they charge a listing fee. We said listing fee zero, free. They're listing orders, ranking orders, they are based on auction base, which means the products have been there for the longest time will sit on top of it. But as a retail model you should put the freshest model on the top of the ranking. So these things are 100% different. And also eBay stopped people, buyer and seller, talking to each other, because that's an auction model, but in China we launched instant messaging, encouraging merchants to talk to consumers. So the ten things eBay doing, we completely changed in China. The top ten things, the most important things eBay doing, their winning elements, their winning recipe in the states actually became the poison, killing their business in China.
Kristie Lu Stout: Let's talk about the momentum of the e-commerce industry. What kind of growth story are we going to see in the years to come?
Oliver Rust: We see the growth potential in e-commerce as significant. That's clear. The question is how fast and to what scale. And what is the impact it's going to have offline as well. And I think somewhere that the future will definitely be smart phones and mobile, m-commerce, if you want to call it that. That certainly will be a big future.
Yu Gang: I can only share our own story. We did not anticipate this rapid growth. We started about five years ago and just passed our five year anniversary month and we will grow something like 20% per month and that was amazing growth and we see the trend still continues.
Kristie Lu Stout: What do you see as the biggest driver for your growth? Is it mobile or China's urbanization drive?
Yu Gang: I think overall as China starts to improve its logistics and online payments and people start to gain confidence in the authenticity of the products buying from online, I think that is going to continue to grow.
David Wei: I agree all of the drivers from the consumer part, but don't underestimate the drivers from the merchants from the brands in China. The retail property cost increased eight times in the last ten years. Probably US it's only 1-2 % growth every year. So the retail property cost becomes the largest cost to traditional retailer and the brands, the consumer brands. So these brands and retailers are more desperate than any other countries in the world to migrate themselves online.
Yu Gang: Another driver is technology development. You can see that we provide better tools for search, simpler interfaces for people to use more conveniently. Also from data mining, we use big data to analyze people's buying behavior, to provide more customized, more accurate referrals, customized services. These are all the drivers.
Oliver Rust: That last point I think, Mr. Yu, is a big one because I think the volume of traffic going through the systems today on online that will drive to understand what the consumers are behaving, will proliferate at a rate that we've never seen before in China, right? And I think somewhere, using that information is going to be the biggest challenge.
Kristie Lu Stout: It has been said that this is the year China will surpass the US as the biggest e-commerce market in the world. Your thoughts on that?
David Wei: First, the population in China is four times bigger than the US. And as I said, the traditional retail in China is under developed that gives the chance for e-commerce to the mainstream. I still believe in the US e-commerce is a niche player, is complimentary to the offline retail business. In China, offline retail will soon become complimentary to the online retailers.
Oliver Rust: I think the population is one, two, the fact that companies are already bigger; some companies in China are already bigger than their counterparts in the US already. The wealth accumulation in China is accumulating at a faster pace. That's going to give them more purchasing power. I think somewhere the online world gives the ability to fuel the consumption based economy. E-retailing today, the e-commerce world, is around 4-5 % of total retail sales in China, so that is only going to increase because that distribution network that they can get to, the reach they have, which is far bigger, so it will have a significant impact and I think that's a good thing. And it will surpass well beyond the US in the years to come.
Yu Gang: I think it's just a matter of time. I mentioned that China is a very suitable market for e-commerce because of the population density and the, you know, lack of shopping malls.
David Wei: And also the products' manufacturing bases are in China, that's also very important. I always agree the consumer side, but I always highlight that to make e-commerce to work, you need the supply side. And on the supply side, China still got millions of factories, manufacturing all kind of products, sourcing is not a big issue.
Kristie Lu Stout: So many questions but thank you so much for answering all of them. I really learned a lot about e-commerce in China. Yu Gang, Oliver Rust, David Wei, thank you so much for joining me.