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The Great Consumer Upgrade

October 15, 2016
By Hans Tung, Jeff Richards and Jane Doe

Earlier this week, Alibaba Chairman Jack Ma and CEO Daniel Zhang wrote letters to shareholders outlining the company’s 30 year vision. As expected, they were audacious — you don’t build a $250 billion company in 16 years without a strong point of view. Two areas that were perhaps unexpected, however, and definitely not well understood by Western observers: 1) a strong focus on China’s offline retail economy and 2) a reference to the “consumer upgrade.”

The first is the concept of ecommerce becoming a traditional line of business, with the online and offline sectors merging over time. Alibaba already owns a large stake in Suning, a large Chinese electronics retailer, having purchased 19.99% for $4.6B in 2015. It also has a reach to the Chinese consumer not well understood outside of China, including payments and banking (AliPay, with more than 400 million registered users and 65% of the mobile payment market in China), entertainment (it owns Youku Tudou, the largest online video platform in China) and has major investments in companies like Didi (China’s largest ridesharing platform) and a number of China’s largest logistics companies. While we would argue Alibaba’s strategy in this area is at least acknowledged by Western observers, it is arguably significantly underestimated and undervalued.

The second component of the Alibaba strategy which is less clear to those outside of China is the concept of the “consumer upgrade.” Alibaba CEO Daniel Zhang wrote:

“The excitement is in leveraging internet-based approaches and new technologies to transform the [$4.5 trillion] China retail market to meet the demands of the ongoing consumer upgrade.”

What is the consumer upgrade?

At a very basic level, it is the idea that after 15 or so years of economic growth, consumers in China have money to spend, and they will spend it on “upgrading” their lifestyle through travel, household goods, fashion, dining and more — driving a continued consumption boom for the next 20 years or more. Instead of paying 5 renminbi (¥5) of coffee at a local shop, an “upgrading” consumer might pay ¥27 (about $4.00 USD) at Starbucks. Or, she might decide to purchase a Japanese brand of makeup on Xiaohongshu (a popular shopping app for millennials) for ¥150 (about $22.00 USD) instead of a local brand at a local store for 5–10 renminbi.

A Starbucks store in Beijing, one of more than 1,500 stores in China

Sound crazy? This “upgrade” has happened in the US and other Western nations over the last few decades — think of your own upgrade from a pair of sweats from Sears to today’s Lululemon, or that daily line for pumpkin spiced lattes you see at Starbucks. Given China’s rapid growth and population of over 1 billion people, it’s happening faster and is more visible than it was in other countries. It’s also being driven partially by the emerging spending power of China’s 300 million millennials, a topic we have written about previously.

And despite what you may have read, Chinese consumers can afford it. $4.6 trillion of net cash on the balance sheet of Chinese households according to Alibaba Group Executive Vice Chairman Joe Tsai (this video interview on CNBC is well worth watching). The Chinese consumer is also less leveraged than their counterparts in other parts of the developed world, with leverage to consumption at about 40%, versus 60% to 70% in the US and Europe. In short, Chinese consumers have money to spend and a long way to go to catch up to their Western counterparts in spending habits.

So who wins in the great consumer upgrade? Retailers like Suning as well as Western brands that have expanded aggressively in China like Starbucks, Nike and Apple or car companies like Mercedes, Audi and GM (China is now the world’s largest market for car sales). Logistics providers delivering packages to consumers; Alibaba merchants ship more than 40 million packages per day (for comparison, Amazon ships an estimated 5–6 million). Travel is a booming sector — Ctrip, Qunar and emerging players like Tujia and AirBnB are positioning to take advantage of the world’s largest outbound travel market (more than 100 million travelers in 2015). And of course online players like Alibaba, JD, VIPShop and Meili.

As you may have guessed by now, the consumer upgrade is a trend we at GGV Capital have been betting on for several years now. Many of our portfolio companies are mentioned above, and we are firm believers that, while there will certainly be bumps in the road along the way, the Chinese consumer is arguably the most powerful economic force the world has ever seen.

Over the next 10+ years, it will be amazing to see this trend play out.

Jeff Richards (@jrichlive) and Hans Tung (@hanstung) are Managing Partners at GGV Capital.