Everyone thinks Asian retail needs online-to-offline integration but no one has been able to pull it off. E-commerce giants have bought physical shopping chains to expand their distribution, and keep up growth as sales plateau. Traditional bricks-and-mortar retailers likewise want to boost growth using e-commerce, and they want more data on their shoppers.
However, S&P Global Ratings surveyed Asian retailers and found that companies were hesitating at the cost and complexity of integration. No offline retailer was looking at buying a digital retailer in the next two years, or vice versa. Those that have invested see little synergy gains. Firms were looking at less ambitious means of integrating, such as forming partnerships.
The stakes are high. We view a well-integrated online-to-offline (O2O) retail strategy as key to staying competitive, and as credit positive. Those retailers that do not master diverse distribution channels risk giving up an Asian retail market worth in excess of US$7 trillion (2018 sales) to a handful of fully integrated giants.
Little illustrates the promise of integration more than Alibaba Group Holding Ltd.'s "Singles Day" shopping event, which increasingly incorporates offline retailers, offering promotions advertised through the Alibaba.com site. Singles Day on Nov. 11, 2019 generated sales of US$38 billion, a year-over-year of growth 26%.
Build It Or They May Not Come
Asian retailers have dragged their feet on O2O. They have found this initiative difficult, and there has been a lack of urgency as most retailers have enjoyed high growth, particularly in China.
But more recently, facing a significant sales slowdown amid stiff online competition, Asia's offline retailers have started to look more seriously at digital distribution.
Similarly, with online sales hitting saturation limits, e-commerce groups have begun searching for their next growth driver. In China we expect annual online sales growth to slow to 17%-22% over the next two years from 25.5% in 2018. Online retail is also becoming more competitive with new e-commerce entrants such as Pingduoduo in China and Kurly Inc. in South Korea.
Taking a cue from Amazon.com Inc.'s US$13.7 billion acquisition of Whole Foods market Inc., announced in 2017, many Asian e-commerce firms have focused on the much larger offline retail market. They see offline sales as a way to fully engage customers. Shoppers fluidly switch between offline and online shopping, the thinking goes, and so should retailers.
To better understand the integration challenges and the credit implications of O2O integration, we surveyed nine major online and offline retailers in China, Japan, and South Korea. This is a small survey number. However, it represents the complete universe of Asia's major rated retailers that are involved in O2O integration.
Most of the retailers we surveyed said that they had not derived meaningful synergies from their O2O strategies, despite considerable investment over the past three to five years.
Consumers Are Driving O2O Integration
Most survey participants cited consumer preference as the main reason to do convergence. Consumers will stay with stores that provide wide product selection, fast delivery, low prices and convenience. Retailers see O2O integration as key to achieving this goal.
While many consumers like the ease of online shopping, most want to see and touch the physical item before purchasing. This is especially true for big-ticket goods such as home appliances. Furthermore, many consumers see spending time at department stores or shopping malls as a fun social activity.
Chart 1
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Most Retailers Have Not Yet Settled On A Successful O2O Model
While all the retailers we polled agreed that O2O integration was inevitable, most hadn't identified a successful model, even after significant investment.
Chart 4
Offline retailers cited a lack of sufficient customer data as a key challenge to moving online. Many offline retailers have created mobile apps and loyalty programs to track customer behavior. However, the data set is somewhat one-dimensional.
Offline retailers also need to reckon with the high capital and operating investments needed to establish an online platform, which typically involves much trial and error. GOME, for example, has continuously been refining its e-commerce platform since 2011.
The upshot is that it is hard for traditional retailers to move into e-commerce. Companies with a weak balance sheet will see the investment as risky, particularly as the payoff is hit and miss.
Chart 5
Online retailers said they found it difficult overcoming a lack of know-how to running physical stores, and the limited economies of scale when moving offline. Physical operations require specialized skills. For example, department store operators need to master the art of product selection, and where to locate items in a store in just the right spot to maximize turnover and margins.
Chart 6
China's online retailers are national in focus, which fits with their objective of achieving maximum scale. It is difficult, however, to replicate that model with a physical branch network in a Chinese market that is geographically vast and economically and culturally fragmented.
By contrast, most large offline retailers stick to a regional focus. Golden Eagle Retail Group Ltd., for example, is the dominant department store in Jiangsu. The company has an established brand name and customer loyalty in the province and continues to deliver a solid performance amid competitive conditions.
Collaboration May Be The Key To Success
Put off by the prospect of major outlays with uncertain results, all retailers in our survey said they did not plan any acquisition to implement O2O in the next two years.
The more likely fix is collaboration. Retailers are working with e-commerce platform providers to create integrated platforms, and vice versa.
While such collaboration still requires investment, the cash commitment is far less than building something from scratch. Alibaba's Taoxianda service is an example.
Chart 7
Taoxianda is an online grocery platform launched by Alibaba in March 2019. The group handles delivery but sources all its groceries from the more than 800 Chinese supermarkets with which it partners.
By integrating with Taoxianda and leveraging its data platforms, offline retailers such as RT MART International Ltd. are able to increase their sales per store. Taoxianda is able to better serve its customers by utilizing a large physical store network at low cost.
Our discussions with online retailers suggest that while some online retailers had invested in brick-and-mortar stores, the purpose may not have been to develop their own offline retail channel, but to explore collaboration with physical retailers, or at least to better understand how offline retail works.
All the online retailers we surveyed preferred an asset-light offline integration strategy and do not expect to make significant investments in offline stores.
Similarly, most offline retailers have budgeted little capital for O2O integration. Many have partially digitalized their operations. However, offline retailers are unclear about their integration strategy, and many are cautious about further investment.
Chart 8
Several retailers has chosen to pursue O2O through acquisitions. However, the path is expensive and the ultimate payoff may be years down the line. For instance, Alibaba has invested at least Chinese renminbi (RMB) 124 billion (US$18 billion) in building an O2O network, which Alibaba refers to as "new retail", since 2014. This amount does not include investment in technology, personnel and other expenses.
Chart 9
Alibaba is widely recognized as one of the leaders in O2O. Somewhat symptomatically for the industry, the benefit to the company's revenue and profitability has not yet been clear.
Appendix
Table 1
| Effect Of O2O On Issuers' Credit Story | ||||||
|---|---|---|---|---|---|---|
| O2O so far | Credit implications | |||||
| Online Retailers | ||||||
| Alibaba Group Holding Ltd. A+/Stable/-- | Experimenting with various O2O models including "new retail" grocery format with Hema and online-offline integration service for offline retailers with Taoxianda. Aiming to provide a turnkey solution for businesses to set up, operate, and manage their offline and online operations, which it calls "business-as-a-service" (BaaS). | We believe Alibaba will remain a dominant force in e-commerce based on its strong technology and partnerships across channels. It is increasingly focused on expanding its penetration into offline retail. However, there is limited upside to Alibaba's rating given restrictions placed by the China sovereign rating of 'A+'. | ||||
| JD.com Inc. BBB/Stable/-- | Penetrating into offline channels in lower-tier Chinese cities through franchising. Opened more than 9,000 franchise stores to distribute home appliances offline. Small-scale investment in offline distribution of other product categories in higher tier cities, such as selling fresh produce via its self-owned 7fresh supermarkets. | Successful roll-out of franchise business model in lower-tier cities may decrease customer acquisition costs. We believe JD.com has advantages in adequate client data, yet it is still fine-tuning its operation with the recently established offline network. Near-term impact on credit profile is limited, given the small operating scale of its offline operations and small investment amount. | ||||
| Vipshop Holdings Ltd. BBB/Stable/-- | Started to open brick-and-motor stores in 2018; acquired a small-scale outlet chain Shan Group in 2019. | Vipshop so far has limited offline experience. The recent outlet acquisition will expand Vipshop's network, future partnerships with offline operators, and brand building. However, given Vipshop's limited experience in managing outlet stores, it could take some time for synergies to materialize. | ||||
| Offline Retailers | ||||||
| Fast Retailing Co. Ltd. A/Positive/-- | Aiming to integrate e-commerce platform with physical stores for better shopping experience, increased customer traffic and improved operational efficiency. Collaborating with players such as Google and Accenture to reach supply chain optimization through digitization. | We expect the O2O trend to be supportive for Fast Retailing. E-commerce accounts for only 11% of the company's revenues, but it maintains a solid record of strong online sales growth (average 30% annually) in the past eight years while keeping up store traffic. This suggests the company's O2O initiatives have been successful thanks to Fast Retailing's network operational expertise. Investment for digitization is also manageable, in our view. | ||||
| Seven & i Holdings Co. Ltd. AA-/Stable/-- | Launched 7iD, an ID used in its mobile apps and e-commerce website, to manage its customer data and boost traffic within the retail group. Partnering with a major online catalog retailer Askul Corp. in e-commerce operations, albeit small in size. | Seven & i has adequate knowledge in offline distribution, and its partnership with an online catalog player is supportive of its O2O development. No material impact on its creditworthiness in the short-run. Limited financial burden from investments in e-commerce business including logistics and digitization while limited growth upside from O2O. | ||||
| E-MART Inc. BBB-/Stable/-- | Competing with other Korean e-commerce players for market share at the expanse of profit. Built a combined online platform with other related group companies (called SSG.com) through the splitting off of its online shopping mall in 2018. | We expect E-MART will show weaker profitability in 2019-2020 due to intense competition. The company's investments in distribution channels will dent its cash flows and add debt. | ||||
| GOME Retail Holdings Ltd. B+/Negative/-- | Started online operation in 2011, have been continuously refining online strategy, all the platforms were recently consolidated into one, gome.com.cn. | Given its many revisions of its online strategy, we are uncertain about when GOME will stablize its online operations and regain market share. Its technology capability may not be as strong as Suning's, which is partnering with Alibaba. | ||||
| Department stores | ||||||
| Golden Eagle Retail Group Ltd. BB/Positive/-- | Focusing resources on offline operational efficiency, exploring a business model or co-operation suitable for the company’s operating attributes with reasonable investment. | We expect Golden Eagle will remain cautious about capital investment, and maintain low debt leverage over the next 12 months. Relatively weak in technology but experienced in offline operations, the company awaits online partners to utilize its knowledge and network. | ||||
| Maoye International Holdings Ltd. B/Stable/-- | Has gradually shifted to shopping mall model to attract traffic. Used WeChat and apps for marketing since 2013, user conversion rate for new members was about 68% in the first half of 2019. Bought an e-commerce business in 2018. | Maoye's experiment with the website it acquired has shown limited synergy so far. However, we view it as part of the trial-and-error process that was not necessarily wrong. On the other hand, its efforts in offline operational improvement seem to be paying off. We expect Maoye's cash flow generation will improve, supported by the move into shopping malls. | ||||
| Source: Company interviews. | ||||||
This report does not constitute a rating action.
| Primary Credit Analyst: | Ava Chang, Hong Kong (852) 2533-3530; ava.chang@spglobal.com |
| Secondary Credit Analysts: | Clifford Kurz, Hong Kong (852) 2533-3534; Clifford.Kurz@spglobal.com |
| Sophie Lin, Hong Kong (852) 2533-3544; sophie.lin@spglobal.com | |
| Ryohei Yoshida, Tokyo (81) 3-4550-8660; ryohei.yoshida@spglobal.com | |
| Minjib Kim, Hong Kong (852) 2533-3503; Minjib.Kim@spglobal.com |
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