The pioneers of China e-commerce are on notice. Sector growth is stalling, competition is rising, and consumers are tightening belts. The credit profiles of Alibaba Group Holding Ltd., JD.com Inc., and Vipshop Holdings Ltd. remain intact for now. But they're increasingly looking over their shoulders at PDD Holdings Inc., which is snapping for more market share. PDD has leveraged consumer desire for value-for-money deals. The company's focus on cheap unbranded products has catapulted it to the second most popular e-commerce platform in China. And its business model has been very profitable.

On the flipside, PDD will face challenges as it seeks to sell more branded products on its platform. Meanwhile, traditional e-commerce giants will continue to generate significant cash flow, even as they sacrifice revenue and profit growth to compete.

How PDD Is Closing In On Alibaba And JD.com

Macro and micro factors are causing pain for China's big online retailers. But PDD is making big strides. The company's scale likely already exceeds that of JD.com; we base our estimate on the total gross merchandise value (GMV) spent on their platforms. PDD's share growth of the e-commerce segment is also profitable, signaling that its GMV share is sustainable. The company's EBIT share of e-commerce has jumped over the past two years, well exceeding that of JD.com.

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At the same time, China's economic growth is slowing. The country's e-commerce market is set to grow by about 8%-9% annually over the next two years, down from a compound annual growth rate of 13% over the past five years. E-commerce spending will decelerate because of slowing growth in macro consumption and already-high online penetration for product categories, such as consumer appliances and consumer electronics.

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(For ease of comparison, we use Alibaba's fiscal year 2017 for calendar year 2016, and so on.)

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Expanding Territory Could Require Large Sacrifices

PDD's momentum will slow as it encroaches on the niche products and services of the traditional players. Alibaba, JD.com, and Vipshop have each staked out their own core consumer group or online consumption pattern.

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To gain share in the other's core market, each platform faces choices that could be costly and risk harming their existing core market.

For example, Alibaba's move to expand its number of unbranded merchants may be hazardous. By prioritizing unbranded merchants to attract highly price-sensitive consumers, Alibaba risks hurting its relationship with branded merchants and their willingness to advertise on its flagship e-commerce platform, Taobao and Tmall. Branded merchants may be less willing to pay high fees to advertise their listing, particularly if such listings appear next to low-priced unbranded products.

Alibaba could also hurt its profitability if unbranded merchants cannibalize branded merchandise. Unbranded products have much lower prices, leading to lower fees and commissions, especially when the merchants' profit margins for these products are already very thin.

PDD faces similar difficulties at the other spectrum. Branded merchants may hesitate to sell their products on PDD's platform out of concern that it could pose a risk to their brand's reputation. And PDD's more price-sensitive consumers may be less receptive to pricier branded products.

Using Subsidies To Woo Merchants

PDD could resort to using subsidies to selectively expand into branded products such as consumer electronics. Over the past few years, PDD has, for instance, selectively offered meaningful subsidies to buyers of iPhones sold by phone dealers on the PDD platform. Selling cheap iPhones is a way for PDD to attract consumers looking for value-for-money branded options and prove to consumers they can buy genuine branded products on the platform. This helps the sale of other branded products on the platform.

For Alibaba, the introduction of unbranded merchants into any product category could affect existing branded merchants. This counter-positioning is a dilemma for the company. It cannot ignore PDD, but nor can it quell the competitive threat by wholly adopting PDD's strategy.

JD.com is in a similar position in managing its relationship with branded merchants. JD's direct sales model and in-house logistics are less suitable when it comes to selling low-cost non-branded products.

Share gains aside, all platforms will strive to ensure products listed on their platforms are competitive, particularly amid soft consumer spending. To achieve this, all platforms will use subsidies, lower fees, and offer incentives to merchants to reduce prices as much as possible. But as long as consumers remain highly cost-conscious such policies are likely to further slow revenue growth and erode profit margins.

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Warnings Signs To Look For

Key data points indicate the general health of an e-commerce platform (see table 3).

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Rating Implications For China E-commerce Issuers

Alibaba (A+/Stable/--)

We believe the company can maintain its dominant market position in e-commerce space, given it has the highest customer base and widest range of online goods in China. Alibaba and other players face many challenges. Primarily, these include the increasing competition from PDD, which is increasing its presence in branded products and has a current advantage in nonbranded products. Alibaba is not standing still, though. We believe the company can attract value-for-money merchants and provide subsidies while still protecting its profitability and relationship with branded merchants.

Key merchants will still aim to tap the 900 million annual active consumers of Taobao and Tmall (TTG), many of whom are seeking branded products. Competition will squeeze margins, but EBITA at the group should remain steady at about Chinese renminbi (RMB) 200 billion a year.

Alibaba's annual free operating cash flow should exceed RMB130 billion each year. S&P Global Ratings' estimate takes into account stronger growth for its overseas businesses, including Alibaba International Digital Commerce and Cainiao (driven by AliExpress). The cash flow supports the stand-alone credit profile (SACP) of 'aa-' on Alibaba and provides plenty of buffer to the long-term issuer rating of 'A+', which is capped by the sovereign rating on China (A+/Stable/--).

Nevertheless, we are vigilant for signs that the 'aa-' SACP is deteriorating. These could include: (1) a notable loss of users or merchants on TTG's platform; and (2) declining profitability and cash flow at TTG. Such deterioration could relate to rising subsidies or sales and marketing costs, falling commission rates or fees, or other signs of erosion due to competition.

JD.com (A-/Stable/--)

Competition from other platforms is unlikely to materially affect JD.com's competitiveness. This is because it proposes a different value proposition to consumers. Online shoppers who prefer JD.com cite its timely delivery and the quality assurance of the products and services sold on its platform. The company achieves such standards because it handles its own logistics across China and uses a direct sales model for the majority of its sales.

JD.com is managing to grow volumes in a tough market, without sacrificing margins. Its EBITDA margin is expanding faster than its revenue. The retailer has parlayed its strength in supply-chain efficiencies and merchant relationship to lower product costs, and subsequently passes on the cost savings to consumers.

The rating on JD.com indicates the company can tolerate some downside risk. Our base case assumes the competition among JD.com and other platforms in 2024 will remain at current levels. If competition intensifies more than we expect, it could pose a downside risk to our 5% revenue growth forecast for JD.com in 2024. The company still has some buffer when we compare its profit or cash flow scale and market position with other 'A-' rated companies.

Vipshop (BBB/Stable/--)

The company focuses on the niche off-price apparel category where it is not directly competing with the larger e-commerce platforms. A slower economy and weaker consumer sentiment have caused Vipshop to be more cautious about increasing spending on customer acquisition. It has focused more on its merchandising to strengthen its product range and ability to offer competitive prices.

Our base case assumes Vipshop will maintain a relatively high EBITDA margin of above 8% in 2024-2025. This will support the company's strong EBITDA and free operating cash flow generation and consequently its credit strength.

On the flipside, in the unlikely scenario that the larger platforms expand into the off-price apparel category, it could weaken Vipshop's market position. The bigger platforms have more financial resources to mount a sustained promotional strategy to gain market share. Were this to occur, Vipshop would be prone to losing more of its price-sensitive customers.

The macroeconomic environment could evolve; new platforms could emerge; competition could intensify; and regulation could tighten. What is certain is that consumer and merchant behavior will change accordingly. How the e-commerce pioneers and the younger players adapt will be crucial to determining which platforms get the edge and defend or gain share in this sizable market.

Editor: Lex Hall

Related Research

• JD.com Can Grow Market Share Without Losing Margin, March 7, 2024
• Alibaba Set To Lose More Market Share To Lower-Cost Rivals, Feb. 19, 2024
• China Retail Sales Will Likely Grow Slower Than GDP This Year, Jan. 23, 2024
• Credit FAQ: Alibaba Stares Down Competitive Threats, Feb. 1, 2023