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Chinese Internet Economy White Paper 2.0 - Decoding the Chinese Internet 2.0: Get Ready for the Next Chapter

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Now that China’s major online players have conquered the consumer space, they’re intent on, digitizing B2B industries and building platform-based businesses. China’s consumer internet is driving the development of the industrial internet, according to a new report by Boston Consulting Group (BCG), AliResearch and the Baidu Development Research Center. Comparing the development of China’s consumer internet and industrial internet with foreign markets for the first time, the report systematically reviews China’s internet players’ entrance into the industrial internet, revealing the unique digitalization path in China and its underlying causes.

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Chinese Internet Economy White Paper 2.0 - Decoding the Chinese Internet 2.0: Get Ready for the Next Chapter

  1. 1. JAN 11, 2019 Decoding the Chinese Internet 2.0: Get Ready for the Next Chapter Chinese Internet Economy White Paper 2.0
  2. 2. 1 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  3. 3. 2 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  4. 4. 3 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Chinese Internet Economy White Paper 1.0: In 2017, we discussed what makes the Chinese Internet unique and the reasons for its unique characteristics Download the Chinese Internet Economy White Paper 1.0: Chinese Internet Economy White Paper 1.0 - CHN: https://www.bcg.com/zh-cn/perspectives/170394 Chinese Internet Economy White Paper 1.0 – ENG: https://www.slideshare.net/TheBostonConsultingGroup/decoding-the-chinese-internet Key questions in white paper 1.0 • China and the U.S. are the dual engines driving the global Internet economy. However, these two markets are vastly different. What makes the Chinese Internet unique? • Why has the Chinese Internet grown so fast for so long? What are the reasons for the uniqueness of the Chinese Internet? • How can players win in this unique but explosively growing market?
  5. 5. 4 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. The increasing trend: China's Internet players are moving offline Key questions in this report Focus of this report: the increasing trend of China's Internet players moving offline and its impact on China's unique digitalization path 1. Calculated based on closing price of HKD 72.65 and exchange rate of 1USD=7.83HKD on its IPO date of Sep 20th, 2018 Sources: company websites, prospectus, company financial reports, BCG analysis • What unique digitalization path has China taken, characterized by a trend from online to offline? • What are the roles of Chinese Internet players in China’s digitalization path? • What is the unique business model as a result of this unique China’s digitalization path? • What is the winning recipe and what are the challenges to win in the "new chapter" of the Chinese Internet? Jan 2018 Luckin Coffee founded. Leveraging effective online customer acquisition, it has opened ~1,700 physical stores in just 11 months since its establishment, second only to Starbucks in China by size. The founder, Qian Zhiya, said “our target is to replace Starbucks in China” Baidu launched Apollo 3.0. Apollo is the first open platform for autonomous driving technology in the world with ~130 partners globally Alibaba announced the ET Medical Brain 2.0 R&D program. Alibaba has already become a key player in the industrial Internet since 2017, providing digital and smart solutions for city operations, manufacturing, healthcare and agriculture etc. Meituan Dianping achieved a $51 Bn valuation for its IPO1 . Didi closed a new round of financing in Jul 2018. With integrated online/offline capabilities, Meituan Dianping and Didi have grown into the new giants of the Chinese Internet market Tencent announced that it starts a systematic org restructuring. Tencent is striving to enhance B2B capabilities and move to the industrial Internet; Pony Ma, the founder, said “this initiative marks a new start of Tencent for the next 2 decades” China's Internet giants are actively digitalizing mom-and-pop grocery stores. Alibaba alone has covered over 1Mn mom-and-pop grocery stores, around one sixth of the national total Jul 2018 Sep 2018 Jul-Sep, 2018 Sep 2018 Dec 2018
  6. 6. 5 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  7. 7. 6 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Driving effect: • Foster digital behaviors among consumers • Drive effective synergy across industry value chain Enablement effect: • Leverage massive amount of consumption data • Provide digital tools and applications China’s unique digitalization path Downstream Upstream Consumer Internet Clothing Food Housing Transport- ation Industrial Internet Supply Product Design Logistics Mfg. … Smart Connectivity Data Integration Smart Decision making Human-robot Collaboration Drives Work Entertain -ment Study Life …
  8. 8. 7 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Sources: BCG Chinese Consumer Survey Database 2015, BCG analysis Top e-commerce Shelf display/ads KOL SNS In-store sales & services Brand's official website WOM Other apps/sites UGC SNS Other e-commerce Traditional media SNS Brand’s social media Discount e-commerce Retailer & e-commerce SNS SMS Top e-commerce Brand's official website Product packaging & trial Promotions WeChat In-store sales & services Social network Price comparison/rating sites WOM Other retailers Other online shopping events Discount e-commerce Apps and other mobile search Shopping malls Other brick-and-mortar stores Domestic integrated e-commerce Department stores Online official store Domestic fashion e-commerce Hypermarket Daigou (overseas shopper) Travel Offline payment with cash/credit card Digital payment for online shopping Digital payment for off-line shopping Online payment with credit card Pay on delivery Offline payment with coupons/membership card... Offline pickup Online delivery Offline delivery Online pickup N/A Online WOM Membership points Offline WOM Coupons... Online return & exchange Offline return & exchange OnlineOffline Online to online Offline to offline Online & offline hybrid Discovery Research Purchase Payment Delivery Aftersales In the downstream, Chinese consumers are highly digitalized, with increasingly integrated online and offline behaviors, thanks to the fast growth of the Chinese consumer Internet BCG Chinese Consumer Survey (n=200 households) • Along the consumer journey, increasing number of touch points with Chinese consumers • Increasing integration of online and offline touch points, and more frequent switches between them Consumer journey Downstream
  9. 9. 8 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 30 3 18 1. The minimum volume per order can be as small as 50 Sources: CEIBS, BCG analysis • ~300 independent small product teams with full P&L responsibility to provide fast changing apparel products tailored to the needs of smaller customer segments • Effective operation with 95% sell-through rate driven by data based product life cycle mgmt • Agile manufacturing1 supported by a centralized digital supply chain platform ~1.5x An online fashion apparel player with fast product iteration1 New digital business model and org. structure Faster product iteration than global peers Digitalized operation platform (e.g. product mgmt., supply chain, logistics, customer service, etc.) Product team Product team Product team Product team Product team Product team… Aplatformorganization basedondigitalization Average # of styles launched annually Unit:1k Traditional brands (average) Downstream: clothing ZARA HSTYLE Almost every element of everyday life in China is highly digitalized — E.g. clothing: new digital business models have enabled fast iteration of products HSTYLE
  10. 10. 9 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Source: company website Picture source:BCG pictures Digital players in China are actively digitalizing restaurants # of cities covered 200+ # of digitalized restaurants ~600K Chinese consumers’ dine-in experience transformed by digitization Downstream: catering 2D Fire Meituan Dianping Meiweibu yongdeng Alibaba local service 2018 Food: Chinese consumers’ dine-in experience has been fully digitalized, with around 600k digital-enabled restaurants across over 200 cities as of 2018 No need to line up at restaurant, shorten waiting time Place order through mobile app Personalized marketing Dish preview on e-menu, with comments and rating Direct connection of front counter to kitchen to shorten waiting time Targeted coupon push to trigger repurchase No manual checkout, no lines; seamless dining experience Mobile payment Electronic order assigning Scan QR code in mobile app to line up
  11. 11. 10 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Sales volume of smart speakers in China surged, reaching 1/3 of global share in one year since launch Smart home1 penetration in China's tier 1&2 cities is close to that of the US, the most advanced smart home market Smart speakers: China’s sales volume share Products launched by Chinese players3 Smart home penetration (%), 2018 20% 99% 80% 65%35% 93% 1% 2017Q4 2017Q3 7% 2018Q1 2018Q2 China Other 27% ~20% Tier 1&2 cities in China2 US avg. Downstream: home 1. Smart home market constitutes the sale of networked devices and related services that enable home automation for private end users; 2. The number of households using smart speakers in tier 1&2 cities is an approximate estimation based on sales volume of smart appliances in tier 1&2 cities; 3. Incl. TmallGenie from Alibaba, Mi AI Speaker from Xiaomi, DuSmart Speaker from Baidu, and other smart speaker products. Sources: company annual reports, Canalys Smart Speaker Analysis, BCG analysis Housing: smart home market in China has witnessed explosive growth
  12. 12. 11 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Innovation: Internet companies partner with auto OEMs to grow connected vehicle business Scale: China's e-hailing services top the world by market scale 20 15 # of daily orders, Mn2017 Downstream: mobility DiDi Uber Source: Company website, Forward Industry Research Institute, BCG analysis China Worldwide 16 18 2016 2017 9 2014 2015 13 Scale of connected vehicles, Mn Alibaba partners with SAIC MOTOR to found Banma, which offers end to end connected vehicle solutions • Provided Internet solutions to ~500k vehicles • Partnered with 3rd- party OEMs, incl. BMW, Dongfeng, etc. 25% Banma Transportation: China has surpassed other countries in the scale of shared mobility services, and China has been actively adopting new business models
  13. 13. 12 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Time to grow to 1,500 stores 10 years 2005-2015 10 months Jan – Nov 2018 Unique business model • Online customer acquisition – Leverage online traffic instead of traditional high-cost offline consumer acquisition • Low-cost stores used also as distribution hub – Mostly with lower rent & smaller space – 2 km maximum delivery range A new retail coffee shop chain ~70% ~6% # of stores in China Unit: 1k Likely to surpass Starbucks1 and become the largest coffee shop chain in China by 2019 Q2 if it can maintain its current growth rate Assuming growth can be sustained Compound quarterly growth rate 2018 A coffee shop chain with online/offline integrated operations • Founded in Jan. 2018 • Opened 1,700 stores across 21 cities by the end of Nov. 2018 Luckin Coffee Starbucks Luckin Coffee Downstream 1. 2017Q4, 2018Q3 and Q4 Starbucks store numbers are actual numbers, 2018 Q1 and Q2 store numbers for Starbucks are estimated by assuming linear growth from 2017 Q4 to 2018 Q3 Note: BCG takes a neutral attitude towards the future of Luckin Coffee. Discussions on Luckin Coffee hereof is based solely on up-to-date observations Sources: company website, expert interviews, BCG analysis 2.9 3.1 3.3 3.4 3.6 0.4 0.7 1.1 2.0 5.8 ’18Q417Q4 ’18Q1 ’18Q2 ’18Q3 ’19Q2E 3.9 Starbucks China Luckin New business model innovations have been flourishing in China's consumer Internet — Luckin Coffee case study
  14. 14. 13 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Unmanned stores to provide 24x7 shopping experience Fast expansion1 in first 2 years • Box-shaped convenience stores in public areas to deliver self- service shopping experience • No staff, no manual checkout — enabled by QR codes, RFID and biometric recognition technologies Select goods E-payment & settlement Scan code to open doors Image recognition & recording Walk out 500+# of stores 40+ # of cities covered 2,000 RMB Average sales per store per day 1. As of Aug 2018 Sources: Lit research, BCG analysis Downstream Bingo Box New business model innovations have been flourishing in China’s consumer Internet — Bingo Box case study Consumer Shopping journey
  15. 15. 14 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 46% 54% 54% 38% 16%21% 35% 25% Digital factories in planning 11%No plan to build digital factories Digital factories established +21% +29% 2017 (N>1,000) Upstream Sources: Capgemini's Digital Transformation Institute (DTI), Smart Factories: How can manufacturers realize the potential of digital industrial revolution; the survey interviewed ~1,000 executives from manufacturing companies with revenue above $1 Bn, among whom 40% are from the US, 10% from China and 9% from Germany; BCG analysis However, in the upstream: China’s industrial Internet still lags behind developed markets; for example, China is highly willing to digitalize its manufacturing, but still has to catch up Survey of digital factories: China only has half the penetration of digital factories as developed markets
  16. 16. 15 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Image source: eyeem.com, keyword “digital factory”, “digital manufacture” Sources: desk research, BCG analysis Smart decision making: optimize mfg. equipment & process via algorithms and distributed analytics & decision-making systems Key gap: still catching up in terms of data analytical capabilities C Human–robot collaboration: Smart machines work with humans to undertake heavy and repetitive mfg. tasks Key gap: adoption of advanced mfg. technology to be increased D Smart connectivity: inter-connected machines, equipment, sensors and personnel Key gap: more equipment to become smarter A Data integration: all data/information integrated across systems to reproduce the real manufacturing process digitally Key gap: lags behind developed countries in industrial IT adoption B Upstream More specifically, China still lags behind the global leaders in each of the four core aspects of digital manufacturing
  17. 17. 16 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. ~5% ~12% Penetration1 of smart sensors2 in industrial sensor market ~40% Investment in industrial sensors ~3 ~4 ~75% 2016 USD Bn A Upstream: smart connectivity 1. Penetration data is based on market share by sales value; 2. Smart sensors: sensor modules integrated with sensing, processing and wireless communication features Sources: Askci, CAICT, Global Market Insights, Desktop Research, BCG analysis Smart connectivity: taking sensors as an example, China lags behind in penetration of smart sensors, which define the level of smart connectivity
  18. 18. 17 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 60~70%1 55% 30~40% 45% Key mfg. processes with digital control1 Key mfg. processes w/o digital control 100% Increase digitalization, e.g. digitalize more key manufacturing processes 2017 1.5x Further integrate data, e.g. improve cloud adoption rate Cloud adoption rate (%) among enterprises 2018 ~30% ~80%2 Upstream: data integration 1. According to Guanyantianxia, around 60-70% of key processes in US are digitally-controlled; 2. Different source having different data for cloud adoption rate in the US, most of ranging from 70% to 90% Sources: National Bureau of Statistics, Ministry of Industry and Information Technology, China Info100, Guanyantianxia, Chinese Institute of Electronics, Evolve IP, RightScale, BCG analysis Data integration: China needs to increase digitalization and further integrate data B
  19. 19. 18 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. China vs. US in distribution of Industry 4.0 patents, 2007-2018 Smart data analytics & decision-making patents % (count) in China 10% (993) vs. 34% (5,203) Smart data analytics & decision-making patents % (count) in US 15,303 patents9,927 patents Factory- wide control system Programed control system Industrial wireless communications network Digital info. processing algorithms Production data cleansing and analysis 3D printing equipm ent Program controlled robots/me chanical arms Industrial energy mgmt. Factory monitoring system & equipment Fundamental information technology 59% Smart data analytics & decision- making 10% Sophistic ated industria l sensors Digital control system Factory energy consum ption optimiz ation Image communica tion system Mixed- signal control system Industrial big data analytics & algorithms Data-driven decision making & forecast Automated monitoring & mgmt. Smart multi- functional robots 3D printing Additive manufactur ing process Smart data analytics & decision-making 34% Fundam ental info. technol ogy 29% In-factory location & navigation Advanced mfg. equipment Advanced mfg. technology 37% Advanced mfg. technology 31% Upstream: data-based decision Note: 'Peaks' and 'troughs' represent the density of patents, Light-colored 'peaks' mean a high density of patents, green 'troughs' mean fewer patents and less similarity Sources: BCG ROVER, a patent search & analysis tool, BCG analysis Smart decision making: according to BCG’s patent analysis tool ROVER®, China is significantly behind global leaders in smart data analytics & decision-making C
  20. 20. 19 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Penetration1 of industrial robots in China (units/10k manufacturing workers) 2016 68 309 189 4.5x Increasing share of China’s industrial robot sales volume Global share Sales volume of industrial robot in China 1,000 units Upstream: human-machine collaboration 1. Penetration = industrial robot inventory / # of employees in the manufacturing industry Sources: IFR, WIND, BCG analysis 201720142013 37 2015 2016 57 69 87 138 Human-machine collaboration: China has adopted industrial robots on a large scale but still falls short on their penetration rate in the manufacturing industry D 36%30%27%26%21%
  21. 21. 20 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Mfg. value added as % of total mfg. turnover 2017 Penetration of key industrial software 2017 21% 37% Upstream 1. Estimated based on US manufacturing industrial software sales and # of manufacturers Sources: US BEA, China NBS, Guanyan Tianxia, ITIF, Onshape, Lisa Picarille CRM World Domination, BCG analysis Estimated average penetration1 of key industrial software in the US 50~60% 34 % 41 % CRMSCMPDM/PLM 33 % Root cause: digitization of upstream manufacturing is highly dependent on the overall development of manufacturing industry… China needs to develop high-end manufacturing further… …and improve its industrial information technology (penetration of industrial SW as an example)
  22. 22. 21 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Avg 64% -4% 15% Production optimizationExpansion of product portfolio Better customer service Avg 43% 24% 7% Avg 43% 8% -5% Survey of 148 manufacturing industry experts in 6 countries — “What do you think are the commercial opportunities of Industry 4.0?” Downstream: consumer side Upstream: production side Avg % among respondents Above/below avg Above/below avg Upstream Source: Acatech Industry 4.0 in a Global Context …In addition, Chinese companies have a tendency to focus more on the downstream consumer side, resulting in slow digitalization of the upstream production side
  23. 23. 22 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. # of autonomous driving start-ups As of July 2017 # of start-ups with valuation of >$100 Mn Total funding1 acquired by autonomous driving start-ups As of July 2017 USD Bn Autonomous driving talent pipeline As of July 2017 # of autonomous driving talents2 (k) 9 10 1.6 1.1 1.0 1.4 Upstream 1. Calculated based on average exchange rate of 1USD = 6.74CNY in 2017; 2. Total number of employee for autonomous driving startups Sources: Tencent Research Institute "A Comprehensive Study on Development of Artificial Intelligence Industry in US and China", IT Juzi, www.iyiou.com, CCID Consulting, LinkedIn, desktop research, BCG analysis However, China has the potential to make a big leap in some emerging technology fields, e.g. autonomous driving
  24. 24. 23 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 0.97 UAV Computer vision NLP 0.20 Robotics Voice recognition 0.29 1.09 2.00 0.46 0.84 2.35 1.82 0.46 2017 USD Bn Total amount of VC investment in emerging technologies1 1. Calculated based on average exchange rate of 1USD = 6.74CNY in 2017 Sources: Tencent Research Institute "A Comprehensive Study on Development of Artificial Intelligence Industry in US and China", IT Juzi, CCID Consulting, BCG analysis Upstream Large amount of capital is flowing into emerging technology fields; total VC investment is on a par with or exceeds US in some fields
  25. 25. 24 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 12k+ developers 130+ partners1 Apollo is the world's first open autonomous driving platform Creates a diverse autonomous driving ecosystem Large scale production of autonomous cars becomes feasible Cloud service platforms • High definition maps • Virtual simulation • Information security Open SW platform • In-vehicle OS • Route planning & vehicle control • Location & LBS Example HWs • Sensors (e.g. radar) • Location devices (e.g. GPS) • Computing units (e.g. GPU) Example vehicles • Drive-by-wire vehicles Examples 1. Partners include OEMs, part suppliers, Internet and tech companies in China and abroad Sources: Baidu Development Research Center, BCG analysis 2018 Achieved large scale production of world's 1st L4 autonomous driving bus 2019 # of autonomous cars powered by Apollo platform Upstream King Long JAC BAIC motor BYDChery Hongqi New business models and ecosystems are emerging around these technologies, e.g. Baidu's Apollo >10K
  26. 26. 25 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 30K 10mth 200% 20Mn HSTYLE Luckin Coffee '18Q1-'18Q2 DiDi China 3K 10yr 50% 15Mn Traditional offline brands Starbucks China '18Q1-'18Q2 Uber Global Clothing Food Housing Transportation Number of styles launched per year Time to reach 1,500 stores Qtly. comp. growth rate of smart speakers Daily orders of shared mobility Example Data integration Smart Connectivity Human robot Collaboration Penetration of industrial robots Penetration of smart sensors Cloud adoption rate among enterprises Example 68Units/10k workers (2016) ~5% ~30% 2018 2016 189Units/10k workers (2016) ~12% ~80% 2018 2016 Smart decision making Patents on smart analytics and decision- making 933 2007-18 5,203 2007-18 Summary: the development of downstream consumer Internet and upstream industrial Internet in China Downstream consumer Internet is highly digitalized Upstream industrial Internet digitization still developing
  27. 27. 26 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Consumer behavior data • Based on aggregated and anonymous 600 Mn consumers • Provides digital user survey tools Reshape product design and development • More precise product design & incubation • More efficient new product development, shortened dev. cycle from 18 months to 6 months Tmall Innovation Center worked in-depth with premium brands on product design and incubation How consumer Internet drives industrial Internet Sources: Desktop research, BCG analysis Driving Driving Effect: downstream consumer Internet is driving upstream industrial Internet — Case study: Tmall Innovation Center FMCG Food Special shampoo designed for China market • 15 mn bottles sold within the 1st month after launch • Top 3 best-selling shampoos on Tmall Special DOVE chocolate package for China • Sold out 5,000 limited edition in 12 hours Covers 600+ premium brands Incubated 300+ new products P&G MARS
  28. 28. 27 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Driving 2003 - 2015 Largely invested in consumer Internet, business model became heavier since 2016 Expanded to supply side digital transformation and became a value chain player F&B review1 Food supply chain solution Catering ERP system SC financing Downstream: develop consumer side Upstream: upgrade supply side Meituan Dianping's milestones in Food & Beverage business F&B group- buying F&B delivery Note: Dianping was founded in 2003 with F&B review site business and mergerd with Meituan in 2015 Sources: Meituan Dianping’s IPO prospectus, Desktop analysis, BCG analysis Infoexchange Transaction matching Product/service delivery 2003 2010 2013 2016 first half 2016 second half • # of annual transactions reached 2.1 Bn while active users reached 206 Mn in 2015 • Active merchants reached 500k in 2015 • As of October 2018, 21 provinces & 38 cities covered by its SC solution … Driving Effect: downstream consumer Internet is driving upstream industrial Internet — Case study: digitization of the F&B industry in China
  29. 29. 28 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  30. 30. 29 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. As example, Alibaba alone has covered ~1/6 of mom-and-pop shops in China 30 50 2018.92016.12 100+ 2017.8 # of mom-and-shop shops covered Unit:10k Digitization achieved through: • Digital supply chain1 • Digital logistics • Digital payment ~1/6 of national total ~67% ~33% Traditional model2 Modern model2 2017 Offline retail sales (grocery as an example) 1. Build direct access to brands and dealers to enrich assortment; 2. Traditional grocery model includes mon-and-pop, etc.; Modern grocery model includes hypermarkets, supermarkets, etc. Sources: CCFA, company websites, company financial reports, desktop research, EuroMonitor, BCG analysis China’s Internet players have played a vital role in driving the industrial Internet: as an example, in the offline traditional grocery model, they are actively digitalizing mom-and-pop shops…
  31. 31. 30 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Alibaba’s investment in offline retailers JD & Tencent’s investment in offline retailers2 Target companies, '15-'18 Top 100 ranking3 Top 100 ranking3Target companies, '15-'18 Internet players have focused investment on top 100 chain retailers Aug 2015 1Suning Nov 2016 89Sanjiang Jan 2017 25Yintai May 2017 8LianHua Feb 2018 NAEasyhome Sep 2017 43NHD Nov 2017 4Sun Art Aug 2015 6Yonghui Jan 2018 10Carrefour Feb 2018 14 BBG Better Life 1. Traditional grocery model includes mon-and-pop, etc.; Modern grocery model includes hypermarkets, supermarkets, etc.; 2. Brand owners are excluded, e.g., HLA and Cosmo Lady investments; JD acquired YHD.com with Series A stocks rather than make direct investment in Walmart and therefore excluded; 3. Based on CCFA“2017 Top 100 retailers" Sources: CCFA, company websites, company financial reports, desktop research, EuroMonitor, BCG analysis Oct 2017 NAOriental Group Oct 2018 NABianlifengNov 2018 NAC-store Sep 2018 NAMiniso …In the offline modern grocery model, China's Internet giants are actively investing in offline retailers ~33% Traditional model1 ~67% Modern model2 2017 Offline retail sales (grocery as an example)
  32. 32. 31 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. # of offline retailers invested 2015 - 2018 Bn USD 2017 15 1 101 16 6.3x 1. Share of the online retail sales by top 5 online e-commerce players: China: 83.4%, US:64.8%; brand owners are not included; 2. Calculated based on average exchange rate of 1USD = 6.74CNY in 2017 Sources: eMarketer, Thomson One, Pintu 2018 Insights on Investments and Innovations in New Retail in China, CCFA, Stores.org "STORES Top Retailers", company websites, BCG analysis Investments in non-US offline retailers are not included 15x Compared to their US counterparts, Chinese Internet giants are moving offline more proactively and investing more in offline retailers # of domestic offline retailers invested by top 5 Internet e-commerce players1… …total retail sales2 of invested domestic offline retailers
  33. 33. 32 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. % of top 100 offline retailers who built their own in-house e-com brand2 , 2017 Share (%) of retail sales among top 100 offline retailers1 2017 99.2% 28% 72% 0.8% In China, online to offline investment In US, offline to online investment 67% 88% 33% 12% No e-com or sell on 3rd party e-com platform In-house e-com brand 1. Based on CCFA “2017 Top 100 retailers"; 2. In-house e-com is defined as branded e-com website that supports the full online shopping journey, e.g., browsing, payment and delivery; excludes mobile e-commerce since sites offered through multiple operating systems (IOS, Andriod, etc.) could be double counted; if included in, China is 59% vs US 90% Sources: eMarketer, Thomson One, Pintu, CCFA, Stores.org, company websites, BCG analysis Invested by Internet companies Not invested by Internet companies Looking at the top 100 retailers, Chinese Internet players have more influence over offline retailers, while U.S. offline retailers are actively building their own e-commerce brands Chinese Internet players are more powerful to influence offline retailers Most leading offline retailers in U.S. choose to build their own e-commerce brands
  34. 34. 33 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Growth of Chinese Internet users slowing YoY growth in no. of Internet users % 201720112007 2009 28.9% 2013 53.3% 2015 12.2% 9.5% 6.1% 5.6% Source: CNNIC Why are Chinese Internet players actively moving into the industrial Internet? Reason #1: need to find new growth engines given the slowdown in online user growth
  35. 35. 34 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. China’s online traffic is more concentrated Different leaders in different sectors in US 1. E-commerce share determined by GMV (gross merchandise volume) while social networking, video, news and search market shares are determined by traffic volume % Sources: PwC, eMarketer, StatCounter, Sensor Tower, BCG analysis sm.cn Tencent iQiyi Others Alibaba Weibo Others JD.com Baidu Others Youku & Tudou Tencent Video Others Google Others Amazon Netflix ebay Others Facebook Pinterest Twitter Youtube (Google) Hulu Others Microsoft Others Why are Chinese Internet players actively moving into the industrial Internet? Reason #2: online resource is more concentrated, therefore it is easier to move offline 100% Horizontal axis does not reflect actual distribution of online traffic 100% Example sectors: Horizontal axis does not reflect actual distribution of online traffic E-commerce Social Networking Video Search E-commerce Social Networking Video Search Market share1 based on GMV or traffic volume (%) Market share1 based on GMV or traffic volume (%) Tencent Ecosystem Alibaba Ecosystem Baidu Ecosystem
  36. 36. 35 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Average sales2 of top 100 offline retailers1 USD Bn, 2017 Market share of top 100 offline retailers1 %, 2017 1. Based on CCFA “2017 Top 100 retailers"; 2. Calculated based on average exchange rate of 1USD = 6.74CNY in 2017 Sources: National Bureau of Statistics of China, US Department of Commerce, CCFA, Stores.org, Annual Reports, BCG analysis 3.2 20.2 6.6x 7.5% 45% Why are Chinese Internet players actively moving into the industrial Internet? Reason #3: China’s offline retail market is more fragmented, harder for offline retailers to go digital by themselves Offline retail market in China is much more fragmented than the US market On average China’s offline retailers are smaller
  37. 37. 36 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  38. 38. 37 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. There are over 150 industrial Internet platforms across the globe according to IoT Analytics — China Alliance of Industrial Internet China has over 50 industrial Internet platforms1 with established influence Illustration, not comprehensive Internet companies Industrial companies Tech companies Yonyou Industrial Internet Sysware ProudThink Alibaba ET Brain Tencent Cloud Baidu IoT OceanConnect IoT Inspur Industrial Internet NeuSeer Gizwits IoT Yonyou Huawei Sysware Pround smart Inspur Neu Cloud Gizwits Haier Mei Cloud Holly Sys Bao Sight Sany iSESOL PCITC CASI Cloud XCMG Foxconn COSMOPlat iSESOL MeiCloud ProMACE HiaCloud INDICS BaoSight Xrea Genyun FiiBeacon 1. Companies dedicated to providing IoT solutions to industry/manufacturing sectors Sources: Press release on Guidelines for the Construction and Promotion of Industrial Internet Platforms and the Measures for the Evaluation of Industrial Internet Platforms by the China Alliance of Industrial Internet, Industrial Internet Platform White Paper developed by the China Alliance of Industrial Internet Platform business model is prevalent in China; platforms are an important force enabling Chinese SMEs to go digital (industrial Internet platform example) Chinese companies are keen to build industrial Internet platforms A large portion of platforms are in China
  39. 39. 38 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Source: provided by Baidu • Baidu Brain has the world’s largest deep neural network, supporting hundreds of billions of samples and feature training • AI technologies such as voice technology, image technology, natural language processing and user portrait have reached world-class level 150+ Core AI capabilities • Intelligent monitoring of crop diseases and pests using AI • Reduced pesticide use by 50% with precise applicationAgriculture • Detect material defects with image recognition • 99.98% Accuracy Manufacturing • Using Baidu AI to analyze diabetic retinopathy • Misdiagnosis rate <5% (both type I and II errors)Health Care Although there are technology-driven enablement platforms in China… E.g. Baidu's AI open platform 400Bn+ Daily use of core capabilities 800k+ Developers Baidu opened up multiple AI technologies through its AI platform… …to improve operational efficiency in various industries
  40. 40. 39 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Analysis of global leading industrial Internet platforms selected by CAII2 and IoT ONE 21 23 China US & EU Focus of platforms1 Data • Manufacturing equipment data collection • Data analytics & processing tools • Industrial mechanism modeling Apps • Digital industrial applications • Resource matching Tech. • Software development platform • Other digital technologies % of platforms with certain focus >50% 25%-50% <25% Leading industrial Internet platforms selected by CAII Leading industrial Internet platforms selected by IoT ONE 1. Each platform may have more than 1 core focus; 2. China Alliance of Industrial Internet Sources: China Alliance of Industrial Internet, IoT one, company websites, BCG analysis …most of China’s industrial Internet platforms focus primarily on applications rather than data and technology development, compared to platforms in the US and EU
  41. 41. 40 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Within applications, China’s platforms focus more on enabling SMEs through resource matching Case study #2: Haier's industrial Internet platform Sources: company websites, expert interviews, BCG analysis Application • Mindsphere doesn't focus on applications • Focuses on industrial applications, such as large-scale customization manufacturing • Opens up its own resources Data&Technology • Covers 10+ industrial data analytical models for the whole flow • Owns data analysis models for only a few industries • Relies on its own equipment data collection & control modules (data points collected for one single company > 20K) • Mainly relies on 3rd party equipment data collection & control modules (data points collected for one single company < 10K) Focus of the platform Haier has opened up its own industrial resources to enable 3rd parties Supplychain resources • Opens up Haier’s supplier resources for home appliance modules – Home appliance and peripheral sectors' procurement needs – Joint procurement of Haier's suppliers Logistics resources • Opens up Haier's warehousing, logistics and delivery resources – Meets enterprises' logistics needs and covers home appliances, furniture, fitness equipment, sanitation industry etc. ~30k suppliers ~50% orders by non- Haier clients Haier COSMOPlat Siemens MindSphere Haida yuan Riri Shun Focusing on Data and Tech Platform Focusing on Applications to drive quick wins
  42. 42. 41 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Industry concentration rate (CR4)1 2016, 2017 Manufacturing industry in China is less concentrated than that in US (selective sub-segments as examples) 1. CR4: market share of the 4 biggest companies in this segment; 2. Apparel is calculated based on sales revenue by brand. Both China and US data are based on EuroMonitor; 3. Auto is calculated based on passenger vehicle sales volume by manufacturers. China number is based on Wind, CAAM and Haitong Security, and US number is based on Autodata Corporation; 4. Chemical products are calculated based on sales revenue in paint & coating segment. China number is based on Huatai Securities, and US number is based on United States Census Bureau; 5. Machinery manufacturing is calculated based on sales revenue of food product machinery. China number is based on Guanyan Tianxia, and US number is based on United States Census Bureau; 6. Steel is calculated based on crude steel production volume. China number is based on China Metallurgy News and World Steel Association, and US number is based on World Steel Association; 7. Cement is calculated based on production volume. China number is based on Wind, dcement.com and Haitong Security, and US number is based on dcement.com Source: EuroMonitor, Huatai Securities, World Steel Association, Wind, CAAM, Autodata Corporation, Guanyan Tianxia 2018 Chinese food machinery market analysis report, China Metallurgy News, Haitong Security, dcement.com, United States Census Bureau, BCG analysis 32% Steel (Crude steel)6 Apparel (by brand)2 Auto (passenger vehicle manufacturer)3 Chemical products (paint & coating)4 Machinery manufacturing (food product machinery)5 Cement7 4% 11% 9% 22% 44% 58%65% 9% 20% 29% 59% Prevalence of the platform model in China is driven by enablement needs of SMEs; China has more SMEs than the US because the manufacturing industry in China is more fragmented
  43. 43. 42 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. 2.9 7.0 12.0 Avg. life span of SMEs1 (number of years) Funding pressure • Capital gap: SMEs contribute ~60% of GDP but account for only 25% of the total bank loan balance Less adaptive to economic environment • Low profit margin: avg. profit margin of 3-5% among small and medium manufacturers in China • Sensitive to taxation & supporting policies: tax-to- profit ratio remains high Business environment to be improved • Services provided to SMEs to be improved: For example, only 21.4% of Chinese enterprises have credit info. records ~4x 1. According to The Ecology of Chinese Private Enterprise Sources: The Ecology of Chinese Private Enterprise, the World Bank, China HRKey, BCG analysis Chinese SMEs have a shorter life span, as they face many challenges... Shorter life span of Chinese SMEs Challenges faced by Chinese SMEs
  44. 44. 43 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Avg. annual salary1 in manufacturing sector (USD 000') China's labor costs have increased dramatically, exceeding many developing nations incl. Vietnam & Mexico 1. Calculated based on year-end exchange rate from 2007 to 2017 Sources: National Bureau of Statistics of China, Trading Economics, IHS, SourceToday, BCG analysis Vietnam Mexico 2007 7.6 2.9 5.8 3.9 9.9 20132009 2011 8.5 2015 2017 4.8 2017 7.9 2017 13.2% 2x 13% …especially rapidly increasing labor costs, which have put pressure on Chinese SEMs
  45. 45. 44 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Sources: AliResearch Status and Development Strategy of Small and Medium Enterprise , BCG analysis 36% Macroeconomy 57%Policy support (e.g. finance, tax) 45% Product innovation Recruitment 30% 22%Company mgmt system 18%Mgmt. concept & vision of company owner 16%New tech. & models (incl. digitization) 7%Others Survey of SME owners (annual revenue <300 Mn RMB) – “What do you think are the bottlenecks impeding the growth of your business?” (2017, N=~4,000) Therefore, Chinese SME owners, who generally do not see investing in digitization as a priority, prefer resource-matching platforms, which enable them to go digital and deliver quick wins
  46. 46. 45 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. What to expect: the winning recipe and challenges in the next chapter of Chinese Internet The business model: a unique platform model The drivers: growing roles of Chinese Internet companies China’s unique digitalization path: consumer Internet is driving the development of industrial Internet Foreword: new trends in the Chinese Internet market
  47. 47. 46 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Go deep in vertical industries: break down the boundary to drive deep integration of online /offline capabilities Launch enablement platforms: operate based on digital technology and resources to enable others …… 1 2 1. Emerging leaders are defined as Chinese Internet companies that had initial public stock offerings in the 18 months prior to the end of 2018 and China's top 10 Internet companies with pre-IPO valuations of $1 billion or more as of November 2018. Source: BCG analysis Finance Medical & Education Auto & Transportation Logistics Industrial AI platform Autonomous driving open platform Alibaba ET brain Baidu Apollo Ant Financial Manufacturing Examples WeBank Lufax JD Finance Ping An Health DiDi Cainiao DJI NIOPu-Xin BEST Foxconn Winning recipe in the next chapter of Chinese Internet: going deep into vertical industries and building enablement platforms Existing giants and emerging leaders1 are either going deep into vertical industries or launching enablement platforms Examples
  48. 48. 47 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Digital platform operations Vertical industry know-how Restructuring B2B organization Disruptive industry ecosystem Source: BCG analysis • How to establish B2B business organizations, how to transform from B2C genes to an effective B2B organization • How to select and build partnership with appropriate players in different vertical industries; whether the existing industry ecosystem can be disrupted • How to integrate digital capabilities with vertical industry know-how to enable traditional players and drive digital transformation in vertical industries • How to further leverage Internet companies' digital advantage to build strong digital platforms and play a vital role in vertical industries Potential challenges Challenges for Chinese Internet players in the next chapter of Chinese Internet
  49. 49. 48 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Digital organization and operations Relationships with Internet companies Handling disruptive industry ecosystem Digital transformation • How to adjust current partnerships and develop new partnerships in order to be better positioned for a potential disruption of the industry ecosystem • How to effectively promote digital transformation for the current business and establish competitive advantage in the digital era • Whether to compete with or collaborate with Internet companies; if the latter is chosen, how can companies build strong partnerships? • How to learn from Internet best practices and leverage digital technologies to transform the organization and internal operations to become more agile Potential challenges Source: BCG analysis Challenges for Chinese players in traditional industries in the next chapter of Chinese Internet
  50. 50. 49 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Localize China operations Revisit China strategy Ride on the tide of Chinese Industrial Internet Build new partnerships with Chinese digital giants • How to actively participate in the development of the Chinese industrial Internet; what opportunities to pursue and how to win • What value proposition and partnership to adopt to establish partnerships with Chinese digital giants • How to reposition in China given the competition from digital players; how to change the China business strategy • Facing strong competition from local digital players, how should MNCs adjust their operational model in China and become more localized? Potential challenges Source: BCG analysis Challenges for MNCs in China in the next chapter of Chinese Internet
  51. 51. 50 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Authors Francois Candelon Boston Consulting Group Senior Partner and Managing Director candelon.francois@bcg.com Chen'ao Yu Boston Consulting Group Principal yu.chenao@bcg.com Jun Wang Boston Consulting Group Consultant Yi Zhu Boston Consulting Group Consultant Ping Xiao AliResearch Researcher xiaopeng.axp@alibaba-inc.com Xin Cheng AliResearch Senior Expert Linli Huang Baidu Development Research Center Director huanglinli@baidu.com Qiang Wang Baidu Development Research Center Deputy Director Experts Xinmin Gao Internet Society of China Vice Chairman, member of Advisory Committee for State Informatization Benfu Lv University of China Academy of Science, School of Economics and Management Professor, Director of Research Center for Cyber- Economy and Knowledge Management Steering Committee Derek Kennedy Boston Consulting Group Senior Partner and Managing Director Jean Francois Van Kerckhove Boston Consulting Group Partner and Managing Director Hongbing Gao Alibaba Group Vice President, Director of AliResearch Cheng Zhao Baidu Vice President, Chief Editor Authors and Steering Committee
  52. 52. 51 Copyright©2019byBostonConsultingGroup,Inc.Allrightsreserved. Acknowledgments Liqi Peng Alibaba Group Vice President Tianqi Song Alibaba Group User Research Expert of Tmall Innovation Center Li Guo Alibaba Group Senior Expert of New Retail Engineering Department Wei Pang Alibaba Group Senior Expert of Foreign and Domestic Trade Experience- driven Center Shuquan Liu Alibaba Cloud General Manager of Computing Technology Zhao Liu Alibaba Cloud Technology Director of Data Intelligence Chen Su Alibaba Cloud Senior Strategy Expert Feng Tian Alibaba Cloud Director of Research Center Jiaqi Feng Ant Financial Senior Expert of Research Institute Jiali Pan Cainiao Network Head of Corporate Social Responsibility Xianchun Xu Tsinghua University Director of China Data Center Lianfeng Wu IDC China Vice President Jianfei Han CCID Institute of Industrial Economics Deputy Director Yifei Zhang Baidu Technical Expert at AI Planning Management Department Gaosi Chu Baidu Senior Business Analyst of Group Strategy BU Fei Xie Baidu Development Research Center Deputy Director Xinyu Wen Baidu Development Research Center Senior Researcher Wenyi Cui Baidu Development Research Center Senior Researcher Chengli Lou Baidu Development Research Center Researcher Shengcheng Zhao Boston Consulting Group Consultant
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