By John Richardson
JUST as hundreds of millions of people in the developing world went straight to mobile phones, bypassing landlines, so looks set to be the case for Internet sales in China’s second and third tier cities. This is one of the insights I have gained from my latest trip to China. More to follow next week.
Second tier cities include Tianjin, Chongqing, Chengdu, Wuhan and Xiamen. Hangzhou and Chongqing are amongst the cities that fall into the third tier category.
The potential in these cities for the equivalent of the jump straight to mobile phones stems from the fact that many lack major networks of smaller, neighbourhood shops. This is unlike first tier giants including Beijing and Shanghai, where it’s difficult to walk more than a hundred metres without coming across a Seven Eleven, or some local equivalent.
If you want good-quality packaged food that has been prepared with high food safety standards in many of these smaller cities, you have to travel some distance to a city or suburban shopping centre, and quite often you will not own or have access to a car. Food safety is a big problem in China, partly because of what are often poor food-preparation standards. Thus, the expected explosion in online grocery sales in these less-developed cities.
The same lack of easy access applies to durable goods, meaning that there is also the expectation that there will be similar rapid growth in Internet purchases of everything from washing machines and refrigerators to furniture.
This doesn’t mean to say, however, that the potential for online growth in China’s biggest cities isn’t also very strong, given this startling estimate: Buying anything online in China is some 50% cheaper than buying the same product in a shop. The cost of running a conventional retail business in China has soared in recent years as a result of more expensive land and rapid increases in wage and welfare-payment costs.
Buying online in the US is in comparison thought to be only around 10% cheaper than visiting a Walmart etc. Another other edge that China’s online businesses enjoy over the US is access to excellent infrastructure. China has spent literally trillions of dollars on upgrading road and rail links. The government-driven concept here has been to build roads and rail links ahead of demand – i.e. quite often in remoter inland regions with small local economies. This has created more jobs and thus stronger economic growth. In contrast, the US highway system and bridges etc. face chronic underinvestment.
Not forgetting, of course, Internet speed. Connectivity in China’s smaller cities is described as very good, whereas as in Shanghai etc. it is outstandingly quick with lots of bandwidth.
This might be fantastic long term good news for the polymers business. All of these additional Internet sales will either or both made of plastic and packaged in plastic. It is possible to therefore contemplate any number of upside scenarios to our base case for linear-low density polyethylene (LLDPE) demand growth in China over the next ten years (see the above chart).
But caution is also in order, especially over the next few years as China attempts to make the difficult transition from an investment-led to a service and consumption-led economic growth model. For every additional roll of LLDPE film needed to wrap online sales, there could be one or more rolls of film sales lost due to millions of job losses in oversupplied industries such as steel and coal. Laid off workers will obviously be cutting back on their spending.
We also don’t know whether the service-based growth model will be able to solve one of China’s major problems: How it raises enough tax revenues to pay for its rapidly ageing population.
The jury is out over whether the corporate and VAT tax boost from Internet sales will be sufficient to replace all the taxes lost from the closure of factories in oversupplied industrial sectors – and what is also bound to be a slimming-down of the conventional retail sector.
And because the cost of each Internet sale will be lower than the equivalent sale through a High Street store, this obviously represents another downside risk for tax collection.
A significant percentage of internet payments in China are also made by cash, which raises the potential of tax avoidance.
Many people I spoke to this week believe that if China cannot tackle its tax collection problem, its attempt to shift from an investment to a services and consumption-led growth model will fail. This would in turn prevent China from climbing out of its middle income trap.
All of this further underlines what I have arguing over the last three years: That China has become much more complex, and much more uncertain. This requires multiple, new strategic approaches.