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    How China’s Middle Class Will Dictate the Future of E-Commerce

    Debt-ridden white-collar consumers will buy a curious combination of high-end luxuries and bargain-bucket essentials.

    This article is co-authored by Gao Limin, a researcher at the Shanghai Institute of Finance and Law.

    China’s online shopping sector is enjoying a period of rapid growth. According to a 2016 report from iResearch Consulting Group, a third-party internet research institute, China’s online shopping market was worth 4.7 trillion yuan ($720 billion), a rise of 2,000 percent since 2009. In comparison, online sales in the United States grew by just 150 percent in the same period.

    E-commerce has grown so much faster in China than in the U.S. due to changes in supply and demand. First, the cost of doing business in China’s traditional retail sector is relatively high, due in large part to lengthy trading chains. In addition, local governments sometimes charge businesses so-called hidden tariffs on goods traded across provincial boundaries. These fees are called “hidden” because they are not outlined in official regulations, but local governments still demand “fines” from companies transporting or distributing products out of their province of origin. Sandra Poncet, a French researcher, has shown that the cost of doing business across provincial lines in China is almost as high as cross-border trade in the European Union, and that between the U.S. and Canada.

    However, e-commerce allows online shop owners to deal directly with consumers, thereby cutting out the middlemen. Online merchants don’t have to maintain a number of physical stores across provinces, can pay fewer inter-provincial tariffs, and save on logistics, storage, and management. In a sense, they have established an internet-based free trade zone within China’s borders, alleviating the tax burdens on firms and the costs of bringing goods to market.

    E-commerce has pushed China’s domestic markets towards unification by forcing them to eliminate practices that contribute to market segmentation. The U.S. has long avoided the problem of internal market segmentation by passing laws and regulations to keep markets from splitting along state boundaries. As a result, compared to their Chinese counterparts, American brick-and-mortar retail outlets are more competitive with their online rivals.

    Second, China’s e-commerce industry has benefitted from the country’s vast labor pool. As online delivery has become more popular than in-store purchases, the barriers to trade have receded. In 2005, delivery services were limited to the country’s largest cities. Now, China has one of the most far-reaching and efficient delivery networks in the world, covering all major population areas. In 2005, couriers delivered 229 million items to the country’s consumers; in 2016, that number exceeded 31 billion. At the same time, shipping fees have fallen: In 2008, long-distance shipping cost as much as 20 yuan (then $3) per item, but by 2016, this fee was less than 10 yuan.

    Migrant labor has therefore increased the e-commerce industry’s competitiveness by helping sellers avoid key problems for China’s traditional retail outlets: high real estate costs, business costs, and living expenses, which city-based firms have historically passed on to the consumer. Urban residents unable to find cheap goods in large cities now turn to online outlets to source goods from other parts of the country. In doing so, they manage to rein in the cost of living in one of the country’s large cities.

    Easy access to cheap labor is the main reason why China’s internet sector stands shoulder to shoulder with its American counterpart. Yet this advantage also reveals the industry’s soft underbelly: The responses of policymakers to the country’s migrant worker problems could have series knock-on effects for the online shopping industry. After all, what’s the point of running an online store if there’s nobody to deliver your products to moneyed urbanites?

    On the demand side, the strong performance of the country’s consumer market has buttressed the development of Chinese e-commerce. In 2009, the total volume of retail sales in China was about half that of the United States. As the U.S. has spent the past decade or so dealing with the fallout from the subprime mortgage crisis that chilled consumer spending, China’s sales figures have risen significantly. By 2016, China’s retail sales numbers had eclipsed those of the United States.

    Chinese e-commerce also caters to bargain-hunting urbanites. Over the last few years, China’s aspirational middle classes have become accustomed to high-end products, services, and experiences, such as vacations abroad, imported food, parenting services and products, and cultural activities like concerts and film screenings. But all of this put extra strain on their wallets. Therefore, to balance the books, many consumers look to cut costs on essentials like clothing, electronics, bedsheets, and drapes, all of which just happen to be products that e-commerce services excel at providing at cheap prices.

    For middle-class urbanites, the picture is complicated further by the ongoing surge in housing prices. China’s property bubble has driven up the ratio of loans to savings from 29 percent in December 2007 to 62 percent in November 2017. Among young people and nuclear families, especially those living in major cities, this phenomenon has given rise to a new social group: the heavily indebted middle class. While this group should, in theory, stand among those with the highest purchasing power, their upscale tastes and expensive housing needs force many into the online bargain buckets.

    Although e-commerce firms have begun trying to offer more upscale products and experiences to cater to people’s consumption upgrade, their business generally remains centered on low-end, low-value products. The most prominent example of this mindset is Singles’ Day, a consumer holiday in November that lures the country’s online shoppers with promises of discounts, deals, and overall value for money.

    What will Chinese e-commerce look like in the future? First, consumers will continue to move away from purchasing material products and toward spending on services. Also, they will shift focus from merely meeting their everyday needs toward improving their overall quality of life.

    These trends are already taking place, as emerging groups of consumers channel money into newfound forms of social status. For example, urban Chinese are currently going wild for marathons and other forms of physical fitness. Others are choosing customized overseas vacations and luxury accommodation. Many shopping centers now offer parenting services as a way to draw in foot traffic, while others bring together shopping, dining, recreation, culture, and family-friendly activities. Meanwhile, malls that only offer shopping are in decline.

    In time, these forms of high-end consumerism with bleed into the e-commerce world too. Yet at present, sellers catering to the above tastes stand at the vanguard of online consumption. In the absence of mature business models, whoever stakes a strong and early claim may emerge victorious.

    Translator: Kilian O’Donnell; editors: Zhang Bo and Matthew Walsh.

    (Header image: Workers celebrate e-commerce website Tmall’s Singles’ Day trading volume of 168.2 billion yuan in Shanghai, China, 11 Nov. 2017.  Mao Mao/VCG)