China’s new retail revolution.

During the pandemic, the rise of middle-class consumers in smaller cities has turbo-charged retail’s digital transformation and could drive the next phase of China’s growth.

With their overhead conveyer belts, tanks containing live imported fish and checkouts offering facial-recognition payment, Alibaba’s Hema supermarkets in China may look futuristic to visitors from the U.S. and Europe used to a more traditional shopping experience.

But this is the reality of the so-called “new retail” in the country, a hybrid of e-commerce and physical shopping that has been a rapidly growing feature for about three years.

Shoppers can scan items using a QR code displayed on digitalized aisles, have their order packed on-site and transported via the conveyor belt to a dispatch station. The order is then delivered to their home in 30 minutes if they live within a three-kilometer radius. They can even opt to have the fresh food they’ve bought cooked in-store.

Accelerated digital transformation

By integrating the online and offline shopping experience, China’s digital retailers have been trying to offset a recent maturing of online purchasing. Annual online shopping frequency was flat year-on-year in 2019, according to surveys by UBS Evidence Lab, an alternative data provider.

Before the Covid-19 pandemic struck, the integration strategy was already starting to pay off. But then a remarkable thing happened on the way to this new retail revolution: thanks to the widespread use of mobile apps in coronavirus test-and-trace schemes, there has been a surge in the “digital IQ” of the Chinese population that is boosting change across a range of activities.

A snap survey carried out by UBS Evidence Lab in April revealed that 38 percent of people aged 45 and older were shopping more online than before Covid-19 struck.

As a result Alibaba’s Hema supermarket, for example, saw a significant increase in engagement from January to early June, with weekly online time spent per active user rising 23 percent to almost 25 minutes, according to UBS Evidence Lab data on leading home-delivery apps.

Just as China’s online giants have been moving into the physical retail space, so traditional “offline” retailers have been digitalizing to counter disruption and improve operational efficiency, strengthening the “stickiness” of their existing customer base.

Sun Art, a Hong Kong-listed retailer that operates a chain of supermarkets, has been digitalizing its offering under a strategic alliance with Alibaba since 2017, according to UBS China 360, a new thematic China research offering that leverages data from UBS Evidence Lab and partners with analysts across the globe.

This includes implementing an enterprise resource planning system used by Hema to manage more effectively digital orders, supply chain, procurement, and logistics.

Taken together, these two sides of China’s retail landscape point to the dominance of an omnichannel approach that looks set to fuel the vitally important consumption element in the next phase of China’s economic growth story. It is one that will combine a superior user experience, winning technology, data capture, and app development.

“These innovations and new retail generally could have a huge impact in terms of being an enabler of consumption in China, particularly for a rising middle class,” says Natalie Cade, Head of UBS China 360.

Rise of the online consumer

Importantly, this will play out over the next couple of years particularly in China’s smaller tier 3 and tier 4 cities where the proportion of middle-class consumers has been rising steadily in the past decade. Middle-class consumers have already headlined the consumption story in China’s largest cities such as Shanghai, Beijing, Guangzhou and Shenzhen.

“These lower-tier cities contained an untapped population base that needs quality products, priced well and available through more efficient distribution channels,” says Christine Peng, Head of Greater China Consumer Research at UBS.

In Huizhou, a tier 3 city in the southern province of Guangdong, there are signs of receptivity to the new initiatives in retail. UBS Evidence Lab recently ran a focus group made up of people ranging from their early twenties to early forties. Almost everyone in it had heard of Hema.

Notably, there was consensus that a new retail store offering fresh products daily and dining services would be priced at a premium level. “I do my research,” said one 29-year-old unmarried consumer, “but it’s OK if similar items are slightly more expensive, as groceries must be of good quality.”

Data-driven infrastructure

Recognition of such “premiumization” is critical for the future growth of middle-class consumption because it locks in higher-paying shoppers and increases margins for retailers.

In 2018, Alibaba launched Ling Shou Tong, a concept that brings digital analytics and infrastructure to the 6.3 million “mom and pop” stores which dominate the shopping experience in tier 3 and tier 4 cities and rural China.

These fragmented stores usually lack proper digital infrastructure and analytics, and are served by multiple levels of traditional distribution that are highly inefficient. This electronic solution offers procurement, logistics, payments and advertising, as well as other services powered by artificial intelligence (AI), such as demand forecasting. Future growth of middle-class consumption and the data associated with that are key drivers behind Ling Shou Tong, for which premiumization in lower tier cities is a longer-term goal.

Not only does the concept help such small stores run their businesses more efficiently, but the data and analytics involved help premium brands reach China’s inner regions by allowing them to track sales data at point-of-sale, which in turn allows them to build a relationship with different demographics of shoppers through promotions and other means.

“The ultimate winners in this omnichannel approach will be the [best-known] brands,” says Ms. Peng. “They will be able to use the data they are getting to displace the smaller regional brands in these lower-tier cities as they expand from the biggest cities, where they are already well-established.”

As this new retail landscape shapes up, the big players will be leveraging their respective strengths to win over such consumers, launching and fine-tuning new models to tap into other trends accelerated by shoppers’ experiences during the pandemic.

Groceries received an outsized boost as consumption of staple products shifted online. UBS believes this will be “highly accretive” to the broader new retail trend, given that only about 6 percent of groceries as a category are bought digitally at the moment. Older consumers—such as those in the survey aged 45 and older—are also joining the ranks of digitally savvy shoppers in a trend that is likely to stick.

New business models

As these consumer dynamics play out, it’s clear that a period of intensified competition is looming as companies jockey for position while testing and evolving their business models.

UBS analysts believe that Sun Art is emerging not only as a role model for digitalization of traditional retail, driven by its partnership with Alibaba, but that its trajectory could offer a glimpse into how traditional stores could even develop in Europe, where data monetization and digitalization are emerging themes.

In the long run, UBS China 360 believes that the most viable way for internet giants to expand their retail footprint will be through the “asset-light” model of incorporating online delivery platforms into existing offline retailers.

Consolidation is also on the horizon. UBS analysts predict that leading companies will likely command as much as 80 percent to 90 percent of the total market in the near future.

Ultimately, the winners will be Chinese consumers—and the rising middle class in particular. “The strength in the overall consumption story will be driven by the growth of the middle class,” says Tommie Fang, Head of China Equities at UBS. “And the more you see stability and growth of this segment, the more stable the growth story—and society—will be.”

Views correct as at 3 September 2020

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