The Landscape Changed Without Warning: Inside the Alibaba–Suning Deal

The contest is now "Alibaba + Suning" versus "JD.com + Tencent."

Suning renamed itself Suning Commerce Group more than two years ago, yet it still hasn't worked out how to grow its e-commerce business. Which giant should it team up with to turn things around?

Within seven hours on August 10, that question got two very different answers.

On the morning of August 10, at the "Internet + Retail" Zijin Summit hosted by Suning Commerce, Wanda Group chairman Wang Jianlin said he was considering a partnership with Suning. Baidu CEO Robin Li was there too, to show his support.

That afternoon, though, the same venue welcomed Alibaba Group executive chairman Jack Ma and Suning Commerce chairman Zhang Jindong. Together they announced a landmark in the history of Chinese retail: Alibaba and Suning Commerce would form a comprehensive strategic partnership.

Under the agreement, Alibaba Group will invest about 28.3 billion yuan in a private share placement by Suning Commerce, taking 19.99% of the enlarged share capital and becoming its second-largest shareholder. In turn, Suning Commerce will pay 14 billion yuan for up to 27.8 million newly issued Alibaba shares.

The 28.3 billion yuan is the largest single investment in Alibaba's history. Even after subtracting the 14 billion yuan Suning will spend on Alibaba shares, it exceeds the US$1.684 billion Alibaba paid for Amap.

"From today, business will no longer be split into old and new by market competition. You have a bit of me and I have a bit of you; there is no commerce without electronics, and no electronics without commerce. This is the traditional economy and the new economy embracing each other." That was how Alibaba Group CEO Zhang Yong summed up the deal.

According to Jack Ma and Zhang Jindong, this "embrace" came together astonishingly fast. The two teams finished all negotiations in just over two months; the two founders met only twice, but trusted each other completely and rarely interfered in their teams' decisions. A source close to Alibaba also told QDaily that Suning did not even bring in any other buyers for the private placement during the talks.

Before the announcement, however, both listed companies were more cautious than usual.

From August 3, Suning Commerce's shares were suspended from trading on the Shenzhen Stock Exchange because the company was "planning a private placement of shares." After Wang Jianlin's remarks on the morning of August 10, the media began speculating about "whether Wanda and Baidu will take stakes in Suning Commerce." Suning refused to say anything, explaining only that it would "announce important news at a press conference on the afternoon of August 10."

Alibaba, for its part, began on August 7 to invite reporters to a "future strategy media briefing" in Zhenjiang, a 40-minute drive from Nanjing. The invitation said the August 10 event would be "the first formal, detailed explanation of Alibaba's strategy this year" and would "involve major group-level strategy announcements, with executives attending and possibly taking interviews."

But after waiting nearly four hours (some even longer), the invited reporters found that the bus meant to take them to a venue in the city center had changed direction on the highway and was heading straight for Nanjing. Neither the Alibaba staff nor the driver would tell them anything, citing a confidentiality agreement.

Any unusual move by the reporters could have leaked news of the deal, and the landscape of Chinese retail and e-commerce would have been upended that much sooner.

Why did Alibaba invest in Suning?

Under the strategic agreement, Alibaba and Suning Commerce will try to link their online and offline channels. Put more bluntly: Alibaba wants Suning's stores and its logistics network. Those two systems are also where more than two-thirds of the money from Suning's private placement will go.

Suning takes its name from its first store, opened in Nanjing in 1990: an unremarkable air-conditioner shop at the corner of Jiangsu Road and Ninghai Road. Over the next 20-plus years, Suning opened stores across China at a staggering pace. At its peak, in the first half of 2005, it averaged 1.7 new stores a day.

Logistics, however, was once the company's weak spot. After Suning announced its shift to e-commerce in 2013, a newly launched logistics system left large numbers of orders undelivered and cost it the trust of consumers. Since then, nearly 20 billion yuan of investment has made Suning one of the strongest logistics operators in China.

In December 2013, Alibaba also paid a hefty HK$2.8 billion to invest in the veteran appliance maker Haier. Of that, HK$1.857 billion went into Haier's logistics subsidiary Rilishun, which was eventually folded into the Cainiao logistics network as the link specializing in delivering large appliances to counties and rural areas.

According to Haier, when Alibaba invested, Rilishun already had more than 7,600 county-level outlets, 26,000 township-level outlets and 190,000 village-level liaison stations across China. Its business covered more than 2,800 counties, with over 2 million square meters of warehouse space, and it had genuinely solved the problem of delivering to third- and fourth-tier cities.

Third- and fourth-tier cities, and the vast countryside beyond them, are exactly where demand for large appliances is strong. During Singles' Day (Double 11) in 2014, first- and second-tier cities still did most of the spending on home goods, but third- and fourth-tier cities already accounted for 30-40% of large-appliance sales on Tmall, and Suning received orders that day from 24,462 townships. Online shopping demand, long held back by the limited reach of stores and logistics, is gradually being released.

With Alibaba and Suning working together, the "stores + logistics" model should hold an even bigger advantage than Haier's. The two sides will design the best delivery plan for each order, with goods arriving in as little as two hours, and Suning's stores can also handle after-sales services such as home installation, repairs, returns and exchanges.

Why does Suning need Alibaba?

For a company that can put up 14 billion yuan for Alibaba shares, money doesn't seem to be a problem for now. At its share price before the trading halt, Suning is still worth more than 100 billion yuan.

What it urgently needs to learn from Alibaba, it seems, is how to run a general e-commerce platform well.

In February 2010, Suning formally launched its e-commerce platform, Suning.com, and began moving beyond appliances, positioning the site as an online department store. At first, a single Suning department ran the e-commerce business. Because the traditional business was making high profits and the new one might eat into it, the company gave it little support.

The change came in early 2011. Suning.com's standing within the group rose sharply, and it began operating independently as a subsidiary controlled by the listed company Suning Appliance. Suning's physical stores were reorganized, closed or improved: in core cities it built super stores and added product categories, while stores in other first- and second-tier cities kept selling mainly appliances, but had to link their goods to Suning.com.

Suning.com's direct rivals, Tmall and JD.com, have grown much faster in recent years. In 2014, Suning.com's gross merchandise volume was 25.8 billion yuan, just 3.4% of Tmall's and 10% of JD.com's. In terms of size, Suning.com has already fallen behind.

In growth, too, Suning.com grew only 18% year on year in 2014, far behind Tmall and JD.com, which both went on to list in the US, and no match for Gome Online's 80%.

The past several quarters have been even worse: the company's revenue, and the share of it coming from e-commerce, have both stayed fairly flat, with nothing driving growth. And because an e-commerce business has to build out logistics before it can enter third- and fourth-tier cities, heavy upfront spending has repeatedly pushed the company into large losses.

On August 15, 2012, JD.com, Suning and Gome, three companies that all started out selling 3C products (computers, communications and consumer electronics) and all run e-commerce platforms, fought a price war. JD.com fired first, announcing zero gross margin on large appliances for three years and promising prices at least 10% below Gome's and Suning's. Suning and Gome then cut their prices in turn, and the war lasted about a week.

That day, Suning.com's sales ran at 8 to 10 times their usual daily level, and its traffic jumped nearly tenfold. Zhang Jindong later told Forbes that the price war sharpened Suning's understanding of online and offline retail, and that the company's goal changed from "become China's Walmart" to "become China's Walmart + Amazon."

Yet Walmart is hardly a good model of a traditional retailer moving into e-commerce.

In the fiscal year ended January 31, 2015, Walmart's global e-commerce sales were about US$12.2 billion, up 22% year on year, while the company's total revenue was about US$485.7 billion, up about 2%. E-commerce made up about 2.5% of total revenue.

Next to its huge and steady traditional retail sales, Walmart's e-commerce business starts from a low base. Although it posts growth rates nearly matching Amazon's every quarter, its overall share remains small. And given that over the past three years Walmart has doubled its costs to double its e-commerce results, the business is clearly still not growing fast enough.

Another company Suning can compare itself with is Best Buy, long the No. 1 consumer electronics retailer in the US. In the third quarter of fiscal 2015, Best Buy's e-commerce channel contributed only 13% of revenue. Although the market research firm comScore ranked it the seventh most popular online retailer in the US, Best Buy's market share in this field was just 7%.

The new e-commerce landscape: JD.com + Tencent vs. Alibaba + Suning

The Alibaba–Suning announcement has already had knock-on effects. Hit by a Morgan Stanley downgrade and by news of the Alibaba–Suning tie-up, JD.com's shares opened lower and kept falling in early US trading today. Barron's reported that the investment poses a direct threat to JD.com's core business.

Four days earlier, JD.com had released its second-quarter 2015 results: gross merchandise volume (GMV) reached 114.5 billion yuan, up 82% year on year; net revenue reached 45.9 billion yuan, up 61%; and the net loss was 510 million yuan, slightly narrower than the 580 million yuan loss a year earlier.

Many observers see Alibaba's huge investment in Suning as a counterstrike against JD.com's 4.31 billion yuan investment in Yonghui Superstores four days earlier. But next to Suning's more than 1,600 stores nationwide, Yonghui's 364 stores, or even the 544 it plans to have by year-end, are not in the same league. JD.com, whose logistics network is already well developed, is probably more interested in Yonghui's supply-chain management for fresh produce, something most general e-commerce companies are bad at.

So for the e-commerce landscape as a whole, "JD.com + Tencent" matters more than "JD.com + Yonghui."

Before JD.com's US listing in 2014, Tencent announced it would buy a 15% stake for US$214 million, and threw in payment entry points inside WeChat and Mobile QQ, along with a set of e-commerce businesses it had not run well.

At the time, the deal was considered a smart move. Through the merger, Tencent would do only what it does best and hand all its e-commerce business to JD.com. With Tencent's entry points and its e-commerce platform, JD.com was expected to gain further market share and compete better with Alibaba, while also cutting traffic costs and running more efficiently.

And according to what JD.com recently told analysts on an earnings call, Tencent's mobile traffic referrals have begun to show real scale: in the second quarter, 20% of JD.com's new users came from WeChat and Mobile QQ, and promotions run through these two apps during JD.com's anniversary sale in June also performed well. It was the first time JD.com had disclosed specific figures on what Tencent's referrals bring in.

The Alibaba–Suning partnership is somewhat different:

• Neither side is giving up its online or offline business; the focus is on how to "connect" the online and offline systems;
• By opening a "super flagship store" on Tmall, Suning will gain an e-commerce platform with nearly as much exposure as Suning.com, but no plan has yet been published for balancing traffic and user experience between the two;
• Suning says products and brands from Alibaba's platforms may get the chance to be displayed and sold in Suning's physical stores, but this will be hard to carry out in practice;
• Finally, none of Suning's stores currently accepts Alipay, and that too needs to happen soon.

Jack Ma, though, seems fully prepared for a period of adjustment: "We may not see results from this partnership for the next two or three months, because both sides have to give up some of their own views and drop yesterday's arguments."

Offline is still the mainstream of retail. Can Alibaba finally make O2O work?

The Alibaba–Suning partnership is billed as an "innovative O2O operating model." Setting aside that worn-out term, using Suning's far-flung stores to offer offline services may be exactly one of the hard problems Alibaba most urgently needs to solve in O2O (online-to-offline).

Until now, the Alibaba O2O models you know have fallen neatly into two types by format: "visible" and "invisible."

The first is represented by Intime Department Store, in which Alibaba holds a stake. It is a traditional department store, and O2O there means merchants in the store coordinating online and offline sales: shoppers can buy online and pick up in store, or buy in store and have the goods delivered home. Miaojie, the mobile app built on this foundation, follows a similar idea.

The second uses products such as Alipay Wallet and Amap as entry points, and focuses on payments and location services. The ride-hailing apps and Taodiandian food delivery you know well both belong in this category.

Two years ago, as Alipay and WeChat competed, we all got used to paying by phone. But in real offline shopping today, what people care about most is still not Alipay's current approach of using big data to analyze behavior and push precisely targeted offers. It is the basic question of "which store takes which mobile payment."

The first takes years of data collection and technology development; the second needs only a strong on-the-ground sales team to do better. So no one can be sure that a better payment experience alone will win them more loyal customers.

But a big-brand offline store that offers reliable payments, and can even plug in more services, would naturally attract more attention and get more use. Suning, with more than 1,600 offline stores nationwide, may be exactly the on-the-ground partner Alipay has always lacked. That is also what Yonghui Superstores means to JD.com and Tencent.

Offline, retail is still the mainstream, which is why Alipay and WeChat, the two mobile payment services, are fighting over department stores, convenience stores and now large supermarkets.

In pursuit of its long-term O2O goals, will Alibaba buy FamilyMart, whose stores are all over Shanghai, next?

Graphics: Lin Yuyao