JD.com, Alibaba, Amazon: Why Are the World's Biggest E-Commerce Companies All Going Out to Buy Supermarkets?

The e-commerce sites that used the internet to beat big supermarkets and department stores have turned around and started running stores of their own.

Lately, subway stations in Beijing and Shanghai have been papered with red ads like this one, the app logos of Tmall and Suning both carrying the words "4·18 Home Appliance Festival."

The posters give the two companies equal billing — "Tmall & Suning," in type of the same size — but this promotion is hard to call a pure "e-commerce festival."

The two ran appliance promotions through their own channels at the same time, at the same prices online and off. They also promised a "buy in the morning, get it in the afternoon" delivery plan: buy a discounted appliance on Tmall and a nearby Suning store delivers it to your door the same day. Tmall and Suning also put out a consumer-electronics and appliance ranking based on online purchase data, and hung it in Suning stores in Beijing, Shanghai, Guangzhou, Shenzhen, Nanjing, Hangzhou and other major cities.

This kind of cooperation is nothing new. Ever since Alibaba became Suning's second-largest shareholder in August 2015, one online-and-offline promotion has followed another, and during collective e-commerce shopping holidays like Double 11 and 6·18, Suning has become one of Alibaba's biggest offline venues.

China's e-commerce giants buying into — and even buying outright — offline supermarkets and department stores began with JD.com's strategic partnership with Yonghui Superstores in August 2015.

Since then, Alibaba has taken a stake in Suning, acquired Intime three years later, taken control of Sanjiang Shopping Club and struck a strategic partnership with Bailian Group; JD Daojia has merged with Dada, and JD.com has taken investment from Walmart. The giants are all heading offline.

On April 10, JD.com CEO Liu Qiangdong announced on his Toutiao account that over the next five years JD.com would open one million convenience stores nationwide, half of them in the countryside — that is, put up signs over the little shops in China's county towns with "JD.com" written on them. The same day, JD.com also said it would build 5,000 maternal-and-infant experience stores within three years.

The e-commerce story is always more or less the same.

Last Friday, word came that the Northeastern U.S. warehouse-club chain Wholesale Club was preparing to sell itself for $4 billion, and that the biggest potential buyer was America's e-commerce leader: Amazon.

Earlier, Bloomberg cited people familiar with the matter as saying Amazon wanted to bid for Whole Foods, the organic food supermarket chain with stores in 20 U.S. states. Amazon had considered buying Whole Foods the previous fall too, but never went through with it.

From shopping malls to supermarkets to the convenience store down the street, the brick-and-mortar businesses e-commerce once set out to replace haven't disappeared. They've become e-commerce's partners.

How did it come to this?

How Are China's Two Biggest E-Commerce Companies Going Offline?

Leaving aside the million convenience stores still on the drawing board, Alibaba and JD.com have each already tied up with hundreds of offline supermarkets and convenience stores, through equity stakes and other forms of cooperation.

On August 7, 2015, JD.com announced a strategic partnership with Yonghui Superstores: it would subscribe to 10% of Yonghui at 9 yuan a share, a deal worth 4.3 billion yuan in total. What JD.com meant by strategic cooperation was using Yonghui's existing procurement channels to improve its own supply-chain management. Once the agreement was signed, JD.com could appoint a director to Yonghui's board.

Four days later, Alibaba announced it was paying 28.3 billion yuan for a stake in Suning, becoming its second-largest shareholder. Suning, in turn, spent 14 billion yuan subscribing to newly issued Alibaba shares. Putting more than 10 billion yuan each into cross-shareholdings says a good deal about how seriously the two took the partnership.

Both deals ran to tens of billions of yuan, and Alibaba and JD.com independently made the same choice: buy into the leading company in a field you're bad at, to "fill the gap." Wherever your own supply chain and experience fall short, invest there.

JD.com's channel strength and warehousing, for instance, were built around 3C goods — phones, appliances, computers — plus books, media and household items, products with almost no shelf-life or freshness requirements. But in fresh produce, processed food and other groceries, Yonghui's main sources of revenue, JD.com's supply chain and warehousing were still in their infancy. Those three categories accounted for 90% of Yonghui's 49.3 billion yuan in revenue in 2016.

As of the end of last year, Yonghui Superstores ranked fifth in China with a 2.8% share of the market, close to Carrefour's 3.1%. Investing in Yonghui gave JD.com not only a channel for fresh produce, but a shot at the shoppers who walk into Yonghui's 477 stores across the country every day — some of whom might never have bought anything from an e-commerce company.

Alibaba, for its part, invested in exactly the category where its own goods were a mixed bag: consumer electronics and appliances.

Ask people about buying electronics on Taobao and "murky waters" is probably the first thing they think of. Is it refurbished? Are the accessories genuine? How long is the warranty? Those are the questions that worry buyers of 3C products on Taobao most. Alibaba's investment in Suning, the strategic partnership, and Suning's flagship store on Tmall all eased, to some degree, the uneven quality of 3C goods on Taobao and Tmall.

The investment market approved at the time, at least. After Alibaba and Suning announced the deal, Alibaba's stock rose 2% and JD.com's fell 6%.

The same gap-filling shows up in the countryside, where e-commerce reaches fewer people. In the 2015 round of deal-making, Alibaba and JD.com each built their own channels to sell in rural areas — though so far the two are hard to compare.

JD.com started opening JD Help service stores in county-level cities in late 2014, and had 1,700 of them by last October. The stores mainly handle delivery, installation, after-sales repair and marketing in county- and township-level cities.

Alibaba's Rural Taobao program started in 2015. Under an agreement between Alibaba and the relevant Zhejiang provincial departments, Alibaba planned to build 1,000 county-level "Rural Taobao" centers and 100,000 village-level service stations nationwide. Each center has a "shopkeeper" who buys goods on villagers' behalf and sells their farm products in return.

How much of the plan has actually been built, Alibaba has not said.

The race to open offline stores stepped up sharply in 2016. That year both companies announced partnerships with large shopping malls and supermarket chains.

Alibaba, which holds more than half of China's e-commerce market, has clearly gone further here: a good many of the large department stores, supermarkets and convenience store chains in the Yangtze River Delta have Alibaba money behind them.

The biggest of these was the department store chain Intime. In November 2016, Alibaba invested in Sanjiang Shopping Club and Intime, picking up access to Sanjiang's 170-odd supermarkets in Hangzhou and Intime's 46 department stores around the country.

This February, Alibaba announced a strategic partnership with Bailian Group, one of China's largest retail groups. Alibaba plans not only to sell goods offline through Bailian's supermarkets and to join forces on supply chain and logistics, but also to connect the two companies' membership systems and bring in Alipay.

Bailian is the biggest supermarket group in the Yangtze River Delta, with more than 5,000 stores nationwide, including supermarket chains of every size — Lianhua, Hualian, Century Lianhua — whose combined market value is about $31 billion. Bailian also owns malls such as Shanghai No. 1 Yaohan, Orient Shopping Center, Yong'an Department Store and Shanghai Hongqiao Friendship Shopping Center.

Count Suning, Bailian, Intime and Sanjiang together and Alibaba has assembled a sizable camp across North China and the Yangtze River Delta.

JD.com has leaned more toward supermarkets. Since last year, with Walmart's money and its stores behind it, JD.com has also pushed further into home delivery.

In June 2016, JD.com took a $4 billion investment from Walmart, which got 12.8% of the company.

The way JD.com tells it, working with Walmart gives it access to Walmart's global procurement and supply-chain system, which, combined with JD.com's national warehousing and delivery network, lets it offer shoppers both domestic and imported goods.

Walmart's Sam's Club then opened an official flagship store on JD.com, and Walmart supermarkets were plugged into JD Daojia, JD.com's two-hour grocery delivery service.

By now, most of China's e-commerce companies and offline stores are tangled up with JD.com or Alibaba one way or another.

Amazon, the World's Most Valuable E-Commerce Company, Is Going Offline Too — Far More Carefully

Unlike Alibaba and JD.com, fighting over first place in China, Amazon, the world's largest e-commerce company, has moved offline much more slowly.

That has something to do with the absence of serious competition. Amazon's e-commerce revenue reached $94.5 billion in 2016. Europe and the United States are essentially its territory, and in India it has forced rivals to cut their valuations and merge.

JD.com and Alibaba passed Bailian, Yonghui, Suning and Gome in market value the moment they went public. Amazon's offline rivals around the world were harder to beat: its market cap didn't pass Walmart's until 2015.

That has made Amazon rather careful about offline investments and experiments.

In 2014 it planned a physical store in midtown Manhattan to handle brand promotion, returns and exchanges, and act as a mini-warehouse. What opened in 2015 turned out to be a small distribution center tucked into an office building across from the Empire State Building — not a store, not a convenience shop.

With street-corner stores selling fresh food, groceries and household goods, Amazon has been experimenting all along, and the format hasn't settled.

On a busy street in Seattle's Ballard neighborhood, for instance, workers are finishing a private driveway with several parking spots, covered by a tall steel canopy to keep off the rain. Filings with the Seattle planning department show that once the store opens, customers will order what they want online, pick a pickup time, drive over, and have Amazon staff load the order into the car.

Across town in SoDo, another Amazon drive-up grocery store is under construction. Late last year, Amazon began testing a new kind of convenience store in Seattle, Amazon Go, which uses sensors and other technology so customers can check out without a cashier.

The well-known independent analyst Ben Thompson has pointed out that staff wages can account for 13.5% of a U.S. convenience store's total costs. But his analysis doesn't apply yet: after months of testing, Amazon Go's sensors stop working properly if more than 20 people are in the store, or if customers pull items off certain shelves too fast.

There have also been reports of an Amazon plan for 2,000 physical stores — some letting customers skip the checkout line, some offering curbside pickup, some working like a drive-through, with the customer buying without leaving the car.

The slow pace of the openings and the testing tells you how careful Amazon is about the offline business.

Buying a supermarket chain, the way Alibaba and JD.com have, is also on Amazon's mind: last week, reports said it was considering buying the grocery chain Whole Foods.

Whole Foods stores aren't as big as Walmart's, but at 4,000 to 5,000 square meters each they are dozens of times the size of the stores Amazon has tried so far. Whole Foods has always aimed at middle-class shoppers and up, stressing green and organic products and charging accordingly. It has nearly 500 stores in the United States, Canada and Britain.

But like its other slow-moving offline experiments, this acquisition doesn't look like something Amazon is pushing hard. The rumor first appeared last fall. Whole Foods is worth about $10.7 billion and takes in $16 billion a year. How much Amazon is prepared to pay is still unknown.

Why Open Offline Stores? One Reason: Delivery Costs Keep Rising

Having drained customers away from the big traditional supermarkets and shopping malls, why are e-commerce companies going offline at all?

The most important reason is probably the pressure of delivery costs.

Amazon has expanded its fulfillment centers fast in recent years. The share of Americans living within 30 kilometers of an Amazon fulfillment center has risen from 26% in 2014 to 44% today, which is what makes two-day delivery possible for 60 million Prime members.

JD.com's delivery network has expanded just as fast, following Amazon's footprints. The goods JD.com sells — household products, 3C products, books and stationery, a wide range, but nothing that has to be fresh or watched for its expiry date — can already be warehoused and shipped through a network covering more than 2,600 counties and cities in China.

But there's a limit to what capital spending buys you in delivery speed.

Amazon spent $17.4 billion (about 120 billion yuan) on warehousing and delivery in 2016; in 2015 the figure was $13.2 billion.

Look closer and, in the fourth quarter of 2016, what Amazon paid to fulfill each order came to 18% of the order's value. In the same quarter of 2014 it was 14%.

For fresh food, where freshness is everything, Amazon has to charge extra to offer the service at all. On top of the $99 a year for Prime, Amazon Fresh costs another $15 a month.

After pouring resources into its online grocery service, AmazonFresh, for nearly a decade, Amazon has made only slow progress. People familiar with the grocery operation say the business has been hard to make profitable, which is why it spreads to new regions so slowly.

JD.com has the same problem. The box you get from JD.com today still says "More · Faster · Better · Cheaper."

Behind three deliveries a day and next-day arrival in medium and large cities is a cost per order that keeps climbing.

From the first quarter of 2014 to the fourth quarter of 2016, JD.com's cost to deliver one order rose from 10.85 yuan to 12.28 yuan, while its revenue per item sold slipped from 160 yuan to 159 yuan. Fulfillment costs have taken a bigger share of revenue year after year.

Even so, none of it has raised demand for fresh food delivered to the door.

Keeping fresh produce and cold-chain goods in good condition means building a new delivery network, or at least rebuilding the existing one, and that costs a lot. In the past three months JD.com has changed its shipping charges three times; the latest change calculates delivery fees for fresh produce separately from everything else.

Wang Xiaosong, who runs JD.com's fresh-produce business, put it this way: "What makes fresh produce different from other categories is that geography limits it far more. The honey peaches from Wuxi in Jiangsu are excellent, for example, but by the time they reach Beijing they may already have gone bad — they only suit regional sales within East China."

So besides the cost of delivery, fresh food also spoils. Bloomberg, writing about Amazon's move into retail, noted that Amazon's food spoilage rate is twice that of an ordinary supermarket, and that customers regularly receive moldy strawberries.

JD.com and Amazon each spend more than 10 billion a year on delivery and warehousing — yuan for JD.com, dollars for Amazon — and online muscle alone still can't make fresh food work.

There Are People E-Commerce Can't Reach — and a Lot of Them

The number of shoppers you can reach over the internet is still small next to the number you can reach offline.

The consumer products research firm TABS Analytics ran its annual survey last year and found that despite the huge investments by companies like Amazon, only 4.5% of shoppers buy groceries online often — barely up from 4.2% four years earlier.

This isn't a problem only American e-commerce companies have. According to 2016 figures from China's National Bureau of Statistics, online shopping accounted for just 12.6% of total retail sales of consumer goods. The share is small and it isn't growing fast either: up only 2% from 2015.

Amazon has taken 70% of online shopping in the United States, and Alibaba and JD.com together 80% of China's. Measured against a whole country's retail industry, that is still a small slice. The internet changed how retail works — no store rent and lower labor costs built e-commerce's early growth — and now the habits of internet users are what hold e-commerce back.

Nielsen's "Online Shopper Trends" report says: "In 2016, the share of price-sensitive shoppers in China rose from 15% to 19%. These online shoppers are older, mostly over 35, with less education and lower incomes; they usually care most about price and think about price first when choosing what to buy."

Price wars and discounts have become the most effective way to stir this group's appetite. "68% of shoppers will shop online when goods are discounted or on promotion," and "shopping festivals reach as many as 95% of online shoppers." But what price wars bring the companies is a lower average order value and more delivery runs. Apart from gross transaction volume — the top-line money passing through — there aren't many numbers worth showing off. JD.com, for one, has seen its revenue growth slow since the start of 2016.

The same story played out at Xiaomi. The company sells 80% of its phones through e-commerce, and early on that let it avoid the cost of stores and of paying distributors a cut. But the fixation of people who buy phones online on price and value for money became Xiaomi's trap too. In 2015 JD.com began opening offline appliance stores, and at almost the same moment Xiaomi began selling phones through offline electronics chains like Suning and Gome.

Some Categories Simply Sell Better Offline

Not every kind of product sells well online. Clothing, for one, is a category where e-commerce isn't necessarily good enough at setting off an impulse purchase.

To get closer to the fashion business, Amazon sponsored New York Men's Fashion Week and India Fashion Week, streamed runway shows live on its site and produced fashion reality shows. Plenty of brands remain unmoved: Nike, Tory Burch, Rag & Bone and many European luxury labels either have channels of their own or worry their goods will end up selling below the suggested price. And Amazon's brand image has too little to do with fashion.

JD.com is doing much the same. At the Shanghai Fashion Week that just wrapped up, JD.com sponsored runway shows for three independent designers; scan a QR code and you could buy their clothes on JD.com. Meanwhile, the Taobao-native brands that grew up on Alibaba's platform have one plan above all once they have money: open physical stores. Last July, Huimei Group, parent of the Taobao brand Inman, filed for an IPO with the China Securities Regulatory Commission. Its prospectus showed that 30% of the 450 million yuan Huimei raised would go toward opening 10,000 physical stores.

Last Double 11, a group of Taobao brands opened stores together inside Intime's shopping malls. They had piled up plenty of online selling experience over the years, but going offline let them reach the people who wouldn't have bought clothes on an e-commerce platform in the first place.

In the End It's All About Growth — and Going Offline Won't Solve Everything

Whether it's rising delivery costs or the need for more users and more categories that is pushing them to take offline channels, what they are all anxious about, in the end, is growth.

From the middle of 2016, Alibaba stopped reporting gross merchandise volume (GMV). One reason is that GMV couldn't keep growing that fast.

The term looks like it means sales, but it also counts canceled orders, refused orders and returned orders — an inflated figure Alibaba has always liked to use. With China's GDP growth slowing, its own core business slowing and a counterfeit problem it can't root out, GMV wasn't expected to keep growing quickly either.

So Alibaba switched to a new story, and a new yardstick: how many people open Tmall and Taobao every day.

For JD.com, which is chasing Alibaba, the picture is worse.

It is closing the gap more slowly, too: JD.com's revenue growth fell from 62% in the first quarter of 2015 to 47% in the fourth quarter of last year.

What Alibaba, JD.com and Amazon are all doing is getting ready before they hit the ceiling. Running convenience stores and supermarkets — businesses people visit far more often — to feed traffic to the e-commerce operation, and pairing up with physical stores, is one way out.

But going offline is no guarantee that an e-commerce company will do the job better than the offline channels it once beat.

In 2015, Amazon opened its first bookstore in Seattle, where it is headquartered, with 6,000 books on the shelves for customers to browse — a modest number next to the 3.4 million titles on Amazon's website. The chain is reportedly meant to grow to three or four hundred stores.

Having grown from a bookstore into today's e-commerce giant, Amazon knows the advantage of selling online: no physical bookstore on earth could hold all the books Amazon sells today, and no supermarket could hold that many products.

Offline, an Amazon bookstore can in theory reach people who won't buy books online. But the main difference between these stores and the competitors Amazon itself defeated comes down to one thing: "using its own data to decide what goes on the shelves."

Amazon Go, which claims technology can replace the clerk, is the other example. When Amazon announced it late last year it released a video of customers taking things off the shelf and walking straight out the door, payment done, no cashier and no line. Behind it is artificial intelligence identifying both goods and shoppers.

Staff wages can account for 13.5% of a U.S. convenience store's total costs. But after months of testing, the video hasn't come true: in a store of a few hundred square meters, if more than 20 customers are inside, or if they grab things off the shelf a little too fast, Amazon Go can't keep the accounts straight.

As for the offline supermarkets JD.com and Alibaba have invested in so far, their main link to the online side is still an app that brings people into the store, and couriers who pick up goods there for customers nearby.

The e-commerce companies have all turned back to learn from the businesses they once beat. But to solve the growth problem and get the offline business right, they will have to do a lot more.

Charts in this article by Feng Xiuxia

Cover image from VisualHunt.com