Alibaba (Part 4): The Future of Alibaba

In Parts 1 and 2 of our Alibaba series, we introduced the history and key business segments that constitute the Alibaba Group ecosystem, while in Part 3, we presented a financial overview of the Group.

In this final installment of the series, we explore the key strategies and overarching growth drivers that management has planned for Alibaba going forward, in addition to discussing important takeaways to conclude.

Alibaba Series Roadmap

Note: Alibaba Group's fiscal year ends in March, so "fiscal year" in our Alibaba series refers to the year ended March 31st.

Note: in the below, Taocaicai (Chinese: 淘菜菜) refers to Alibaba's community buying program (see Part 1) which was previously known as Taobao Grocery (Chinese: 淘宝买菜).

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New Segmentation

We first touch briefly on the new segment reporting approach brought up by management during the Group's December 2021 Investor Day presentation. Specifically, management is adopting a more granular accounting segmentation approach going forward.

As mentioned in Part 3, the company currently divides its ecosystem into four segments: commerce, cloud computing, digital media and entertainment, and innovation initiatives and others.

Note: Alibaba DAMO Academy refers to the Alibaba Academy for Discovery, Adventure, Momentum, and Outlook, an organisation founded in 2017 to pursue scientific and technological research and innovation. Other businesses listed are covered in Part 1 (commerce) and Part 2 (cloud computing, digital media, and innovation initiatives).

As part of the new approach, Alibaba breaks down the commerce segment further into four individual components: China commerce, international commerce, local consumer services, and Cainiao, in addition to the three non-commerce segments.

Note: Alibaba DAMO Academy refers to the Alibaba Academy for Discovery, Adventure, Momentum, and Outlook, an organisation founded in 2017 to pursue scientific and technological research and innovation. Other businesses listed are covered in Part 1 (commerce) and Part 2 (cloud computing, digital media, and innovation initiatives).

We find this new segmentation approach to be well-balanced and useful, as it provides more information than the original four segment approach above but is more concise than the detailed seven segment breakdown of commerce previously shown in Part 3. We note that a retail versus wholesale segment breakdown would not be very necessarily given that China wholesale and international wholesale each contributed to only 2% of Alibaba's total revenues in fiscal 2021 (see Part 3).

Three Strategic Engines

Next, we move on to Alibaba's overarching drivers for future growth.

Management identifies three "strategic engines" to drive the Alibaba ecosystem going forward: China consumption, globalization, and technology. China consumption is predominantly driven by the China commerce segment, and to some extent the local consumer services and Cainiao segments. Globalization is driven by Alibaba's international commerce segment, while technology is represented by the cloud computing segment.

It is noted that management does not mention the digital media and entertainment or innovation initiatives and others segments in discussing the company's future. This is presumably due to: (1) the relative lack of success in and less promising prospects of Alibaba's digital media enterprises in comparison to its core commerce competency or growing cloud computing business, (2) the constantly evolving nature of the Group's innovation initiatives, and (3) the fact that both digital media and innovation initiatives contribute only a very small percentage of the Group's total revenues.

We discuss each of the three strategic engines in further detail below.

Management is pursuing three strategies to boost consumption within the Chinese market: increasing user growth, expanding each user's share of wallet, and enhancing overall value creation. We discuss each of these strategies in turn.

#1: Increasing User Growth

Naturally, Alibaba is committed to increasing its user base. However, as the Group's penetration rate (as a percentage of the online population) in China's first and second tier cities has reached 99% by September 2021, almost all of Alibaba's new users will necessarily be from third and even lower tier cities (see our guide on Chinese cities here). This is not an entirely new challenge for the Group, as the majority of Alibaba's new China retail users in recent years are from less developed regions (see Part 3). However, Alibaba will definitely have to ramp up its efforts in penetrating demographic groups with consumer characteristics that can potentially be very different from the Group's existing core commerce clientele.

With the most obvious difference between consumers from more economically developed regions and less developed regions being price sensitivity, Alibaba has launched the Taobao Deals and Taocaicai (previously Taobao Grocery) initiatives to compete with lower income market incumbent Pinduoduo in 2020 (see Part 1). While it will be a matter of time before we can evaluate the relative success of these ventures, we do have two key concerns regarding the relatively high cost of user acquisition and the lower retention rate evident among low spending users.

First, management mentions during the Group's 2021 Investor Day presentation that Alibaba is facing higher costs of new user acquisition. We think this is presumably similar to the high operating costs (primarily due to marketing expenses and incentive programs such as price concessions) faced by Pinduoduo as part of Pinduoduo's rapid expansion into the lower income markets (see here).

Second, management data shows that only 66% of consumers that spent an average of less than RMB2,000 on Alibaba's China retail platforms during the year ended September 2020 continue to transact on Alibaba's platforms the subsequent year, in comparison to 96% of consumers who spent an average between RMB2,000 to RMB7,000 and 98% for consumers who spent more than RMB7,000. Management does not provide an explanation for the discrepancy in retention rates, although we think it is possible that lower spenders on Alibaba's platforms (who tend to have lower income levels) may have another platform of choice (potentially Pinduoduo) due to a myriad of potential factors (e.g. broader product offering, wider scope of cities and areas covered, or simply lower prices).

Overall, the combination of high acquisition costs and low average user retention rate suggests that Alibaba's lower income business initiatives may yield smaller profit margins and could perhaps be considered as less economically worthwhile.

#2: Expanding Users' Share of Wallet

Management refers to the growth of user spending across more product categories as "share of wallet expansion".

The diagram below shows the number of annual active consumers (AACs) for each product category as a percentage of Alibaba's total China AACs along the horizontal axis, along with Alibaba's estimated gross merchandise value (GMV) market share as a percentage of the total China retail market size for each product category across the vertical axis.

In terms of category penetration, the two most popular categories among Alibaba's China retail users, which coincide with two of the most popular product categories on Taobao and T-Mall, are apparel and fast-moving consumer goods (FMCG), each of which has a penetration rate of approximately 70%. In contrast, secondhand products (mostly sold on Idle Fish) and travel (sold via the Fliggy platform) are the two least popular product categories, each with a penetration rate of only about 10%, as is perhaps also reflected by the relative lack of popularity of the two platforms. The remaining four categories (home products, health products, electronics, and groceries) have each penetrated between a third to over one half of Alibaba's China AACs.

In terms of GMV market share, Alibaba has a relatively high share of the electronics, fashion apparel, and FMCG markets, and relatively little of the travel, health, and especially food and groceries markets.

Management aims to boost user spending across more product categories in order to increase revenue and Alibaba's market share for each category. In order to do so, Alibaba is expanding its membership program (for Taobao and T-Mall), introducing new brands and additional sub-categories for products, expanding its supply chain, as well as improving the logistics and delivery experience for consumers.

The Role of New Retail

Supply chain and logistics infrastructure development is also part of Alibaba's new retail strategy introduced in 2016 that has the purpose of integrating the Group's online and offline capabilities to produce an omni-channel approach that can meet the needs of a wide range of consumers. As part of Alibaba's new retail expansion, the Group acquired offline hypermarket retailer Sun Art and launched premium supermarket and local fulfillment centre Hema, in addition to founding manufacturer-to-consumer business Taobao Deals and community buying program Taocaicai (formerly Taobao Grocery) (see Part 1). The additional retail approaches supplement Alibaba's traditional e-commerce model by providing a broader range of product offerings along with different delivery timespans that meet consumers' various needs.

We note that management mentioned two "pillars of growth" in Alibaba's annual reports (namely new retail and cloud computing), although new retail was only touched on briefly in last month's Investor Day presentation.

#3: Enhancing Value Creation

Alibaba refers to value creation as the broad concept of "helping the ecosystem's merchants to serve customers better". Management explains that value creation is accomplished through the provision of diversified services (such as Cainiao logistics services and Alibaba Cloud technology services) to merchants in order to enhance their consumer lifecycle management (including consumer outreach, engagement, and loyalty retention) processes and product lifecycle management (e.g. sales and marketing, and brand establishment) processes with the ultimate outcome of boosting sales.

While value creation sounds like a rather vague concept, we interpret this as the coming together of and resulting positive synergies between Alibaba's different business units

With the slowing growth and saturation of the Chinese e-commerce market, Alibaba has been and will continue to look towards cross-border and international markets for further growth opportunities. As part of the strategy to expand the Group's presence globally, Alibaba is planning to expand its logistics infrastructure, especially in the southeast Asian and European regions.

Alibaba's presence in southeast Asia thus far has been through the acquisition of regional e-commerce platform Lazada (see Part 1), which focuses on connecting local buyers and sellers in each country. Management states that they aim to expand the local commerce infrastructure in this region in order to facilitate further cross-border businesses with China (i.e. connect Chinese sellers with southeast Asian buyers). In contrast, Alibaba pioneered the European markets with its cross-border AliExpress business that focuses on selling Chinese goods abroad (see Part 1). The Group's goal in the European continent going forward is thus to explore localization in certain key strategic markets.

Additionally, Alibaba also aims to expand its payment infrastructure globally by increasing the coverage of the Group's payment platform (i.e. AliPay) via Ant Group.

Alibaba's technological goals going forward primarily pertain to the Group's cloud computing segment, where management aims to strengthen Alibaba's existing core competency in cloud computing, as well as develop industry solutions for other businesses. Furthermore, the Group is looking to expand its cloud computing business internationally by first breaking into the southeast Asian markets.

Concluding Alibaba

Alibaba is one of China's most iconic and globally-renowned companies that holds a place in many (if not most) China-oriented portfolios. In light of the recent developments over the past year, the question of Alibaba's future has undoubtedly crossed the minds of many investors. We don't provide a definitive prediction or answer to conclude this series, but rather highlight the multi-faceted and highly dynamic nature of Alibaba Group, along with what we believe are common shortcomings in analysis.

Note: for the most part, our discussion below does not pertain to Ant Group (which we discuss in our Ant Group series here), as a financial technology company necessarily faces distinct and unique risks and challenges.

Alibaba Is Past Its High Growth Stage - The Era of Rapid E-Commerce Expansion is Ending

Some analysts seem to perceive Alibaba as the company it was five years ago, but not what it is now. The e-commerce market in China has evolved drastically, with close to complete saturation in the country's economically prosperous first and second tier cities, along with the emergence of community buying programs and group purchasing schemes in less developed areas. The rapid growth that marked the dawn of Chinese e-commerce is ending, bringing about a transition to a more competitive landscape between industry incumbents and new, experimental shifts in business models as companies adapt to try and find new competitive advantages or match their competitors.

In this sense, we view Alibaba as a mature company with a strong (domestic) commerce business at its core. This also means we don't expect to see high growth rates as in the past, especially pertaining to the China commerce business which comprises the bulk of the Group's revenues. Although there were fears that the Chinese regulators' anti-monopoly crackdown and government's common prosperity speech would severely dampen the Group's future prospects, we think that anti-monopoly enforcements such as the ban on competitor exclusion acts (i.e. "pick one (platform) from two", Chinese: "二选一" ) and any attempts made by management to align with common prosperity goals would have the potential effect of reducing Alibaba's profit margins, but not significantly impact its growth trajectory. Rather, Alibaba is already nearing (or at) the end of a rapid growth phase.

Alibaba is Still a Commerce Company

As part of Alibaba's attempts to adapt and expand, the Group has ventured to develop commerce-related support businesses (e.g. Cainiao logistics services and, to some extent, Alibaba Cloud) as well as non-related businesses. Although some analysts may view Alibaba as a diversified conglomerate, we think it is more accurate to think of the Group as a core commerce company in very much the same way that the Evergrande conglomerate should be viewed as a core real estate company rather than a diversified group (see here). Commerce unwaveringly constitutes 86% of Alibaba's total revenue (see Part 3), and even though the cloud computing segment seems relatively promising, we don't think that Alibaba's revenue structure will change significantly in the foreseable future.

Alibaba's Strong Ties With The Chinese Markets Should Not Be Underestimated

In spite of Alibaba's global diversification efforts, the Group's businesses are still very much tied to the Chinese markets, even though this concentrated exposure is sometimes underestimated or ignored. The commerce sector is a relatively straightforward example, with cross-border and international commerce only accounting for 8% of the Group's total revenue in fiscal 2021, in comparison to the 78% accounted for by China commerce (see Part 3). Although Alibaba is planning on scaling up its international commerce operations, the expansion efforts will require time, while the southeast Asian and European regions of focus cannot compare with China in terms of sheer population.

Turning to the cloud computing segment, we think Alibaba's plan to expand its cloud computing business globally will be restricted to certain countries or regions due to political and regulatory reasons (for example, following national security investigations in the US, TikTok migrated its services from Alibaba Cloud to presumably an American cloud provider in 2021). Consequently, we think it is unlikely that Alibaba Cloud will someday be able to compete and dominate globally at the level of existing cloud players such as Amazon or Microsoft, although of course this is not to say that the business does not have the potential to grow and become a dominant national and/or regional player. Similarly, we think it would be difficult for AliPay to dominate globally, especially given the additional regulatory burden associated with financial servies and products.

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An Overview and Timeline of China's E-Commerce Sector

Alibaba Series

Alibaba (Part 1): Introducing the Alibaba Ecosystem and Commerce Empire

Alibaba (Part 2): Alibaba Cloud, Digital Media, and Innovation Initiatives

Alibaba (Part 3): A Financial Overview of Alibaba Group

Alibaba (Part 4): The Future of Alibaba

Ant Group Series

Part 1 - What You Need to Know About History's Biggest IPO

Part 2 - How Big is Small? 7 Mind-Staggering Facts You Need to Know

What Happened to Ant Group's IPO? Interpreting the New Online Microlending Regulations in China

JD Series

JD (Part 1): Understanding JD

JD (Part 2): The Future of JD

Pinduoduo Series

Pinduoduo (Part 1): Targeting China's Forgotten Consumers

Pinduoduo (Part 2): Business Performance, Financial Snapshot, and Key Marketing Investments

Pinduoduo (Part 3): Pioneering AgriTech and Pinduoduo's Future

Pinduoduo (Part 4): Concluding Pinduoduo's Future

Comparing Alibaba, JD, and Pinduoduo

Glossary

CN Glossary