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.


Alibaba Group Current Segmentation
Source: Alibaba 2021 Investor Day Presentation

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.


Alibaba New Segmentation
Source: Alibaba 2021 Investor Day Presentation

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.


China Consumption

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.


Alibaba Consumer Growth Trends
Source: Alibaba 2021 Investor Day Presentation (click to expand image)

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).


Alibaba Retention Rate
Source: Alibaba 2021 Investor Day Presentation

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

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