JD (Part 2): The Future of JD
In Part 1 of our JD series, we provided an overview of JD's history and development, past and current business strategies, and key financial statistics.
In this second instalment of our JD series, we discuss the future of the JD ecosystem, with a breakdown of individual business segments, business strategies, and potential challenges going forward.
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Overview of the JD Ecosystem Going Forward
As mentioned in Part 1, we think that JD is best viewed as an ecosystem of related businesses rather than as a single business unit or e-commerce company. Up until the end of 2020, JD identified itself as consisting of two business segments: JD Retail and New Businesses, where JD Retail consisted of the company's online retail and marketplace businesses, and New Businesses referred to JD's logistics services, overseas businesses, technology initiatives, and asset management services to logistics property investors.
According to JD's Q1 2021 earnings report, the company now classifies JD Logistics as a distinct business segment separate from New Businesses.
A breakdown of JD's three business segments going forward based on the company's Q1 2021 report is shown below, while a more detailed discussion is provided in subsequent sections.
Business Segment Breakdown: JD Retail
The JD Retail segment consists of JD's traditional e-commerce business (both direct retail and online marketplace) and, perhaps more surprisingly, JD Health.
After taking a look at JD Health's prospectus (the company went public in December 2020), we believe that JD included JD Health as part of its retail segment because the bulk of JD Health's revenues are from direct sales of pharmaceutical products. Specifically, direct pharmaceutical sales account for almost 90% of JD Health's revenues during the 2017 to Q2 2020 period, while direct sales and marketplace commissions (from third-party merchants that sell products on the JD Health platform) combined account for approximately 95% of total revenues over the same time period.
We think that the inclusion of JD Health in the retail segment indicates that JD intends to continue treating JD Health as an extension of its e-commerce business, rather than developing the subsidiary into a distinct business model with different revenue and cost functions. With this in mind, JD Health's development of online consultation services and expansion in user base can be viewed as part of JD's overall efforts to continue growing its e-commerce portfolio. In terms of future prospects, we think that pharmaceutical sales have good growth potential in line with China's overall macroeconomic trends of continued rising income and an aging population.
As the official exhibit suggests, the JD Retail segment captures JD's core business which generates positive operating income but also has lower (albeit still growing) revenue growth.
Business Segment Breakdown: JD Logistics
The recognition of JD Logistics as a stand-alone business segment, and perhaps more importantly, the spin-off of the business unit and its IPO on May 28th 2021, reflects JD's increasing emphasis on logistics and infrastructure development. Although JD has been a market leader compared with other e-commerce peers in pioneering its own logistics infrastructure since 2007, the renewed emphasis on logistics indicates the company's strategy to leverage its logistical capabilities for enhanced revenue generation above and beyond those related to delivering e-commerce goods. Indeed, JD describes itself as a "technology-driven e-commerce company transforming to become a leading supply-chain-based technology service provider", with JD Logistics being spun off and developed to further these goals.
Out of the three segments, JD Logistics is projected to have the highest potential revenue growth, although the subsidiary is still operating at a loss and the magnitude of earnings is still very small compared with JD's core retail business.
We discuss JD Logistics further in a forthcoming article.
Business Segment Breakdown: New Businesses
The New Businesses segment as defined by JD consists of Jingxi, JD Property, and JD.ID. We provide a summary of each constituent below.
Jingxi is JD's e-commerce solution to lower tier cities where the purchasing habits of lower income consumers can differ significantly from those of residents in wealthier first and second tier cities that JD originally focused on.
Jingxi was previously known as JD Pingou, an e-commerce platform launched by JD in 2014 with features including group buying, social buying, and red packet sharing (we further explain these terms in the exhibit below). The company did not focus heavily on developing JD Pingou until 2019, when the platform was renamed Jingxi and restructured as its own separate business unit. JD subsequently implemented more push marketing strategies to promote Jingxi, including redirecting the "shopping" button on WeChat (please see the Future Strategies section below which explains JD's strategic cooperation with Tencent) to Jingxi rather than to the main JD platform as originally structured.
According to JD's Q1 2021 earnings call, Jingxi includes a main social e-commerce platform named Jingxi, an online convenience store named Jingxitong, and a community group purchase platform named Jingxi Pinpin.
It is interesting to note that Jingxi was transferred from JD Retail to the New Businesses segment in 2021. This likely indicates that JD is less certain with regards to its business model targeting lower tier cities - we could perhaps expect to see the company modifying Jingxi's structure or strategy over time as it tests the waters to see what works best for the demographic group.
We think that Jingxi can be viewed as a business model in the experimental stage with significant growth potential from China's untapped lower income market, as well as significant risks with regards to success. We anticipate that increasing attention will be paid to China's less developed cities as the demand for e-commerce in first and second tier cities become saturated, leading to intense competition especially between JD and Alibaba, two companies that have traditionally focused on larger cities unlike the lower income market incumbent Pinduoduo.
As mentioned in Part 1, JD Property was established in 2018 as a subsidiary that owns, develops, and manages JD's logistics facilities and other real estate properties to support JD Logistics. The business group has established logistics investment funds with Government of Singapore Investment Corporation (GIC - Singapore's sovereign wealth fund) and Mubadala Investment Company (MIC - an Emirati sovereign wealth fund), in addition to engaging in preference share financing agreements with Warburg Pincus and Hillhouse Capital. In this regard, we think that JD Property is better viewed as an extension that provides a support function to JD Logistics, rather than as a distinct business subsidiary.
In previous years, JD Property was classified under the JD Retail segment, but has been moved to New Businesses starting in 2021. We think that the reclassification may indicate JD is considering or planning to expand its property investment and management business as a supplementary source of income. JD recorded gains from sales of development properties worth RMB3.89 billion in 2019, RMB1.65 billion in 2020, and RMB82.76 million in Q1 2021, compared with operating income of RMB9 billion, RMB12.3 billion, and RMB1.66 billion over the same time period.
Note: JD's operating income is relatively low in Q1 2021 due to higher share-based compensation expense compared with the same quarter the previous year.
JD.ID, full name PT Jingdong Indonesia Pertama, is JD's Indonesian arm first launched in October 2015. The company originally focused on selling electronic products similarly to JD's original business model, but subsequently expanded to offer other consumer goods.
JD.ID became Indonesia's sixth unicorn in February 2020. Even though the Indonesian market offers substantial growth potential over the coming decade, we don't think that the road for JD.ID will necessarily be easy given the presence of competitors that are likely to be more familiar with the local market.
Overall Segment Performance
As a whole, JD's New Businesses segment is operating at a larger loss than JD Logistics, with subsidiaries that have (at least for now) less well-defined business strategies.
Based on our analysis, JD will pursue two key business strategies going forward.
#1: Expand the E-Commerce User Base with a Particular Focus on Lower Tier Cities
The first strategy is to continue expanding the company's user base, with a particular focus on lower tier cities. JD's customer base has exhibited strong growth over the past four years, from 292.5 million annual active users in 2017 to 471.9 million annual active users in 2020 and 499.8 million annual active users in the first quarter of 2021.
How JD Got This Far - Strategic Cooperations
One way in which JD has tried to increase its customer base in the past is to engage in what the company describes as "strategic cooperations" with various companies, including Walmart, Google, and most notably, Tencent. Specifically, in March 2014, JD engaged in a cooperative agreement with Tencent which provides JD with two key benefits: (1) increased access points to acquire new users, and (2) a non-compete agreement.
As part of the first point, the strategic cooperation allows JD to gain exposure to potential users via Tencent's social platforms WeChat and QQ, with the former having 1.225 billion monthly active users as of the end of December 2020. For example, as mentioned above, JD has entry points from WeChat and QQ, with the "shopping" button on the WeChat and QQ platforms leading to JD's (and later on Jingxi's) e-commerce platform.
As for the second point, the non-compete agreement specifies that JD is Tencent's preferred partner for all physical goods e-commerce and that Tencent will not engage in any retail or managed marketplace business model in physical goods e-commerce in Greater China (i.e. mainland China, Hong Kong, Macau, and Taiwan) and a few international markets for a period of eight years.
JD's strategic cooperation with Tencent was subsequently renewed for three years in May 2019.
The impact that JD's strategic cooperation with Tencent has is naturally difficult to quantify, and JD does not provide any numbers regarding the new users they have gained through Tencent's access points. However, we do believe that a large part of the value of this strategic cooperation lies in the pre-emptive nature of the non-compete agreement. WeChat is such an integral part of people's everyday lives in China that many companies trying to expand their user base even make WeChat-compatible "mini-programs" in order to leverage this access point. If Tencent were to pursue its own e-commerce business, the company would definitely have a significant advantage over JD in terms of its access to potential users. Similarly, JD probably also does not want its competitors to benefit from Tencent's vast user base.
Note: Tencent founded an e-commerce platform (named Paipai) in 2015 but sold the business to JD in exchange for a 15% stake in JD and the right to buy 5% of JD's shares upon IPO when the two companies signed the non-compete agreement in 2014. Subsequently, JD closed down Paipai in 2016 before re-launching the platform in 2017 as a second-hand trading marketplace.
Going Forward - Expansion into Lower Tier Cities
As first and second tier city markets are becoming increasingly saturated, e-commerce companies are turning to China's forgotten consumers, i.e. those living in third tier or smaller cities and even rural areas. Pinduoduo was the first company to recognize the potential of lower tier cities in late 2015, and has since been experiencing rapid growth as the company was able to successfully meet the needs of particularly price-sensitive consumers who enjoy Pinduoduo's "social shopping" platform. In recent years, both Alibaba and JD have relied on lower tier city and rural area residents for new user growth, with approximately 70% of Alibaba's new users during the twelve months ending March 2021 and approximately 81% of JD's new users during the first quarter of 2021 coming from lower tier markets.
We think that expansion into lower tier cities would be quite challenging for JD given its focus and reputation for selling high premium products, as well as the company's commitment to speedy delivery and superior service. With regards to the first point, purchasing power levels in lower tier cities are still significantly lower than those in first and second tier cities, so consumers who are more price-sensitive often prefer sacrificing authenticity and quality for a lower price. With regards to the second point, first and second tier cities in China are more clustered together which makes rapid delivery more feasible. Expanding to a wider geographic area means that JD would either have to compromise its delivery speed, or invest a substantial amount in infrastructure and logistics, which can be a significant strain on cash flows.
Naturally, with lower income consumers being the next target market of e-commerce companies, we would expect intense competition in this sector between JD, Alibaba, and the incumbent Pinduoduo.
#2: Invest in Logistics Technology and Infrastructure to Become an Integrated Logistics Services Provider
JD's second strategy, which we think the company is more certain about and placing greater emphasis on, is to leverage its core competency in terms of logistical capabilities in order to expand its scope of business and stand out from other competitors. The spin-off and eventual IPO of JD Logistics, as well as the related investment in and continual development of JD Property, are clear indicators of JD's increasing focus on logistics management. We think that JD's concept of being (according to the company's own words) an "integrated logistics services provider" can be viewed as a work-in-progress notion which JD will continue to adapt and refine in order to best complement its core e-commerce business.
What is an Integrated Logistics Services Provider?
Whilst "integrated logistics services provider" is a rather vague term, we think that this refers to JD's goal of providing additional value added to clients by optimizing their supply chain processes and offering inventory management solutions. Given its long term emphasis on logistics investment, JD arguably has one of the most efficient logistics management networks in China, with a logistics handling process that is far more efficient than most, if not all, of its individual merchants' logistics systems.
The strengths and advantages of JD's logistics system include: (1) JD has more developed automated processes that expedite logistics handling compared with other logistics networks that may rely on inefficient manual processes, (2) JD's logistics network has greater coverage across different regions in China, and (3) JD has access to a much larger volume of data that is more conducive to big data analysis, including the identification of consumer trends based on criteria such as region or seasonality, which can allow the company to allocate products and manage inventory more efficiently. These factors combined could potentially allow JD to enhance the supply chain efficiency of individual merchants and improve the customer experience by reducing the amount of time a product is sitting in inventory and distributing products more optimally among different warehouses to allow for faster delivery.
Determinants of Success
We think that one of the most influential factors determining JD's success as an integrated logistics services provider will be the extent to which the company can entice existing and potential new merchants to opt for JD's logistics handling services over what they are already using, whether it be their own warehouse system and delivery fleet or other delivery companies’ services. For example, merchants selling goods with low margins may find it not worth it to pay for JD's services, whereas merchants selling high margin goods may think JD’s service fees are worth the opportunity cost. Moreover, merchants selling perishable goods or goods with a short shelf-life may place higher value on efficient inventory management, while merchants who sell goods with lower inventory turnover rates may benefit less from JD’s logistics services if the merchants are charged higher fees for goods with longer inventory shelf lives.
As it currently stands, JD has no direct competitors in the specific field of integrated logistics services and is an industry pioneer in this sense. However, there are several indirect competitors worth mentioning, including Shunfeng, people’s go-to speedy delivery courier in China, and Cainiao, a logistics platform developed by Alibaba Group to connect senders and recipients with delivery couriers and to standardize the logistics shipping process.
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