Last week, I wrote an article on JD.com’s IPO for Ti’s free Logistics Briefing service ‘IPO to spur on JD.com in the race to build an effective distribution network in China’. Within that article I considered the implications of the move and what we might presume to infer about a Chinese e-commerce market that, to many of us, is as alien as it is competitive. Let me put it this way – you probably read about it on the tablet you bought from Amazon, some of you will even have read about it on the Kindle Fire you bought from…
In the briefing I highlighted, fleetingly, the fundamental difference between the business models of Alibaba and JD.com, here I will explain that difference in more detail.
Alibaba, which is by far and away the largest e-commerce provider in China, operates a marketplace model. What does that mean? Well a marketplace model means that Alibaba is just that, a market, rather like those you once saw in the real world, back when you had to leave the house to go shopping. The company is the proprietor and each business pays a fee to establish a stall within. In reality this means that Alibaba provides the web platform and infrastructure through which merchants can sell their goods.
This model works for merchants because it eliminates the need for them to establish their own web sales platform and manage their distribution. It works for Alibaba because it allows the company to offer a vast range of goods to its customers without the concern of maintaining costly inventory. Instead of keeping stock in vast warehousing, inventory is held, and paid for, by the merchants themselves. In this sense Alibaba is more similar to eBay than Amazon.
In contrast JD.com operates a direct sales model. This is the more traditional method of sale and is not too dissimilar to that operated at a physical retail store. JD.com buys goods from wholesalers to sell on to its customers through its website platform. The company must therefore maintain relatively high levels of inventory which bring not inconsiderable warehousing costs. Accordingly, it must attempt to predict demand accurately in order to maximise profit opportunities whilst keeping costs down; a trade-off between the desire not miss out on sales because of insufficient stock and the wish to keep costs to a minimum by maintaining low inventory levels. The difficulties therein are most elegantly demonstrated by MIT’s Beer Game. Evidently when the founders of Alibaba were shown this at university they found it to be so tricky that they simply decided to circumvent the problem altogether.
While it might seem that the marketplace model is clearly superior to direct sales it does have some drawbacks. The model generates revenue through charges paid by participating merchants for the privilege of using the web platform and its distribution network. Consequently, it misses out on much of the potential margin to be made by the sale of the goods themselves. The reverse is true for a direct sales model, but that is equally disadvantaged by inventory costs.
In the context of a comparison between the rapidly expanding JD.com and Alibaba I would argue that, because of the high capital costs associated with establishing warehousing, JD.com is hamstrung in its race with Alibaba for market share.
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