Those who are bullish on Alibaba (BABA) stock like to point out BABA’s high margins, especially in relation to other online retailers like Amazon (AMZN) and JD.com (JD). However, high profits in a certain industry tend to attract new entrants into that field, reducing profits as competition increases. Alibaba shareholders should be asking themselves whether BABA’s high profits can be sustained in the long-run.
In 2015, Alibaba boasted both operating and net margins in the 30% range. Amazon, on the other hand, only had an operating margin of 2% and a net margin of just 0.6%, and for JD both these figures were negative.
It appears that Alibaba will face more competition in the years ahead. Other companies realize that the Chinese market is large and the potential profits are very high, and will increasingly compete with BABA in the years to come. More competition could reduce BABA’s profits.
Alibaba Threat #1: JD
JD.com is China’s second-largest online retailer, a B2C marketplace competing with Alibaba’s Tmall. JD buys products and resells them to customers, and this gives JD a greater degree of control over product quality than BABA, but also a thinner margin. Alibaba has sustained such high margins since it operates as a platform and connects buyers to sellers rather than being involved with the warehousing and delivery like JD or Amazon.
JD also has an edge over BABA with logistics, with a strong delivery system in place that gives JD more control over fulfillment. Alibaba, on the other hand, must rely on third parties for delivery. Alibaba is playing catch-up, joining with other firms in 2013 to form Cainiao, which operates a logistics network. Speed of delivery is important to Chinese consumers, and 80% of JD orders were delivered either on the day the order was placed or the next day. JD’s advantage in logistics makes it a powerful competitor.
Alibaba will have to invest more in this fulfillment infrastructure if it wants to keep pace with JD, and Cainiao is planning on spending 100 billion RMB in the years to come. However, increasing capex could prove to be a drag on free cash flow for BABA.
BABA Threat #2: The JD-Tencent Alliance
Tencent Holdings (TCEHY), owner of mobile instant-messaging apps such as WeChat (Weixin) and QQ, took a 15% stake in JD in 2014. At the end of 2015, WeChat had 697 million monthly users, while QQ had 853 million, dwarfing users of Alibaba’s mobile apps, who numbered 393 million. This alliance gives JD a powerful platform on which it can market its products and a wealth of data about the shopping habits of mobile users. Cooperation with Tencent has proven beneficial for JD; half of JD’s first-time users on Singles Day in 2015 accessed the website via WeChat and QQ.
Busy smartphone users might end up doing more shopping on Tencent’s platform, and this could drive business away from BABA. TCEHY and Alibaba are battling each other on mobile apps; in 2013 Alibaba banned sellers from using WeChat. Last year WeChat shut out several BABA apps, including Alipay and music apps.
Alibaba Threat #3: Traditional Retailers Moving Online
Brick-and-mortar retailers in China have been going through difficult times and are moving to e-commerce. This means more competition for BABA and potentially thinner margins down the road.
The Dalian Wanda Group, the largest owner of shopping malls and cinemas in China, has formed a joint venture with Baidu (BIDU) and TCEHY known as Ffan. Ffan is an online-to-offline services platform where users can do things such as buy film tickets and find local deals and promotions. This new e-commerce platform is both B2B and B2C, challenging Alibaba. Wanda seems to be adapting to the changed retail environment, closing stores and moving to e-commerce.
Another retail heavyweight, the Hong Kong-based property developer and jewelry chain Chow Tai Fook, is moving online as well. Chow Tai Fook has built up an e-commerce platform, CTFHOKO.com, which sells imported products such as baby formula and make-up, and the firm has a decades-old reputation which distinguishes it from BABA and JD. The firm is building up online retail in response to slower sales at physical stores.
Alibaba shareholders should not rule out the possibility of stronger competition in the future, which could squeeze BABA’s margins. High profit margins inevitably entice new businesses to enter the market; Amazon founder Jeff Bezos likes to say “Your margins are my opportunity.” In a rapidly evolving sector such as e-commerce, the competitive landscape may look very different a year from now.
As of this writing, Lucas Hahn did not hold a position any of these stocks mentioned.
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