Alibaba And JD.com Business Model Analysis: Which Is Better?

| About: Alibaba Group (BABA)
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Summary

The “platform” business model usually generates higher margins than the “direct retailing” model.

Alibaba’s platform business model has drawbacks such as lower control of product quality and weak logistic services.

The demonstrated customer adherence to Taobao and Tmall marketplace plus the strong executive force in solving problems with its platforms will make Alibaba a more attractive investment opportunity than JD.

Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) are the two largest online retailers in China. In the first half of 2014, Alibaba's Tmall platform commended 57.4% of the B2C market, ranking No. 1 in market share followed by JD with 21.1% of market share. Both companies have been growing their businesses very fast. In third quarter 2014, Alibaba's GMV increased 49% and active buyers increased 52% year-over-year. JD grew even faster with GMV and active buyers picking up 111% and 109%, respectively, for the quarter. Although both companies are riding the trend of accelerated e-commerce in China, I believe Alibaba provides a better investment opportunity primarily because of its "platform" business model.

Alibaba adopted a "platform" model. It derives the revenue from online marketing services and earns commissions on merchandises sold on its platforms, whereas JD is an online direct seller and earns the mark-up from products sold to customers. Although JD has also developed the marketplace for third-party sellers, it represented only 6% of total net revenues. As the cost of acquiring products constituting a large part of the cost base, JD has pretty thin margins. In addition, the fulfilment expense as a result of establishing its own national fulfilment infrastructures also squeezed the margins. To the contrary, Alibaba carries an asset-light business and earns hefty profit margins because it doesn't procure, store and deliver the products itself, but offers a marketplace to sellers, buyers and logistic service providers. The below table summarizes the major differences between the two companies.

Table 1 Comparison between Alibaba and JD

Alibaba JD
Business model Online platform for retailers Online direct sales
Means of making money Earn from merchants through online marketing services, commissions on transactions. etc. Directly procuring, storing and delivering goods to earn a margin
logistics Partnership with third-party logistic companies to provide logistic services Own nationwide dispatch and fulfilment centers, and delivery networks
After sale services Almost none Well established customer services, fast response to after sales queries
Assortment of goods Greater assortment 40.2 million SKUs (Electronic products and home appliances account for 63.6%)
Merchandises' price in general Relatively low due to vast number of sellers that increase the competition and beat down the selling price Relatively high as selling price has to at least cover the cost of sales
Profit margins(3Q14)

Gross margin

Operating margin

71%

34%

9.9%

-0.8%

The fact that the "platform" model generates higher margins is not unique in e-commence market in China, but also appears in mature markets, such as the US. Take eBay (NASDAQ:EBAY) and Amazon (NASDAQ:AMZN) for example. The former is a pure platform operator whereas the latter is a dual player in online direct sales and marketplace operating, but online direct sales take greater weight in Amazon's total net sales. Table 2 compares the profit margins of the two companies. We see from the table that eBay has much higher gross margins and operating margins than Amazon. Admittedly, there are other factors, including the management's strategic decision that lead to Amazon's near-zero operating margins. For instance, in the prime membership program, Amazon offers members unlimited free shipping, which resulted in the shipping cost exceeding the shipping revenue. Nevertheless, the comparison between eBay and Amazon did illustrate the difference of profitability between the two business models.

Table 2 Comparison between eBay and Amazon

eBay Amazon
Business model "platform" model Mix of "platform" and direct retailing model
Gross margin(NYSE:TTM) 68% 28.6%
Operating margin(TTM) 19.8%(37.3% for Marketplace segment only) 0.1%

Back to Table 1, we see there is a negative side in Alibaba's platform model, which is primarily its weakness in controlling counterfeit products. Many people think of Alibaba's Taobao marketplace as a chaotic bazaar. The prevailing counterfeit products have resulted in the loss of trust from many online shoppers. In contrast, as JD sells its own merchandise, it takes product quality seriously, placing strict quality check from sourcing the products. Hence, JD has been gradually establishing credibility among customers.

In addition, JD provides better delivery and after sale services. For example, relying on its own fulfilment infrastructure and delivery network, JD promises the "same day" delivery in some major cities. JD also promises home pick-up of the defected product if a quality problem is identified within 15 days from the sale and promises to replace the defected product with a new order or refund within 100 minutes. Moreover, JD provides the home repair services if a quality problem arises within one year from the sale for their direct selling products. None of these are achieved from Alibaba's marketplaces at present.

Considering both the pros and cons of the two business models, I believe the "platform" model is more attractive for an e-commerce business. As we can see, both Amazon and JD originated from direct retailing and are scaling up the third-party business. Having that in mind, I still prefer Alibaba over JD for the following two reasons:

1. Alibaba's marketplaces displayed strong customer adherence.

First, price and product assortment are still the most important factors for Chinese shoppers. The development of the online retailing industry usually has to experience three stages. The first stage is the competition on products' availability and price, where retailers or platforms that sell products with a lower price and greater assortment will stand out. The second stage is the competition on products' quality and delivery services. Passing through the first two stages, successful online retailers or marketplace operators will be able to establish their brand and gradually accumulate their brand value. In the third stage, the market competition will hinge on consumers' shopping experience and their brand loyalty, i.e. consumers will choose their favorite shopping site. Platform operators or retailers with a brand reputation and that give consumers a better shopping experience will be the winner of the market.

In China, as e-commerce is still in the early stage of development, I think the industry is transitioning from the first stage to the second stage, i.e. products' availability and price are still paramount, though more and more shoppers, particularly those in the first and second-tier cities, started to care more about the services. From this prospective, though JD leads Taobao marketplace and Tmall in after sale services, low price and a variety of choices remain the primary concern for the majority of Chinese online shoppers. Therefore, Taobao and Tmall are still the No. 1 shopping sites in China.

Second, if breaking down the market share by product categories, we find that the only category of products of which JD has taken away the market share from Tmall in the B2C market is the computers, communication and consumer electronics products (3C-products). In 2012, JD had 38.1% of the market share in 3C-products as compared with Tmall's 25.6%. In all the rest of the product categories, Tmall still possesses the largest market share. This is understandable as 3C-products are the kind of products that consumers care about the quality the most.

2. Alibaba will be able to conquer the problems and bridge the gap with JD in the near future.

In my opinion, JD's advantages are not enduring. Alibaba has the capacity to catch it up. The top priority for Alibaba is to crack down on counterfeit goods and rebuild credibility among consumers. Once Alibaba can guarantee the quality of the merchandise sold from its platforms, it will be able to defend the attack from competitors and strengthen its market leading position. In fact, Alibaba has adopted a number of measures, including launching the rating system for sellers, adopting more stringent admission standards for sellers who intend to open stores in Alibaba's platforms, shortening the time for investigation of the vendors who are suspected to be involved in selling fake products and more severe punishment for vendors selling counterfeits. We have seen the Taobao marketplace and Tmall becoming more and more regulated.

The second is to improve the logistic services. China's logistics industry is highly fragmented, featuring intense competition, low profitability and poor services. It's said that complaints towards dispatch and delivery services from online shoppers in China accounted for 80% of total complaints. To combat this problem, JD invested heavily to develop its own logistic network - an integrated logistic system that JD controls every stage of the logistic process, which leads JD to an asset-heavy business. Alibaba has chosen a different way- it partnered with selected logistic companies through equity investment. Although at the current stage the delivery services from Alibaba's marketplaces are not as satisfactory as that from JD due to lack of direct control over the fulfilment, dispatch and delivery process from Alibaba, it has the potential for significant improvement in the future - Alibaba has established a logistic information system operated by China Smart Logistics in which Alibaba committed RMB2400 million for a 48% stake. The system provides useful information to buyers, sellers and logistic partners to improve the efficiency of logistic services, such as real-time tracking, self-service pick-up, performance analytics, customer satisfaction rating, route planning and order volume forecasts, etc. This information allows Alibaba's logistics partners to operate more efficiently by optimizing their warehouse, transport and people resources to effectively meet consumer demand. Its goal is to enable the delivery of over 100 million packages per day anywhere in China within 24 hours of an order being placed. Though it looks ambitious, it demonstrates that Alibaba is on the right track to improve the logistic services.

Conclusion

For an e-commerce business, a "platform" business model is superior to a direct sales model. Although Alibaba's marketplace has its drawbacks, such as prevailing counterfeit products and inferior logistic services, such problems will not substantially undermine the attractiveness of its platform model. We believe Alibaba will have the capacity to combat these problems in the foreseeable future, making BABA a valuable investment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.