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Amazon, but made in China
If you live in the US, you probably are familiar with Amazon deliveries. Every day, millions of dollars worth of products flow through Amazonās fulfillment centers to arrive at your doorstep, but have you wondered how this process works? how many different steps are involved to get products shipped to you?
There are over 200 such fulfillment facilities in the US alone, along with 60 sorting centers, 250 delivery stations, and 50 Amazon prime hubs spread all over the U.S. to give Americans the best of class, yet differentiated experience. In total, there are now 860 active facilities in the US as of July 2021.
Similar fulfillment centers are all around the world (updated by mwpvl monthly). From Singapore to the US, to Europe and India, packing and sending millions of products to customers.Ā
But not all centers do the same thing, here is a flowchart of different facilitiesā roles during this process. The 800+ facilities mentioned above all play their small parts in the process to make sure you get your product intact and timely. These services are differentiated depending on whether it is fulfilled by Amazon or by third party delivery companies. In addition, if you pay more, you may also get the air freight service. Long story short, this is consumerism at its best.
One thing these centers have in common though is that most of the products sold on Amazon originate from China, and the % of Chinese-originated products is increasing dramatically amid the pandemic.
In this post, I will cover,
How much influence does China hold over Amazonās business
A brief history of āmade in Chinaā
Amazonās dilemma, to China or not to China
Can Amazon ever cure āfake reviewsā
Amazonās real challenge
How much influence does China hold over Amazonās business?
People often underestimate the scale of Chinaās influence over Amazon's online marketplace. Since 2018, the trade war rhetoric has taken over public discourse, tempting us to believe in a declining trend for trade between China and the US. But if you look into the numbers, it couldnāt be further from the truth. (when it comes to Amazon)
Chinese Sellers grew significantly in the past years
Between 2015 to 2021, in a short span of 6 years, sellers from China dominated the Amazon marketplace, outcompeting and outnumbering their US counterparts. 2020 was a key moment in this process, sellers from China accounted for over 49% of total sellers on the platform, surpassing the U.S. sellers for the first time. (show 47%)Ā
Whatās even more alarming is that the process is accelerating. In the first quarter of 2021, over 75% of new sellers on Amazon are based in China. Chinese sellers now represent 63% of Amazon marketplace sellers in the US, the number is higher elsewhere.Ā
So what is driving this huge uptick? The more I look into this topic, the clearer is the divide between rhetoric and reality. Regardless of the geopolitical tensions, Amazon is doing the opposite, recruiting more Chinese sellers, not less. Doubling down on a supply network more reliant on China, not less.
This is Jeff Bezos on September 23rd, 2015, along with the top business leaders from the US, and the reason heās there? China! The entire event was diplomatic, conducted right after Xi, the president of China announced buying 300 Boeing Airliners. Nevertheless, Jeff Bezos was there to āshow faceā because Xi and China are critical to his business. (Leiās note: this is why Peter Thiel (Palantir) is not there and never will be in a China event, neither will Larry Ellison.)
So, why is China important to Amazon? To understand why the Chinese sellers now dominate Amazonās marketplace, the first thing we must do is to understand the industry. The Chinese sellers have always been dominant, the only difference this time is that they are increasingly cutting out their American arbitrageur to directly sell on Amazon. Whatās more? Amazon also encourages this behavior because American consumers benefit from lower-priced products, which makes Amazon more competitive, Iāll explain more later.
A brief history of āmade in Chinaā
Back in the 80s, China was poor, it had just come out of decades of turmoil and suffering. Deng Xiaoping, the leader who advocated for reform and opening up had just taken over. To leaders in his generation, decades of communist revolutions had not produced the utopia they had visioned for China and it's time to chart a new course.Ā
Dengās student years in France had made an impression on him. While other leaders in China wanted a moderate course towards reform and opening up, Deng wanted a complete U-turn of the economic system, to accept as many US factories as possible to train the Chinese workers.
Back then, to the people of China, everything from the west was better, from the Levis to the music and the movies, consumerism spread from the west was a kaleidoscope of all shades of colors compared to the Communist uniformity.
The West was exciting, it represented an ideal state of living, and it was the future. But the problem for the Chinese economy is this, under the Soviet bloc in the 50s and after that, complete isolation from the world in the 60s & 70s, China had focused on heavy manufacturing for far too long. Aside from its missiles and nuclear capability, it didnāt have any products to sell to the rest of the world. (This was a key failure of the communist bloc, most countries focused on producing heavy machines rather than consumer products.) The only thing China had was a hard-working, industrious population.
From 1949 when China got independence to 1976 when Mao died, Chinese peopleās life expectancy went from 41 years old to 68, their literacy rate increased from 15% to 80%, close to 100% among young people, and the immunization rate went from 0 to 100%. This laid a great foundation for China when Deng took over in 1978 at the 11th Central Committee of the CPC.
But hey Lei, wait a second, I thought we are talking about Amazon today, why are you giving us a lecture on Chinaās history?
Well, hereās the point. Circumstances shape choices, and to the Chinese businessmen in the 80s and 90s, global demand for cheaper commodities dictated what China should and must produce. Whatever American and European consumers wanted, Chinese factories produced.
With a lack of capital, all that the Chinese had was labor. Therefore, the Chinese launched themselves into a labor-intensive growth model, beginning their decades of manufacturing apparel, toys, and electronics devices. It also happens that countries like Japan and Singapore are moving up the value chain, so naturally, lower-paying factory jobs went to China.
Gradually, workers learned to be engineers, engineers learned to be managers and managers eventually build their own factories and became shareholders.Ā
If you look at the developed world, America, Japan, Germany, France, and so on. The transition from light industries to making heavy machinery, cars, and tanks took 200 years and was super boosted by the wars, but China had to do it in 4 decades.Ā
By 2020, Chinaās manufacturing output has become the combined output of the US, Japan, and Germany. It is now the worldās factory.Ā
Amazonās dilemma, to China or not to China
Ok, I get it, Lei. China is good at manufacturing, thatās not news.
What does it have to do with Amazon?
It turns out, if we compare Chinaās export data today with Amazon's most popular product categories, Chinese manufacturers dominated popular product categories on Amazon. Electronic and electric devices, apparel and accessories, toys, and furniture. All of these are sectors in which China wields tremendous power. In research done by the Atlantic in 2011, China produces over 90% of PCs, 70% of smartphones (90% in 2018), 80% of energy-saving lamps, and 80% of air conditioners, the list goes on.
Because of this, Amazon had no choice but to kowtow to āmade in chinaā products. This is not to say that Amazon has a weaker negotiation power vis-a-vis its Chinese suppliers, it simply means no other country has the supply chain, and the production capability to make 200 million iPhones in a year, only China has the scale. There are still plenty of possible substitutes for made-in-china products, but ironically, made-in-china product substitutes are made in China as well.
As I said, 90% of PCs are made in China. If Amazon said no, these sellers would be devastated to lose the distribution channel and some would go bankrupt Iām sure, but in a bid to survive, some would go to Amazon competitors like Shopify and eBay, which would devastate Amazonās business. There are simply no alternatives out there.
Further, Chinese manufacturers dominate these product categories not only because of their production advantage but also for the competitive Chinese eCommerce scene.Ā Because of the country's backwardness in the 80s, when the Internet came alone, Chinese consumers leapfrogged the brick-and-mortar model to adopt online stores in the early 2000s. By 2020, total online sales in China had reached 50% of total retail sales. For your information, the same metric is at 28.9% for South Korea, 15% for the US, and 12.8% for the EU.Ā According to UNCTAD data, Alibabaās total sales were 1.1 trillion dollars, over twice the amount of Amazon. The other Chinese eCommerce giant also topped the list with impressive GMV results.Ā (If you compare the GMV results with their market caps, you know how bubbly the US stocks are at the moment)
Because of this highly competitive and developed Chinese eCommerce market, many competent Chinese sellers are looking for an alternative, and Amazon became the natural target. It has great profit potentials, is not as cutthroat in terms of competition, and has the highest market penetration rate in the U.S. On the other side, Amazon also loves direct manufacturer stores on their platform, which means lower prices for their customers. Win-win on both sides. This led to Amazonās push to attract more Chinese sellers in 2017 which resulted in today's Amazon landscape.Ā
Can Amazon ever cure āfake reviewsā?
But when the Chinese sellers came, so did the problems, fake reviews, and counterfeit products. To be clear, this is not a new problem for any eCommerce websites, when you have 3Pp sellers on a platform marketplace, they will take advantage of the systems, and inevitably a small percentage is corrupted. But this problem had become particularly pointed for Amazon in recent years and it had to react by closing stores that violate its rules, one of which has sales of over 1 billion dollars a year.Ā
But should we expect Amazon to fully solve these problems? No. Amazon is not an independent actor because it is profiting tremendously from 3p sellers from China.Ā
Over the last year, Amazonās GMV increased by 63% from 300 billion to 490 billion, which consists of 3p sales and direct Amazon sales. But the bigger portion of that sales by far comes from 3p vendors, which is driven by the increasing number of Chinese sellers on the platform. Not only that, out of the 300 billion GMV by 3p sellers, Amazon makes 15% for sellers fees, 10% for FBA, and 15% for ads. Thatās 120 billion revenue for Amazon, much bigger than what it makes from any other business. This is the āhidden fortuneā behind Amazonās choices, by allowing for more Chinese sellers, Amazon keeps prices low for its customers and makes more money.Ā
Amazonās real challenge
Amazon, nevertheless, must face critical challenges - a major one came from other online platform competitors such as companies like Shopify, Shein, and even Google.
As seen above from a Mckinsey report and the chart above, in the retail market, Amazonās market cap is growing the fastest, other online pure plays are also growing but not as fast; offline grocery shops and retail lacked demand. This means that the pandemic, in fact, strengthened Amazonās market position. The total pie has improved by 35%, and Amazon has outcompeted its rivals to grow at +62%. āSuper 25ā in the graph represents the top 25 players in the retail market, over 91% of market value gain went to them, these include Chinese platforms like JD and Alibaba.
With such a strong competitive landscape, therefore, strategically, as long as sellers are still on Amazon, Amason is happy. Amazon does not like fake reviews, sure. But it will only punish sellers who write āfake reviewsā when its action is ānet positiveā to attract more sellers to Amazon. If the action started to backfire and hurt Amazonās bottom line and drive out Chinese sellers to platforms like eBay, Shopify or to start their own websites, Iām not sure how enthusiastic Amazonās leadership would be.
So, among retail players, Amazonās competitor mainly comes from online pure plays like Shein, Gearbest, Club Factory, and more, less competition is felt from traditional offline retailers. This is a key behavior change that will have powerful consequences.1 Other than retail competitors, Amazonās key challenges are the following three factors.
US Government
The real challenge of Amazon, I believe, comes from the US government. The antitrust actions that are being played out are the biggest threat to Amazonās market dominance. Imagine three Amazon companies, Amazon retail, Amazon 3P marketplace, and Amazon cloud. This will significantly decrease their market power and put them in direct competition with one another.
Growth in the next decades is in Asia
Amazonās inability to figure out the Asia piece is another challenge. Hence, SEA is dominated by Lazada and Shopee, which are subsidiaries or affiliates of Alibaba and Tencent, Chinese in nature. Amazon has tried many years in Asia, with little success. Amazon India is doing better at the moment with a 30% market share splitting the Indian market with Flipkart, which is a Walmart subsidiary.
Bytedance (parent of TikTok) - video streaming + short videos
You may be surprised to see your favorite online video platform here in an eCommerce analysis, but I am totally serious. As of 2020, Bytedanceās GMV in China through Douyin, the China version of TikTok, has crossed over 70 billion USD (link in Chinese), and if you have an idea of how the Chinese eCommerce landscape looks like, youād know how important video streaming and short videos have become for eCommerce platforms. According to Qianzhanās analysis (link in Chinese), the total GMV through video streaming and short videos is approaching 1 Trillion RMB (154 billion USD).
Lack of ability to adapt to the new communication medium (video) may become Amazonās Achilles heels. Just a side note, Shopee is winning this game in South East Asia because of its adaptability. Video space for eCommerce has strong potential, imagine yourself watching Japanese farmers live stream selling their watermelon, Iād be tempted to buy. Itās radically authentic.
Though we should be careful when analyzing Amazonās market cap because right now, I believe we are in an inflationary market and much of Amazonās value is bubbly. If you do a simple comparison between Uber and Didi from China, youād know how irrational the current valuation is for them, Didi is wildly more profitable can cash-rich than Uber. Coming from a fundamentals analysis perspective, the US stocks are valued at a premium over their Chinese equivalent, which means one of their market cap prices is not right, either the Chinese firms are consistently undervalued or the US tech stocks are under-inflation.