How Alibaba is Transforming Payments and Banking in China

Alibaba is the largest e-commerce network in the world by total retail sales.  Going public has a variety of implications for the payment space and for global internet retailing. The online payment platform for the series of websites under the Alibaba banner is Alipay, which in turn is a wholly owned subsidiary of Small and Micro Financial Services Company, which is owned by Alibaba’s Chairman Jack Ma and a series of investors. This separate company, and the subsequent other companies of Small and Micro Financial Services are not included in the IPO. The separate ownership of the Small and Micro Financial Services Company was positioned as a move to appease regulators concerned of foreign ownership of a payment platform in China. Alipay is the largest third party payment platform in the world by several metrics and is poised to expand even further as it reaches beyond its domestic borders.  Alipay is already accepted on other e-commerce sites not owned by the Alibaba Group. Alipay may have initially reflected PayPal’s structure, but it has quickly grown into a variety of new channels and now could provide a few lessons to PayPal on how to address more of their customers’ needs. In under a decade Alipay has become roughly twice the size of PayPal by total users, processed value and four and five times as large in terms of number of transactions and mobile processed value respectively. However, Alipay is primarily constrained by its domestic market and internet retail value is expanding at a slowing rate in China suggesting Alipay will need to move overseas to maintain growth.

Chinese Internet retail value share

The internet retailing competitive landscape in China has drastically shifted in the past five years with the emergence of Alibaba. In China, Amazon’s share of the total retail value has dropped from eight percent in 2009 to less than one percent share of the total market in 2013. Although Alibaba was first established in 1999, its online marketplace and Alipay were only formed in 2003 and 2004 respectively. The several companies that have evolved from the original all focus on reducing the friction of commerce in the world’s most populous country, as well as commerce between China and others.   Although Alibaba is not without competition in terms of facilitating e-commerce, it is by far the largest with 45% share of all internet retail value in China in 2013 according to Euromonitor International.  Alibaba has aggressively moved into other sectors as well with more than US$5 billion in investments and acquisition in the first five months of 2014.

Alipay Prospects

Alipay seems to have two strategies for expansion going forward based on its recent activities; expanding the range of financial services offered to existing domestic customers and merchants, and expanding throughout the region through partnerships with local e-commerce platforms. Of the nine months ended in December of 2013 international revenue only accounted for 8.7% of the company’s total revenue. PayPal and eBay have successfully moved internationally with 48% of PayPal’s total payment value originated outside the US. Payments accounted for 41% of eBay’s total revenue in 2013. And although Alipay can offer access to an increasingly wealthy Chinese middle class, it still lacks the global network of PayPal.

The first strategy of increasing its products and services to domestic users has accelerated rapidly since the separation of Alipay and subsequent formation of the Micro Financial Services Group in 2013. Although the division was not initially disclosed to Alibaba’s largest investors (Yahoo and Softbank), the group eventually settled on terms. Although Alibaba initially offered consumer lending through the national financial institutions in China, they found them frustrating partners and so applied for their own financial institution license which they received in 2010. However, Alipay is only the payments arm of the Micro Financial Services Group.  The whole organization also has three other areas of focus; micro-credit (Aliloan), guarantees and retail financial services including wealth management (Yu’e Bao), and insurance. The group has replicated the capabilities of retail banks, and the innovation has created the largest money market fund in China that offers twice the interest of the state controlled banks. This has required the retail banks to increase the interest rates but also led to regulation on how much a Chinese consumer could deposit in Alipay accounts. Despite this setback, the rate of innovation is unlikely to stop as the company continues to transform other sectors, including small business lending.  The Aliloan program leverages the merchant information that Alibaba has from their transaction history to determine their creditworthiness. The program has lent billions already and boasts a write-off rate less than one percent. Founder Jack Ma insists his companies are targeted at reduce barriers for small businesses, and so far he has delivered and maintained profitability. Chinese internet retail value growth

Growth of online retail value in China has slowed since its peak in 2009 but remains robust in terms of absolute value growth with US$33 billion of additional value from 2012 to 2013. On a per capita basis, Chinese consumers went from averaging US2.50 in 2009 to US$73 in 2013. This is projected to jump to US$253 by 2018. However in terms of growth rate of absolute value on a yearly basis it has steadily declined. The moderating growth could signal a potential limit for Alipay and Alibaba in its domestic market.  China internet retail value reached its slowest rate in 2012 to 2013 since 2007 to 2008 but was still considerable at 39% y-o-y growth.  This growth greatly outpaced the region and the global growth of 23% and 16% respectively. However, Chinese internet retail value is projected to continue to moderate over the forecast period to 17% from 2017 to 2018.

The total internet retail value that will come from mobile devices in China is projected to reach US$27 billion by 2016, or 13% of total internet transaction value according to Euromonitor International retailing data. Alibaba is ahead of the trend with 29% of its processed value coming from mobile devices in 2013. While transitioning to be more mobile friendly has been the challenge of the tech giants in developed markets, Alibaba has demonstrated its ability to do so. However, the online consumer base is constantly demanding more in terms of functionality and ease of use that ensure that a leader in the field today may not be tomorrow. The massive valuation of Alibaba is at least in part rooted in the company’s demonstrated ability to recognize this and invest appropriately.

Alibaba has already transformed online commerce in China and has started to change the way the country views financial services. The sizeable unbanked population in China which stood at 462 million people over the age of fifteen in 2013 are consumers that can strongly benefit from more user friendly financial services. If Alipay and the whole Small and Micro Financial Services group are able to avoid regulatory challenges and the entrenched traditional banking network there is a very good possibility that a company that started in online payment processing could sustain its transformation to become a full retail and commercial bank.