University of Haifa
Department of Asian Studies
Chinese Market Entry Strategy –
Analysis and Recommendations for PayPal
Einat Cohen
30 June 2010
Dr. Yoram Evron
125.4306 Business and Economy in China
1
Content
Introduction ................................................................................................................................ 3
Chinese Online Shopping Market .............................................................................................. 4
Chinese Economy Growth and IT Prioritization .................................................................... 4
Market Potential ..................................................................................................................... 4
Market Characteristics............................................................................................................ 5
Future Market Trends ............................................................................................................. 5
Competition Structure ............................................................................................................ 6
Market Entry Strategies .............................................................................................................. 6
Threats and Risks ....................................................................................................................... 7
Recommendations ...................................................................................................................... 9
Appendix A Statistical Data ..................................................................................................... 11
Figure 1: China’s GDP and Yearly GDP Growth Rates. .................................................... 11
Figure 2: Chinese Online Retail Sales Percentage in the Total Chinese Retail Sales. ........ 11
Figure 3: Value of Transactions in the Chinese Online B2C and C2C Market. ................. 12
Figure 4: Average Online Purchasing Amounts per User per Year. ................................... 12
Figure 5: Value of Online Shopping Transactions by Region, 2008 .................................. 12
Figure 6: Market Share of Online Payment Providers in China, 2008 ................................ 13
Figure 7: Entry Modes to Chinese Markets ......................................................................... 13
Figure 8: Chinese Market Entry Model ............................................................................... 14
References ................................................................................................................................ 15
2
Abstract
PayPal is a technology and platform for e-commerce that has 81 million active accounts
across the world. PayPal, an eBay subsidiary, is trying to assess its best way into China,
currently the world’s biggest and fastest growing Internet market (Galante, Bloomberg
Businessweek 2010). Before developing PayPal’s business in China and defining its market
entry strategy, in addition to analyzing the e-commerce market potential and opportunities in
China, there is an imperative need to perform an in-depth analysis of the Chinese business
practices, e.g., the legal and regulatory systems, the possible risks in this market and the
required investments.
This paper has four major parts; the first one will present the online shopping market
opportunity in China, the second part will review a model for market entry strategies to
consider, the third part will present an analysis of entry threats and risks and the final part will
summarize the recommended market entry strategy to PayPal, based on the market
opportunity and threat analysis.
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Introduction
According to marketing research conducted by the Shanghai office of CBC 1 and
Fribourg University (Lee 2009), online retailing in China is soaring regardless of the world
economic downturn. Chinese customers prefer the cheaper online prices and increase their
online transactions. Online shopping also provides other benefits to Chinese consumers such
as searching capabilities, communication with other shoppers about products, and product
recommendation services. Online buyers can easily choose the best tailored products for their
needs. However, for a foreign e-commerce MNC2 like PayPal, understanding the technical
issues and cultural differences in China are critical for entering this market. Over less than a
decade, the Chinese e-commerce market has changed entirely. The local online shopping
platform Taobao founded in 2003 now leads the market, while eBay, who held 85 percent of
the market in 2003 has shrunk to 30 percent (So and Westland 2009). Amazon, who acquired
the Chinese firm Joyo in 2004, is still struggling with the local rival Dangdang and has not yet
achieved profitability. Also Baidu, the Chinese leading search engine controlling 76.9 percent
of the Chinese online search market, has moved into the online C2C shopping market in
October 2008 and has aspiration to enter the B2C market as well (Baidu 2009).
In such a high competitive market with low entry barriers, only companies who are
able to understand and satisfy local customers can seize the opportunity. PayPal, with its
competitive advantages such as technology and product uniqueness, premium services and
marketing knowhow, has a potential to win over the local competition but will have to
collaborate with local partners to cover for its lack of market understanding. PayPal should
plan its offered online payment options in a comprehensive mode that will be tailored to
Chinese customers’ purchasing habits. For example, cash on delivery (CoD) is a preferred
payment method by Chinese online shoppers. Another popular payment option is mobile
payment (i.e., payment via the mobile device) which recently emerges all over Asia, including
China (Tauli 2010). Additionally, all aspects of service localization are critical to succeed in
the Chinese market.
Another critical lesson PayPal should learn from its parent company eBay, is that
technical issues have a significant influence on system usage in China. Chinese customers are
1
CBC Marketing Research is a Swiss Marketing Research Group with global operations in China (Shanghai,
Beijing, Guangzhou and Hong Kong) as well as in India and Japan. The CBC market research in use in this
paper was created in collaboration with the Swiss University of Fribourg.
2
MNC stands for Multi National Corporation.
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highly sensitive to service slowness and will leave such a service without any delays (So and
Westland 2009). PayPal should make sure its Chinese services run smoothly and without any
critical failures. To summarize, PayPal should be prepared for an intensive local competition
and will have to continuously innovate and customize its services.
The following chapters will provide recommendations on market entry options to
China for PayPal. The first chapter Chinese Online Shopping Market includes a brief analysis
of the relevant market, for assessing the business opportunity and the existing players. The
next chapter Market Entry Strategies will review the possible options PayPal may consider
before operating in China. The chapter Threats and Risks will include a summary of possible
issues that needs to be taken into account prior to making the final decision, and the final
chapter Recommendations will summarize the market entry recommendations. Appendix A
includes a list of statistical charts and graphs that are used throughout this paper.
Chinese Online Shopping Market
Chinese Economy Growth and IT Prioritization
Due to the global economic crisis, the demand for Chinese export has shrunk. The
Chinese GDP growth rate has slowed from an average of 11 percent between 2003 to 2007,
down to 9 percent in 2008.3 The current priority of the Chinese government is to drive up
domestic demands to increase the GDP (Lee 2009: 3). Electronics and information technology
was chosen as one of the ten prioritized IT industries for the governmental ‘rescue package’, a
total cash injection of RMB 40 billion [USD 5.9 billion] for IT industry, approved by the
State Council (Xinhua 2009). Despite the reduced growth rate, Chinese economy is still
growing rapidly compared to other countries, and according to World Bank estimates the
Chinese GDP growth rate will reach 7.7 percent in 2010 (Xinhua 2009).
Market Potential
According to the CNNIC,4 the number of online buyers in China reached 87.9 million
by June 2009, increasing from 74 million in 2008. One out of four Internet users has
purchased online in 2009 (CNNIC 2009: 31). The online market value reached RMB 128.2
billion [USD 18.8 billion] in 2008 with a growth rate of 128.5 percent compared to 2007
3
See figure 1 in Appendix A - a chart of China’s GDP and Yearly GDP Growth Rates.
4
ChiNa internet Network Information Center (CNNIC) is the governmental network information center of China
established in 1997. It is responsible, among others, mainly on services such as Chinese domain name
registration, Chinese IP address allocation, and relevant Internet survey information services (CNNIC 2010).
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(iResearch 2009: 14). Online sales accounted for 1.2 percent of total retail sales in 2008.5
Chinese online shopping market is highly C2C-oriented, covering 93.2 percent of total online
sales in 2008. While online B2C sales accounted for only 6.8 percent of total online sales in
2008, it is growing rapidly. Online B2C sales doubled in 2008 compared to 2007. As more
enterprises enter the online B2C market, sales are expected to grow further (iResearch 2009:
19). 6 In 2008, the purchasing amount per person was over RMB 1,600 [USD 234.3], an
increase of RMB 582 [USD 85.2] compared to the year 2007 (iResearch 2009).7
Market Characteristics
The most popular products sold online are fashionable goods, and the standardized
products like books, audio and video products. According to Lee (2009: 16), as online
customers gain more experience with e-commerce systems, a broader product portfolio can be
added to the online offering. According to iReaserch (2009: 84) Chinese online buyers have
the highest average income and education level among Chinese Internet users. Their male and
female ratio was 45.6 percent and 54.4 percent respectively in 2008. Major online shopping
buyers are aged from 18 to 30, accounting for more than 57.4 percent of total online
customers (Lee 2009: 17-18). Online customers are concentrated in major cities including
municipalities and sub-provincial cities. In 2008, the online customers in Beijing, Shanghai
and Guangzhou accounted for 28.8 percent of total online buyers.8
Future Market Trends
According to Lee (2009: 24) potential changes in Chinese e-commerce increase the
business opportunities. Online shopping will penetrate more widely in the daily lives, as users
spend more time on the Internet, and gain more confidence in the technology and services. As
their confidence grows, wider product categories will be purchased. Online sellers will learn
to accommodate customers’ needs and provide more personalized products and services. As
online customers gain more knowledge about online shopping, price will not necessarily be
the dominant deciding factor. Convenience will become one of the core values, especially for
middle classes who appreciate efficiency and flexibility in their tight schedules. According to
iResearch (2009: 26-27), smaller cities will provide more opportunities for the continuous
5
See figure 2 in Appendix A. For comparison, US online sales accounts for 6% of total retailing (Lee 2009: 13).
6
See figure 3 in appendix A – showing the value of transactions in the Chinese online B2C vs. C2C markets.
7
See figure 4 in Appendix A – showing the growing spending of online Chinese customers from 2003 to 2008.
8
See figure 5 in Appendix A - showing the value of online shopping transactions by region in 2008.
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growth in this market, as the large metropolitan areas already account for the main part of
online shopping sales.
Competition Structure
According to CNNIC (2009: 32) 86.2 percent of online buyers have used online
payment services by June 2009. Other fund transfer methods are cash on delivery, bank or
post transfer.9 Major service providers for online payments are Alipay, Tenpay, and UnionPay.
These three operators cover 78.1 percent of the Chinese online payment market share. The
rest of market is divided by more than 50 smaller service providers (Lee 2009: 22). Providing
services similar to PayPal, Alipay and Tenpay belong to Alibaba and Tencent group
respectively (competitors to eBay in China). UnionPay is the government-owned online
payment system which connects major Chinese banks.10
Market Entry Strategies
For MNCs, there are several available entry modes into the Chinese market. Story
(2003: 224) recommends the following methodology for analyzing market entry options: the
chosen entry mode can be exercised by top management answering two questions that yield a
simple two dimensional matrix with four possible combinations (see figure 7 in Appendix A).
The two dimensions at question are the expected significance of the Chinese market to the
global operation of the MNC (high or low) and the expected bargaining power of the MNC
with the Chinese government (high or low). This matrix produces the following four
approaches:
1. Low market significance and bargaining power – the recommended entry mode is to
avoid trouble by not going in, or limit the commitments while keeping options for the
future.
2. High market significance and low bargaining power - the recommended entry mode is
to ally/agree/go along with the local government demand. Focus on entry as the most
critical objective.
3. Low market significance and high bargaining power – an opportunistic approach may
be useful. Top management attitude should be flexible as long as they are not getting
soaked into some distracting course that demands too many resources.
9
Cash on delivery is still a preferred payment method offered by major online retailers (Lee 2009: 22).
10
See figure 6 in Appendix A - showing the market share of major online payment providers.
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4. High market significance and bargaining power – challenge the local demands and
negotiate favorable concessions with Chinese public officials.
Once the approach is selected and going in is voted for, there is also a need to define
the entity that will be used for entrance. For example, alliance with a local firm could be
critical for reducing investment risks and gaining competitive advantage (Tse et al. 1997: 780,
Deng 2001: 63). This alliance can be formed through a joint venture, that was a popular
alliance form in the 1980s and early 1990s, however is much less favorable since 1997 due to
risks and lack of control that are associated with such a partnership (Deng 2001: 63,
McGregor 2006: 92-93). These risks will be described in the next section. Other forms of
alliance could be partnership with other Asian firms, licensing or formation of a local
subsidiary through M&A.11 China has experienced a fundamental change in the way it attracts
foreign investment, and over the last decade, Wholly Foreign-Owned Enterprises (WFOEs)
are becoming the dominant entry mode into Chinese market (Deng 2001: 63). The
recommended entry model and approach for PayPal will be discussed in the
Recommendations chapter.
Threats and Risks
The major issues that PayPal might encounter entering China are the government
limitations on the ability of foreign firm to provide services and the closed economies of the
inland provinces. As mentioned on page 5, these areas could be the major potential for growth
after the penetration rates in the eastern metropolitan areas will become saturated in the future
(Story 2003: 211, Lee 2009: 25, iResearch 2009: 26-27). This might require PayPal to join
forces with a local firm to bypass these limitations. As much as considering the benefits that
such a partnership may bring, PayPal also has to take into account the risks that it entails. The
table below lists the threats and risks that are associated with any of the possible market entry
strategies compared with its potential advantages.
Table 1: Comparison of Market Entry Modes in the Chinese Online Shopping Market
Entry Strategy
Advantages
Disadvantages, Threats and Risks
Go Alone
1. Full control over operations
1. Growth might be slow
2. Obtain experience from the
2. Lack of market knowledge
beginning
3. Large investment from the beginning
4. No immediate cash inflow
11
See figure 8 in Appendix A – showing a generic model for Chinese market entry (based on Tse et. al 1997).
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Entry Strategy
Advantages
Disadvantages, Threats and Risks
Collaborate
1. Access to partner's
1. Incompatibility of partners
With Partners
knowledge
2. No fully control on partner’s decision
2. Eliminate risk to a certain
level
Merger and
1. Cash inflow from beginning 1. Risk of unsuccessful takeover
Acquisition
2. Acquire existing customer
(M&A)
base
3. Access to partner's
2. Integration of company cultures,
business concepts, employees and
distribution channels is needed
knowledge
3. Capital intensive
4. Fast expansion
4. Risk of overpay
(Source: Lee 2009: 62)
Other risks which are critical for PayPal are the lack of sophisticated communication
infrastructure outside major cities, the lack of skilled workers, fierce competition and piracy.
The availability of high-end communication infrastructure is essential for smooth service
operation that is vital for the success of the online payment service, specifically in China,
where loyalty to foreign brands is significantly low, and PayPal services are still not in use.
Lack of skilled labor requires relocating or importing of expensive external resources, which
break the advantages of cheap labor in China. Only 0.6 people out of 1000 are recorded as
having science and technology backgrounds in China compared to 5.4 in France. Taiwanese
can be recruited however their wage will be up to double the salaries they get in Taiwan
(Story 2003: 218).
The competition risks which are mainly the low barriers to entry that were discussed
on page 3, essentially will force PayPal to constantly innovate and improve its services. The
Chinese infamous price war competition strategy is also a high risk for PayPal. PayPal is
known for its high commission charges even in western markets, which then lead to higher
product prices by the online retailers (Selby and Manning 2008: 173). In China, such an
approach may impair retailers’ competitiveness in the highly price-sensitive market such as
China, and they eventually may choose not to use PayPal systems. Finally, piracy is a market
culture in China which has so far been difficult to eradicate by regulations. Western brand
names such as Procter & Gamble, Unilever and Nestle as well as eBay and Amazon see their
Chinese market ‘eaten up’ by local brands and pirates (Story 2003: 220, So and Westland
2009, Lee 2009: 66).
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Recommendations
As suggested by Story (2003: 216), ‘getting the entry strategy right can save a lot of
trouble: a China commitment is expensive in time’. In the chapter Market Entry Strategies on
page 6, a model for market entry strategies was presented, suggesting four different
approaches for entering China. In this chapter, the relevant approach will be discussed and
recommended. As mentioned in the previous Threats and Risks chapter, it appears that the
Chinese market although entailing a huge potential for online shopping, it is also highly risky,
specifically for a technology platform and service provider such as PayPal. In such a case the
bargaining power of PayPal with the Chinese government is relatively low. This high market
significance with low bargaining power, according to the model, suggests the second entry
approach, i.e., to form an alliance with a local partner and go along with the local government
demands.
In terms of the recommended alliance form, as discussed in the previous chapters
Market Entry Strategies and Threats and Risks (and see also figure 8 in Appendix A), there
are several alliance options available. Based on recent research and following business lessons
such as the Morgan Stanley experience, the Dell experience, the China Unicom case and
others, it is recommended to avoid a joint venture with any Chinese partners, and particularly
if this partner is connected to the Chinese government, such as e.g., national banks (McGregor
2006: 92-93, Deng 2001: 63-64, Chuang 2000: 519-521). As for establishing a WOFE, this
seems like an advantageous option mainly through M&A of a current active player with a
significant market reach and market understanding, however, this approach will be capital
soaking and there is no guarantee that the success will be maintained for a long term. The
eBay case of market leadership loss and the long term lack of profitability over price wars for
both Amazon and its main rival Dangdang are lessons to be carefully learned by PayPal (So
and Westland 2009, Sun 2007).
It appears that a very careful approach is required in this case. The following proposal
may turn to be somehow complex legal-wise, but since it requires relatively gradual
investments and as it allows high level of control, this approach of ‘crawling’ rather than
rushing into the market may be more appropriate for PayPal. This approach will allow for
slow market penetration while waiting for changes in the Chinese legal systems that are
required by the WTO to take effect. As mentioned by Chuang (2000: 523) ‘China's rule of
law will not change overnight’. The proposed market entry is involved in creating a Chinese
entity in Hong Kong that should be controlled by PayPal, appointing staff which will have to
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be Chinese. PayPal will need to carefully choose a small player/competitor from Hong Kong
to form a Chinese entity that will be approved to operate in the inland areas. This partner has
to be flexible enough for PayPal to apply their own management staff, which also has to be
Chinese or Taiwanese. This way, PayPal may use a local service provider with market
knowledge and legal permission to operate in high potential areas that currently are limited to
foreign firms, without the problem of control and critical management conflicts.
Though in these areas there are still problems of infrastructure and high skill labor, the
firm will be rather small with modest financial and market share goals at start, hence this
should not be a problem for the short term. This inland market penetration pilot will give time
for PayPal to exercise its ability to localize its system, to innovate its services and more
importantly, learn how to become more efficient so that it can charge lower commissions and
thus become competitive also in the more lucrative metropolitan areas.
In addition, PayPal can also pursue to create new business niches on areas where it has
critical advantages, for example, allowing Chinese SMEs to trade with external parties that
are already using PayPal. This means that when Chinese SMEs would like to trade with
external SMEs or larger organizations that are using PayPal in their countries, they will also
need to use PayPal to trade with these organizations. Here PayPal has a critical advantage that
is working in their favor and will allow them to create a new B2B niche market instead of
trying badly to compete on the crowded and saturated C2C market and even on the emerging
B2C market.
Before entering Chinese C2C and B2C markets, PayPal should extend its platform to
support payment modes that provide convenience and are widely covered. Chinese customers
have relatively low usage of credit cards. Local third party payments (such as provided by
PayPal), Cash on Delivery (CoD), online banking and offline fund transfers are widely used
instead. Lately, mobile phones payments are gaining popularity. CoD for instance presents a
specific challenge both to online retailers and to PayPal. From customers’ points of view,
paying upon delivery creates a sense of trust and convenience in online purchasing. From
retailers’ perspective, CoD can result in increasing operational costs due to slow cash
collections and risks of fraudulent behaviors of sellers. For example, if products are defective
upon arrival, buyers can request the third party payment providers like PayPal to postpone or
further return the funds. There is also a risk of fraudulent sellers that may not fulfill the
replacement responsibility on faulty items. These examples demonstrate the importance of
complementary payment systems to provide security, convenience and wide coverage that
PayPal must support in order to be relevant in the Chinese market (Lee 2009: 50-51).
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Appendix A Statistical Data
Figure 1: China’s GDP and Yearly GDP Growth Rates.
(Source: Lee, 2009: 3)
Figure 2: Chinese Online Retail Sales Percentage in the Total Chinese Retail Sales.
(Source: Lee, 2009: 13)
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Figure 3: Value of Transactions in the Chinese Online B2C and C2C Market.
(Source: Lee, 2009: 14)
Figure 4: Average Online Purchasing Amounts per User per Year.
(Source: Lee, 2009: 14)
Figure 5: Value of Online Shopping Transactions by Region, 2008
(Source: Lee, 2009: 21)
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Figure 6: Market Share of Online Payment Providers in China, 2008
(Source: Lee, 2009: 22)
Figure 7: Entry Modes to Chinese Markets
(Source: Story, 2003: 222)
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Figure 8: Chinese Market Entry Model
(Source: Tse, K. David et al. 1997: 783)
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