I often get asked how JD competes with Alibaba (in ecommerce). Who is going to win? My answer is below. But first a little theory on the sources of competitive strength.
My Checklist for Competitive Advantages
I put competitive advantages in five buckets, with a total of 15 sub-types. That’s my checklist. But keep in mind, well-defended companies almost always have several competitive advantages. It is rarely just one. We are most often looking for combinations of multiple components.
I break competitive advantages into revenue and cost advantages. The idea is that a competitive advantage means higher than average economic profits. Which starts with the equation for return on invested capital (ROIC):
ROIC = (Revenue – Cost) / Invested Capital
However, we only care about operating returns, not financial returns. So, technically, the equation is:
Operating ROIC = (Operating Revenue – Operating Cost) / Invested Capital in Operating Assets
Operating ROIC = NOPAT / Invested Capital in Operating Assets
Where NOPAT is net operating profits after taxes.
But NOPAT can only be higher than competitors over time if its operating revenue is higher or its operating costs are lower. So, competitive advantages can be thought of as revenue and/or cost advantages. You must be generating more revenue or operating at a lower cost in the same business to have a higher ROIC (relative to rivals).
That is not a bad way to think about competitive advantage for traditional businesses. But it gets more complicated when you look at digital businesses. Because, as mentioned many times, digital businesses can build competitive advantages in activity as well as in transactions. Interactions with customers, suppliers, and other users can be far more than just transactions.
Network effects, often called demand-side economies of scale, really don’t make sense if you view them only as revenue from transactions. It doesn’t explain companies like TikTok and YouTube. Let alone phenomena like digital platforms and open source.
We need to expand these definitions to other types of demand and supply:
- Revenue and Demand Advantages
- Cost and Supply Advantages
Based on this, I detail five types of competitive advantages.
- Revenue and Demand Advantages: These can be captive customers, premium pricing, repeat purchases, and other phenomena that create competitive strength on the demand side relative to rivals.
- Network Effects: This is a type of revenue and demand advantage. But it is worth breaking out separately.
- Production, Manufacturing, and Other Variable Cost Advantages: These are cost and supply advantages that show up in variable costs and with any volume of activity.
- Supply-Side Economies of Scale and Scope: These are cost and supply advantages that depend on having a greater volume of activity than a competitor.
- State-Granted Advantages: These include government actions but also actions by non-government actors (military, royals, political parties, etc.) These are a much bigger deal than most people think.
So How Does JD Compete With Alibaba?
My answer is that while these companies have somewhat similar ecommerce offerings, they actually have very different sources of competitive strength. They are actually playing different games. It just doesn’t look that way from the consumer perspective.
Online retailers and early JD (before it added a marketplace) have most of their power on the cost and supply side. And having a sustainable competitive advantage in cost and/or supply generally shows up in a couple of ways.
- The business has supplies or resources its competitors do not have. Or that its competitors can only acquire at significantly higher costs.
- The business has similar supplies or resources as other competitors but can acquire, produce or utilize them at a lower cost.
With a cost and/or supply advantage over rivals, a company may:
- Outspend rivals in a strategic cost such as marketing and R&D.
- Price lower than competitors to protect or to expand market share.
- Price similar to competitors and add that extra operating cash flow to a strategic cost – such as marketing, logistics or R&D.
- Price similar to competitors and take higher than normal profits (which benefits owners).
You’ll notice that for competitive advantage graphic, I have put the symbol of a sword and a shield. Because they can be used for both offense and defense.
JD have been pursuing strategies of “profitless growth” for decades. Basically #2 and #3 from the list. It uses its cost advantages (over both offline and online retailers) to keep prices below competitors. This protects and expands its market share. At the same time, it also outspends rivals in IT, logistics and R&D. This strategic spending (in theory) gives JD greater and greater advantages over time. They are using their cost advantage for both offense and defense. This has resulted in:
- Continued growth and market share expansion
- Superior spending in strategic areas such as logistics and R&D.
- Perpetually showing zero net income. Hence the term “profitless growth”.
None of that is the Alibaba is playing. They are building a marketplace platform. They are focused on building network effects. They want to increase users, engagement and data. Second to that they are building infrastructure, which is web services, logistics and new retail.
Online retailers like early JD compete on different factors than marketplace platforms like Alibaba.
- Alibaba and marketplace platforms compete on:
- Barriers to entry – including the chicken-and-egg problem and the cost of the logistics network.
- Competitive advantages – including network effects (main one) and economies of scale in logistics, marketing and IT.
- Early JD and pure online retailers (i.e., not marketplaces) compete on:
- Barriers to entry – including the cost of the logistics network.
- Competitive advantages – including production advantages, purchasing economies and economies of scale in logistics (mostly), marketing and IT.
The important take-aways are that:
- Pure online and traditional retailers derive most of their power from cost and supply competitive advantages over time.
- Purchasing power with suppliers is really the most important competitive advantage to understand.
Purchasing Power on the Supply Side of Retail
There are lots of cost and supply competitive advantages. But the one that really matters in physical and online retail is being able to buy the goods that go on the shelves cheaper (and with better working capital terms) than your competitors. It’s a supply cost advantage based on bargaining power. For example:
- Walmart can buy goods cheaper than smaller physical retailers.
- JD can buy goods cheaper than smaller online retailers.
- Big health insurance plans can buy medical services cheaper than smaller plans.
I list this as CA12: Economies of Scale in Purchasing (i.e., purchasing power). It can be in any inputs, such as labor costs, capital costs, energy costs, and supply costs. But most advantages in this area don’t last long. Moving factories to Vietnam gets you lower labor costs but competitors tend to match that quickly. Lower capital costs tend to disappear with capital cycles. But supply cost advantages based on bargaining power can persist. Some examples:
- JD has big supply cost advantages because they serve all the Chinese consumers. This gives them bargaining power not only with suppliers in China but also internationally. Capturing Chinese consumers gives you a lot of power globally with merchants and brands.
- Oxford Health, a now closed New York-focused health insurance plan, had lots of bargaining power. But only with New York physicians and hospitals. They had lots of New York consumers so they were good at negotiating with New York physicians for cheaper prices. This was economies of scale based on purchasing power, but it was strictly a local advantage.
It’s also important to note that this is a relative advantage. Only the larger players can have this. And only relative to the smaller rivals.
This is really JD’s big lever as an online retailer (not a marketplace). It shows up as a 16-20% gross profit on goods sold, which is higher than their online and physical retail competitors. And they are using this cost advantage to keep their prices lower. These lower prices help them acquire and retain customers and market share. Plus, they can also outspend rivals on IT and logistics.
A Final Point on Keeping it Simple in Retail
I often say that you always want to look at a business from the customer and competitor viewpoints. It’s easy to get lost in all the factors and pros and cons. But ultimately, business comes down to customers making a decision. So the customer and competitor viewpoints are where the rubber hits the road.
- What does the consumer care about most in general retail? The big factors are usually breadth of products, cost, acceptable quality and convenience / user experience. The big retailers like Walmart are all about offering tons of products at low prices – with easy access. It basically means consumers have no reason to go anywhere else. Low cost, convenience and acceptable quality are the biggest factors in most retail. JD is pretty much the same but is positioned for higher quality and a better user experience. Alibaba is completely different here.
- Can a well-funded, well-run competitor enter the space and take market share? Entering is actually not hard. You just open a store or a website. The hard thing long-term is to match the cost of goods sold (and therefore price) of a company like Walmart or JD. And that comes mostly from bargaining power with suppliers. This requires matching JD’s scale, which is very difficult.
JD has some other competitive strengths in online retail. But this is their biggest one. And this is what consumers care about most for most products. You want to keep it simple in most retail: big selection, convenience and low price usually wins.
That’s it. Have a great day – jeff
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From the Concept Library, concepts for this article are:
- Economies of scale in purchasing power
From the Company Library, companies for this article are:
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
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