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China’s internet platform ecosystem has had a bumpy ride over the past couple of weeks. First, Ant Group’s IPO was aborted at the last minute due to regulatory changes that would alter the scope of their business and in quick succession, the Chinese State Administration for Market Regulation (SAMR) came out with a set of draft anti-trust principles for internet platforms. So what’s going on?
Leaving conspiracy theories around Jack Ma’s personal fallout with the powers that be aside, in a nutshell, they are looking at roughly the same issues that the other globally significant regulators are considering (summary courtesy of Ark Invest):
- Players cannot enter into monopolistic agreements: horizontal, vertical, and hub-and-spoke, among others.
- Players cannot abuse their market dominance by selling below cost, refusing to deal fairly, and treating users and suppliers differently without justification, among other admonitions. Market dominance can be a function of market structure, financial health, and barriers to entry, among other factors.
- The SAMR will investigate concentration amassed illegally. Operator concentration camouflaged inside VIE structures will face anti-trust examination.
However, my main question really is: to what extent does this really matter given the way the platform economy has already developed and how can it potentially impact industry participants and market structure?
My primary conclusion is that it probably will not make a meaningful difference, even if the current vague scope of anti-trust is further clarified and enacted.
While providing my perspective on this more broadly, I will also focus on Alibaba, since at first glance, it seems to have been targeted / impacted both directly and indirectly via it’s 33% minority interest in Ant Group.
1) So what are the constraints on Ant?
The main constraint on Ant seems to be around an increase in capital required to fund credit through the platform from 1-2% currently to 30%, along with various proposed borrowing limits on consumers and SMEs.
Undoubtedly, this will have a major impact on both loan growth, ROE and also, given that Ant charges its partner funding banks sizeable high margin fees for using its proprietary credit risk algorithms, a fall in overall profitability should this service also end up being restricted.
However, in principle, it is appropriate to make sure that more equity is put up against loan balances. That serves to align interests around risk taking and risk parcelling. Also, I can see the argument for regulating credit risk models more carefully, particularly if price discrimination leads to social consequences (certain classes of people are excluded from credit, leading to them being worse off, making it even harder to get credit etc.).
However, even with a 50% haircut of expected profits (taking into account that credit is at least 40% of their profit base), the fact is that Ant’s scale in a regional duopoly is massive and here to stay. Consumers are primed to deal with either Ant’s Alipay app or Tencent’s WeChat Pay app; the most valuable commodity - people’s attention and conditioned usage on their mobiles for payment and payment influenced tasks - has been captured. That still sets the stage for further product led growth potential in the future rather than simply relying on balance sheet growth, which I think is much stickier and better quality.
2) Let’s consider the point about monopolistic agreements…
The biggest constraint I can see revolves around the monopolistic behaviour in a horizontal sense - i.e. preventing these platforms from monopolising adjacent services. Historically, both Tencent and Alibaba have tried to build out walled ecosystems, either through buying equity stakes in other companies (and then putting restrictions on using other platforms) or trying to prevent other counterparties from using competitor’s services forcibly (e.g. tying merchants in).
We’ll definitely see more heightened scrutiny around majority equity investments or direct buyouts but minority investments should continue to be feasible. Furthermore, if buying in future growth becomes incrementally harder, it puts more emphasis on creating new growth vectors internally. All of the major platform companies, including Alibaba, are still staffed with some of the best talent in China and the power of having captive distribution cannot be overstated when testing new products or features in an iterative manner.
Also, with consumers being as savvy as they are in China (the average customer journey begins months in advance of a purchasing decision, price sensitivity is high so people naturally look around for options and brand loyalty is more about influencer loyalty), its effectively redundant to try and tie retailers and manufacturers to a single platform. The marginal benefit of doing this is diminimous at best.
Controlling for vertical integration is also largely pointless at this point in time, particularly in the e-commerce space. The reality is that the entire workflow and value chain is already highly optimised. For example, Alibaba’s logistic’s network through Cainiao is already highly developed and has had a tremendous amount of capital invested in it. Similarly with JD. Where companies haven’t yet built out their vertical integration deeply (e.g. Pinduoduo’s delivery capabilities), controlling for further vertical integration would be regressive given the need to compete with already established competitors.
3) What about market dominance through predatory pricing, price discrimination etc.?
Given the scale of market share that each of the players has in their particular domain, sustained predatory pricing is highly unlikely at this stage.
Price discrimination is potentially more of a problem. It seems inherently unfair to offer a middle class person living in Shenzhen who consistently shops for discretionary goods a different price to a villager somewhere in Central China. There’s no good answer to this. I suspect that instead of a blanket ban, there may be that there are some categories of goods where it is acceptable to engage in data driven price discrimination with controls built in (much like it makes sense for health insurance to be priced differently based on positive behaviour, without adversely discriminating on vectors like race, gender, socio-economic stratification etc.).
An area I can see this type of price discrimination being allowed is around cloud infrastructure provision, since that is essentially a B2B offering and ‘consumer’ protection seems to be concentrated on the impact to the individual (bear in mind that most cloud infrastructure providers have fantastic deals for extremely small startups since that is their future pipeline - they’re not going to kill of that golden goose).
The reality is that during the past few years, competition HAS been able to muscle its way in. Pinduoduo is barely 5 years old and the likes of Kuaishou have come through (live streaming commerce) as consumer behaviour has evolved. New platforms can establish themselves if there are inflection points in behaviour, and essential factors that matter, such as customer services infrastructure that becomes economic with scale, can still be put in place early on since the capital is available to fund their growth journey.
4) What about concentration amassed illegally, including through VIE structures?
All acquisitions should face scrutiny but at the end of the day, it comes down to what the relevant scope of market definition is. For example, Alibaba may control a large chunk of e-commerce but it certainly doesn’t have dominance for all retail in China.
At the end of the day, I expect the sort of steady compounding growth for the likes of Alibaba to continue, especially with their cloud offering firing on all cylinders and the “productizable” optionality that is built into the nature of the business itself.