Chinese marketplaces – lower commission drives faster growth

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We invest in a lot of marketplaces and one of the questions we wrestle with a lot is determining the optimum commission level. Most of the time 10-20% feels like the right answer. I say ‘feels’ because it’s impossible to know for sure when you start out. At the 10-20% level you can make enough money to build a big business (particularly when non-transactional revenues are layered on top), but commission is low enough that it will be tough for competitors to undercut you. Bill Gurley makes this argument well in his seminal post A rake too far.

The chart above from Mary Meeker’s Internet Trends presentation published this week shows that 3-5% commissions have worked extremely well for a couple of Chinese marketplaces. As you can see they’ve enjoyed much faster growth than their US equivalents which charge much higher commissions.

We should be wary of assuming correlation implies causation, but there’s definitely something interesting to think about here. In the case where the market is huge and/or the underlying transaction costs are very low then taking sub 10% commissions merits thorough investigation. A radical way to look at this that might work in some markets would be using transactions as a loss leader to sell buyer or seller services.

  • http://twitter.com/L1AD LIAD

    Version One blog has a few interesting posts and comment threads on marketplaces and optimal take-rates.

    http://versionone.vc/blog/

  • http://www.theequitykicker.com brisbourne

    That’s a great blog. Now on my Twitter list. Thanks.

  • http://www.lowpan.com Jon Smirl

    Low commissions have other impacts – for example on returns. When high commissions drive up the sales price I am much more picky about everything working right and I will insist on returns and refunds. All of my fussing obviously drives up costs for the distributors. After all, those high commissions are supposed to be paying for “service” and I want my service. If I buy something from Alibaba for under $100 that doesn’t work, I just toss it into the trash can. In both cases I am very cautious about buying again from the involved vendors.

    To a manufacturer high commissions provide a giant incentive for parallel channels. I really, really hate retail price maintenance agreements forced onto manufacturers by many retailers. Those agreements are designed to keep the manufacturer from creating parallel channels. For example, a $60 wholesale item with $100 suggested retail. A large retailer can insert clauses to force the manufacturer to sell at $100 on their website. But then the retailer turns around and runs 20% off sales every other day. So the manufacturer is stuck at $100 on their website and the retailer is then effectively at $80. To combat this the manufacturer issues coupons good at their website, but then the consumers get mad when they can’t use the coupons at retail.

    On the other hand, if the channels were working at a 8% mark up instead of 40% all of this conflict would disappear.

  • http://www.theequitykicker.com brisbourne

    Commissions should correlate with the amount of work done by the middle man – your first point put differently. Most retailers take stock and manage logistics, as well as acquiring and managing customers. Difficult to do that for 8%.

    Nic Brisbourne
    Managing Partner

    @brisbourne | forwardpartners.com | theequitykicker

    Forward Partners
    COMMERCIAL UNIT 2, 124 EAST ROAD, LONDON, N1 6FD

  • http://www.lowpan.com Jon Smirl

    I’m don’t care what the retail markup is, the annoying thing is how retailers use their contracts to manipulate prices in alternate channels. I’d like to have a wholesale price at $60, a web price at say $70, and then the retailers can price however they want – probably $80-90 while buying at $60. It’s this fiction of trying to force list prices up elsewhere in order to hide the retailer’s high costs that bothers me. It’s ok if retail is $80 and the web is $70 – I know I am paying that extra $10 for convenience. But retailers want web $100 and themselves at $80 so that they appear cheaper. I’d rather they’d just be truthful in charging for their value add instead of trying to hide it in suggested list prices and then pretending their service is free. That behavior makes my product seem expensive when what is really expensive is the cost of the retail channel.

  • http://www.lowpan.com Jon Smirl

    One way to get out of these contract restrictions is to create two slightly different SKUs. One for web sale and one for retail. The retail SKU is always $100 suggested list even when it is sold on the web. The web only SKU is $70. Of course what is inside the box is almost identical.

    The will lead to the next problem of the retailer demanding access to the $70 SKU but with a 40% discount which is impossible to give them.

    On low price products these issues aren’t too severe. But I work with $500 goods where these retail markups are $200 a box.

  • http://www.pioneers.london Sierra Choi

    Mary Meeker often has great insights, and I think we have to take into consideration a few things:

    1) Alibaba makes the majority of their revenue from Taobao and T-Mall (and not Alibaba, the wholesale site which is in English); Taobao and T-mall, although they ship to Australia and the United States, their sites are entirely in Chinese. Alibaba has purposely kept those sites insulated to the Chinese speaking demographic.
    2) China has a population of 1.4 billion vs English speaking nations 402 million (US/Australia/UK)
    3) ebay has a different site for each country, and currently there is no ebay in china meanwhile there is only one Taobao and T-Mall site for multiple nations
    4) Taobao and T-mall have more similarities to Etsy than Ebay, making it easier for people to purchase/sell items to/from other nations and have a philosophy of empowering small businesses, while Ebay and Amazon makes it extremely difficult to sell/buy items internationally; therefore Chinese sellers prefer to use Taobao/T-mall and Etsy as opposed to eBay and Amazon out of convenience.
    5) Etsy also has a take rate of 3.5% similar to Alibaba’s 3% (I’m curious why Mary Meeker did not include Etsy in this graph? I gather because Etsy’s low take rate does support her argument that low rates are the reason why Chinese e-Commerce has surpassed the US ones, rather the underlying reasons are a combination of language barriers and international laws)

    With a population of 1.4 billion in China and e-Commerce sites that only cater to the primary language they speak, I think growth rate will explode regardless of the optimal commission rate. However, it appears to me that Alibaba has set the optimal commission rates in relation to the relative income of the population demographic they are targeting (Chinese speaking population). The average Chinese income is $5,000/year or £3269/year; therefore their optimal commission rate is actually decent compared to the relative income of the average Chinese resident.

    My conclusion is that if British e-commerce companies want to scale- it might be to their benefit to expand into China first as opposed to the US. Of course, expansion into China requires creating the right partnerships with Chinese corporations and navigation around Chinese laws.

  • Rmicals

    Interesting piece of information. Of course you’re right about being wary of correlation but seems like there could be a couple of compelling causal factors.

    The first being the price of skilled labour in China is really low vs the west and so maybe 3%-5% is feasible and the second is the massive middle class that have embraced ecommerce with penetration much higher than the west. In the words of Jack Ma ‘in the US ecommerce is still dessert , supplementary to their main business but in China Ecommerce becomes the main course’