China: E-commerce trumps retail

May 20, 2013


Not so much.

FORTUNE -- Just as cash-strapped consumers in the developing world bypassed so-called landline phones in favor of mobile devices, so China’s lower-income consumers are skipping physical stores in favor of e-commerce sites.

A recent report by McKinsey & Co. shows that e-commerce sales in China reached an estimated $190 billion last year, almost equaling the U.S. market as largest in the world. China’s online retail industry is expected to grow to at least $420 billion by 2020 -- which would total more than the U.S., Japanese, U.K., German, and French markets combined. China will overtake the U.S. for the top spot next year, if it hasn’t already.

In an economy known for astonishing growth, e-commerce stands out. China’s market has grown at a 120% annualized clip since 2003 compared to the U.S.’s 17% growth rate. It shows no signs of stopping.

What interests McKinsey isn’t just the massive growth -- it’s the potential for e-commerce to drive the government's goal of increasing domestic consumption and diversifying the world’s No. 2 economy from a reliance on infrastructure projects. The authors of the report, titled "China’s E-tail Revolution,” conclude that consumers are more than replacing what they might buy at the mall. E-commerce is driving consumers to buy new stuff, especially in the so-called lower-tier, lower-income cities where physical retail stores, if they exist at all, don’t have anywhere near the same selection as online marketplaces.

MORE: The IPO market is back—for enterprise tech

"China remains an under-retailed country, and customers’ needs are very strong overall," says Peggy Yu Yu, co-founder of Dangdang, a Beijing-based e-commerce site that competes with Amazon China. "I live [in] downtown Beijing, and I drive any direction, and one hour later, still within Beijing, I don’t see good stores anymore, be it supermarket or clothing store."

More than 70% of China’s e-commerce business is consumer to consumer. eBay-like  (ebay) auction sites called Taobao, Tmall, and Paipai host hundreds of millions of listings. But Amazon (amzn) wannabes such as 360Buy are setting up operations in second-tier cities, and analysts believe they’ll eventually start moving into third- and fourth-tier cities.

While the ordering process on many e-commerce sites is done via mobile phones and apps, distribution is often a combination of high-tech and old-fashioned customers service -- which suits Chinese consumers just fine. 360buy, for example, offers same-day delivery (depending on when the order is placed) often via bike messenger.

Consumers in smaller cities like to pay via cash on delivery; one upside is that the customer can try on their wares before making payment, employing what’s been called the "mobile fitting room" option.

MORE: The only Fortune 500 company that's grown faster than Apple

What’s surprising in the McKinsey report is that consumers in China’s lower-tier cities actually spend as much online as higher-tier cities even though their consumers have far less disposable income. In the small and mid-size cities dotting the countryside, e-commerce sites are proving a revelation. Many consumers can now buy books, movies, clothes, and other goods for the first time.

That means lower-income consumers who shop for newly available goods online are increasingly propelling the economy forward, even as some are skeptical that China can transition into a consumption economy. For China, as it becomes the e-commerce capital of the world, that might be the best news of all.

All products and services featured are based solely on editorial selection. FORTUNE may receive compensation for some links to products and services on this website.

Quotes delayed at least 15 minutes. Market data provided by Interactive Data. ETF and Mutual Fund data provided by Morningstar, Inc. Dow Jones Terms & Conditions: http://www.djindexes.com/mdsidx/html/tandc/indexestandcs.html. S&P Index data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Terms & Conditions. Powered and implemented by Interactive Data Managed Solutions