December 30, 2020
Emerging Digital Economies: 2020 in Review
This year upended the personal and working lives of billions around the world and transformed how people communicate, work, and consume. Technology was at the center of many of these changes.
In our previous year-end note, we wrote about how Kora concentrates its research and investments on Emerging Internet and Niche Financials. Framed in a different manner, this focus is a mandate to invest in the emerging digital economies across our markets.
In 2020, these digital economies grew meaningfully, yet they still only represent a tiny fraction of overall economic activity in our research footprint (with China the notable exception). We believe the paths these economies are following toward continuing digitalization will coincide with a broadening and deepening of associated profit pools in the years ahead.
Below we narrow in on two representative segments of this digitalization – digital payments and e-commerce – and discuss the structural opportunities and local idiosyncrasies we observe in each.
Digital Payments — Overview
Digital payments provide the underlying liquidity for many of the activities that take place in the digital economy.1 The below chart comparing the rates of digital versus non-digital payments in our core research regions shows a wide range of adoption, with China the most advanced at nearly 70% penetration and Japan surprisingly low (given how “developed” the economy is), at 25%.
Digital Payments — China
We estimate digital payments penetration in China will reach 69% as of the end of this year, the highest penetration globally and still amongst the fastest growing, with total payment volume effectively doubling every two years.
These penetration figures reflect in large part the success of the two dominant consumer internet platforms in China, Alibaba and Tencent, whose payment arms Ant Financial and Tenpay (and associated services), respectively, collectively serve 1.2 billion monthly active users and, in our estimation, facilitate over 90% of digital payment volumes.2 These two payments platforms started with niche use cases – in Alibaba’s case to escrow payments between buyers and sellers on its e-commerce marketplace, and in Tencent’s case to allow for friends to send “lucky money” (gifts) to each other – but now their services touch virtually every aspect of business and social life in China. Today, Ant Financial and Tenpay are accepted by everyone from taxis to luxury goods stores to street food vendors. This broad adoption has served as a customer funnel for all sorts of financial services, with Ant Financial, for example, now the largest digital lender and the largest online asset & wealth manager in China.
Digital Payments — India
While penetration in India has historically lagged almost every other country globally, adoption over the past several years has been rapid in absolute terms and has also outpaced the rate of growth in China.
Government-led technological innovation has been an important contributor, with the launch of the national Unified Payments Interface (UPI) the most important example of this. Launched in 2016, UPI is among the most innovative payments systems globally, allowing instantaneous inter-bank transfers, bypassing the need for credit/debit cards and bank account information. It now powers 60% of digital payments3 and has been critical in reducing transaction costs, which in turn drives higher frequency and enables transactions with small order values.
Another important contributor has been the broadening of consumer access via an inflection in the adoption of smartphones, with 450 million added in the last seven years.4 While there are, as of yet, no dominant integrated fintech platforms, as there are in China, a diverse ecosystem of (mostly domestic) digital payments companies has emerged over the past several years, which we are following closely.
Digital Payments — Japan
Japan is one of the more surprising outliers from our digital payments tracking work. Despite its advanced economy, Japan has the lowest digital payments penetration of any of our major markets aside from Indonesia.
We believe there are many reasons for this historical anomaly. Culture and demographics play a role, with spending concentrated in an older population that strongly prefers cash payments, even for goods ordered electronically. Regulation has also been a headwind, with various paper approvals and corporate seals required for transactions. This is rapidly changing, with consumer adoption being forced by COVID-related restrictions and the government taking a much more supportive approach (for example, recently announcing a new digital transformation agency to be established in 2021 and laying out a long-term vision for achieving 80% digital payments penetration).
While it is still early, we believe an emerging ecosystem of digital payments and online consumer and merchant lenders is helping remove important points of friction.
E-Commerce — Overview
Retail is one of the largest and typically earliest economic activities to become digital. Further, once built, e-commerce platforms have powerful network effects that make them natural centers for further bringing online a multitude of adjacent activities for both merchants (e.g., cloud-based enterprise software) and consumers (e.g., digital credit) transacting on these marketplaces.5
In the below chart we show how online retail penetration rates have evolved across markets, aiding this comparison by time-shifting them to when they each began their e-commerce journeys (which we define as when a market first reaches 1-2% penetration).
From this visualization, two trend lines clearly stand out as does one phenomenon:
A steep “China adoption curve” that Indonesia alone seems to be following with very rapid e-commerce penetration growth;
A more gentle “U.S. adoption curve” that the other digital economies seem to be following; and,
A “COVID inflection” that tilts all of the digital penetration curves upward this past year, with potentially lasting effects.
The below chart compares the state of play today, showing the percentage of e-commerce penetration in each country and highlighting the dollar size of each market for context. As with digital payments, China leads with over 40% penetration.
E-Commerce — China
While a close second to the United States in the absolute value of total retail sales, e-commerce in China is already nearly twice the scale of e-commerce in the United States as a result of more than twice the level of e-commerce penetration, and is larger than any of the overall retail markets of the other countries we follow.
COVID had a material impact on e-commerce trends in China (see our Kora Insights post from earlier this year), but the chart below frames how digital penetration is part of a much longer-term trend, with physical retail in China only averaging 9% annual growth over the past 15 years while e-commerce grew at 54% and gained significant market share.
While China’s lead is obvious, less so are the rapid iterations and innovations that continue in our view to widen the gap between China and the rest of the world. Two such examples of this would be discovery-based e-commerce, where products are “pushed” by the platform (as opposed to consumers actively searching for what they want), and algorithm-enabled, group-based purchases that activate discounts. These two innovations were at the heart of the rise of Pinduoduo, which we estimate will generate US$250bn in gross merchandise value (“GMV”) this year and has alone contributed to a 700bps increase in e-commerce penetration in China over the past five years.6 We see many such interesting trends in China today, from e-commerce livestreaming to the gamification of shopping to the integration of online and offline shopping (known as online-to-offline, or “O2O”), which may prove idiosyncratic to China or as breadcrumbs for the rest of the world to follow.
E-Commerce — Indonesia
The market in Southeast Asia reminds us of China a decade ago, with per capita GDP now rising to approximately US$4,000 threshold (which China achieved in 2010),7 a level beyond which we believe discretionary consumption typically inflects, and widespread smartphone adoption. A growing ecosystem of e-commerce providers such as Shopee, Lazada, and Tokopedia, powered in part by significant pools of China-based strategic capital (Tencent has invested in Shopee, Alibaba in both Tokopedia and Lazada) provides the backdrop for a rapid expansion in penetration. By the end of 2020, we estimate overall e-commerce penetration in Indonesia will have risen 10x in only five years.
Shopee, the e-commerce leader in Indonesia (as measured by users, orders, and time spent), has been a major contributor to these developments, helping to grow the market and now generating approximately US$10bn in GMV in e-commerce, an approximately 20x increase from CY17.8
E-Commerce - India
Similar to Indonesia, e-commerce penetration in India has grown rapidly off a very low base, increasing 5x over the past five years. An inflection in access has also been critical, with nearly 400 million smartphones added during this same period.9
Unlike many of our other markets, and consistent with much of India’s digital economy, global players are dominant in India today. The two largest e-commerce platforms in India, Flipkart and Amazon India, are both foreign-owned, with the former acquired by Walmart in 2018 and the latter a wholly-owned subsidiary of Amazon. Together, we estimate these players have a combined 80-90% market share in e-commerce.
Looking ahead, we believe the size of the opportunity and the low starting point suggest the path for e-commerce penetration will inevitably lead higher, but the pace of this adoption will depend on several idiosyncratic factors. One major hurdle will be finding a balance between affordability for consumers in lower-tier cities and operational costs, as companies will need to invest heavily in logistics ahead of scale. Another will be encouraging digital payments which, as noted above, are scarcely adopted and yet are a critical factor in reducing basket abandonment and a required precondition to implementing online credit options (such as buy-now-pay-later) that can facilitate broader affordability for higher-priced goods.
E-Commerce — Japan
As with digital payments, online retail is surprisingly underpenetrated in Japan and also growing at a slow pace. A confluence of consumer habits, government regulations, and a lack of compelling digital offerings have all historically been headwinds, but we believe these are abating. In addition to the two dominant e-commerce platforms, Rakuten and Amazon Japan, which together control the majority of the e-commerce market,10 we are observing a proliferation of software and service providers that allow merchants to sell digitally, similar to Shopify in the United States.
As in other corners of the digital economy in Japan, we expect digital adoption will occur at a relatively slower pace compared with our other research regions. However, given the absolute size of the market opportunity and the potential inflection in the pace of growth, we believe e-commerce in Japan presents a compelling opportunity for long-term research and investment.
Conclusion — Digitalization Over Time
We often observe in operating businesses that supply comes online in discrete, step-function phases while demand grows in a more linear fashion. This year, the pandemic inverted this dynamic, as digital demand experienced a step-function change higher across the economies we research. Demand will likely return to a more linear pace of growth in the years to come, but regardless of the specific slope of future growth, it is starting off from a notably higher base. We believe a phase change has happened, and digital economies across the globe have been enabled and embraced.
Stepping back to look at the bigger picture, below we summarize the comparative growth in digital payments and online retail in the markets we follow from 2014, when Kora launched, to today (excluding U.S. data).
Despite the above-trend digitalization that occurred this year, we believe the broader narrative remains – dynamic and fast-growing digital economies are in their earliest stages of penetration, providing innovative companies the runway to emerge and scale in the years ahead. This sets the stage not only for Kora’s research today, but for the long-term future as well.
Footnotes
1 We define "digital payments" as all non-cash, paperless consumer-to-business ("C2B") payments by end consumers — including credit cards, debit cards, e-wallets, and innovative digital account-to-account payments like UPI in India; but excluding checks, bank slips, and traditional direct bank transfers. Consumer-to-consumer ("C2C") and business-to-business ("B2B") payments are excluded. We define "total consumption" as all private personal consumption expenditure in the economy.
2 Source: Company Filings, Kora Estimates
3 Source: Reserve Bank of India
4 Sources: techARC, BGR India, Counterpoint Research
5 We define "e-commerce" or "online retail" as all business-to-consumer ("B2C") sales of goods online to end consumers — including direct-to-consumer, first-party, and third-party marketplace sales, but excluding online services such as food delivery, ride-hailing, travel booking, digital media, or entertainment. We define "total retail sales" as all of the above e-commerce sales, plus B2C offline sales of goods, excluding sale of fuel at gas stations.
6 Sources: Company Filings, Kora Estimates
7 Sources: World Bank, China National Bureau of Statistics
8 Sources: Company Filings, Kora Estimates
9 Sources: techARC, BGR India, Counterpoint Research
10 Sources: Company Filings, Kora Estimates
Disclosures
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