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Subsidy subsidence

23 November 2015 By Peter Thal Larsen

As the internet boom of the late 1990s neared its peak, venture capitalists used to joke about setting up a website that would sell dollar bills for 90 cents. The startup would attract customers through word of mouth, and quickly start generating revenue. Initial heavy losses were justified in building a user base. Profitability would come later.

The gag summed up the frenzied mentality of the dotcom era, as websites like Pets.com burned through cash by flogging dog food at less than it cost to buy and deliver. But a decade and a half later, online groups in the world’s two most populous countries are once again gambling on winning customers through generosity.

Chinese group-buying sites like Meituan, Dianping and Nuomi are using investors’ money to lower the cost of booking massages or eating in restaurants. Indian retailers such as Flipkart and Snapdeal, whose online marketplaces sell everything from smartphones to new apartments, offer shoppers flash sales and heavy discounts. They encourage sellers to cut prices by waiving commissions, or give customers cash-back or credit.

These companies, bankrolled by large internet groups like Alibaba, Tencent and SoftBank, are making a simple bet: use headline-grabbing discounts to get customers into the habit of ordering takeaway meals or buying movie tickets on their devices. Then collect commissions when prices go back up.

For customers, the frenzy is an unalloyed bonus. Chinese couples can book a pre-wedding photo shoot worth 1,000 yuan ($157) for 20 yuan on Dianping. Nuomi, a subsidiary of Chinese search giant Baidu, offers Beijing residents a 150 yuan manicure for less than 10 yuan. Indian consumers recently spent $200 million on discounted smartphones during Flipkart’s “Big Billion Days” sale.

For the companies, though, the payback is distant and a lot less certain. India’s online marketplaces, which match buyers and sellers, want to follow Alibaba, China’s $196 billion e-commerce giant. In China, startups are hoping to benefit as consumers increasingly turn to their phones to book travel or order food. If they can capture a chunk of the 10 trillion yuan that Chinese consumers spend on services each year, or so the argument goes, the outlay will be more than justified.

Massive sums are at stake. Baidu will spend 20 billion yuan over three years developing what it calls “transaction services”. Helped by subsidies, the value of services ordered on its platform more than doubled to 60.2 billion yuan in the third quarter. But this financial support lopped a stonking 32 percentage points off the search company’s operating margin. Chief Executive Robin Li told investors in July that Baidu’s multi-billion dollar cash warchest enabled it to “fight a war through subsidy” if necessary.

Happy hour

Discounting is as old as business itself. Restaurants attract diners by offering cheaper meals; bars use “happy hour” prices to tempt drinkers. Supermarkets slash the price of bread and milk in the knowledge that most shoppers will buy other full-priced products.

Spending heavily to grab market share in a fast-growing business is not necessarily flawed. Think of mobile network operators subsidising new phones, or pay-TV operators absorbing hefty installation costs to win viewers.

Where Asia’s online land-grab diverges from the business school case study, however, is that there is no certainty that customers will stick around. Social networks like Facebook become more valuable as more people join. Taxi-hailing apps – another industry that is spending heavily on subsidies – are more attractive if they have a larger number of drivers and passengers.

By contrast, e-commerce sites are only as attractive as the prices they offer. The transparency of the web means established operators are always at risk of being undercut by new rivals, limiting their ability to raise prices. Without the bait of discounts, Chinese movie-goers may simply go back to buying tickets at the cinema, or ordering their takeaways from restaurants that are convenient.

Already there are signs that investors are tiring of financing handouts to consumers. Under pressure from their respective backers, which include Alibaba and Tencent, Meituan and Dianping joined forces last month. Scores of smaller startups have folded.

Those that survive will hope that users who have settled into a routine of ordering on their phones will continue to do so even when the discounts dry up. Reams of data on customers’ shopping habits should also allow operators to target special offers. But even Baidu admits that it could take three to five years for the payback on its spending to become clearer. For investors, the lure of helping companies sell products for less than they cost is unlikely to last that long.


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