Move Over Amazon—Here Comes a Chinese Online Juggernaut

Student in front of an online Taobao shop.
Philippe Lopez | AFP | Getty Images

Shanghai resident Grace Tng buys almost everything she needs online, from groceries to makeup, as she finds it more convenient than going to a store.

The 29-year-old arts curator who moved to the Chinese city 18 months ago from Singapore says she shops on the internet a lot more now than when she was living in the city state.

"In China, I think almost anything can be found online," Tng told CNBC. "Here there are little shops all along the streets and I may not be able to get everything at one go, so shopping online is actually more convenient for me."

Tng is one of millions of shoppers in China who are turning to the web, fueling a booming $64 billion online retail market.

Increasing internet subscribers and mobile phone users along with rising incomes and an influx of foreign consumer products into China have led to a rapid expansion of the e-commerce market, which was virtually non-existent half a decade ago.

An example of this boom is Tmall, China's business to consumer or B2C website, which according to market research firm Euromonitor International, will overtake U.S. online retail giant Amazon in sales to become the world's largest internet retailer by 2016. Tmall sales are projected to hit $100 billion that year, compared to $94 billion for Amazon.

Tmall, run by China's second-largest Internet company Alibaba Group, has already overtaken popular consumer to consumer (C2C) portal or online auctioneer, eBay in sales this year, according to Euromonitor. Tmall's sales are projected to hit $32.5 billion in 2012, compared to $27.7 billion for eBay.

Just five years old - spun off from sister website Taobao, a Chinese version of eBay - Tmall's success is based purely on sales in one single market. Unlike its American counterparts, which run global operations with over 50 percent of Amazon's sales coming from outside of the U.S., according to Euromonitor, Tmall operates only in Greater China.

"What you have to take into account is that they [Tmall] still haven't expanded abroad. it's just operating in the Chinese market and seeing the sales volume it's seeing at the moment," Lamine Lahouasnia, senior retail analyst at Euromonitor in London said.

"If it were to start thinking about pushing the brand abroad perhaps to another Chinese speaking region of the world, we could potentially see the overtaking of Amazon happen a lot sooner," he added.

Tmall controls 50 percent of China's online market and is making inroads into the Greater China region that includes Hong Kong and Taiwan. It has over 1 million registered users in Hong Kong, which works out to about one in seven people in the Chinese territory, while in Taiwan it has about half a million users.

In total, China only represents 12 percent of global internet sales, while developed markets like the U.S. account for more than a third of the pie, according to Euromonitor.

But despite having larger developed markets in the West, Alibaba's chief strategy officer, Zeng Ming told CNBC that Tmall's expansion target would be Southeast Asia.

According to Lahouasnia, this would make more sense as these markets already have a large Chinese community, who would be familiar with the Tmall brand, rather than entering a western market that already has dominant online retailers.

Its All About the Price

For example, Howe Choon Tang, who used Taobao while he worked in China, said since his return to Singapore two years ago, he still shops more on Chinese websites than on Amazon or eBay.

"It's more about pricing - it's much cheaper," the 37-year-old graphics designer said. "It's not about how great the experience is. Amazon has a much better experience I guess - but the prices are better on Taobao."

Tang gets the goods delivered at a address in China and then arranges for it to be couriered to Singapore.

In China, meanwhile, Shanghai resident Kirk Lau, who shops online once a week, said the deals online make it much easier to shop without having to haggle over prices with shop owners.

"I don't have to bargain online, because all the prices are listed, they have to list the most competitive price" the 34-year-old engineer said. "And for shipping, usually we're talking about 5 yuan (80 cents) or 10 yuan ($1.60). If I go out and take a subway, a round trip will probably cost the same amount."

Price plays a major factor behind why consumers are flocking to Chinese e-commerce websites, according to Lahouasnia, who said sales go "through the roof" even when products are slightly discounted.

"Even if it's like a 10-15 percent cut in prices, Chinese people really use that period to buy what they may need not just now, but perhaps in the next 12 months or so," Lahouasnia said. "There's a huge element of bargain hunting."

During a shopping festival on November 11, Tmall broke the world record for single-day sales when it processed a staggering $2.1 billion in sales, beating an Amazon record set in the U.S. on "Cyber Monday" in 2011, according to Euromonitor.

Nascent Market

Looking ahead, analysts told CNBC that Tmall will grow together with the e-commerce space in China, which is still in a nascent stage.

China's online retail sales only account for up to 5 percent of the country's total retail volume, whereas in markets like the U.S. and U.K. it takes up about 10 percent, according to data from Alibaba.

(Read More: Chinese Give Luxury Goods a Pass, Go on Holiday Instead)

Alibaba's Zeng said that growth in online retail is expected to come from China's third and fourth tier cities, where consumption is growing much faster than in the bigger cities.

"[We're] definitely focusing on China," Zeng said. "No matter where you are in China, even in remote areas, as long as you have a mobile phone, you can access the same number of products as anyone living in Beijing or Shanghai and you can buy a product at the same price as they do."

Transaction volumes for both Taobao and Tmall from China's third and fourth-tier cities grew 60 percent year-on-year in November, compared with 40 percent growth in the country's largest cities, according to Alibaba.

Rising incomes and a lack of big retail stores is driving online demand in smaller towns, according to Carrie Yu, retail and consumer partner for China and Asia Pacific at PricewaterhouseCoopers (PwC).

Challenges Ahead

In November, Tmall's parent company Alibaba Group announced that second quarter profit more than doubled to $273 million, compared to a year ago and revenue grew by over 70 percent in the same period, Reuters reported. Yahoo owns about 20 percent of Alibaba Group.

While the company did not say what percentage of its earnings came from Taobao and Tmall, these websites are considered the company's crown jewels and driver of profit, said analysts.

In comparison, Amazon reported its first quarterly loss in more than five years in the third quarter of $274 million.

Despite the surge in online shopping in China, Jinkyu Yoon, head of internet research - Asia ex Japan at Nomura, warns investors about placing bets on the sector.

"Certainly the emergence of e-commerce is at a very early stage, but it doesn't mean that investors could go out there and make significant returns because many of these companies are just not going to be profitable in the long run," Yoon said.

Popular e-commerce sites in China like Tmall and are seeing an increase in competition that has led them to spend a lot on marketing and advertising to gain market share, pressuring their bottom line, added PwC's Yu.

Another factor that could harm the sector according to Lahouasnia of Euromonitor, is the increase in the number counterfeit goods being sold online. This diminishes confidence in online shopping and encourages retailers to distance themselves from a marketplace where "fake" goods are sold, to set up their own websites.

"If you have a situation where brands choose not to sell through Tmall, they post their own site and organize their own distribution, then obviously Tmall aren't getting the revenue as more and more consumers will start to go elsewhere," he said.

Spanish chain Zara, owned by the world's largest clothing retailer Inditex, for example, launched its own Chinese website in September, to sell directly to consumers instead of selling through Tmall like a lot of western clothing retailers.

Taobao, however, passed a major hurdle in December when the U.S. dropped the e-commerce giant from its annual list of "notorious" markets for pirated and counterfeit goods. The U.S.Trade Representative's office said Taobao had taken considerable effort to clean up its site in the past year.

Despite the chance of buying a knock-off, Tang said he still feels like he's getting a better deal on Chinese sites.

"Our expectation is lower when we buy from Taobao, so we don't feel as bad when we get a lemon," Tang said.

- By CNBC's Rajeshni Naidu-Ghelani.