Thematic Report

China’s Online to Offline Services

by Elinor Leung / May 22, 2016

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Due to poor offline distribution channels, underused capacity and a fragmented market of mostly independent stores, O2O (Online-to-offline) services are a key growth pillar of the Chinese economy. To meet consumer demand, China has become a global leader in developing O2O services in industries such as restaurants, travel and housekeeping. The tertiary industry also shows great O2O potential, remaining in double digits (11% YoY in 1H15) and contributing more than half of total GDP (53% in 1H).

CLSA asked 573 people about their preferences and usage behavior in 10 major O2O-service categories and compared user experiences on leading O2O app. We discovered a high adoption rate: over 70% of respondents had booked food delivery, restaurants, hotels, movie tickets and taxis online; about 65% had increased usage in the past six months; and over half expect to use these services more. Over 70% of O2O users have raised their overall consumption and half already spend more online than off. Subsidies matter, but 50% of respondents say they will keep using O2O services even if subsidies drop. Most want a one-stop O2O service platform.

The service industry created 17m new jobs in 2014, offsetting the decline in manufacturing employment and we estimate the consumer service market could be worth Rmb11tn by 2019. Restaurants are the largest segment with a 41% share, followed by travel, healthcare and education. At 23% blended online penetration, we forecast O2O-service GMV to reach Rmb2.5tn by 2019, with revenue of Rmb156bn using an average 6.2% take rate (O2O service providers already have 5-15% take rates). Current losses are due to heavy subsidies to acquire users, but subsidies should decline as the market consolidates and matures. We believe the long-term Ebit margin could be sustained at c.25%.

O2O services have tremendous potential, given the large economies of scale and the ability to deploy a low-cost sales force to scale the business. China has 270 cities with more than 1m population (versus 10 cities in the USA). Chinese O2O GMV has jumped with more players and investment, growing 200% YoY for food and 50% YoY for travel in 2015.

China tourism is likely to become a US$1.1tn market by 2020, with online booking expanding even faster at 30%. Online travel agents (OTAs) will be the biggest beneficiaries as 80% of Chinese will own a 4G smartphone by 17CL. As the world’s second-largest tourism market, China accounts for half of the growth in the global travel industry. But penetration is still low, especially for outbound travel. Its citizens take only 0.09 overseas trips per annum (versus the USA’s 0.3 and UK’s 1.2). We expect them to take 65% more trips or spend 80% more on tourism in the next five years. Rising income, more relaxed visa policies and a rapidly expanding number of flights will fuel outbound demand. Meanwhile, domestic travel will benefit from favourable policy, better infrastructure and new theme parks like Shanghai Disneyland, which 90% of respondents from our online study plan to visit in 2016.

CLSA predicts that O2O will be as disruptive to services as e-commerce was to retail and will accelerate China’s transition to a service-led, consumption-driven economy. We forecast O2O-service gross merchandise value (GMV) to reach Rmb2.5tn by 2019.