In the world of online retailers, Liu Qiangdong’s Jingdong Mall is a rare success story–a brick-and-mortar chain that made the transition to the internet. Earlier this year, Associate Professor of Strategic Management Teng Bingsheng looked into what has enabled Jingdong to stand up to giants like Gome and Jack Ma’s Taobao. Here’s what he found. Extracts from his case study:

A Chinese proverb, “Crisis creates opportunities” rings true with entrepreneur Liu Qiangdong, whose powerful online mall, Jingdong Mall, also known as 360buy.com, had its roots in the 2003 SARS crisis.

Two years after graduating from Renmin University in 1996, Liu Qiangdong started his own company, Jingdong Mall, in Beijing. With RMB 12,000, Liu rented a booth, and started selling electronics in the massive Zhongguancun Electronics Market. By 2001, Liu’s operation had become China’s number one retailer of opto-magnetic products, and had gained dealership rights to four well-known electronic brands.

In 2001, his total revenue was RMB 60 million and Liu had 12 stores in Beijing, Shenzhen and Shenyang. His product range included speakers, drivers, CD burners, computer keyboards and many other peripheral IT products. “I sold almost everything except core computer components, as profits were relatively higher,” explains Liu.

However, disaster struck when Liu was forced to close all 12 stores during the 2003 SARS epidemic. During the lock-down, he paid his staff and even gave them food supplies. Liu had them stay at home to avoid the infectious disease, while he sat alone in the empty office wondering about the company’s future.

Facing large stocks in the warehouse, inspiration struck: “If the epidemic stops people from selling and buying things face to face, why not start trading on the internet?” Liu thought. He quickly put his inventory list on the largest online blog sites where customers could read product information and place orders. Buyers would pay in advance and receive their goods at home, delivered by Liu’s company. A month later, Liu’s online sales were not very encouraging: just 100 IT products were sold, and most went to his long-term customers rather than to new clients.

Fortunately, the SARS epidemic ended soon enough, and the brick-and-mortar Jingdong Mall reopened for business. The short-lived e-commerce experiment, however, left a strong impression on Liu.

He began gathering information on the internet, learning about e-commerce models employed by American companies such as Amazon.com. With the advantage of lower costs, higher efficiency, and better risk management, e-commerce seemed more attractive to him than managing a bunch of brick-and-mortar stores.

Liu decided to put his own e-commerce concept into action and it went live in January 2004. Managed by a team of four, the online business, 360buy.com, made RMB 10 million in revenue in 2004, a small addition to Liu’s 12 stores that were bringing in 80-90% of total income.

A Bold Plan

By 2004, business at both 360buy.com and the offline Jingdong Mall stores were thriving. But it raised a new question for Liu: how to integrate the two very different business models? Restrained by limited resources, Liu could not keep developing both models evenly at the same time. “Trying to do both might end up with me not managing either well,” says Liu.

Therefore, he looked at the IT market and weighed the costs of traditional retail operations and sales channels, which to him seemed unmanageably high. He knew what to do. In a management meeting at the end of 2004, Liu proposed a bold business plan. He would abandon the brick-and-mortar stores and focus entirely on the online business.

The first problem was convincing his management team. General IT purchase and sales manager Sun Jiaming, who had joined Jingdong Mall in 2001, says: “In view of the general business environment in China, e-commerce was just emerging. We knew very little about it despite being in the IT industry ourselves. At the time, 90% of our business was conducted through traditional offline stores. When the staff is asked to do something completely new, it’s natural for them to hesitate, because no one could predict the future of e-commerce in China.”

Fortunately, Liu anticipated resistance to his e-commerce plan. “Eighty percent of my people were worried; they thought I was taking a gamble with e-commerce. But with the resources we had, it was not possible to develop both the traditional offline business and e-commerce at the same time. We simply had to concentrate on one area of expertise. This was the only way to make a breakthrough.”

Selling the Online Vision

To gain support from his staff, Liu talked up e-commerce on every occasion, whether at meetings or dinner engagements. After much heated discussion, Liu persuaded his employees, who were thinking about jumping ship, to trust him with the new online business model.

Liu closed Jingdong’s 12 retail stores between January and June 2005, and focused on the company’s website, 360buy.com. Since most of the company’s profit had come from the offline stores until then, their closure resulted in major losses, and left many employees without jobs. Since Liu had promised not to dismiss anybody, he urgently needed to create new roles for them. With this in mind, a large warehouse was built in Shanghai in 2005, easing employment pressure at the company.

According to Liu, “I believed we would overcome these teething problems. I was not worried, since I knew we had more than RMB 10 million in cash to ride it out. Besides, our operational costs were low. We had our own offices, and did not need to pay rent. I estimated that even if we didn’t make a profit for three years, I would still be able to pay salaries.”

While shuttering the offline stores reduced revenue, 360buy.com grew far faster than anyone expected. Its first month’s revenue in 2004 was RMB 30,000. That paltry figure skyrocketed to RMB 3 million a month by the end of the year. One year later, sales had increased to RMB 30 million, after which the monthly growth rate settled at about 10%, reaching RMB 360 million in 2007.

In March 2009, Jingdong became China’s first B2C e-commerce company with monthly revenue exceeding RMB 200 million. In June, its monthly revenue reached RMB 300 million, equal to its annual revenue in 2007. More than 20,000 online orders were being processed by Jingdong every day. Sales reached RMB 10.2 billion in 2010, and Jingdong became China’s number 1 e-commerce company with 33.9% of China’s B2C e-commerce market.

Innovating Beyond Challenges

Despite the company’s rapid ascent to the top of the market, there were still many problems Jingdong had to deal with.

First, Jingdong has three types of upstream partners: manufacturers, distributors and dealers. Goods are purchased from one of its partners, and then sold via its online store. Jingdong’s sales are nationwide, leading to the problem of ‘cuanhuo’, or cross-regional distribution. In China, prices often differ in different markets through regional distributors. Since the same products are sold in different regions at different prices, cross-regional sales by a regional distributor are often not allowed.

At the beginning, 90% of Jingdong’s suppliers viewed ‘cuanhuo’ as a problem and would not permit the practice. Liu had a different opinion: “E-commerce should not be confined by when and where the trade is made. If I buy from manufacturers in Beijing but sell the products in Shenyang, in the traditional business sense, this is ‘cuanhuo.’ However, in e-commerce, this concept does not and should not exist.”

Prior to e-commerce, Jingdong had accumulated six valuable years of dealership experience and established sales channels for many products. Jingdong used this experience to break barriers and build additional channels and in March 2007, business started to pick up. HP took the initiative to contact Jingdong, followed by other major IT manufacturers such as Lenovo and Intel, which extended their support to the company.

In addition to breaking through the traditional sales channel sclerosis, Jingdong also foraged ahead with an innovative membership and advertising programs. Members were classified into eight levels according to purchase volume. With priority in buying goods, members also enjoyed discounted delivery costs and other benefits. The company’s registered members totaled 15 million in 2010.

Jingdong’s advertisements target its members and people likely to fit their members’ profiles (young males), with more than 60% of advertisements placed on online platforms. “People who don’t use the internet are unlikely to become our customers,” Liu says. “Both ad costs and running costs are low for the online group.” Although Jingdong did not have a large advertising budget, its business still grew fast, attributable mainly to word-of-mouth promotion.

One of Jingdong’s mottos is “a long journey won’t stop people tasting good wine”. Customers tend to be highly loyal and often come back to buy more. In 2007, Jingdong customers on average purchased products 6.7 times every six months.

Further, Jingdong was one of the first firms to understand how to set up payment for online purchases in credit-card averse China. Jingdong customers can pay by bank transfer, online payment, by mail or cash on delivery, which is well-suited to China’s cash-oriented society.

Expansion

In 2008, Jingdong broadened its range of products and categories significantly to include home appliances, electronics, telecom products and general merchandise which sold much cheaper on 360buy.com than in offline stores. Customers could browse Jingdong’s product information online and read feedback and reviews from other online buyers.

Food and beverages were added to 360buy.com’s inventory inevitably involved deepening engagement with product supply chains, technology, payment and logistics. In addition, good human resource management became even more essential to success.

According to Jingdong’s vice president Yi Rangyue, “We have to find the right people before starting a new venture.” Next to human resources in importance was capital. In January 2009, Jingdong received investments totaling $21 million from Today Capital and Bull Capital Partners.

Competition

But Jingdong’s rise did not come without competition and some controversy, particularly price undercutting criticisms from China’s two leading appliance and electronics giants, Gome and Sunning, both of which established online malls while maintaining their offline outlets as well. And China’s “eBay,” Taobao, established Taobao Electronics Shopping Mall (Tmall) in January 2010 with 13 categories of home appliances and consumer electronics products being integral parts of Tmall. In 2010, Taobao’s total revenue reached RMB 400 billion, and its registered customers numbered 370 million.

Taobao has long been accused of selling bad quality and counterfeited products. Therefore, when it decided to establish Tmall it prioritized engaging with customer concerns by providing them with a safer, securer shopping environment.

Unlike Jingdong, Tmall does not sell anything itself. It only acts as an online platform for other companies to sell their products. Sales, logistics, stock and after-sales are all taken care of by the sellers themselves.

Taobao only allows registered companies to become sellers on Tmall. Individuals are not eligible for Tmall stores. There are three types of registered shops: “flagship shops” for manufacturers to sell products directly, and two types of authorized dealers, ones that are authorized to sell more than one brand and ones that are not. Since Tmall does not get involved in the actual trades, it makes profit by charging fees from shops. These include a real time technical support fee, annual technical support fee of RMB 6000 and a commission fee of 2% of transaction values.

The biggest difference between Tmall and the rest of Taobao is Tmall’s emphasis on the “quality guarantee.” Customers have a non-conditional refund within seven days, an anti-counterfeiting guarantee and a nationwide after-sales service. Because Taobao does not have its own logistics facilities, Tmall’s logistics have to be outsourced, and complaints about delivery led Tmall to build its own delivery platform for shop owners. In several aspects of e-commerce, such as IT, channels, services, marketing, stocks and logistics, shop owners can put their goods in the Tmall warehouses. The logistics center prepares the goods, and a delivery company will then take care of the rest. Tmall’s logistics platform was first built in Beijing, Shanghai and Shenzhen and then expanded to other cities.

Funding for the Future

By the first quarter of 2011, China’s online B2C business achieved total revenues of RMB 47.07 billion. Tmall’s strategy had worked and it led with a 31.4% market share, and Jingdong had come second with a 10.2 % market share.

But Jingdong Mall, as a big player in China’s e-commerce, had never been short of attention from venture capitalists. In 2011, Jingdong received a US$1.5 billion capital injection from six funds including DST Russia and Tiger Fund, as well as individual investors including a number of celebrities. This is so far the largest investment into any Chinese internet company to date and Jingdong has decided to use the money to improve its logistics facilities and delivery system. After Jingdong’s own delivery team was established, the company has accelerated the development of its logistics system to cover the entire country. Jingdong has three warehouses Beijing, and can store products from more than 600 suppliers. In addition, an even bigger “Asian No.1 Warehouse” is planned in Shanghai. Jingdong will invest RMB 700 million in a 150,000 m2 warehouse. With logistics in first tier cities established, Jingdong has begun deploying its logistics network across the country. Currently, 70% (in some first tier cities even 100%) of total delivery is done by Jingdong’s own delivery team.

The company’s investment in logistics facilities has started to show direct customer benefits. Jingdong now has a refund policy involving home collection of unwanted goods. A fast delivery program called “211 Express Delivery” was introduced, so that orders placed before 11:00 a.m. can be delivered the same day, and orders placed before 11 p.m. can be delivered by 3p.m. the next day. A parcel online tracking system was also established. Liu stresses the importance of Jingdong’s customer support system. “Customers care about three things: products, price and services. Added value is very important.”

Facing fierce competition, Liu believes there are two key factors for success: cost and efficiency. “Competition in cost and efficiency has been fundamental to Jingdong’s focus for the past 10 years,” he says.