State Of Ecommerce: Open System Vs. Closed System

This article first appeared here.

GGV Capital’s new Digital Economy Index has shown that fast-growing ecommerce companies with differentiated offerings might yield higher returns sooner than towering incumbents like Alibaba or Amazon. Here’s a deep dive into why we think certain ecommerce companies are better performing than others.

Choose the open system players in digital commerce over closed system incumbents if you want to see a better bang for your stock-market buck, according to GGV Capital’s new Digital Economy Index, launched last week at its Evolving|E Summit.

For context, an open system generally refers to a company, system, technology or industry which provides a platform to which anyone can freely contribute, without the platform or system itself acting as a gatekeeper. The Internet is a strong example, where anyone can put up a website, as is the Android operating system which allows anyone to develop on its platform. A closed system means the gatekeeper, usually a single company, can control and limit services and contributor freedoms. For example, Apple must review and approve every new app in its App store.

Historically, investors and technologists have prized open systems as an ideal model over closed systems. Open systems allow for free exchange and testing of creative ideas, which make for a potentially richer experience and could open up the path for innovation and new companies. For instance, both the Android and iPhone were launched in 2007, but today Android’s command is three times the global market share of iPhone. However, closed systems tend to be more user-friendly and thus more quickly adopted initially, especially in a new product category, thus generating higher, faster returns. The gatekeeper of the closed system can more carefully maintain a specific user experience. Closed system companies also can track high-performing products from independent brands and then create their own labels to compete with those brands, effectively cannibalizing merchants on the platform. Amazon’s launch of products like office supplies or suitcases under the new Amazon Basics brand is a good example of this behavior. This development in turn drives brands into the arms of open system platforms like Shopify, Big Commerce, and WooCommerce.

Thus, even though bigger and traditionally closed system companies like Amazon or Alibaba have skyrocketing performance, the Digital Economy Index illuminates how open system competitors, particularly in the ecommerce sector such as Shopify or Pinduoduo (the largest open ecommerce platform in China rivaling Alibaba), still may yield more upside potential over the next few years.

Open system companies like Shopify and Pinduoduo have the potential to grow much faster because they strategically compete with differentiated slices of a system controlled by closed system companies. In ecommerce, this means that new open system entrants can become number one in their category by sourcing private labels, manufacturing, or providing the online platform, logistics, and distribution management to compete against incumbents. These open system companies further cement winning strategies through proxy investments, strategic alliances, and specific product offerings. For example, the Shopify platform offers merchants more direct engagement with their own customers and control over their own brand, allowing merchants to bypass Amazon’s gatekeeper-like hold. To conquer the distribution aspect, Shopify, which has a stronghold on access to merchants, has developed a strategic partnership with Facebook, which has similar unhindered access to consumers. Together, they are successfully competing with the platform and distribution slices of a system that Amazon once controlled alone.

The counterattack strategy on Alibaba is interwoven and even more complex than the Shopify/Facebook-versus-Amazon rivalry. Tencent, which is primarily a social networking and gaming company and the owner of WeChat, executed a multifaceted strategy against Alibaba. First, Tencent invested in the ecommerce platform JD to attack Alibaba from the top via brand sales. Then it partnered with Pinduoduo through promotions and discount offerings in lower-tier cities to attack Alibaba from underneath. Acknowledging the benefits of differentiated offerings typical of open system companies, Alibaba has become more willing to give merchants creative control over their own users’ experiences. Alibaba’s investment in Baozun, the equivalent of China’s Shopify, was a stark example of this, as the platform gave merchants a win/win opportunity by coupling the offerings of increased creative control/brand freedom with access to Alibaba’s massive consumer base.

Emerging Markets

As global investors, we’re continually interested in developing ecommerce landscapes in other emerging markets. In Latin America, for instance, Magazine Luiza, one of Brazil’s largest retail chains, conducted one of the most impressive digital transformations by creating a multi-channel ecommerce strategy, resulting in a +1600% share price increase over the last three years. Mercado Libre, the main incumbent and pure ecommerce player, has continued to grow and successfully attract big brands, such as Apple, to its marketplace offering. As Amazon continues to expand in the region (it just launched Prime in Brazil in Sept/2019) and ecommerce adoption in LatAm increases through growing penetration in the clothing and groceries categories, we see similarities to the evolvement of China’s ecommerce landscape and we’re keen to see how local players will defend their territory and what open and closed systems will emerge.

Social Commerce: What’s Next

A couple of troubling spots in the digital economy include direct-to-consumer (DTC) and classified listings, which are defined as listings of goods and services such as those provided by Craigslist and eBay. Interestingly, despite the rise in Shopify, DTC can best be thought of as one channel through which a brand can sell. It is not a business model in its own right as it is not clear that these brands can reach a large enough audience to secure fast growth through DTC alone. As a result, we expect a rise in social commerce, as social media companies increasingly leverage their access to a wide consumer base and partner with the merchant platforms or merchants themselves, such as with the Shopify/Facebook partnership, Pinduoduo/WeChat partnership, or TikTok. This rise makes open system companies all the more favorable.

In the next article in our Digital Economy Index series, Rita Yang weighs in on the rise of social commerce and the emerging opportunity for brands and investors alike to leverage new marketplaces. At GGV Capital, we’re excited to contribute to the conversation with the Digital Economy Index and use our platform to learn from others, too.

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