As growth indicators such as commodities and oil test their lowest price levels for more than 10 years, the fear of deflation that gripped Japan for many decades is quickly becoming a global phenomenon. Even in the U.S., where economic growth is relatively strong, there is a noticeable lack of wage inflation in the face of strong employment reports over the past 12 months.
While we can blame part of this problem on the aftermath of the global financial crisis of 2008, I place at least some of the blame on the rapid proliferation of Internet technology. A clear example is the loss of traditional retail jobs to ballooning online sales.
South Korea is a good leading indicator on this issue because of its heavy Internet penetration and dense population, making it a good market sample for other economies to track. South Korea’s retail industry is also an interesting case of being both a victim and beneficiary of the creative destruction of traditional retail channels caused by the onset of e-commerce.
South Korean retail businesses are dominated by large corporations, often part of one of the country’s huge conglomerates known as chaebols. The scale these corporations enjoy at the group level gives them a huge cost advantage over small to medium sized enterprises, which need to build from the ground up. Right now, e-commerce is killing retail businesses through intense price competition that is driving down margins.
In South Korea, traditional retailers are hurt not just by domestic online sales but also overseas Internet purchases. In 2014, the value of purchases from overseas websites delivered to South Korean homes reached more than $1.5 billion, from $274 million five years earlier. This figure slipped slightly in 2015 because of government restrictions on purchases, but will continue to rise in the coming years at the expense of traditional retailers and their workers.
For decades, chaebols operating in domestic retail and consumption industries enjoyed outsized margins due to protectionism against imported goods. In the last decade, however, the South Korean government has forged trade agreements with 52 nations far and wide, including one with China just last year.
The combination of e-commerce and trade deals has driven the rapid rise of overseas online purchases, especially from the U.S., where a much broader selection of products is available, often at huge discounts to local prices. South Korean shoppers have become so successful at arbitraging this pricing gap that the South Korean government has placed an unofficial limit on cross-border online transactions that qualify for exemption from customs duties.
Viable competitor
Another driver of online imports is cheap and efficient delivery, made possible by a growing logistics industry. Strong growth in e-commerce has allowed for rising efficiency in deliveries, which now makes it a viable competitor to offline retailers.
Overseas online purchases hurt all South Korean retail and consumer brands, but they hurt the large corporations most. For two decades, the chaebols have enjoyed government support through import protection and distribution networks built over many decades of lobbying and cooperating with myriad regulatory hurdles.
South Korean SMEs never benefited from this because they were usually niche players in crowded markets. As a result, the flood of foreign brands coming into South Korea through online purchases threatens the profitability of large corporations more than the SMEs. A good example is Samsung Electronics’ 60 inch LED TVs, which South Korean shoppers have been buying from U.S. e-commerce shopping sites. Even after delivery and customs duties, prices are up to 20% cheaper than in South Korea.
But these developments are not all bad news for South Korean retailers. The advent of technology will also allow South Korean SMEs to penetrate a much bigger market: China.
Historically, when South Korean companies wanted to expand overseas, they would spend years investing in distribution channels and learning how to deal with customs and local regulations. As a result, expansion outside South Korea was a high-risk strategy that yielded patchy results for smaller companies. But the rapid development of e-commerce in China is making the expensive and time-intensive task of establishing distribution channels as quick as the click of a mouse. Already we are seeing companies that have rocketing China revenues, driven by online sales that would previously have taken years of investment and experience to achieve.
The speed at which China’s online giants are making e-commerce accessible to outsiders will help companies from South Korea that have a good following at home but lack the scale to expand overseas. As South Korea continues to attract millions of mainland tourists annually, recognition of domestic-oriented brands will spread through China and create follow up demand.
Right now, investors seeking to benefit from Chinese interest in South Korea are focusing on duty free stores. But the next phase of investor attention will be consumer brands that attract attention from Chinese customers seeking to buy outside duty-free channels. E-commerce and information distribution via the Internet will accelerate that process.
As China tries to promote domestic consumption to compensate for the declining economic growth coming from falling investments, the tax incentives that duty free stores attract will have to decline. That will put brand owners in pole position in the China market rather than traditional retailers such as department stores, hypermarkets and duty free channels.
Peter S. Kim
