Ep. 58: China Grocery E-Commerce: Bloodbath or Gold Mine?

Transcript

(Y: Ying-Ying Lu; R: Rui Ma )

[00:00] Y: Happy New Year! It’s been a few weeks since our last episode! We hope that everyone had a fabulous holiday season and are having a great start to the new decade. We’ll get one more episode out to you in time for the very tail end of the Year of the Pig, and then all of China will be off for a week to welcome the Year of the Rat, which officially begins on the 25th of January, 2020.

R: Those are usually light news days, although not necessarily light work days. It depends on which company you’re working for. Life could be pretty rough if you’re working on the WeChat wallet team, for example. That’s because if you remember our Episode 38 on Battle of the Red Packets, sending money to each other in celebration of the New Year is a national obsession. It has also become a key battleground for Chinese internet companies to win over new users during the biggest festivities of the year.

Y: It’s one of those things that’s hard to understand unless you live in China. But for all of you today, we are covering a topic that’s got a much lower cultural barrier — grocery e-commerce. Yup, buying fresh food over the internet.

R: Does it though? While the concept might be easy to understand, I would argue that it’s one of those things that is more tricky than it appears precisely because it seems so intuitive. Unless you’re a plutocrat or celebrity with an army of staff, you probably have been to buy fresh food yourself. But depending on where you live, a lot of your intuitions may not actually be true, because well, the daily details of living in China may be quite different from what you’re used to.

[1:49] Y: So we’ll go over those and make sure we’re all on the same page, and then we’ll try to answer the question why grocery e-commerce is so exceedingly popular in China as a startup category to fund, how it’s evolved over the years — because it has actually been the “hot thing” for most of the last decade, not just 2019 — and why it’s been so extraordinarily hard to get it right.

R: Yeah, at this point it doesn’t seem like anyone has pulled it off at scale, really, not even your usual suspects. Alibaba, JD and Meituan have all sunk in serious money and resources, but all seem to have hit roadblocks. As for the smaller players, winter isn’t just coming, it’s here. At least three very well-funded startups in the space were recently in the news for having run out of money, closing down locations, or mass layoffs.

Y: So let’s see. By the end of this episode, we hope we’ll have helped you form an opinion on the Chinese grocery e-commerce market. Is it a bloodbath or gold mine? You decide!

[3:21] R: Hi everyone! We are TechBuzz China by Pandaily, powered by the Sinica Podcast Network by SupChina!

Y: We are a biweekly podcast focused on giving you a peek into what’s buzzing within the tech community in China.

R: We uncover and contextualize unique insights, perspectives and takeaways on headline tech news that don’t always make it into English language coverage. So you can be smarter about the world of China tech. TechBuzz China is a part of Pandaily.com, an English language site that tells you “everything about China’s innovation.” I’m one of your two co-hosts, Rui Ma.

Y: And I’m your other co-host, Ying-Ying Lu. We’d like to acknowledge our partners DealStreetAsia and SupChina, the creator of the Sinica Podcast Network! In addition to TechBuzz, you can also find Sinica which covers current affairs, NuVoices and Ta for Ta on women, the business-oriented ChinaEconTalk, and the Caixin-Sinica Business Brief from China’s leading business magazine.

R: Also a shoutout to our friend Matt Sheehan who just launched Heartland Mainland, a podcast on Iowa and China from MacroPolo. We love it when our friends create awesome stuff. Anyway, as always, if you enjoyed listening to TechBuzz, please leave us a review on iTunes or whichever other platform you use.

[4:44] Y: Oh, and one more thing before we start, we want to tell you about a brand new Master’s program nearby, at the University of San Francisco. USF’s Master’s in Applied Economics combines econ training with the practical skills in data analytics that you really need to understand today’s new digital economy. Their curriculum covers skills like R and Python, machine learning, and experimental design. To learn more and to get a fee waiver for the Fall 2020 class, please go to usfca.edu/techbuzz.

[5:24] Y: Before we begin, let’s clarify what we mean by grocery e-commerce. And unfortunately, the definition is actually somewhat convoluted. In Chinese, what we’re talking about is 生鲜电商, which translates to “fresh food e-commerce,” but most people, by which we mean investors, entrepreneurs, analysts, and journalists, also include within this category “new retail” concepts like Alibaba’s Hema, which are offline supermarkets with mobile-app driven experiences and home delivery capabilities.

R: So not really e-commerce, but a hybrid online-offline experience, which means that technically, they should really be saying, 生鲜电商与生鲜新零售, or grocery e-commerce and grocery new retail, but most people aren’t this exact, and usually mean both, as we also will in this episode, because when it comes to shopping for groceries in China using technology, we just don’t think you can exclude the new retail part of it.

Y: No you can’t, although new retail is one of the newer additions into the space. You see, there’s been at least a few waves of investments. Actually, if you go on Zhihu, China’s Quora, which we covered, you’ll see that there are people referring to grocery e-commerce as the hottest trend of 2013. Yeah, That’s a long time ago, at the beginning of the last decade, before the years of what we’d call the hypergrowth of Chinese consumer internet.

R: Yeah, I can barely remember back that far, things were pretty different then. But unlike most other top trends that have come and gone, usually after a winner emerges to clean up the market, this hasn’t happened in grocery e-commerce. The lack of a solid success has not stopped people from continuing to jump in though.

[7:21] Y: Not at all. According to incomplete data from the Chinese Institute for e-Commerce, $1.7Bn was invested into Chinese grocery e-commerce startups in 2018, and while 2019 data isn’t out yet, there’s every reason to believe that the enthusiasm for this sector hasn’t abated in the least. In fact, pretty much everywhere you go, you’ll hear that this is one of the few “blue oceans” in Chinese internet.

R: Chinese people love the blue ocean / red ocean analogy. Blue oceans, of course, refers to the as of yet unexplored, unexploited, and therefore hopefully profitable market opportunities. Why’s grocery e-commerce a blue ocean? Well, the reason given is pretty simple — immense market size and high purchasing frequency. By immense, we’re talking about a total grocery market of over 1.3Trn here. Trillion, not billion.

Y: Impressive addressable market size, as would be expected for such a basic necessity, but let’s not forget that blue ocean means unexploited opportunities, which this segment has, because it’s got such a low e-commerce penetration. In China, where some categories like consumer electronics are already at more than 40% in terms of online retail penetration, groceries is under 5%.

R: So you guys probably thought two things when you heard that — at a trillion dollar market size, even a few percentage points has many zeros after it, so there must be some multi-billion dollar players already, right? And two, if people have been working on this since 2013 or earlier, how’s it that penetration is not even 5%?

[9:15]Y: Well, since we already know that the definition of grocery e-commerce isn’t the most precise, we can just provide a directionally correct number here, but basically somewhere along the order of $35Bn. So yes, to your first question, very large market size, and still growing very quickly, by the way, with projections of a 35% annual growth rate over the next three years. However, there’s no super large players yet, aside maybe from Alibaba’s Hema that we mentioned earlier, because there are literally thousands of players in the space.

R: Yup. 4000 players, actually, who’ve entered the space in the last few years, according to analysts. And why haven’t you heard of them? Well, it could be that 9 out of 10 were loss-making, and so probably are either dead or dying, with just 1% estimated to have made it to profitability. 1% of 4000 is 40 companies. Well, I don’t know, if you ask me, even 1% seems a stretch. The number might be in fact closer to single digits.

Y: It’s honestly not very easy to verify, because these are mostly private companies or subsidiaries within larger firms, but let us tell you about the one everyone talks about, and that is Yonghui Cloud Technologies — which operated a series of new retail grocery stores called Super Species 超级物种. Yonghui, the parent company, is China’s #5 grocery chain by revenue, and in recent years received investment from both JD and Tencent. Because Yonghui is listed in China, there are some numbers we can actually look at here.

R: Large, existing grocery chain partnering up with the second largest e-commerce player JD.com and later with the support of the largest check-writer in China tech, Tencent. What could go wrong? I remember coverage of the first deal, when only JD invested, was mostly positive. That was back in 2015, by the way, before Pinduoduo burst onto the ecommerce scene, when it was still just JD vs. Alibaba.

[11:32] Y: Well, apparently even this winning combination was not enough. Over three years, the stores lost about $150mm, which meant that its net margin over this time period was -50%. Very painful for a publicly listed company with already pretty thin earnings. Worse when this was a concept where losses widened as the business expanded into different cities. In any case, apparently the losses were alarming enough that the board decided it had to be divested.

R: But the founders, who are a pair of brothers seem to believe in the strategy long term. One of the brothers stayed on Yonghui, and the other left to run Yonghui Cloud. It’s probably easier to fundraise for the new retail business separately because it’s got a totally different risk / reward profile from the core stores. But even if you’re cash rich, like Alibaba, you’re not necessarily hitting out of the park either.

Y: Right, Alibaba’s concept is Hema or freshippo, because it sounds like hippo in Chinese, in line with all their animal themed products. You can google for videos of the stores if you’ve never seen one, but basically, I’d describe them as pretty nicely decorated supermarkets but with two key differences: delivery people fulfilling online orders into baskets that whiz by above your head on a conveyor belt like contraption, which I actually found to be quite noisy; and food stalls where you can eat things made-to-order, say from the seafood you see in the tank in front of you.

[13:11] R: Right, they also tout the fact that everything is digital, meaning you can scan the items and pull up more information on them inside your app, and of course pay for your purchases digitally, but I would also consider them super minor conveniences. Honestly, I would choose a Hema over many other stores simply because it’s just a nicer place to shop. There are fancier chains in China, but those are really upscale and not affordable for the average person.

Y: If we really had to describe it, in our opinion, a Hema is kinda like a better-than-Safeway but not-quite-Whole-Foods level grocery store. But what are the alternatives? Most supermarkets are smaller and not as nice, or you can shop at hypermarts like Walmart which are much bigger and sell everything else in addition to groceries. But also not very nice. So we can see the appeal.

R: But, that’s if you go to the store, right? Presumably, all the nice decor would mean nothing to you if you’re ordering online. I mean, I get the point that the nice stores are a great way to attract customers initially, and it’s true that for many sectors, online acquisition costs have ballooned out of control making offline acquisition channels cheaper than online, but what about in the long run?

[14:40] Y: Well, it doesn’t look like we have to wait to answer your question because the long run seems to have maybe already arrived. Since launching in 2015, there are already over 150 Hemas in 17 Chinese cities, with more than 20 each in Beijing and Shanghai and 15 or so in Shenzhen. But the pace of store openings has already slowed significantly, and one location even shut down within a mere 8 months of opening.

R: I don’t want to be annoying and say “I told you so” but from the very beginning, I was very very skeptical. The format just didn’t make that much sense to me. Again, it’s a nice store, but the niceness seems expensive to upkeep and doesn’t matter to me for online orders. And yet the entire Chinese internet jumped in and tried to create their own Hema because Jack Ma christened it with the name New Retail. Jack Ma, is after all, pretty much the godfather of Chinese e-commerce. When he talks about the future of how people are gonna shop, everyone listens.

Y: So that’s what happened. We already know Tencent and JD made a bet with Yonghui Super Species. Tencent also invested in Carrefour 家乐福, the French supermarket giant, in 2017, which we’ll assume wasn’t an amazing bet because it didn’t try to buy the chain’s China operations when it looked to sell a majority stake last year.

[16:12] R: There’s also Meituan, whose concept was called Ella Supermarkets, and JD, whose own entry was called 7Fresh, even though yes, it had invested in Yonghui, and had a partnership with Walmart as well. And the folks who eventually bought Carrefour China? That was Suning, which was founded years ago as a consumer electronics retailer, has since then expanded aggressively into e-commerce in recent years with Suning.com, with Alibaba in tow as a major partner and shareholder. But Suning also had its own concept, SuFresh.

Y: You get our point. All the top internet companies in China were busy entering into investments or partnerships with offline grocery chains and launching their own new retail concepts, effectively making multiple bets in this space. Amazon bought Whole Foods in 2017, but Chinese tie-ups between internet companies and offline grocers have been happening since 2015, with a lot more activity than we’ve seen in the US.

R: Because … blue ocean. Signs that the ocean isn’t quite so blue though emerged when not just Alibaba Hema, but also Meituan began closing stores in the first half of last year, due to “mismanagement,” although we’ve seen that referred to in Chinese as not meeting financial expectations. Whatever the true reason, it seems that they’re planning to shutter lower-tier city locations and focus on Beijing for the moment.

[17:42] Y: JD also failed to reach its ambitious store opening targets, which I think by now doesn’t surprise anyone. But don’t think that these companies have given up trying. No, the trend of the last year was basically to deploy another model that we think makes more sense — downsize. That is, think more small neighborhood grocer, rather than proper chain supermarket.

R: So here is a good segway into what exactly is the current buying behavior of Chinese consumers when it comes to grocery shopping? Well let’s take a look at myself first, a typical Californian. I do all my own shopping, and I mostly buy from the supermarket. Sure, farmer’s markets are great, but they’re inconvenient because of their limited hours. And I just don’t care enough about produce to spend time sifting through bunches of celery to look for the least wilted stalks. If it’s organic, it’s good enough for me.

[18:40] Y: Well, congratulations Rui, that does makes you a typical American consumer. In the US, 90% of grocery shopping is done through supermarkets. But, that’s not at all the case for China. Nationwide, nearly three-quarters of Chinese groceries are still bought in wet markets or 菜市场, which are like your farmer’s markets in the US, except generally a lot dirtier, messier, noisier, and maybe also more meat and seafood heavy.

R: Yeah, I lived next to one in Shanghai, and it was very, shall we say, pungent. But it was also super convenient, because it had everything. I mean, some urban wet markets in China are huge. But I rarely went, because while the prices and quality were great, they would be closed by 7pm or earlier. Now, I didn’t cook much anyway because I had a helper that did sometimes, but I can’t imagine with the 996, working schedule that many professionals have these days, that is 9 a.m. to 9 p.m. 6 days a week. They can’t hope to get home by 5 to get to their local wet market to buy the ingredients to make dinner. There’s just not enough time!

Y: That’s exactly it. It can be hard to make it to a wet market if you’re working, especially with some of these long commutes Chinese people have. And plus, it’s just a stressful, noisy environment. If you’re younger and less price sensitive, you’re much more likely to want to go to a supermarket, where the produce is generally more expensive, but it’s just much more convenient. And these are the people who’re also easy to convert to using an app.

[20:21] R: That is, if they’re cooking at all, because so many people I know only order out these days. But yeah, consider a typical Chinese scenario. If you’re a frequent grocery shopper, in other words, the type of customer all these grocery e-commerce companies want, you’re highly likely to have a chill job, be stay-at-home, have a helper, or just be older and retired. And by the way, retirement age in China is as young as just 50 years old for females, so there are a lot of retired folk.

Y: That last group is actually doubly important because plenty of young people in China live with their parents, some even after marriage. This group of uncles and aunties, 大爷大妈们, hold a lot of purchasing power in this market. It’s this group that is the target audience of Hema mini, which is what it sounds like, Freshippo’s small store concept from Alibaba, just launched in the second half of last year.

R: We haven’t yet gone to visit one in person, but it’s pretty self-explanatory. They’re much smaller, at 10,000 sqft or so, with just 4,000 SKUs, compared to 10-20K for a regular supermarket. They’re also much cheaper to set up, costing only $300,000 or so, less than 1/10 of a regular Hema. There are no gimmicky conveyor belts, although you can still order online and get it delivered, but also, it just looks a lot less nice than a regular Hema. For one, the produce is not individually shrink-wrapped but sold like you see in a wet market, just in a pile so you can pick and choose the exact carrot or celery stalk you want to take home.

[22:11] Y: The produce in regular Hemas are indeed individually wrapped, for aesthetic reasons and also to reduce spoilage and maintain freshness. But for the Hema Minis’ uncles and aunties, they want the best produce and have the time to spend picking it out. They’re also price sensitive and not environment sensitive, which means that they’re not going to accept the markup for a nicer shopping environment when as far as they’re concerned, the cheapest and tastiest wins.

R: They’re also not tech-savvy. Which means, there is a cash checkout line at Hema minis, unlike Hemas which are all digital. But you can also use Alipay, of course, usually for an additional discount, and that’s how they’re training the uncles and aunties in the suburbs of Beijing and Shanghai and rural China to do “grocery e-commerce.”

Y: But is this really e-commerce? How is this different from just building out retail stores? Very good question. We don’t know, but maybe it doesn’t matter, at least for now. If China is to go the way of the US, then that 70%+ wet market share is probably going to go down, maybe get shifted mostly to supermarkets, so now seems a good time to jump in and build a business.

R: I can’t see millennials or younger people really enjoying the wet market experience, unless they also get major upgrades, so I’d have to agree that just that demand alone is super enticing. But, is a hybrid offline-and-online solution like a Hema Mini the way to go? Or should we be looking at purely online solutions, because that’s the way everything seems to be going anyway?

[23:53] Y: Yeah, I mean even the newly launched Hema Minis are seeing 50% or more of their orders coming from online, so maybe all that joy about picking out your own groceries is overrated except for the extremely picky customer. If you are of the “it’s all going all online soon” anyway mentality, then you’re thinking more like Wang Xing at Meituan, who launched Meituan Maicai 美团买菜 last year.

 R: Meituan Maicai, which literally means “buying groceries,” is a pure-app offering, because there is no storefront to visit. There is a physical location, but that location is a small warehouse, or what the company calls a “service center,” where drivers go in and pick up orders to serve the surrounding community. It’s not a store. Deliveries are for residents within a roughly 1 mile radius and don’t have a guaranteed time, but the app notes that it can be “as low as 30 minutes.” I actually tried to order something when I was in downtown Beijing last week, but alas, I was not in a service area.

Y: No surprise there, because Meituan’s strategy has always been to go after the lower-tiered cities first, and that’s precisely where it dominates in food delivery as well, but it’s also where every e-commerce player is focused these days in China anyway. But maybe Meituan has an advantage. Currently, Maicai has no minimum basket size and no delivery fee. According to Meituan, the grocery delivery business is really complementary to their food delivery business because food delivery has lumpy demand, usually centered around mealtimes, whereas groceries, if there is any spike at all, would be before mealtimes, or at least, not at mealtimes.

[25: 38] R: Let’s not make it seem like Meituan is the first to do this. Not at all. This has been around for a while. Remember Yonghui from earlier? Well, they launched a similar product called 卫星仓, or Satellite Warehouse, back in 2018. 3000-6000 sqft in area, 3000 SKUs, temperature controlled, with about 1-2 days worth of goods. Also delivery only, within a 2mile or so radius.

Y: And there are a ton of independent startups doing this. It’s impossible to talk about them all, so we’ll mention one of them briefly, and that is the Tencent-funded MissFresh, 每日优鲜 in Chinese. It’s raised $1.4Bn since being founded in late 2014, making it one of the highest-valued private companies in this space. But other than a membership based system for promotions and to increase user stickiness, it’s not that much different from the two much younger services we just mentioned.

R: Yeah, it basically has a “last mile” distribution center network from which it delivers about 2000 SKUs of mostly fresh foods, but also common non-perishable kitchen items. Some Chinese analysts translate their centers as “front warehouse,” to distinguish from the warehouses in the back of the store of a hybrid solution like a Hema. Whatever you want to call it, it’s the hottest thing in China grocery e-commerce right now, after new retail failed to be as world-changing as Jack Ma promised.

[27:10] Y: The companies are trying to give it new-fangled names so as to sound like it’s something innovative, but I think we all know that this is just nothing more than basic logistics. The difference though, is that this network is much more complex to build out than say, mailing packages of nonperishable items. Those of you who have any experience in food at all will know what I’m talking about — the cold chain.

R: Simply speaking, transporting food, especially in today’s world when the place of origin of the food can be very far away, maybe even across the world, from where it’s ultimately sold, is a very complex thing. Many items need refrigeration, or maybe even freezing. And different foods need to be refrigerated at different temperatures. All that, if you didn’t know, is called the “cold chain.”

Y: China’s cold chain market was about $40Bn in 2018, and growing at double digits, so it’s not small. But, for such a large country and population, it still lags far behind developed countries in freezer capacity and refrigerated trucks per capita. I didn’t know until I was researching this episode, by the way, that these were things people calculated, but it makes sense. These are numbers that probably scale close to linearly with population, so we can be fairly confident that unless Chinese people all begin only eating locally, those numbers are going to have to grow as living conditions improve and everyone eats better.

[28:44] R: And cold chains are not just about buying more refrigerated trucks. Setting up software-enabled monitoring and inventory management systems are crucial as well. Since the industry was super fragmented as late as 5 years ago, we’re talking about the top 100 firms making up less than 0.5% market share, it seems that many players have gone ahead in building out their own systems out of necessity, which has of course taken lots of money and time. Take a company like Benlai, who’s one of the few profitable companies in this space and who made its name selling fruit online. After 7 years, it’s managed to build seven 600,000 sqft cold storage warehouses in major cities. Impressive, but also, took a long time!

Y: Even when you’ve solved the cold chain capacity problem though, you have another problem on hand — inventory. How are you going to know what to keep in stock when you’re using these small warehouses with just a day or two of goods on hand? Most companies are seeing this as a machine learning and data challenge that they can solve with AI. The one who does it best is going to have the least waste and maybe also the best customer experience.

[29:53] R: OK, I think we’re pretty groceried out by this point and I am ready to wrap up the episode. We covered a bunch of stuff today, but there are a few key takeways that we’d love for you to walk away with. I’ll start. One: the Chinese grocery e-commerce market is super fast growing and attracting a ton of investment and interest. People believe that it’s one of the few remaining “blue ocean” e-commerce opportunities because even though it’s already at $35Bn, that’s still less than a 5% penetration of the entire Chinese grocery business, which is,by the way, literally a trillion dollar business.

Y: Two: the penetration rate is low for several reasons. There’s the cultural one, where that’s just not how many Chinese consumers, especially older individuals, buy groceries. The vast majority still make their purchases at the local wet market, where the perception is that quality is higher because it’s more fresh, selection tends to be greater, and prices are often lower as well. The opportunity though, is that the hours are not practical for your typical office worker, and the environment is not very nice. So if you’re looking for a relaxing and convenient shopping experience, this is not it.

R: Three: another reason the industry hasn’t just flipped from offline to online immediately is the fact that this is just a difficult logistical problem to solve. Food requires what’s called a cold chain, with lots of temperature-controlled warehouses and trucks and the like, and this simply takes time and money to build out. The perishable nature of produce also makes inventory management a challenge. But presumably, software and sensors are going to make these problems much more manageable soon.

Y: And these factors, mixed up together, is how we’ve ended up at today’s industry landscape, which has two main ways you can cut it. One is by whether the service is purely online, or hybrid online-offline. The former is just a network of warehouses, whereas the latter is usually referred to as grocery new retail in China, or 生鲜新零售, and one of its best known examples is Alibaba’s Hema supermarkets.

[32:16] R: The other way to categorize this sector is by distribution network and coverage. Are your warehouses sparse and large, or are they dense and small? Each Hema supermarket, for example, needs a surrounding population of at least 200,000 to survive, whereas their Hema Mini concept, requiring just 1/10 the startup capital, also needs a much smaller base of buyers to break even. In tier-one cities with dense downtown areas like Beijing and Shanghai, the larger markets seem to do okay, but as soon as you get out of those areas, most of the players are trying the nimble, smaller footprint model now.

Y: The suburbs and rural China have been the overwhelming opportunity for most Chinese internet companies in the past few years, and it looks like grocery e-commerce is no exception. So it’s one of those markets where everyone knows where to go, but it’s unclear which decisions are the right ones to make. For example, do you only run your own inventory like Meituan or also deliver for other platforms like JD and Alibaba?

[33:25] R: Yeah, and do you keep on building on your own, maybe with offline partners, or adopt something new altogether, like franchising, which Alibaba has said they might explore with Hema Mini, and which MissFresh has already been using as a model of expansion?

Y: It’s risky though, as managing the franchisees and making sure food safety standards are observed can be tricky, and MissFresh has come under fire for that. Since food safety is no joke, and it’s also the top concern for Chinese consumers, I hope they take it much more seriously than they have been.

R: So what do you think? Chinese grocery e-commerce — bloodbath, or gold mine? We think it’s going to take a bit of time and a lot more investment before the logistics are sorted out, but when safety and quality are both up to par, surely the wet market lovers are going to discover the wonders of ordering from their phone and find something else to do with their time, like more square dancing 广场舞. Tweet at us and let us know what you think!

[34:43] R: OK, that’s all for this week folks! Thanks for listening. We really enjoyed putting this together, and we are always open to any comments or suggestions. You can find us on twitter at thepandaily, at techbuzzchina, and my personal Twitter account is RUIMA.

Y: And my Twitter is spelled GINYGINY. Techbuzz China by Pandaily is powered by the Sinica Podcast Network on SupChina. Pandaily.com is an English language site that tells you “everything about China’s innovation.” Our producers are Caiwei Chen and Kaiser Kuo. Thank you for listening!