China B2B trading platforms: Business friendly

In Zhaogang, a company that connects suppliers and buyers of steel products, investors in China’s B2B trading space might be about to see their first liquidity event. The platform, which filed for Hong Kong IPO last year, has gone through five funding rounds since its establishment in 2012. Zhaogang’s valuation of more than RMB17 billion ($2.5 billion) is justified by its status as China’s leading online marketplace for steel, with a registered customer base of 106,000 and a gross merchandise volume (GMV) of RMB60 billion in 2017. 

B2B platforms have attracted far less attention than their B2C and C2C peers, which include multi-billion-dollar players like JD.com and Alibaba Group’s Tmall and Taobao. But Zhaogang has shown that you don’t have to be consumer-facing to become big – and it only operates in one vertical. 

“In the US, there are between 10 and 20 B2B platforms with market capitalizations in excess of $10 billion. Such companies will likely turn up in China soon, so the B2B space looks lucrative,” says Jiayu Yi, a partner at Buhuo VC, which has invested in B2B platform Wanqiangongpin, a marketplace for industrial equipment components including bolts and springs.   

There are more than a dozen major B2B platforms in China, most of which emerged in 2012-2013. They operate in verticals such as pharmaceuticals, fabrics, fast-moving consumer goods, and industrial products and materials. Investors are already reasonably active in the space, participating in everything from early-stage bets to late-stage rounds for the likes of Zhaogang. Local e-commerce news portal 100ec.cn claims investment reached RMB21.2 billion in the first half of 2018, up 60% year-on-year. 

The core function of these platforms is simple: using technology to aggregate demand and supply in fragmented markets and allowing customers to find pricing information and make trades with a few clicks rather than phone calls and factory visits. Zhaogang claims that by eliminating intermediaries between manufacturers and end-users it can deliver cost savings of 5-10%. Repeat customers account for more than 80% of transactions.

Zhaogang has also established a trend of platforms trying to further monetize this loyalty by providing logistics, warehousing, processing and data analytics services as well as financing solutions for small companies. Nevertheless, nearly all the company’s RMB17.5 billion in revenue for 2017 was generated by buying steel products from manufacturers and selling them directly to customers. Value-added services – as well as fees for brokering transactions between third parties – accounts for only a small part of the business. Investors expect this to change.

“Zhaogang is doing really well and is likely to list soon. Both its commission-based business and its additional services are growing quickly,” says Guillaume Dry, a partner at Bull Capital Partners, which committed around $29 million in the company across two funding rounds between 2013 to 2015, according to AVCJ research. Zhaogang has raised RMB2 billion in total from the likes of Sequoia Capital China, Matrix Partners China, Huaxing Growth Capital, and IDG Capital Partners.

An evolving model

The early B2B platforms were mostly created using offline agents, who captured supplier and customer information in person or over the phone and then aggregated by hand. Needless to say, it was difficult, if not impossible, to achieve scale on a national level. 

By the 1990s, online marketplaces had emerged, with Alibaba’s 1688.com and Hong Kong-listed Huicong360 among the most prominent practitioners. They created the essential virtual infrastructure for businesses to connect with other businesses, by offering tens of thousands of small companies the chance to list their product information. Gradually, Yellow Pages was supplanted by online alternatives.

Both 1688 and Huicong360 still exist, but they remain broad-based business models. This was the gap in the market identified by the second generation of platforms. In addition to Zhaogang, they include Baibu, Meicai, Zhangshangfucai and Yijiupi, which specialize in fabrics, fresh produce, home decoration materials, and consumer goods, respectively. In each case, the goal was to leverage technology to disrupt inefficient segments, even if businesses in these areas had previously done little trading online. 

“Zhaogang came as a pleasant surprise to many investors in that it engaged in the business of steel trading, a vertical that previously saw limited online penetration. We have since seen more and more B2B platforms emerge across multiple verticals in China, in part due to higher mobile internet penetration,” says Xingshi Wang, an executive director at Source Code Capital, one of the most active GPs in China’s B2B space. “We believe B2B platforms have potential across other verticals, with growth dependent on how fast players can transform their underlying businesses into online marketplaces.”

If achieving scale quickly is the key to making a new platform concept stick, investors warn that this does not have to come at the expense of economic viability. Companies can become sustainable by cultivating strong and exclusive relationships with suppliers and buyers, and making good use of the data generated, rather than offering subsidies to build market share.

“A lot of B2C platforms gave out subsidies at crazy rates and they died. In the B2B space, you can spend money on boosting your traffic and GMV, but you also need to consider whether you are in the right industry or have the right customer group so that you can reap meaningful rewards later,” says Hao Li, an executive director at Lighthouse Capital, a financial adviser that has worked on numerous B2B platform funding rounds, including those involving Yijiupi.

Picking the right industry at the right time appears to have been integral to Zhaogang’s breakthrough. Several state-owned groups that operate in the steel trading space tried to move their businesses online around 2000, but at that time there was a shortage in steel production capacity, and sellers had little motivation to find new sales channels. By 2012, though, under capacity had become overcapacity, so there was sufficient demand for a platform that made pricing more transparent and transactions easier. 

A good fit

Industry participants agree there are several general characteristics that make a vertical suitable for B2B players: fragmentation on both the supply and demand side; no standardization in the transactional process; and goods that frequently change in price, which means transparency is attractive to traders.  

Baibu is a case in point. The company has raised over $155 million across five rounds of funding from investors such as Source Code, Yunqi Partners, Chengwei Capital and Bull Capital. The GPs were attracted by the big picture numbers: China’s fabric industry is worth RMB19 trillion and is populated by more than 5,000 suppliers producing about three million types of fabric. Baibu had a meaningful market to attack and it duly built a customer base of 4,000 top-tier suppliers and 100,000 garment manufacturers.

“Textiles do not come with universal standards. On one level, there are textiles made of different materials, and on another level, you have various colors and patterns for each product, which implies that the number of stock keeping units (SKUs) can be very large. Baibu’s value lies in that it provides both suppliers and buyers with a cost-effective online marketplace,” says Wang of Source Code.

In addition, the company is like Zhaogang in that it primarily sources and sells products itself, rather than functioning as a traditional marketplace and receiving fees for brokering transactions. This gives it more control over pricing and wider profit margins. “The core of Baibu’s business is aggregating customer demand and then directing such demand to factories. In this way, the company helps to redistribute and optimize the allocation of the factories’ capacity,” says Li of Lighthouse.

Taking advantage of the pricing differential between goods sourced and goods sold does not necessarily leave customers out of pocket. Yijiupi, for example, aggregates orders from multiple buyers and secures discounts from manufacturers because it buys in bulk. If customers went through normal channels, passing orders through several regional and local liquor distributors, each of which takes a cut, their cost would still be higher. 

However, there is a reason they B2C platforms tend to opt for the marketplace model and generate revenue from transaction fees and advertising services. Engaging in direct sales means taking on inventory risk, so a sudden shift in demand that results in product going unsold could blow a hole in their balance sheets. 

Direct sales is arguably a more feasible approach in the B2B space because it is confined to specific verticals – platforms are dealing in smaller volumes and demand patterns are easier to predict. That said, profit remains elusive. Zhaogang incurred a net loss of RMB124 million for 2017, down from RMB822 million for 2016, partly due to rising costs relating to the procurement and storage of stock.

Diversification of revenue channels is seen as the way forward. While charging membership fees – as is the practice among older players like Huicong360 – may not be the answer, start-ups are keen to establish a presence in supply chain finance and other value-added services.

“Breaking into supply chain finance is almost a must for B2B players as they have a lot of data and insights on certain verticals, so they can do better risk control,” says Yi of Buhuo VC. “Whether it means lending from their own balance sheets or bringing in banks as partners, there are viable ways to do this kind of business.”   

 

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• Topics
• Greater China
• Technology
• Industrials
• Expansion
• Early-stage
• China
• TMT
• Bull Capital
• Source Code Capital
• Buhuo VC