China's pet products industry: Paws for thought

Kanglin Li, a partner at Tiantu Capital, started looking at opportunities in China's pet products and services industry in 2010 after a few foreign private equity firms made investments in the space. He didn't like what he saw. "We found that the sales channels for products and services were highly fragmented and hard to scale up, while the products specifically were dominated by foreign brands," Li recalls. "We couldn't identify any domestic company worth betting on."

Fast forward to 2017 and the situation has turned on its head. A cluster of strong domestic players have emerged, such as Crazy Dog, a pet products manufacturer that also maintains a strong online retail presence. The company won backing from Tiantu last year and it has now raised RMB400 million ($57 million) across two funding rounds. Fosun International, AB Capital and Ares Asia Management are the other investors.

Once dismissed as purveyors of low-quality goods, China's pet products companies are now marching on a fast-growing middle market, while foreign brands still occupy the luxury segment. Rising disposable incomes are responsible for this phenomenon, but so too is the bond between man and beast. From young singletons living alone in the city to aging parents whose children have left home, pets are a growing source of emotional support.

"China's pet industry is going through a phase of rapid development. Owners have become more advanced and scientific in how they raise their pets, while people who don't own pets are consuming more pet-related content [such as online video]," says Surea Liu, a managing director at Fosun RZ Capital, the VC arm of Fosun. "The growth of the industry will continue at a rapid pace."

The challenge for investors is picking a vertical that makes sense and then moving in quickly on target companies before the leading players are snapped up.

Big spenders

Spending on pets will reach RMB472 billion over the next five years, up from RMB172.2 billion in 2018, according to Frost & Sullivan. Last year, average expenditure per cat or dog hit RMB5,580. This money is flowing into three main categories: pet services, including healthcare providers; online and offline retail sales channels; and staple foods and other pet products such as toys. The latter category is the largest.

The enduring obstacle in pet healthcare is fragmentation. Hillhouse Capital has made approximately seven investments into companies that together control more than 1,000 clinics, including Ruipeng Pet Hospital, which operates almost 400 outlets. Yet scale operators are few and far between. There are more than 17,000 clinics in China, suggesting that consolidation will be drawn out and hard to predict. 

"Few owners would drive several miles only to get their pets admitted to a famous clinic. The most important factor influencing consumer choice is convenience, especially how close clinics are to the home," says Li of Tiantu. He believes the pet products opportunity is much larger, with the potential to monetize the brand through parallel channels as well as sell goods. 

Meanwhile, the dominance of established platforms dedicated to selling pet food and supplies on Alibaba Group's Tmall, JD.com and Amazon offers little hope to new market entrants. Tellingly, around 95% of pet products sold online in China last year were transacted through Tmall and JD.com. This may not bode well for specialists like Epet.com, an online pet products retailer that was founded in 2008 and raised funding from IDG Capital in 2017.

"We approach the pet industry from a consumer goods perspective, which we believe is the best angle for investing in the space. The industry leaders have already been formed and they have set the entry barriers high," says Liu of Fosun RZ.

For those targeting pet products, the preferred strategy is to back businesses with a high level of brand awareness. Industry participants argue that a strong brand not only signifies quality but it also helps conveys a fun and healthy image to consumers. Companies need to position themselves carefully if pet products follow the same evolutionary curve as baby products, as Tiantu's Liu predicts. 

"Chinese consumers might prefer foreign brands when they first become parents or pet owners, but gradually, as they build up experience, they will start to notice domestic players," he explains. Once that tipping point is reached, it is imperative that brands break through on Tmall and double down on their newfound recognition.

Tell a story

Crazy Dog achieved this goal, ranking third among Tmall's dog food brands by sales as of March 2018. Smart pet devices manufacturers PetKit and Pidan have also found popularity on e-commerce platforms. All three were successful in leveraging social media channels, including ByteDance Technology's TikTok short video platform to stimulate consumer interest. 

This is an area in which most foreign brands are playing catch up as they continue to rely on either local suppliers or third-party service providers that manage their online presence. Neither of these partner types has the bandwidth to saturate social media – but ultimately brands will be judged on more than just marketing.

"Just having a good promotional strategy will not enable a company to enjoy a market-leading position forever. They need quality products and a deep understanding of their customers," says Alex Zhang, a partner at Hosen Capital, a mid-market food and agriculture specialist that has invested in the pet food space internationally. "This does not mean young companies cannot have good prospects, but they have a long way to go before they can become mature consumer products companies."   

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• Topics
• Greater China
• Consumer
• Technology
• Early-stage
• Expansion
• China
• Tiantu Capital
• Fosun Group
• Hosen Capital
• Growth capital