China fresh produce retail: Changing channels

Fresh produce retailers with online ordering and offline delivery capabilites were among the main beneficiaries of COVID-19 in China. With cities under lockdown, families had no option but to eat at home and needed their supplies.

Bunnymaicai, an online-to-offline (O2O) grocer, tells AVCJ that sales increased nearly fourfold during the pandemic. Yipin Shengxian – which operates community supermarkets coupled with an online ordering app – has increased its targeted new store openings for 2020 from 650 to 800. Nice Tuan, a community group-buying platform, saw a fivefold jump in paid users between February and March.

“People used to say that China’s internet users have all been discovered, and there is no more space for growth, but suddenly we are witnessing another wave of growth. COVID-19 has forced people to build new habits,” says Wei Zhou, founder of China Creation Ventures.

Investors are throwing money at these companies. Yipin Shengxian raised RMB2.5 billion ($360 million) in Series C funding last month, while Nice Tuan has secured about $240 million this year across three funding rounds. In July,  online grocer Miss Fresh secured $495 million.

The speed and size of these investments – and the valuations they attach to the underlying companies – appear to be of little concern.

Joy Capital, an investor in Nice Tuan and Bunnymaicai, notes that fresh produce is one of the few industries in which the internet has yet to make a significant impact. Three-quarters of China’s fresh produce is still bought at wet markets. The e-commerce share was 3% in 2018.

What is a store?

Nevertheless, there is fierce debate as to which business model can most effectively capture this trend, notably whether an offline presence is necessary. “Fresh produce is not something that can be entirely online. That’s why Amazon bought Whole Food and Alibaba launched its Hema supermarket chain,” says David Wei, a founding partner of Vision Knight Capital.

As the boundaries between online and offline continue to blur, the function – even the definition – of a store is changing. Yipin Shengxian is primarily an offline player with about 900 stores across 17 cities in China. But its community supermarkets operates under a franchise model, with existing convenience stores often added to the tally of new outlets when they join the network.

“We can bring RMB80,000-100,000 in additional revenue to a community store,” said Dongqing Chen, Yipin Shengxian’s CEO, in a speech in March. Serving as a pick-up point is enough to be included in the network; an auto repair shop could sign up as a new store.

In this sense, comparisons can be drawn between Yipin Shengxian’s business model and that of group buying platforms. According to Haiyan Wu, a partner at China Growth Capital, these platforms effectively operate on a franchise basis. They revolve around community leaders who gather orders and distribute goods and then get a share of the profits.

Xu Dong, Nice Tuan’s marketing director, explains that its offline support is very flexible. Customers can collect goods from dry-cleaning shops, courier stations or convenience stores.

The franchise model has its critics. First, it is impossible to guarantee consistent service quality. Yipin Shengxian’s solution is to attract customers through attractive pricing, but if this is the sole advantage, loyalty levels will be low. Customers often sign up to multiple platforms and move between them easily.

Second, the low-cost group-buying model isn’t necessarily suited to fresh produce, which requires supporting infrastructure. “If you look at the product lists, most items are daily necessities, not fresh meat or green leafy vegetables,” says one industry expert. “The pickup points don’t have any equipment to keep items fresh.”

While some investors argue that the group-buying has transformed fresh produce retail and delivered efficiencies by first aggregating demand from customers and then placing orders to suppliers, the system is not perfect. In many cases, fresh produce items generate traffic, but the profit comes from other product categories.

In contrast, Miss Fresh has made substantial infrastructure investments, promulgating what is known as front-end warehouse model. JD.com builds its warehouses in suburban locations for cost reasons. Miss Fresh, conscious of the need to keep its products fresh, operates small warehouses in the city centers. Each one covers a 3-kilometer radius with guaranteed delivery in under 30 minutes across 16 cities.

The model makes economic sense as well, according to Wu of China Growth Capital: “Our research found that Tmall’s delivery cost per item is about RMB30. Miss fresh’s is much lower. When they deliver the goods from the front-end warehouse to your home, they don’t need packaging to keep them fresh. It’s just like going to buy vegetables in your local wet market.”

It is unclear whether these savings on last-mile delivery offset expensive downtown rents, but technology is employed to control costs in other areas. Although Miss Fresh operates its front-end warehouses on a franchise basis, it uses an algorithm to predict the needs of certain districts and provides the corresponding products.

“For example, warehouses that cover a wide range of residential areas, will have more vegetables and meat; for warehouses based around office buildings, the snacks and alcohol proportion will be higher. In this way, we can effectively control our management costs,” Yuan Sun, COO of Miss Fresh, explained in a podcast produced by GGV Capital.

As a backer of both Miss Fresh and Nice Tuan, China Growth Capital’s Wu believes the two business models work for different markets. Miss Fresh is a solution for tier-one cities, where high quality, on-demand services are popular among upwardly mobile professionals. Moreover, many traditional vegetable markets are being demolished to make way for new developments, so it’s online or nothing.

Nice Tuan, on the other hand, basically targets the lower tier cities where price advantage is still the major factor to attract customers, Wu says. These customers typically have more time to pre-order and pick-up.

The fundamental question that underpins all this business model analysis is what can deliver the best financial performance. Wei of Vision Knight advocates avoiding broad-based online grocers and group buying platforms in favor of specialist players.

He is an investor in Guoquan, a hotpot ingredients supplier that raised $110 million this year in two tranches led by GenBridge Capital and IDG Capital respectively. The company initially served small and medium-sized restaurants, but then started selling directly to households. An aspiring leader in the “hotpot at home” market, it wants to emulate HaiDiLao’s success in the hotpot restaurant space.

“This is our only investment in the sector. I’ve looked at many fresh produce players and have finally chosen Guoquan. It sells frozen items; the shrinkage rate is much lower; deliveries can be made weekly instead of daily which saves on transportation; the ticket size is larger than for typical fresh produce purchases,” says Wei. He adds that the margins are better than those of fresh produce retailers.

While Guoquan and Miss Fresh operate in different market segments, they are distinguished by a common focus on supply chain management.

Guoquan created a strong sourcing network through its earlier coverage of hot pot restaurants and now relies on own-brand ingredients for about 80% of its revenue. Miss Fresh claims to have China’s largest self-built cold chain logistics system for instant delivery and has ambitions to take it up to the production level. Over 70% of goods are already procured directly from the source farm or manufacturer.

Competitive dynamics

When asked to give his verdict on competing business models, Chen Hua, founder of Bunnymaicai, dismisses the context. The disruption effect on conventional retail is still in its early stages, which means there are plenty of incumbents to go after first. “We are all grabbing the market share from the traditional vegetable market and supermarkets,” he explains.

Meanwhile, these traditional players are trying to fight back. Yonghui Superstores, a leading domestic supermarket chain well known for its fresh produce, has launched several new business lines. The company now takes orders via app and makes deliveries through community-based mini-supermarkets.

Yonghui recorded revenue of RMB50 billion for the first six months of 2020, up 22% year-on-year, while net profit rose 35% to RMB1.8 billion. Fresh produce was the key driver, increasing 27% year-on-year to RMB23 billion. Revenue from e-commerce came to RMB4.5 billion, a gain of 243%. It now accounts for 9.7% of overall sales.

Zheng Xu, Miss Fresh's founder and CEO, told investors he expects online fresh-produce supermarkets to enter a stage of rapid growth in the next five years. “It will go from being a supplementary channel to the main purchase channel,” he said.

These tailwinds will support growth and continued funding for a range of strategies, from pureplay online retail to O2O hybrids to group buying platforms, though some will perform better than others. At the same time, investors are targeting the domestic consumer brand space as a proxy for the fresh produce boom.

Recent activity includes Series B rounds for Saturnbird, Wangbaobao, and Baijia Food, local brands specializing in coffee, oatmeal, and instant noodles, respectively. They tap into familiar themes around an emphasis on product quality and the use of online delivery channels.

“It is difficult for these new brands to enter traditional channels, because those channels are controlled by old brands and the entry costs are very high,” says China Growth Capital’s Wu. “New channels, on the other hand, welcome these new brands. For example, sales of sugar-free beverages like Yuanqi Senlin have increased substantially, and most of them are promoted through these new channels.”

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• Topics
• Greater China
• Technology
• Early-stage
• Expansion
• Consumer
• TMT
• China
• e-commerce
• Vision Knight Capital
• Joy Capital
• China Creation Ventures
• China Growth Capital