Chinese e-retail worried about ‘profitability of the customer, not the product’

O2O

MCKENZIE

“The thing that I take for granted that I forget from a foreign perspective is end delivery is 30 minutes, which is quite remarkable,” says Richard McKenzie, partner in retail and consumer goods, Asia Pacific, at consultancy Oliver Wyman.

The retail expert estimates that in the microcosm of his Shanghai office, around 98 per cent of staff buy groceries online, with the channel making up a 60-70 per cent market share.

“Now that is young, well-paid, time-poor people, but it gives you a sense of how far it can go,” he clarifies.

McKenzie points to statistics that even claim almost half the population of greater Shanghai buys its groceries online, but he believes those figures might be suspect.

And of course, Shanghai is not necessarily reflective of the entire country, with the rest of China typically “three to four years behind” what happens in the modern metropolis.

Gathering consumer data in China is notoriously difficult unless you work within the rather oligopolistic sphere of Alibaba and JD/Tencent, but anecdotes like this are certainly strong signals for the direction of e-retail. 

With his colleagues Wai-Chan Chan and James Yang, McKenzie co-authored the report ‘Chinese Grocery’s Age of Empires’ earlier this year, focusing on how these two nebulous ecosystems were vying for power and the innovative methods used to capture market share.

The report highlighted 60 per cent of mobile app usage in China came from the JD/Tencent and Alibaba ecosystems.

JD includes WeChat and a plethora of other companies and platforms, while Alibaba is renowned for establishing the world’s biggest shopping event, Single’s Day, which takes place every November 11, as well as the payment processing service Alipay. 

Some 97 per cent of mobile payments in China are processed within these two systems, and Oliver Wyman estimates people use their mobiles to pay for around 35 per cent of grocery purchases.

Nearly 10 per cent of Chinese people shop online for groceries — compared with just over 7 per cent in the UK – and the consultancy sees room for growth, especially considering around one in 20 people buys exclusively online.

The Chinese e-retail space is complex, but in this interview with PBUK, McKenzie distills the market to its essence and what can be learned for Western retailers and suppliers. He exclaims online-to-offline (O2O) is definitely not an experiment and is “here to stay,” while explaining the philosophy driving change and how buying functions are set to become more centralised. 

Q: To begin, would you be able to give us a summary of your perspective of what’s happening in Chinese e-retail?

A: How I tell the story of what’s happening is about grocery and how the role of fresh within grocery has changed here. So let me just take a step back — e-commerce in China has gone from nowhere eight years ago to almost certainly being world-leading — I think Korea might be challenging it, but China pretty much is world-leading.

It followed the normal course of development, but about four years ago what was different I think is grocery started to take off. That was initially with the business that Walmart subsequently bought and then sold to JD.com called ‘Yihaodian’, which literally means ‘One good shop.’

This is where the story gets interesting because grocery has become an immensely strategic category for both JD.com and Alibaba as it drives the frequency. I think e-commerce has gotten to a stage of development now where they are not necessarily looking at grocery as a category to make profitable, but they’re looking at it because they want the customers coming to their online shops very frequently. And as you know, grocery is the most frequent thing you shop. 

In China, historically people would go to the wet market or the hypermarket four or five times a week. Getting share of the end customer’s wallet is what’s driven them very hard into grocery. JD.com and Alibaba are absolutely neck-and-neck competitors. 

That gives you the story up until two years ago. Obviously within grocery, the critical category particularly in China is fresh produce, and historically it’s pretty difficult to have fresh produce online. And I mean that in a pure sense, not in an O2O type environment. 

The Chinese consumer has always been very fussy. I always used to joke that in an offline world you’d have the professional grandmother shopping and she’d take 20 minutes picking up a piece of broccoli, turning it over and deciding if that’s the piece of broccoli she wanted to buy. In a wet market, the dynamic is not far off a farmers’ market somewhere else, although not with a premium.

That then became, for want of a better word, the next ‘hurdle’ for Alibaba and JD, which led Alibaba to set up this shop called Hema, which literally means ‘Hippopotamus’. They set this up explicitly as an O2O business.

Frankly, I think what is fairly good about Hema is they’ve taken fresh — a category which as you rightly identified earlier the Chinese consumer is most paranoid about with food safety issues — and it’s a little bit like you can go into the Amazon warehouse and check out the produce.

As a consumer if I’m ordering fresh at home, I want to check out the produce. I go into the Hema store and I can see it, and it’s more wrapped and packaged than it traditionally is in China, which while it’s an ecological disaster kind of gives the consumer reassurance. It’s got things like sell-by dates much more clearly printed on it than you’d certainly find traditionally in other retail formats.

Q: What do you find most fascinating in terms of how food is sold through this O2O model and how the space is changing? 

A: What I find interesting is the merger of foodservice, by which I mean restaurants, and supermarkets here. So the Hema store has lots of fresh products in it and lots of open kitchens around the back of it. From a consumer point of view I can go in and see the veggies, see the seafood — and Hema’s big hero category is seafood —and I can see the kitchen where it’s cooked. You can even see the little bag whizzing around the ceiling on the conveyor belt round the back to take it to my home.

If I’m sitting at home, rather than ordering from a local restaurant, I know I can order from Hema and have seen the raw ingredients; I know the kitchen it’s cooked in, and I therefore see the entire value chain where I’m getting it from. At the same time I can order my fruit, my veg and any other packaged items I want. 

I think fresh is the unlock for it because it’s something that hasn’t been trusted before, but from an Alibaba-Hema point of view, they make the economics work because in fresh produce, the margin in China is in the order of 20 per cent or less actually; it’s very low gross margin. 

But if you’re selling it coming into the kitchen where it’s being cooked, you’re selling it at a gross margin of 60 or 70 per cent, so suddenly the basket that’s being delivered has a much higher gross margin.

Q: The dynamic reminds me of the wet markets in China, where you’ll have an open market, people are buying fresh food and there will be pop-up restaurant stands next door. I suppose it’s a similar experience, except there is a stronger food safety element and a more modern setting. 

A: It’s like you’ve put a wet market in a Waitrose kind of environment and you’ve kind of got it.

And the thing that I take for granted that I forget from a foreign perspective is end delivery is 30 minutes, which is quite remarkable. So rather than relying on the clunky vans that drive around in Europe, there’s a man on a bike and that delivery is 30 minutes. You’re sitting at home hungry, you want your takeout meal, you order it from Hema and it’s with you very quickly. And it’s free delivery within three kilometres.

Q: So it’s basically like Uber Eats but from a supermarket that prepares meals?

A: Correct, and then it’s probably worth looking at the other side of the story here. You’ve basically got two ecosystems in China — one being the Alibaba system this all operates in, and the same thing for the JD ecosystem.

JD operates something translated as ‘JD to home’, JD Daojia, which is effectively Uber Eats. Whereas Hema is owned by Alibaba, JD does it differently. They are doing O2O delivery for people like Yonghui, which is partly owned by JD, and with Walmart which owns part of JD

So you’ve got this ecosystem developing around JD with big grocers doing O2O delivery with the JD Daojia business. Some of them have started to develop Hema-like stores themselves. Yonghui have started to develop stores called Super Species, which are very much like Hema. 

Alibaba is also experimenting with other formats, so there’s a mini-Hema, and there’s a much more restaurant-type business they’re developing. They now effectively bought out the Taiwanese side of Sun Art — Sun Art was a JV between Auchan from France and a Taiwanese business. The Taiwanese effectively sold their side of the business to Alibaba, so Sun Art is now effectively a JV between Alibaba and Auchan, and now they’re rolling this out. I’m told they want Sun Art to become a franchisee of the Hema business and roll out Hemas independently.

Q: So it’s a real web of interconnected companies and different JVs, some of them domestic, others with foreign players.

A: Absolutely. Honestly, there’s no need to scratch the surface of that. There are these two slightly nebulous ecosystems, which also goes into payments and online video and all sorts of other things less related to fresh. You can call them platforms, ecosystems, but they’re both competing so that the customer never leaves that ecosystem.

Q: And how loyal are consumers to these different ecosystems? If they’re buying from JD this week, are they buying from Alibaba next week or are they very much fixed to one?

A: Honestly, I don’t have any statistics on it. My belief is that most people will shop across the two; it’s not unlike two big supermarkets trying to compete for your service and offer you everything.

Q: This gives us some good background. What would you say China is doing that the Western world hasn’t been able to do, and how can Western retailers — whether it be in the UK, continental Europe or the United States — learn from the Chinese example? Or is the Chinese context too different to really learn from?

A: I think the situation is different. One angle is from the consumer. The profitability of the product is less important; all they’re worried about is the profitability of the customer, which I don’t think is where Western retailers have got to.

They’ve basically said: “We are selling some of this product and some of this produce particularly at very low gross margins because we want to get customer loyalty.”

The second thing I think is different is the frequency of speed of delivery, and I think the model of delivery. I think you could replicate that in very high-wage markets, but I think that’s the Uber Eats kind of model.

The third aspect I’d highlight again is this merger of fresh and restaurants. 

Q: Do you think this type of delivery in China has been made possible because of relatively lower labour costs compared to Western countries?

A: Again, I haven’t got the numbers in front of me, but an average delivery man is not poorly paid. They do work extremely hard, so more relaxed labour regulations are probably as much of an issue as the cost.

Q: That makes sense, especially as where these retailers have thrived has often been in more opulent parts of big cities like Shanghai and Beijing. That brings me to another point — what about the second- and third-tier cities? Is this model expanding inland from the coastline to other urban centres?

A: It is. It’s slower — typically everything in China happens three to four years behind what happens in Shanghai. But it’s developing — Hema is now being rolled out into other cities, so I don’t see why that’s going to stop. I think there are some challenges to it — you’ll have to adapt the model and make some of it less premium.

Q: So you have the Chinese using their phones for so many aspects of life, more so than in other parts of the world. They are well-accustomed to mobile online payment services, are witnessing levels of GDP growth that not many of us in the West are used to and that is combined with infrastructure development and greater urban density. In your report, you wrote about how 10 per cent of the population is buying groceries online, but the speed of change is fast in China. How do you see that percentage growing in the future?

A: It’s going to massively increase. I can give you a trivial example that illustrates it  — if you go around our office in Shanghai, I’d say 98 per cent penetration of purchasing groceries online, and probably a 60-70 per cent market share going online. Now that is young, well-paid, time-poor people, but it gives you a sense of how far it can go.

Certainly there are some stats around the food in packaged grocery online saying it’s got 40-50 per cent share in greater Shanghai – I think those numbers are a bit suspect, but they give you a sense of where it’s going.

While you’ve got the two ecosystems pushing these categories and prepared to subsidise delivery as they are at the moment, there’s no obvious end to how far the packaged grocery will go, and I think they will push the fresh alongside it as an O2O product coming out of the stores.

Q: These are trends that need to be understood by those who supply fruits and vegetables to the Chinese market, both locally and from overseas. What do you need to have in mind if you’re going to tap into this market and build brand loyalty? That could be to a specific produce brand, a country of origin or even a seasonal product. Should they be aiming to get their produce items in more prepared meals at O2O outlets? Should they be trying to supply fruits and vegetables that can be delivered more easily? Please share your thoughts.

A: One thing I would highlight is there is much more transparency. Hema does make a big deal out of having QR codes on all its shelves – you scan the QR code and it gives you the history of the product, the prominence of it, and that comes out of the food safety area, but it’s actually gone much more into tell me about which cow it comes from, which farm and why that farm is super safe and so on, and I think that ability to tell your story is increasing in a way that just hasn’t happened before

On the flipside, the buying is going to get more centralised. So the fear, and this isn’t just in produce but across FMCG [fast-moving consumer grocery] as a whole, is that Alibaba starts to buy for its entire ecosystem at some point. 

Don’t get me wrong, we’re not there yet. I’m kind of painting the future, but I think this is probably one of the last areas they get to. With branded consumer goods, they are starting to move towards centralising their purchasing — it’s not there yet, but it’s coming, and I don’t see any reason that down the line it won’t come for produce, as well.

Q: As there’s this greater transparency, increased trust in leading e-retail brands and subsequently increased trust in the products they sell, are we going to see a change in the dynamic whereby the Chinese tend to prefer imported products over local ones?

A: It’s a very good question. It’s slightly the million-dollar question. I believe not, and actually if you look at some of the trends you see on the internet in China in food, it’s actually driven quite a lot of import, so the internet has given consumers access to snacks. You see snacks from all sorts of Asian countries booming because the Chinese consumer for the first time has discovered them.

You see a lot of Japanese fruit online for example. My belief is you need to have a story to tell, and the import story is a strong one provided there is a story. I think just being a cheap producer from a random country, it won’t be enough. You see a lot of Japanese apples turning up, they are enormous and they are different, so they’re noticed in the market. If there is something unique and special about you, I think it really presents an opportunity. If you’re a commodity producer of apples, I think it’s going to be an increasing problem for you. 

Q: You’ve covered a lot of what O2O means for the retail space. I’m curious though, are there any other independent O2Os that we need to watch?

A: All real O2O operations of scale are occurring around the two ecosystems, and those people who have tried to do it on their own have failed. I won’t mention which company — a big grocery who tried to do it on their own — they just got no volume compared to if you’re working in these ecosystems, because you need the online traffic. If you don’t put the app on within an ecosystem, you just don’t get the online traffic.

The history of most things online in China is that there are a lot of good ideas — I think Fruitday started like this, but as you noted before the interview, they then get bought.

On the one side, you’ve got Alibaba that’s got plenty of cash flow and will spend it to defend its position, and on the other side you’ve got JD who’s got very patient shareholders [in Tecent], will raise capital and will spend it. So independents tend to have got snaffled into the ecosystems.

Q: In your report with Wai-Chan Chan and James Yang, you mentioned developments like unmanned retail and automated shopping carts. What do you think the future holds for those technologies?

A: Personally, whereas I sense the O2O formats are not an experiment and are here to stay, I think these ones I still think are very experimental and I think it’s not obvious exactly what’s going to happen there.

Q: With all this discussion of online, can you talk about where some of the impetus for O2O began – the tradition of wet markets. What happened to it as this shift played out?

A: Some of those have held up surprisingly well. What tended to happen is the movement of food online has taken some of the traffic out of the modern channels of hypermarkets and supermarkets; you used to go to a hypermarket because you wanted to do an integrated shop, and you wanted to buy a bit of fresh and some packaged goods.

Now typically you’re buying your packaged goods online, so there’s no reason to go to the hypermarket. And the wet market is typically of better quality and a little bit cheaper in terms of fresh, so what you found is the first step is: “I buy my packaged online, therefore I can’t be bothered going to a hypermarket, and then I’ll go to the wet market where I prefer my fresh produce.”

So they’ve been in long-term decline, but that long-term decline has not accelerated.

Q: Do you think wet markets still have a future in China?

A: You get this bifurcation of good and bad. You’ll find the good ones which are well run will do quite well — over time they’ll smarten up and so on, but the bad ones will go out.

Consumers still like them. Go around my office and see the young people — it’s not the case that they go and say, “We can’t buy things from the wet markets.” Actually they like the wet markets. 

To me the main thing is the strategic role of fresh in the market has changed — it was always the thing that most grocery shops were driven by fresh, and that’s really what Alibaba and JD have latched onto. They’ve decided: “We need to get that in because that’s so strategically important to us.”

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