China grocery e-commerce was one of the business segments that saw strong demand during the Covid-19 outbreak.
Many major online retailers are accelerating steps to expand their presence in the fresh food sector. This also includes grocery new retail concepts like Alibaba’s Hema. New Retail are offline supermarkets with mobile-app driven experiences and home delivery capabilities.
I will be exploring why grocery e-commerce is so exceedingly popular in China, how the landscape has evolved and what are the challenges in this industry.
What is So Attractive about China Grocery E-Commerce?
For those familiar with the blue ocean strategy, blue ocean refers to the uncontested market space, unexplored and untainted by competition.
China grocery e-commerce is just Like the ‘blue’ ocean’, vast, unexplored and has lots of opportunity and profitable growth. Its total grocery market is worth over US$1.3trillion. The gross merchandise value (GMV) of fresh good e-commerce is forecast to hit over US$75 billion by the end of 2021.
Most importantly, unlike some categories like consumer electronics which has more than 40% in terms of online retail penetration, the grocery category is only about 5%.
The pandemic has sped up the adoption of online grocery shopping. According to a Oliver Wyman survey of Chinese consumers, 56% of survey respondents reported that they have gone beyond their go-to online platforms to other online grocery platforms to meet their needs.
Growth in this segment will due to advancement in technology like cold chain infrastructure. Rising incomes are also a key driving force to increased spending by consumers.
Growing Investor Confidence
Grocery E-commerce is still not profitable at this moment in time, but that is not stopping the startups as well as expansion of the bigger players like Hema.
Capital markets are also pouring money into this cash burning industry. For example, Tencent-backed grocery delivery startup Missfresh has raised $495 million in funding. This is also the largest single fundraising in China’s grocery e-commerce industry.
Types of China Grocery E-Commerce Business Models
China Grocery E-commerce is very broad. These are where the fresh food wars are fought.
1 – New Retail
Besides fresh food delivery, part of grocery e-commerce also includes “new retail” concept; Offline supermarkets with mobile-app driven experiences and home delivery capabilities.
In 2016, Alibaba founder Jack Ma introduced his concept of “new retail” as a means to blend online and offline shopping experiences and integrate more technology into the retail supply chain.
Hema is part of Alibaba’s “New Retail” strategy. Hema is a high-tech supermarket which offers customers an app-driven experience. They can use the app for everything in the store, from placing items in a digital shopping cart while you shop for groceries, to getting product nutritional information, to paying for your goods.
There is also a restaurant where you can choose live seafood for the kitchen to prepare.
Besides that, each Hema supermarket is also used as a fulfilment centre. Employees pick online orders in store. Once they have been picked they are placed on a conveyor belt that carriers the order to the back of the store for delivery.
This website has a pretty good summary of how Alibaba and Hema is redefining grocery shopping.
Unsustainable Business Model
While Alibaba is aggressively deploying its new retail business, other companies also decided to enter this space. Tencent (00700.HK) has invested in Super Species, the fresh grocery store under Yonghui Superstores (601933.SH), while JD.com launched fresh food store 7Fresh.
However, this new retail business model is unsustainable as Hema and its competitors are making huge losses. Some companies like Meituan and Yonghui Supermarket have also closed their stores due to mismanagement (which I deemed it as not meeting financial expectations).
This does not spell the end of new retail, but rather I feel that they are in the midst of consolidation and strategic adjustment. The cost structure of running offline retail, however efficient, is not the same as online grocery delivery.
Grocery retail is complex, and this business model would probably take years of trial and error to mature. An excellent example would be Amazon’s acquisition of Whole Foods.
2 – Fresh Food Delivery
There is actually two business models in this category.
The first model is where online platforms like Ele.me rely on third party merchants to fulfil orders and provide delivery service to the customers. This model works well to convert customers who frequent wet markets to do their grocery shopping online instead.
The second model is the use of a front warehouse. Fresh food is delivered from the city distribution centres to the front warehouse (cold storage). These front warehouse are strategically located such that it can serve customers staying within 1-3km radius. The products are then delivered to the users in an hour.
MissFresh and Meituan Maicai are the front runners of this model. MissFresh also adopts a membership system to keep customer stability by offering member privileges. At the same time, the membership system also helps collect data regarding the preference of consumers and provides accurate advertisement targeting.
It also seems like Alibaba has intentions to move in this direction too. Their recent acquisition of Sun Art stores could be used for locations of forward deliveries and service points within their network. .
3 – Community Group Buying
Community group buying is where customers staying within a community placed their orders for products together. The goods are then delivered to a specific place within the neighbourhood. From there, the customer will pick it up. It takes Pinduoduo’s social buy model and makes it local.
Compared to online e-commerce, community group buying has a major advantages in pricing. This is because the order quantity is much larger and the products comes directly from the supplier. In community group buying, the goods are delivered to a specific location only and the customers must collect it themselves. This also provides cost savings to the supplier in terms of logistics.
Community group buy is mostly conducted via WeChat’s mini programmes. There are two tiers of players in this space. The first tier is the pioneers of this industry such as XingSheng Youxuan and Shihui Group. Alibaba, JD.com, Pinduoduo, Meituan and Didi. They are new players entering this segment.
The Challenges of China Grocery E-commerce
Despite the great potential of grocery e-commerce, we also need to understand why is it so hard for it to take off.
1 – Cultural issues
Nearly three quarters of fresh foods are bought in wet markets. Many Chinese consumers still prefer to shop for fresh produce, meat and seafood at these local markets.
Of course, China’s urban expansion and strong adoption of digitisation meant that online platforms are catering for such local services to provide convenience to their consumers. Alibaba’s Ele.me(饿了么？) and Meituan’s Meituan Maicai (美团买菜) are some of the online platforms that provide grocery delivery services.
2 – Low Gross Profit
Fresh food is a very difficult business. The producers and farmers upstream cannot raise their prices due to intense competition. The consumers are also very price-sensitive. Yonghui Superstores (SHA:601933), one of the largest grocery chains in China, reported that the gross profit margin of their fresh food sector is only 15%. This is very low compared to other sectors like coffee (around 80%) and cosmetics (90%).
There are currently more than 4,000 entrants in the domestic fresh food e-commerce field, of which only 4% have flat revenue, 88% are in a loss, and only 1% are ultimately profitable.
Therefore, to succeed, the company must be able to pull it off at scale. Companies that have the financial muscle are more likely to make it. Smaller players will find it very hard to get it right.
3 – Supply Chain Constraints
To convince customers to shop online, the speed of delivery needs to be close to that of the consumer taking the product home themselves for basic necessities. It usually takes 1-2 days for things that are not required urgently. Above all, quality needs to be guaranteed.
Big data, AI, Internet of Things and other technologies can be applied in the fresh food supply chain. This can help track the users’ behaviour, accurately predict the market demand, to control the purchase quantity and arrange for storage and logistics. By doing so, retailers can minimize the inventory and reduce warehouse costs.
One of the difficulties faced by grocery e-commerce is the constraints from cold chain logistics. Transporting and storing food, especially in today’s world when the place of origin of the food can be very far away, is complicated. Many items need refrigeration, or maybe even freezing. And different foods need to be refrigerated at different temperatures.
One of the ways to improve cold chain logistics would be to install a monitoring system that can control temperature and humidity in real time. This is to prevent the products from going bad and losses, improving the efficiency of cold chain logistics.
4- Quality of Products
How do customers trust a process they cannot see? Unlike traditional grocery shopping, the quality of the products delivered to your doorstep depends on the retailer.
JD.com’s solution is to lay out the entire supply chain of a particular product on the product description page.
From procurement to storage and then delivery. Sometimes there are tips on how best to enjoy the item. This could be a recipe or a suggested combination of ingredients. Food products can even be traced using blockchain technology. This provides access to information like quality control team, license plate of the delivery truck that transported it to the warehouse and how the product was stored.
China grocery e-commerce market is developing at a very fast pace. As the internet giants are entering the industry and the capitals are active on the market, new players and innovative models will keep emerging.
People believe that this is one of the few untapped markets because there is only a 5% online penetration rate of the entire Chinese grocery business. The penetration rate is low for a reason. There exists a difficult problem to solve. Food requires a cold chain, with lots of temperature-controlled warehouses and trucks to transport products. This requires a lot of investment. This is crucial for development of fresh food e-commerce and is one of the key areas to win the market share.
The perishable nature of produce also makes inventory management a challenge. However, software and AI technology are going to make these problems much more manageable soon.
These factors added together is how we end up at today’s industry landscape. The future of grocery e-commerce in China will only grow more sophisticated. It is a race to provide the freshest, safest and reliable food produce with continued efficiency and quality of their supply chain and operations.