Click to read the original article for details ********At a time when MissFresh is at risk of bankruptcy due to funding gaps, Dingdong Maicai has delivered a phase of profitability. In Q2 2022, Dingdong Maicai's total revenue reached 6.634 billion yuan, up 42.8% year-over-year; net loss was 34.5 million yuan, compared to 1.9374 billion yuan in the same period last year; GMV reached 7.1152 billion yuan, up 32.3% from 5.3781 billion yuan in the same period last year. Notably, on a Non-GAAP basis, Dingdong Maicai achieved a net profit of 20.6 million yuan during the reporting period, compared to a net loss of 1.7285 billion yuan in the same period last year. Logically, profitability should be a shot in the arm for the capital market, but Dingdong Maicai's stock price, which had been declining, did not improve and even fell 1.8% after the earnings release. Over the longer term, Dingdong Maicai's current closing price of $4.42 is down 80% from its high of $28 in October last year. Where is the problem? 01 Non-Conventional Profitability The phenomenon of "Huawei falls, Xiaomi feasts" seen in the smartphone market has not been replicated in fresh food e-commerce. During the same period that MissFresh was retreating on a large scale, Dingdong Maicai was also closing cities in rapid succession. According to the Dingdong Maicai app, it currently operates in only 28 cities, down 8 from the 36 cities disclosed in its Q2 2021 earnings report. The large-scale city closures occurred in May this year, leading some to link Q2 profitability to this. From a timing perspective, "cost reduction" may be quickly reflected, but "efficiency enhancement" is not achieved overnight. The real reason can be traced back to the transformation that began in the second half of last year. Since its listing, Dingdong Maicai's primary market strategy was rapid expansion, so the persistently high fulfillment costs in 2021 dragged down the optimization of its UE model, with per-order operating losses remaining high and even widening. The transformation from "scale priority" to "efficiency priority" that began in the second half of last year was reflected in business operations by exiting "low-efficiency" cities, optimizing the UE model in high-tier cities, and striving to get rid of losses. In December 2021, Dingdong Maicai's operating profit margin in Shanghai turned positive, with a 28% gross margin covering 21% fulfillment costs for the first time. Subsequently, Dingdong Maicai replicated this across the country, applying the "three tricks" from Shanghai: increasing gross margin, optimizing fulfillment costs, and reducing sales expenses. First, gross margin. The front-warehouse model is considered a "hellish" business, mainly because the gross margin on fresh produce is too low. In 2021, the gross margin for fresh produce in offline supermarkets was only about 15%. Although fresh produce is a rigid demand for residents, most products are highly homogeneous, limiting the markup. Therefore, for fresh food e-commerce to achieve profitability, breakthroughs must be made in the following areas:

  1. Adjust the category structure, using fresh produce as a base to expand into non-fresh food and daily necessities; 2. Increase the proportion of private label products and prepared dishes; 3. Reduce spoilage. Category structure and spoilage rate are unavoidable challenges for fresh food e-commerce. The former relates to adjusted average order value and repurchase rate, while the latter involves technical difficulty. Hema's spoilage rate is below 5%, but its management stated that further optimization through technology could only reduce it by another 1%. Dingdong Maicai, with fresh produce SKUs accounting for over 44%, has focused on increasing the proportion of private label products and prepared dishes. In Q4 2021, private label products, self-developed products, and prepared dishes accounted for 10.2%, 6.5%, and 14.9% of GMV, respectively. By Q2 this year, private label products had reached 17.5%. Not to mention the higher-margin prepared dishes; for example, the "oden" in 7-Eleven has a gross margin of 39.4%, far exceeding the 16% for fresh produce. Second, fulfillment costs. For front-warehouse models, fulfillment costs include the following:
  2. Outsourcing costs for sorting center and front-warehouse workers and riders; 2. Rent for sorting centers and front warehouses; 3. Logistics transportation costs from sorting centers to front warehouses. The dilution of fulfillment costs is achieved through two means: one is increasing order density to spread fixed costs such as rent, utilities, and logistics; the other is improving rider delivery efficiency to optimize last-mile delivery costs. With the rise in per-warehouse order volume and optimization of rider delivery efficiency, Dingdong Maicai's per-order fulfillment cost decreased from 20.6 yuan in 2019 to 18.8 yuan in 2021. In Q2 this year, fulfillment costs as a percentage of total revenue dropped from 36.5% to 23.2%. However, there is still significant room for optimization in overall delivery efficiency. In Q4 2021, the average daily delivery orders per rider in Shanghai was 89.5, while the overall average was 74.8. Finally, sales expenses. During the reporting period, Dingdong Maicai's sales and marketing expenses were 150 million yuan, down 64.2% from 410 million yuan in the same period last year, mainly due to "product development capabilities becoming the primary growth driver, thereby attracting customers more effectively." 02 Too Early to Say the Future is Promising In business competition, the exit of a competitor undoubtedly signals a good time to accelerate, but Dingdong Maicai did not invest heavily to reclaim the territory left by MissFresh, indicating that it also faces unspoken difficulties. These difficulties have not surfaced because Dingdong Maicai chose not to continue expanding; otherwise, it might have fallen into the same quagmire as MissFresh. For example, in increasing gross margin, Dingdong Maicai has increased the proportion of private label products and high-margin prepared dishes, but there is another easily overlooked option: reducing subsidies. Front-warehouse subsidies are of two types: 1) subsidies on goods sold, which are directly deducted from revenue in accounting; subsidies are included in GMV but not revenue, so the GMV/revenue ratio can measure the degree of subsidies. Dingdong Maicai's GMV/revenue ratio dropped from 116% in Q2 2021 to 107% in Q2 2022, a significant decline. The figures for 2019 and 2020 were 121.4% and 115.0%, respectively. Data from Changqiao Dolphin Investment Research also shows that Dingdong Maicai's subsidy intensity has been declining since the same period last year.
  1. New customer acquisition subsidies (only for attracting new customers, not selling goods) are included in sales expenses and can be measured by the sales expense ratio. In Q2 2022, Dingdong Maicai's sales and marketing expenses were 150 million yuan, down 64.2% from 410 million yuan in the same period last year. In other words, if Dingdong Maicai continued to expand, the above two subsidy costs could not be saved. In 2021, Dingdong Maicai paid 2.81 billion yuan for coupon subsidies, accounting for 12.4% of GMV. Another key point is fulfillment costs. The difficulty in achieving profitability with the front-warehouse model lies in the fact that gross margin cannot cover fulfillment costs. Based on 2021 per-order data, Dingdong Maicai's per-order gross profit was 9.9 yuan (gross margin 19%), per-order fulfillment cost was 18.8 yuan (fulfillment cost ratio 37%), and at the UE level, per-order loss was 8.9 yuan. In contrast, in Dingdong Maicai's most mature Shanghai region, the data for operating profitability in December 2021 was: per-order gross profit of 18.5 yuan (gross margin 28%), per-order fulfillment cost of 13.9 yuan (fulfillment cost ratio 21%), and per-order profit of 4.6 yuan at the UE level. In Q2, the overall reduction in fulfillment cost ratio was mainly due to the contraction of low-efficiency cities and front warehouses, optimizing the per-warehouse fulfillment cost ratio. After closing some front warehouses, the overall rent and utility costs decreased, along with the corresponding reduction in riders and sorting teams, directly leading to lower fulfillment costs. In other words, if cities were not closed or expansion continued, the overall fulfillment cost ratio would remain high. Although "cutting off one's arm to survive" carries a hint of tragedy, doing the right thing at the right time is also a strategic choice. Dingdong Maicai's victory over MissFresh in competition was precisely because it bet on "repurchase rate" and invested heavily in it. But in the latest earnings report, "repurchase rate" and a host of related data were hidden by Dingdong Maicai. If we look only at GMV, Dingdong Maicai's Q2 total of 7.1152 billion yuan, up 32.3% year-over-year, is fine, but the problem lies in the data driving GMV growth, which Dingdong Maicai did not disclose. The drivers of GMV are order volume and average order value. Dingdong Maicai explained in its Q2 report that higher average order value drove product revenue growth. This increase included pandemic factors, similar to the average order value increase in 2020. Order volume almost completely disappeared from the earnings report. Whether from the supply side (number of front warehouses * orders per warehouse) or the demand side (number of purchasing users * purchase frequency), Dingdong Maicai did not disclose any of these. In fact, Dingdong Maicai has selectively disclosed key data in past quarters. As of now, user data (10.5 million) remains at Q3 2021, front warehouse count remains at Q4 2021, and order data (80.6 million) remains at Q1 2022. 03 Strategic Contraction Likely to Continue Due to the unprecedented lockdown measures caused by the COVID-19 outbreak in Shanghai, Dingdong Maicai's Q2 profit may be an unusual event. But company executives want investors to believe that its profitability will not be one-off. "By the end of this year, Dingdong Maicai can achieve comprehensive profitability," founder and CEO Liang Changlin told investors on the Q2 earnings call, adding that the company is confident in its business model. However, Dingdong Maicai's hiding of core data has deepened external doubts. One of them is: who is actually driving the increase in GMV and revenue? Whether it is higher average order value or increased order volume, for Dingdong Maicai, higher order density is the better choice. If it is higher average order value, then pandemic factors must be considered an important reference. That is, Q2 profitability is difficult to normalize, and relying on high average order value is not a long-term solution. MissFresh's average order value has always been higher than Dingdong Maicai's. In Q1 2021, MissFresh and Dingdong Maicai had average order values of 89.6 yuan and 61.7 yuan, respectively, but high average order value may also be one of the reasons suppressing purchase frequency. High average order value means the platform must seek premium pricing in private label or non-fresh products, but these products are naturally low-frequency, dragging down repurchase rates. Tianfeng Securities estimated in a research report that under the assumption of a 20% gross margin, Dingdong Maicai could achieve UE-level profitability when the revenue-based average order value reaches 62 yuan and daily orders per warehouse reach 1,200; under the assumption of a 25% gross margin, it could achieve UE-level profitability when the revenue-based average order value reaches 58 yuan and daily orders per warehouse reach 1,000. In simple terms, the higher the gross margin, the lower the corresponding average order value and daily orders per warehouse. Currently, Dingdong Maicai is indeed using various means to increase gross margin, including increasing investment in prepared dishes. This extends to Dingdong Maicai's scale expansion. After large-scale city closures, the probability of reopening cities in the short term is decreasing. At this stage and for some time to come, ensuring gross margin has become Dingdong Maicai's primary task. It may even continue strategic contraction, exiting more low-efficiency cities. 04 Epilogue Strategic contraction is not a pejorative term in the current market environment, and even less so in the hellish fresh food e-commerce market. Investment banks like to compare Dingdong Maicai with MissFresh because they are the only two front-warehouse players today. Looking back at their divergence, 2020 was a key time point. The former placed repurchase rate in a strategic position, while the latter vigorously promoted average order value. Ultimately, average order value affected purchase frequency, leading to a decline in order volume. Dingdong Maicai, on the other hand, survived the gross margin trough through repurchase rate, then used private label products and prepared dishes to raise gross margin again. Of course, whether Dingdong Maicai's model can succeed remains to be tested. After all, whether it is investors or the capital market, what they want to see now is a money-making machine, not a money-burning machine. References: [1] Local Life Special Topic Research: Life is Hot Because of You, Zhongtai Securities [2] Dingdong Maicai, Living in the Shadow of MissFresh, Kaiboluo Finance [3] First Quarter Profit, Dingdong Maicai Becomes the 'Last Brave Soul of Front Warehouses', Changqiao Dolphin Investment Research [4] Fresh Food E-commerce Multi-model Development Period: Front Warehouse Segment Shows Resilience, Players Show Their Skills, Orient Securities [5] Internet Media Industry Deep Report: Instant Retail: A Trillion-yuan Track, Prioritizing 'Speed', Zheshang Securities [6] Dingdong Maicai's Core Data 'Riddle': First Quarterly Profit, Just a Flash in the Pan?, Consumer Finance World [7] Front Warehouse Industry: Dingdong Maicai, Leader in Front Warehouse Model, Shows True Colors Under Pandemic, Tianfeng Securities [8] New Business Format Series Report (II): Looking at the Future of Front Warehouse E-commerce from Dingdong Maicai and MissFresh, Ping An Securities [9] Media and Internet Industry: Dingdong Maicai Achieves First Quarterly Profit, Douyin Tops Global Mobile App (Non-game) Revenue Chart, Dongxing Securities Disclaimer: This article is based on publicly available information or information provided by interviewees, but Decode and the author do not guarantee the completeness and accuracy of such information. In any case, the information or opinions expressed in this article do not constitute investment advice to anyone. Source: Decode (ID: kankeji001) Author: Wang Xinyu -END-