Preface From 2016 to 2017, we spent considerable time studying new retail and consumption upgrades, recommending leading supermarket stocks. Why did both primary and secondary investments point to supermarkets? What changes have occurred in the channel landscape of the FMCG market represented by supermarkets? Retail is an ancient industry, evolving from barter to currency exchange, and then to transactions that also exchange emotion and belief. Domestic modern retail started in the 1970s, and the explosive growth of e-commerce after the 21st century has profoundly impacted the FMCG industry. The online-offline integration that began in 2016, with Hema and Yonghui Life opening stores aggressively and JD Daojia's extensive collaborations, has brought new trends. This article aims to analyze online and offline trends, as well as the reasons, phenomena, and investment directions behind online-offline integration. I. E-commerce Growth Bottlenecks and FMCG Breakthroughs 1. The End of the Traffic Dividend Era and the Arrival of the Stock Game Era Globally, China's e-commerce industry has achieved leading accomplishments, with its full-scale explosion related to factors such as domestic population base, economic growth, social demand, infrastructure improvement, and information asymmetry. However, since its inception in 2003, e-commerce growth has shown a downward trend. In 2016, the online shopping market size was 5.33 trillion yuan, a year-on-year increase of 39.2%, with growth expected to slow to around 35% in 2017. Notably, the growth in online shopping users has fallen below 10%. It is expected that the growth of online shopping users will continue to decline in the coming years, and the era of e-commerce traffic dividends is basically coming to an end. According to QuestMobile data, as of the end of 2017, China's internet monthly active devices reached 1.085 billion, a year-on-year increase of 6.3%, marking the fifth consecutive month of single-digit growth. Meanwhile, the average weekly internet usage time has hovered between 26.2 and 26.5 hours for two consecutive years. Currently, there are approximately 4.06 million apps in the Chinese market, with 50% of users installing fewer than 25 apps and 80% installing fewer than 35 apps. This means that the competition for users among websites and apps has essentially entered an era of "stock population" and "stock time" competition. The battle for e-commerce users has never been calm; it is a constant ebb and flow. Although Alibaba's ecosystem accounts for about 65% of total online shopping GMV, with Tmall holding a 50.2% market share in B2C e-commerce in H1 2017 (more than twice that of JD.com), this does not mean Alibaba is safe. It faces relentless pursuit from old rivals like JD.com and Vipshop, as well as the rise of new social e-commerce platforms like Pinduoduo and Xiaohongshu. According to data on users' installation of independent e-commerce apps, in December 2016, users with only one e-commerce app installed on their mobile devices accounted for 48.2%; by June 2017, this figure had risen to 71.3%, during which Alibaba's ecosystem consolidated its advantage, with exclusive users accounting for nearly 60% of the entire market. However, after the Double 11 and Double 12 shopping festivals in December 2017, 71.3% of users had two or more apps installed, and those with four or more reached a record high of 28.9%. Consumer loyalty to a single platform is often hard to maintain. New platforms emerging in niche markets attract consumers' attention. (The author's phone typically has eight e-commerce apps installed, including Taobao, JD.com, Suning, Amazon, Yanxuan, Hema, and Yonghui Life.) 2. Traditional Three Major Categories Approaching Penetration Bottlenecks The traditional three major categories have contributed the main growth to e-commerce. During the rapid e-commerce development period from 2011 to 2016, the most important categories driving online shopping growth were apparel and footwear, consumer electronics, and home appliances. Using Euromonitor's B2C e-commerce sales categories as an example, in 2011, apparel accounted for 20.2%, consumer electronics 31.5%, and home appliances 16%. By 2016, sales in these three categories were 51.9x, 13.1x, and 15.6x their 2010 levels, contributing the main growth to e-commerce scale. If C2C is included, the share and contribution of apparel and footwear would be even larger. From the perspective of online penetration, the three largest categories—apparel, home appliances, and 3C—had already reached approximately 30%-35% penetration in 2017 (B2C). If C2C e-commerce is also considered, the penetration for apparel, home appliances, and 3C is estimated to be close to 35%-40%. We believe that by 2020, the total scale of these three categories will be around 5.3 trillion yuan, with an e-commerce penetration ceiling of about 50%, leaving limited room for further growth. 3. E-commerce Has a "Disease", Is FMCG the "Cure"? After analyzing the current fundamentals of e-commerce, let's summarize the problems and solutions: a. The end of traffic dividends and the beginning of stock competition b. Traditional e-commerce categories approaching growth bottlenecks We believe that increasing FMCG sales is one way to solve e-commerce's difficulties, for the following reasons: 1) FMCG categories can increase consumer stickiness and retention In a stock competition market, user stickiness determines the total user base, whether users keep the platform's app, the frequency of app opens, and potential purchases. Therefore, the replacement cycle of traditional categories like 3C and home appliances (especially large appliances) limits the number of purchases per user. Although apparel, footwear, and accessories are better than home appliances and 3C, FMCG and fresh produce have the highest purchase frequency on average. According to Bain & Company and Kantar Worldpanel data tracking 40,000 Chinese households in 2016, among FMCG categories, yogurt, biscuits, and infant formula had annual purchase frequencies exceeding 10 times, while other personal care or home care categories also had relatively high shopping frequencies. Attracting consumers to purchase FMCG categories on e-commerce platforms helps increase consumer stickiness and retention, which is advantageous in the stock competition. This is why we saw prolonged price wars between Tmall Supermarket and JD Supermarket in 2016-2017. 2) FMCG categories have a large market with low online penetration Traditional categories, especially large home appliances and 3C, will contribute less and less to e-commerce growth. We believe that the categories with greater growth potential in the future are FMCG (with a market size of about 14 trillion yuan by 2020), where the overall penetration is currently around 7%. Sub-category penetration rates include: food 10.4%, beverages 2.5%, alcohol 2.3%, beauty and personal care 22.2%, and home care 13.1%. By city tier, first-tier cities, due to logistics convenience, had an FMCG e-commerce penetration of 11.4% in 2016, while third- and fourth-tier cities currently have a penetration of about 6.6%. There is significant room for future growth, and FMCG can replace home appliances and 3C to contribute to e-commerce GMV growth. Furthermore, since e-commerce GMV = traffic × conversion rate × average order value × repeat purchase rate, although FMCG categories have significantly lower average order values than home appliances and 3C, the improvement in repeat purchase rate, as analyzed above, will also help drive GMV growth. II. The Fit Between the FMCG Industry and New Retail 1. Pure Online Models in FMCG Are Difficult to Profit in the Long Term Since FMCG is of great significance for improving e-commerce user stickiness, repeat purchase rates, and sales scale, the next decision point for e-commerce is: Even without considering short-term price wars, can selling FMCG be profitable in the long run? To some extent, offline FMCG channel construction has already explored a multi-party equilibrium point for retail gross margins. In supermarkets, FMCG gross margins are around 15%-20%; in convenience stores, they are typically 30%-35%, with private label products potentially adding another 5%-10% when considering backend profits. Since e-commerce platforms generally have lower average prices for the same SKUs compared to offline, we refer to JD.com data to estimate the profitability of selling FMCG through a pure e-commerce model for self-operated platforms: Assumptions:

  1. Average order value is 100 yuan per order;
  2. Gross margin: assuming no large-scale promotions (such as spend 99 get 50 off), FMCG gross margin is 15%;
  3. Selling and logistics expenses refer to JD.com's H1 2017 data: selling expense ratio is about 4%, and fulfillment cost per order is 11.53 yuan;
  4. Other expenses are not considered for now. Calculation: Gross profit per order = 100 yuan * 15% = 15 yuan Selling expenses = 100 yuan * 4% = 4 yuan Logistics expenses = 11.53 yuan Net profit = 15 - 4 - 11.53 = -0.53 yuan Therefore, if a pure e-commerce model is adopted, it will be difficult to cover costs and expenses in the long term. So, which costs or expenses can be reduced in the above process? 2. The Significance of New Retail We no longer need to elaborate on what new retail is; we only need to remember that the essence of new retail is to improve efficiency. E-commerce needs FMCG as a major category to quickly fill the growth gap. So how to resolve the long-term profitability contradiction between e-commerce and FMCG? We believe it is new retail, with supermarkets and e-commerce as carriers. 1) How to Increase Repeat Purchases The key to increasing repeat purchase rates lies in optimizing categories, focusing on products with high-frequency demand—namely, FMCG in supermarkets and even higher-frequency fresh produce categories. Fresh produce, as a daily consumption category, significantly increases the probability of consumers retaining the app and further enhances repeat purchases. 2) How to Increase Gross Margins Ways to increase gross margins include: a. increasing average order value; b. adding high-margin SKUs; c. increasing the gross margin of existing products; d. accelerating product turnover and reducing loss rates, among others. For the first two points, we believe we should combine with a particularly interesting phenomenon in FMCG e-commerce sales: Unlike the common impression of low prices online, the average selling price of many sub-categories online is actually higher than offline. This is because consumers tend to buy more high-end or imported brands online, which raises the average price of the e-commerce channel, and these high-end or imported brands often have insufficient offline distribution. 3) How to Reduce Logistics and Selling Expenses Reducing logistics costs mainly depends on lowering packaging costs and reducing the cost of delivery from city warehouses to consumers. Offline stores acting as forward warehouses can help solve these two problems: packaging costs can be reduced from cardboard boxes to plastic bags, and for fresh food, from ice packs or dry ice packs to plastic wrap; logistics costs also decrease significantly because the distance from warehouse to consumer shrinks from over 20-30 kilometers to within 3 kilometers. In terms of selling expenses, combining online and offline data and using LBS for effective push notifications can improve marketing precision. Moreover, stores serve as natural traffic entrances, further expanding traffic. Based on the above views, we believe that 2018 will still be a major year for online players to acquire and integrate offline supermarkets, with more emphasis on the implementation and transformation of specific models compared to 2017. In the past two months, Alibaba took control of Gaoxin Retail, Tencent increased its stake in Yonghui, Yonghui increased its stake in Hongqi Chain, Bubugao suspended trading, and Tencent and Yonghui signed a strategic cooperation agreement with Carrefour. In 2018, we will see revenue growth and gross margin improvements in the transformed offline supermarkets. 3. Final Questions and Recommended Targets Next, let's look at a few more questions, the answers to which are already clear. 1) Why are offline stores getting smaller? 2) Why are offline stores eliminating their back warehouses? 3) Why are offline stores reducing their SKU counts? Because the offline supermarkets that "cure" e-commerce's "disease" do not need to stock 10,000-20,000 SKUs; instead, they need to curate products that increase repeat purchases and relatively high-end products that can raise average order value or gross margins. Because current and future offline supermarkets do not need to be far from consumers; they need to be close to consumers, with online-offline linkage, thereby improving consumer experience while reducing logistics costs during delivery. As for eliminating back warehouses and daily replenishment, these depend on the construction of backend supply chain systems and B2B logistics systems. The final question: What kind of channel brand can succeed in the post-e-commerce era? What targets should be chosen for investment? Those with e-commerce traffic support, Those with continuously improving supply chain systems, Those with store expansion and operational capabilities, ... Source: Zhang Ming Modern Consumption Service Observation (lzmzalman1111) -END-