"We are sorry for failing your trust, and we feel deeply pained and guilty." On May 7, Pagoda, which is preparing for its Hong Kong IPO, issued an apology on its official Weibo. △Apology statement, source: Pagoda's official Weibo The apology came after the self-media account "Internal Affairs Inspector" released an exposé video showing two Pagoda franchise stores engaging in irregular practices, such as selling overnight fruit, making fruit platters from spoiled fruit, or passing off small pineapples as large ones. The video quickly sparked online discussion, with more people directing criticism at Pagoda. The company had to issue an apology on its official Weibo, and the hashtag #PagodaApologizes# soon trended on the platform. Many consumers took to Weibo to complain that they often bought rotten or poor-quality fruit at high prices from Pagoda, feeling "like they were being taken advantage of." The matter did not end with the apology. The next day, the Shanghai Consumers' Rights Protection Commission publicly named Pagoda, saying that brands should not blindly pursue expansion speed. The commission noted that many violations of consumer rights are related to franchise stores, and that brands often neglect management and supervision of franchise stores in their rush to open more outlets. Indeed, during rapid expansion, Pagoda's heavy reliance on franchise stores and fast store openings have shown drawbacks. This incident of selling spoiled fruit platters has again sounded an alarm for Pagoda. According to the prospectus, Pagoda has a total of 5,351 offline stores, of which only 15 are self-operated, with the remaining 5,336 being franchise stores. With over 90% of stores being franchises, standardized management has become a major issue. The franchisees who once shouldered the goal of 10,000 stores have, on the eve of the IPO, turned from Pagoda's "expansion weapon" into its "weakness." At this critical juncture of the IPO, it remains uncertain whether the food safety incident at franchise stores will add variables to Pagoda's listing path. But Pagoda's eagerness to go public, after lingering at the gates of capital for years, is increasingly evident—evidenced by three IPO attempts in two years. Additionally, two other major fruit chain brands, Hongjiu Fruit and Xianfeng Fruit, are also actively pursuing capital markets. Who will become the "first fruit stock" is still unknown, but competition in the fruit industry will intensify. For fresh food platforms, product quality and service are especially important. Given that the expansion model relies on franchising, which still works for Pagoda, ensuring the quality of franchise stores and maintaining consistent service levels are essential for Pagoda to continue winning consumer favor in the market.
****The Fruit Business Plagued by Quality Issues "Some stores have fruit that's been there for two or three months; one and a half months is considered short." In the video by "Internal Affairs Inspector" titled "Undercover at Pagoda: Spoiled Fruit Used for Platters, Moldy Apples Still Sold," a store clerk ignored a box of pear fruit that had been sitting for a month and a half, saying, "If customers get sick, it's not my problem; whoever sold it is responsible. If you sold it, they'll come to you." Ironically, Pagoda adopts a "daily clearance" model and has always claimed to be committed to providing better-tasting fruit across its official channels. This is not the first time Pagoda has been exposed for quality issues like "passing off inferior goods." As early as 2008, Shenzhen TV's "First Scene" reported that a Pagoda store was complained about by a customer for selling domestic bananas as Philippine bananas. That year, Pagoda was in its seventh year of operation and had opened 100 stores. The incident had a significant impact on Pagoda's reputation at the time. In 2009, Pagoda became the first in the industry to introduce the "unsatisfactory, no-questions-asked return" policy (no receipt, no product, no reason), winning over a large number of fans. Since then, with its taste-oriented fruit quality grading system and the "unsatisfactory, no-questions-asked return" policy, Pagoda, positioned as a high-end brand, has attracted more consumers seeking delicious fruit. However, the high price, high-quality fruit, and almost no-questions-asked return service have not built a solid quality barrier or reputation defense for Pagoda. A consumer who frequently buys fruit at Pagoda told Link Insight that while prices haven't changed, the quality and taste are not what they used to be, and there's not much difference from fruit sold in supermarkets. Link Insight also noticed on the Black Cat complaint platform that complaints about Pagoda have remained high, totaling over 1,200. Among them, complaints about fruit quality are the most common, focusing on "bugs in fruit," "rot," and "poor taste." △Consumer complaints about Pagoda, source: Black Cat complaint platform In fact, Pagoda's fruit business is not easy. Pagoda's revenue mainly comes from the sale of fruit and other products, accounting for over 97% of total revenue, with most sales occurring in offline stores. An analyst who has long followed the fresh food industry told Link Insight that the fresh food category has high spoilage rates, and different fruits, such as mangosteen, bananas, and durian, have significantly different management methods, storage conditions, and shelf lives, with low standardization. In addition to the inherent issues of the fresh food industry, the rapid pace of franchise store openings has made Pagoda more susceptible to the backlash of poor franchisee management, making it impossible to fully control product quality. Link Insight found in the prospectus that Pagoda's "franchise system" emphasizes "self-management," meaning each franchise store is responsible for its own operations. Therefore, the success and quality of franchise stores ultimately depend on the franchisees themselves, and Pagoda cannot control their actions. In other words, even if the franchise management system is mature, Pagoda cannot guarantee that franchise stores will meet the technical and quality standards set by Pagoda. Currently, Pagoda has 5,351 stores, far from the goal of "10,000 stores by 2020" set by Chairman Yu Huiyong. This also means that the product quality risks Pagoda faces may increase as the number of stores grows. △Number of Pagoda stores, source: Pagoda prospectus More than a decade ago, a domestic economist told Yu Huiyong that the West has not had a fruit chain format for many years, indicating that the fruit chain format itself has fatal flaws. This was a heavy blow to Yu after founding Pagoda, but he insisted on "selling fruit like McDonald's." On one hand, Pagoda is branded as a mid-to-high-end fruit retailer; on the other, product quality issues persist. As it stands, it is not easy for Pagoda to tell a satisfactory fruit chain story to the capital market.
****Pagoda Trapped by Franchisees Success comes from franchisees, and so does the trap. On July 28, 2002, Yu Huiyong, a graduate of Jiangxi Agricultural University, opened the first Pagoda store on Fuhua Road in Shenzhen with his wife Xu Yanlin and a group of employees. The store, covering over 50 square meters, achieved sales of nearly 410,000 yuan in its first month, far exceeding Yu's expectations. While other fruit stores were still mom-and-pop shops, Yu Huiyong innovatively introduced the chain operation model in the industry, quickly opening up the market. In an earlier interview with Southern Metropolis Daily, Yu highly praised the franchise model, saying, "To scale up, a chain enterprise must rely on franchising. The charm of franchising lies in integrating social resources to achieve a chain effect from zero to one to infinity." Starting from the sixth Pagoda store, the company shifted from direct operation to franchising, rapidly expanding. From 2002 to 2008, Pagoda expanded quickly, opening 100 stores in seven years. But franchising is a double-edged sword: it allows for rapid store openings, but the downside is that franchisees vary in quality, leading to issues like unauthorized procurement, which severely damaged Pagoda's reputation and revenue, causing losses for seven consecutive years. So, in 2008, Pagoda stopped accepting new franchise stores and spent three years buying back existing ones. It wasn't until 2018, with capital support, that Pagoda officially opened its franchise business to the public. What is the franchise business? How is it different from Pagoda's previous store model? Currently, Pagoda's official website shows two main franchise plans: A and B. Plan A requires a total investment of about 280,000-350,000 yuan, while Plan B requires about 100,000-150,000 yuan. △Pagoda franchise plans, source: Pagoda official website Plan A is not significantly different from the general franchise model. The franchisee fully invests and is responsible for operations. The difference with Plan B is that Pagoda covers the costs of store decoration, signage, and equipment installation, and it takes a cut—monthly, the headquarters takes an increasing percentage based on gross profit. Regardless of the plan, Pagoda has successfully built its brand awareness through dense store openings via franchising, but this has also become a source of future problems. Now, from a channel perspective, Pagoda's model relies heavily on offline stores. From 2019 to 2021, Pagoda's online business contributed revenues of 0.3 billion yuan, 2.8 billion yuan, and 3.3 billion yuan, accounting for 0.4%, 3.2%, and 3.2% of total revenue, respectively. And among Pagoda's offline stores, most are franchise stores where product quality is harder to control. Currently, of Pagoda's 5,351 stores, 5,336 are franchise stores, and only 15 are self-operated. How much money does Pagoda make from franchise stores? In 2021, Pagoda's revenue was 10.289 billion yuan, with 10 billion from selling fruit and other products, of which 8.1 billion was generated by franchise stores, accounting for about 81%. The heavy reliance on fruit categories and offline stores has been Pagoda's business inertia and path dependence for 20 years, and it also determines that Pagoda's scale expansion and economic benefits mainly depend on the number of stores. Therefore, Pagoda also stated in its prospectus that it will need to rely on franchisees to implement its plans. It is clear that Pagoda will continue to emphasize the franchise model in the future. Yu Huiyong has also tried to seek new growth points to address the issue of a single revenue source. In 2018, Pagoda attempted to launch a paid membership business. However, the prospectus shows that the "membership store" plan was not very successful. Pagoda currently has 67 million members, but only 780,000 are paid members. A year later, Pagoda launched the "Baiguo Xinxiang" mini-program, expanding from fruit to the entire fresh food sector, but it did not make waves in the market. Additionally, to counter the impact of community group buying platforms, Pagoda launched its community group buying brand "Panda Daxian" in 2020. But "Panda Daxian" severely dragged down Pagoda's gross margin. The prospectus shows that the gross margin of Pagoda's online channel decreased from 2.8% in 2019 to -4.9% in 2020. These actions have not yielded results; Pagoda's fresh food business has not gained traction. Pagoda's development ultimately still depends on fruit franchise stores, which is its biggest weakness.
****Can Pagoda Turn Its "Weakness" into "Armor"? The hidden problems of the franchise model are becoming more apparent. Can Pagoda manage its franchise stores well in the future? "After eating durian from Pagoda, I had diarrhea, and this has happened several times. Pagoda is no longer what it used to be; I'm giving up on this platform," a netizen couldn't help complaining on social media, and many others echoed similar sentiments. Clearly, the franchise stores that once helped Pagoda quickly capture the market have now turned against Pagoda's reputation. It must be understood that the franchise model inherently has management drawbacks, making it difficult to effectively solve issues of product quality control and service in stores. The frequent food safety problems at brands like Wahaha and ChaPanda milk tea are proof. Once external franchising is opened, it is difficult for the brand headquarters to achieve absolutely effective management over stores scattered across the country. But unlike other industries like milk tea that can implement standardized processes, the fresh food industry's high spoilage and high costs, combined with Pagoda's "daily clearance" model, make Pagoda's fruit franchise business even harder to manage, and quality cannot be guaranteed. Zhu Danpeng, a Chinese food industry analyst, said in an interview with Securities Daily, "After Pagoda opened franchising, there is great pressure on operational standardization, so I am not optimistic about fruit retail brands doing franchising. Just the quality aspect is very worrying, because it poses great difficulty for Pagoda's supply chain, food safety, and management operations." Pagoda is actually well aware of the drawbacks of the external franchise model. The fact that it bought back franchise stores in 2008 through equity participation and encouraged internal employees to hold shares in franchises proves that it has tried to solve the problem. But after capital intervened, Pagoda reopened franchising. A franchisee once told Securities Daily in an interview that Pagoda's Plan B is only for internal employees to cooperate with Pagoda, which is "internal franchising." Plan A is open to external franchisees. And the vast majority of franchise stores in the market use Plan A. "In fact, the headquarters' control over external franchisees is not very strict," a person close to Pagoda's internal staff revealed to Link Insight: "Sometimes when stores are out of stock, many franchise owners directly source from wholesale markets, and the headquarters can't do anything about it." In its prospectus, Pagoda directly states, "Although we have established a strong franchise management system to train, supervise, and manage our franchise stores, we still cannot monitor and operate them as effectively as our self-operated stores." It also did not provide practical improvement measures. However, the prospectus shows that Pagoda will continue to expand its stores in the future, including going into lower-tier cities to explore market opportunities. It is evident that Pagoda's franchise model still has huge hidden dangers, and as franchise stores continue to expand, this will become Pagoda's biggest weakness in the future. In previous years, Pagoda focused on first-tier cities, but with the emergence of various fresh food formats in these cities in recent years, consumer recognition of Pagoda has gradually weakened. A procurement employee at a fresh food platform said, "In cities like Guangzhou and Shanghai, almost every Pagoda store has a Qian Dama next to it. Qian Dama can use Pagoda to attract customers to its own store and also sells similar fruit products. In this way, Qian Dama, positioned as a 'community fresh food convenience store,' is a dimensionality reduction attack on Pagoda. Pagoda has to extend its franchise stores to lower-tier markets to explore more opportunities." Facing the growing number of "external" franchise stores, if managed well, they can become Pagoda's armor; if management is not strengthened, in the long run, Pagoda may suffer from "internal friction" and be abandoned by consumers. Therefore, strengthening franchisee management, improving product control capabilities, and turning "weakness" into "armor" is the path Pagoda must take in the future. *The header image of this article is from Pagoda's official website. Source: Link Insight (ID: lxinsight), Author: Zhang Fei. -END-