Discounted products like 2-yuan sparkling water, 6-yuan Japanese biscuits, and 10-yuan shampoo are attracting consumers amid economic downturn. As the pandemic dampens consumption, discount stores such as HotMaxx, Hi-Tego, and Elephant Life have emerged and expanded rapidly, becoming a rare bright spot in the new consumption track. HotMaxx, founded in April 2020, opened nearly 400 stores in just 1.5 years with annual sales in the billions. According to ChinaVenture, by the end of 2021, HotMaxx's valuation had surged over 100 times to $500 million. Taoqi Capital noted that although financing deals in the new consumption track have plummeted this year, the discount retail industry is booming against the trend. From 2021 to 2022, multiple institutions have frequently invested in the discount retail track, and "value-for-money" businesses are increasingly popular among domestic consumers. The logic behind the explosion of discount stores is easy to understand: they help brands and distributors solve inventory problems while offering consumers low-priced quality goods. From a broader perspective, discount stores, warehouse clubs like Costco, discount grocery stores like ALDI, community 10-yuan stores, 100-yuan stores, and even outlets and Vipshop all fall under discount retail, a market worth trillions. Chongying Capital, after studying the origins of global retail giants, found that during economic downturns, discount retail often harbors huge opportunities—Walmart, ALDI, and Japan's largest discount retail group Don Quijote were all born and grew rapidly during economic downturns. As ALDI's founder's mother said, "The worse people's situation, the better our lives."

"Counter-cyclical" Nature

But in China, the discount store business model focusing on "value for money" is still relatively vacant. 2021 was the first year that investment institutions heavily invested in discount stores, with many brands receiving funding and expanding rapidly. But in fact, discount stores are not a new business; they've just been given a "new twist" in the past two years. As early as 9 years ago, the online app Haoshiqi was established for near-expiry products and received multiple investments from Alibaba, but its development has been lukewarm. Similarly, before becoming a capital darling, HotMaxx was formerly known as "Tuituigou," focusing on online distribution, with mediocre performance. It wasn't until it transformed into HotMaxx that it gained high favor from capital and entered the fast lane. Why has this track only exploded in the past two years? Multiple investment institutions attribute the reason to the impact of the pandemic and changes in the domestic economic environment, which have drastically altered consumer purchasing behavior and habits, making "value for money" a key factor in consumption decisions. Reviewing industry history, it's easy to see that discount retailers like Walmart, ALDI, and Don Quijote were born and grew rapidly during economic downturns, and they are not new models globally. Developed countries have already experienced periods of stable and declining economic growth, and the discount retail industry has developed over decades or even centuries. Deloitte's report "2022 Global Powers of Retailing" points out that discount stores account for over 10% of the global top 250 retailers, and their overall position cannot be underestimated. It's just that the corresponding business model is still relatively vacant in China. From the demand side, the main connotation of discount retail is not entirely consumption downgrading, but also the pursuit of pragmatism and value for money. China has already crossed the threshold of $10,000 GDP per capita. After experiencing consumption upgrades, mainstream consumers' requirements for product quality are hard to regress. But at the same time, economic downturn and unstable future expectations prompt them to be more budget-conscious and practical. In the domestic market, besides the gradually heating up discount stores, more warehouse clubs imitating Costco, and even several livestreamers who can get the lowest prices for big brands, are essentially discount retail. The popularity of these new formats fully demonstrates the "counter-cyclical" growth trend of discount retail. Several top livestream rooms that can get the lowest prices for big brands are essentially discount retail. From the supply side, with economic development, material production has entered a stage of overcapacity to some extent. When residents' consumption willingness and ability are insufficient, oversupply leads to a large amount of inventory and surplus goods. Taking imported snacks, the most common category in discount stores, as an example, the "2020 China Imported Food Industry Report" shows that in 2019, China's imported food amount reached $90.81 billion. If calculated at 5% inventory, that's $4.5 billion. Qicheng Capital, when studying Japan's largest discount retail group Don Quijote, interpreted this as: "The more new products mainstream channels launch, the more surplus goods society has; the more surplus goods, the more supply for discount stores. Don Quijote is an enterprise born out of the characteristics of Japanese retail. It is the shadow of Japan's retail industry; the larger the sunny side, the larger the shadow."

How Do They Make Money?

"Near-expiry food is more of a traffic tool, while second- and third-tier products with higher gross margins are the main business." The birth and rise of discount stores conform to changes in the economic environment and have benefited from the pandemic. But current players are mainly early entrepreneurs, and the business model is not yet fully mature. Many institutional investors and potential franchisees of discount stores have a common question: Discount stores sell products at "rock-bottom prices," and the average transaction value is not high, yet they open stores in expensive commercial complexes. Can they be profitable? In fact, before large-scale capital intervention, the business of selling near-expiry food already existed. In many provinces and cities, there have long been individual and small-scale chain discount food stores without prominent brands. This means that with careful operation, it can be a profitable business. Imported goods with little brand recognition are one of the key categories for discount stores. However, discount store brands are significantly different from the individual stores mentioned above. First, they heavily enter expensive commercial complexes, leading to higher rent and labor costs; second, their product categories are not mainly imported near-expiry food, and most are not even near-expiry food. From actual visits by multiple media outlets, in HotMaxx and Hi-Tego stores, truly near-expiry products account for only a small portion; most snacks still have a considerable shelf life. Product categories are mainly retail and beverages, but also include skincare, daily chemicals, alcohol, and seasonings. Rather than near-expiry food stores, they are more like multi-category discount collection stores. Regarding their business model, Zhu Danpeng, a Chinese food industry analyst, said in an interview, "Near-expiry food is more of a traffic tool, while second- and third-tier products with higher gross margins are the main business—earning both manufacturer promotion fees and price difference profits, plus income from near-expiry products, achieving 'one arrow, three eagles.'" In addition, some discount store brands can expand using partners' money through cooperation and franchising. Taking HotMaxx's "partner" model as an example, according to Phoenix Net Technology, HotMaxx partners need to invest hundreds of thousands upfront, including 340,000 yuan in goods deposit to the headquarters and 19,800 yuan in training fees. For stores with daily sales around 10,000 yuan, partners can receive a 12% share of store sales. It is reported that HotMaxx has already covered major cities such as Shanghai, Beijing, Guangzhou, and Shenzhen, and plans to exceed 5,000 stores in the next three years. However, without a fully proven business model, whether discount store brands can make their partners (franchisees) profitable is also unknown, which is a significant test for long-term brand operations. Some media reported that a HotMaxx store in Wuhan closed just over 2 months after opening last year; Dianping shows that HotMaxx's Tongtai Times Square store in Shenzhen has also suspended operations.

Controversies and Opportunities

How China's local retail discount formats should develop is still a matter of debate. Despite being able to lower prices through large-scale procurement, increase profits with higher-margin second- and third-tier products, and expand through cooperation and franchising, whether leading discount store brands can achieve scale profitability and run through their business models remains unknown. There are many investors and professionals both bullish and bearish, with some even questioning whether they are cutting the leeks of franchisees and investors. ChinaVenture quoted an investor who looked at discount store projects but didn't invest, saying that discount store product prices not only lack advantages but also suffer from severe SKU homogenization. For example, self-heating hot pot can be found in any discount store with at least three to five different brands, heavily discounted but hard to sell. "Opening in a top business district is suicide." Japan's discount chain giant Don Quijote had revenue of nearly 100 billion yuan in 2020. There are also industry insiders questioning the instability of discount store supply chains. Currently, the supply channels for near-expiry food products come from manufacturers, distributors, and e-commerce platforms' inventory and returned goods, all of which have great uncertainty in terms of product shelf life, volume, and pricing space. This leads to frequent product changes, stockouts, and poor consumer experience. Tian Yun, co-founder of the near-expiry food supply platform Super Warehouse, said in a media interview that as more people enter the near-expiry food business, the demand for supply sources is increasing, and supply cannot keep up with the growing demand. This is an inherent flaw of the soft discount retail model. Discount formats are divided into soft and hard discounts. Hard discount reduces SKUs and operating costs to build vertical supply, with ALDI as a typical example; soft discount achieves ultra-low prices by selling surplus and leftover stock, but product supply is hard to guarantee, with Don Quijote as a typical example. Regarding the soft discount model, Japanese retail scholar Shunichi Atsumi once commented: "Soft discount, due to supply chain instability, is difficult to manage and operate. Good-selling items sell out quickly, while unsold ones gather dust, making stores prone to becoming 'garbage dumps.' Consumers are not loyal; they come to take advantage. Store employees have heavy workloads, and bosses may make some small money, but the enterprise ends up exhausted." This is clearly not the result domestic discount store brands want. In response to this issue, how China's local retail discount formats should develop is still a matter of debate. Kearney Director Ma Jintao said in a media interview that whether brands will shift to "hard discount" retailers in the future is a trend worth watching. Behind the controversy lies the persistent business model problems of domestic discount store brands.

In Conclusion:

As a new retail channel, the emergence and rise of discount retail conform to changes in the domestic economic environment and consumer demand, and also represent the development trend of China's retail industry. The development history of developed countries' counterparts has fully proven that this is a long and wide super track, not a short-term trend. So how should China's local retail discount formats develop? Discount models, product categories, and channel layouts are all adjustable means, and future changes may be diverse. But no matter what, the underlying logic of discount retail is the ultimate pursuit of cost-effective quality products, and customer value orientation is the highest principle for industry development. Source: JuChao WAVE (ID: WAVE-BIZ) Are you "watching" me?