Source: Lianxian Insight (ID: lxinsight)

"Master, your package is ready and flying to you." Every time you order a bag of Three Squirrels, you receive such a shipping notification.

Obsessed with building its squirrel empire, Three Squirrels has captured the hearts of many foodies. In 2019, Three Squirrels became the "first national snack stock." At the listing ceremony, three "squirrel dolls" rang the bell on behalf of the founder.

Not long ago, Three Squirrels just concluded its tenth Double 11 shopping festival. Unsurprisingly, it secured the top spot in leisure snacks across 14 online channels, including Tmall, Taobao, and JD.com. Moreover, it also ranked first in leisure snacks in livestreaming rooms of influencers like Viya and Xin Ba.

Behind a decade of championships and multiple "firsts," Three Squirrels' food safety issues keep emerging.

Image source: Three Squirrels official Weibo

Recently, a netizen posted on social media that nuts purchased from a livestream had gone moldy, sparking attention. Specifically, the "Daily Nuts" they opened were completely spoiled, "sour, moldy, and mushy."

In response, Three Squirrels told Beijing News yesterday, "Three Squirrels will take full responsibility for the issues raised by consumers. We have already compensated the consumer in this case and will send the returned product for inspection."

Notably, according to the netizen, the production date of the nuts in question was October 18, 2021, with a shelf life of six months. This means the problem was not due to expiration, but possibly due to the "OEM model" that Three Squirrels has failed to control.

In fact, while the OEM model has led to frequent food safety incidents, Three Squirrels' revenue and profits are hard to balance, and its stock price keeps falling. As of press time, Three Squirrels' stock price dropped to 37.75 yuan per share, with a market value of only 15.138 billion yuan, having evaporated over 20 billion yuan from its peak.

This stark contrast prompts the market to re-evaluate Three Squirrels. With frequent food safety issues and deteriorating performance, how will this "first national snack stock" consolidate its "iron throne" in a snack track full of emerging brands?

A "Snack Porter" with Frequent Food Safety Issues

Three Squirrels has once again been exposed for food safety problems.

On the day after the Double 11 shopping festival, a netizen posted on Weibo that the Daily Nuts purchased from a livestream had gone moldy. The netizen said, "I opened a bag of completely spoiled and moldy nuts. The merchant refused to admit it, saying I should send back the remaining unopened bags, and only if 'the rest also have problems' would they 'refund this order amount'..."

As the incident escalated, Three Squirrels took further action. According to the netizen, Three Squirrels agreed to send the moldy nuts back for testing and compensate 1,000 yuan. Yesterday morning, the netizen said they had received the compensation.

Image source: Screenshot from the netizen's Weibo

Interestingly, as of now, Three Squirrels has not responded to the incident through official channels.

In fact, Daily Nuts is a best-selling category launched by Three Squirrels. According to Three Squirrels' 2021 semi-annual report, Daily Nuts sales exceeded 500 million yuan during the reporting period, ranking first in the Tmall mixed nuts category. According to Lianxian Insight, the nuts in question are the newly launched probiotic Daily Nuts.

Before this incident, it was hard to count how many food safety issues Three Squirrels had encountered.

In May this year, according to a sampling inspection announcement by the State Administration for Market Regulation, a batch of Three Squirrels' opened pine nuts had excessive peroxide value, exceeding the standard by 3.4 times. At that time, Three Squirrels issued a statement on its official Weibo, saying it immediately recalled the unqualified products, was willing to take responsibility, and would rectify the issue.

Looking further back, in October last year, the carcinogen content in Three Squirrels' original flavor crispy chips exceeded standards; in 2019, a fly was found in a Three Squirrels bread; in 2017, Three Squirrels' pistachios were fined 50,000 yuan for mold exceeding standards, involving unqualified food.

Additionally, issues like insects in canned fruit and moldy beef jerky and chestnuts have also occurred. As of November 16, there were 1,575 complaints about Three Squirrels on the Black Cat complaint platform, involving issues such as package swelling, insect eggs, mold, and spoilage.

After repeated food safety issues, netizens seem to have become "used to it." Comments like "Haven't they had problems before? Why still buy?" and "I'm already used to it" fill the comment sections of related incidents.

Just like the catering industry, food safety is the lifeline of the snack industry. The biggest reason Three Squirrels keeps stumbling on the same issue is its unstable "OEM production" model.

As is well known, Three Squirrels is dubbed the "snack porter." It has always adopted an OEM model where products are produced by contract manufacturers. According to its annual report, Three Squirrels first develops products based on consumer data, then hands them over to OEM factories for production, and finally attaches its own brand for sale.

In simple terms, Three Squirrels itself does not truly participate in the production process.

When mentioning food safety risks, Three Squirrels stated in its semi-annual report this year: "In the company's daily operations, there may still be situations where upstream suppliers fail to produce in accordance with relevant regulations and company requirements, quality control systems and standards are not strictly implemented, and production and testing processes are improperly operated, which may not completely avoid food quality and safety control risks."

Three Squirrels cannot delve into every detail of the processing, and with complex categories, product quality control inevitably has problems.

Under various factors, when products bearing the Three Squirrels brand reach consumers and food safety issues arise, it directly impacts the brand's strength.

Heavy Marketing, Light Asset Model "Lays Mines"

Three Squirrels' rise cannot be separated from the tailwind of e-commerce traffic.

Many know that Three Squirrels was founded in 2012. But few know that this year was also when Taobao Mall was renamed Tmall, and Alibaba began cultivating "Taobao brands." In June of that year, Three Squirrels became one of the first-generation Taobao brands.

At that time, as a new brand, Three Squirrels participated in its first Double 11. Fortunately, after enjoying the benefits of Taobao's huge traffic pool, Three Squirrels became the top seller in the nut snack category on Tmall during that Double 11, with one-day sales reaching 7.66 million yuan, thus becoming famous overnight.

Riding the wave of online traffic, Three Squirrels experienced rapid development for several years, with revenue exceeding 10 billion yuan in 2019. In the same year, Three Squirrels officially listed on the A-share market.

The world is not static, and Three Squirrels' over-reliance on online traffic has now become evident.

According to Lianxian Insight's review of Three Squirrels' financial reports, in 2019 and 2020, Three Squirrels' "promotion fees and platform service fees" were 660 million yuan and 961 million yuan respectively, with a year-on-year increase of 45.61% in 2020. According to this year's semi-annual report, "promotion fees and platform service fees" have reached 721 million yuan, accounting for 65% of total sales expenses for the period. Additionally, compared to 398 million yuan in the same period last year, it surged by 81% year-on-year.

Image source: Three Squirrels 2021 semi-annual report

Moreover, Three Squirrels has fallen into a vicious cycle of "increasing revenue without increasing profit." Lianxian Insight reviewed Three Squirrels' 2020 annual report and found that full-year revenue in 2020 was 9.794 billion yuan, with net profit of 301 million yuan. Compared to 2018 full-year data, revenue was 7.001 billion yuan, with net profit of 303 million yuan.

Image source: Three Squirrels 2020 annual report

From the comparison of these two sets of data, Three Squirrels' revenue is increasing, but net profit is decreasing. This means costs are rising, and a large portion of revenue is spent on sales expenses. Among sales expenses, promotion fees and platform service fees always account for a significant proportion.

It is worth noting that in the latest third-quarter report, Three Squirrels did not disclose this data, only stating that total sales expenses for the third quarter were 1.47 billion yuan. If estimated based on the 65% proportion of "promotion fees and platform service fees" in "sales expenses" from the semi-annual report, Three Squirrels' "promotion fees and platform service fees" for the third quarter would be approximately 960 million yuan.

Additionally, Three Squirrels' third-quarter report this year shows that Q3 revenue was 1.8 billion yuan, a year-on-year decrease of 8.59%, marking the third consecutive quarter of revenue decline. In response, Three Squirrels explained: "During the reporting period, the company continued the adjustments around scale and profit made in 2020 based on the 'internet decentralization' environment. The main brand Three Squirrels, guided by profit output as the strategic adjustment period, continued to reduce SKUs and focus on the nut category, which put pressure on short-term revenue."

After ten years of development, Three Squirrels' light-asset model, which once relied on traffic, seems to be failing. Three Squirrels' founder Zhang Liaoyuan also realized this. In September last year, he said in a public speech, "Three Squirrels must forget the traffic era and get used to slowing down growth."

Having lost the advantage of traffic, product strength remains the core of competition. But Three Squirrels, which adopted the "OEM + brand" light-asset model from its inception, still faces significant challenges.

Three Squirrels' business model Image source: Three Squirrels 2021 semi-annual report

The quality control issues caused by the OEM model have always been the "Sword of Damocles" hanging over Three Squirrels.

From the supply chain perspective, Three Squirrels mainly uses a model of joint processing for nuts and dried fruit products and pure OEM for snack products.

Specifically, the procurement and processing of dried fruit and nut raw materials are undertaken by OEM factories; the company is responsible for quality inspection, product screening, and repackaging; products mainly imported nuts are procured by the company and processed by OEM factories; all snack products are entirely handled by OEM factories. According to its semi-annual report, Three Squirrels has partnered with 34 upstream suppliers to create a factory-direct shipping model.

It can be seen that while the OEM model saves the high investment of building factories, the weak supply chain management capability has laid hidden dangers for Three Squirrels' long-term development.

It is worth mentioning that not only is supply chain investment low, but from the semi-annual report, R&D investment in the first half of this year was 26.13 million yuan, a year-on-year increase of 9.36%, which is only a fraction of the 721 million yuan marketing expenses in the same period.

More importantly, the new consumer brand market is now a red ocean, and competition in the nut segment is fierce. As the industry enters a war of attrition, if the "OEM model" encounters competitors bidding for high-quality raw materials, Three Squirrels will face increased costs or even a "rice shortage."

It should also be noted that product gross margin is a key measure of brand capability. In the context of rising raw material prices, not raising prices will lead to a decline in product gross margin.

However, under the OEM model, costs such as raw materials and labor are dominated by OEM manufacturers, leaving Three Squirrels passive in controlling production costs. On the sales side, without independent production capacity, Three Squirrels dares not easily raise prices, resulting in lower gross margins compared to peers.

According to iFinD data from Hithink, among the seven A-share leisure snack companies last year, Three Squirrels' gross margin of 23.9% lagged far behind Yanjin Shop and Lai Yifen, which had gross margins in the 40%-50% range, and Qiaqia Food and Bestore, which had gross margins in the 30%-40% range.

From Three Squirrels' semi-annual report this year, it can be seen that the company has made some efforts in supply chain control.

In 2014, Three Squirrels passed ISO9001 quality management system and HACCP certification. Additionally, after the alliance factory is completed, it will achieve comprehensive quality control from raw materials to processing to finished product testing. For nut repackaging, Three Squirrels has built a globally scaled nut repackaging factory in Wuwei, Anhui, with 85% automation rate and a daily capacity of 4 million packages. For logistics and transportation, Three Squirrels has established 8 distribution centers in major cities such as Wuhu, Tianjin, Chengdu, Guangzhou, and Wuhan, through self-owned or leased methods.

But this has not changed the problem of Three Squirrels being "trapped in OEM." Essentially, the supply chain is the moat of the snack track. As platform traffic becomes increasingly expensive and more new products impact consumer minds, Three Squirrels' path of "light assets, heavy marketing" becomes even harder.

Three Squirrels "Can't Manage" OEM Factories, and Is Even Losing Business to Them

Since its products first appeared, Three Squirrels has called itself the "snack porter."

In simple terms, all Three Squirrels snacks are produced through OEM, with no direct production. After labeling snacks with the Three Squirrels brand, changing packaging, and placing them on channels, they reach consumers as Three Squirrels snacks.

This also means that Three Squirrels lacks the ability to produce snacks. When OEM manufacturers have varying capabilities, quality control becomes a thorny issue.

Now, what is even harder for Three Squirrels to accept is that it cannot control the quality of OEM products, and it is also being robbed of snack business by these OEM factories.

Lianxian Insight found on Xiaohongshu that there are over 200 notes about "Three Squirrels OEM factories." On Douban's snack comparison group, posts about OEM factories for big-name snacks have attracted thousands of discussions. Specifically, snacks produced by OEM factories for brands like Three Squirrels and Baicaowei are highly cost-effective.

Take Three Squirrels' hand-torn bread as an example. In the official Three Squirrels flagship store, the price is 25.9 yuan for 23 packs, or 1.12 yuan per pack. According to the packaging, the OEM factory for the hand-torn bread is Anhui Lejinni Food Co., Ltd. Lianxian Insight found that on the same platform, the OEM factory's flagship store sells hand-torn bread at 29.8 yuan for 34 packs, or 0.87 yuan per pack.

Three Squirrels hand-torn bread, image source: Three Squirrels official Weibo

Obviously, as products from the same OEM factory, the taste will not differ much. This means some consumers will choose the more cost-effective OEM products, and these OEM factories are eroding Three Squirrels' snack market.

On the other hand, it must be noted that the OEM model is an important factor troubling Three Squirrels' brand strength. Looking at the food safety issues mentioned above, such as mold, damaged packaging, and foreign objects, they have never been fully resolved.

When OEM factories start offering "affordable alternatives," Three Squirrels faces even greater difficulties.

Bad news doesn't stop there. Just one day before Three Squirrels' offline stores exceeded 1,000, the second and fourth largest shareholders announced share reductions.

From the third-quarter report, the second largest shareholder and its concerted action party each reduced their holdings by 0.52%. Both companies are funds under IDG. It is worth noting that IDG Capital participated in Three Squirrels' angel round and appeared in subsequent financing rounds. At that time, IDG Capital's optimism about Three Squirrels was evident.

Additionally, LT GROWTH, the second largest circulating shareholder under Capital Today, led by "investment queen" Xu Xin, also reduced its holdings, cutting about 2% from the end of Q3 2020 to the end of Q3 2021.

Continuous shareholder reductions are just a microcosm of Three Squirrels' unfavorable development. From the capital market perspective, in May last year, Three Squirrels' stock price peaked at 91.09 yuan per share, with a total market value close to 36 billion yuan. However, since June last year, the stock price has continued to decline. In March this year, it fell to a low of 34.01 yuan per share, a drop of over 60%.

Due to various factors, the capital market may have lost confidence in Three Squirrels' long-term development. Internet-famous brands cannot stay popular forever, especially in the fast-iterating consumer goods track.

Overall, although the leisure snack market has a large overall scale and fast growth, the more obvious problems are scattered layout and low concentration. More critically, the entry barrier for snack brands is low, with numerous mid-tier brands. Even top brands inevitably see their sales eroded by new brands. According to a CITIC Securities report, from January to July this year, sales of Three Squirrels, Baicaowei, and Bestore all declined, with Three Squirrels' decline far exceeding the industry average, with sales down 37% year-on-year.

It is certain that with many brands, product homogenization is particularly prominent, and consumer loyalty to snacks will decrease. The ultimate competition among brands will return to quality and reputation.

For Three Squirrels, the urgent task is to "defuse the mines," either by building its own supply chain or by strengthening control to thoroughly eliminate food safety hazards. Without this hard work, market share will soon be snatched away by competitors.

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