1. Wholesale is essentially "distribution" in the supply chain, and physical wholesale and other distribution systems are mutually substitutive;
  2. The existence of wholesale markets is based on complete product categories and small-lot wholesale, which is a more efficient distribution model than order-based systems;
  3. How the internet transforms physical wholesale markets: on one hand, online wholesale platforms break physical space limits, enabling massive product listings and easy search and sourcing; on the other hand, online transactions establish evaluation and credit systems, forcing merchants to improve quality and delivery;
  4. Wholesale markets are essentially a marketplace, and their functions of information aggregation, price discovery, transaction, and logistics are gradually separating under the influence of the internet;
  5. Overall, wholesale markets will significantly decrease. Those closely integrated with industrial clusters and able to radiate globally/nationally ("origin-type" markets) still have room for development and are evolving; pure distribution hubs and second/third-tier markets will polarize based on product category (volatility of end demand): some transform into retail, others into logistics parks.

China's wholesale markets (also known as commodity trading markets or specialized markets) are an interesting phenomenon: numerous and complex, they include agricultural product markets common abroad, as well as consumer goods, hardware and building materials, and industrial MRO markets unique to China; they include origin-type markets and pure distribution or sales-area markets. According to data from the China General Chamber of Commerce, by the end of 2013, there were over 90,000 commodity trading markets nationwide, of which 5,089 specialized markets had annual transaction values exceeding 100 million yuan, with total transaction scale reaching 9.7 trillion yuan and employing tens of millions of people.

As a shared sales network for small and medium-sized enterprises, wholesale markets connect small manufacturing enterprises with supply capacity on one end and small enterprises with procurement needs on the other, forming an important and unique part of China's circulation system and a significant component of the real economy.

In the internet age, the market environment and technological foundation on which wholesale markets rely have undergone major changes. How will the circulation functions carried by wholesale markets change? Where will they go in the future? In response to these questions, the Ali Research Institute, based on theoretical research and observations of the latest business practices, puts forward the following views for discussion with industry experts.

1. Wholesale is essentially "distribution" in the supply chain; physical wholesale and other distribution systems are mutually substitutive

Through the dense shops, cluttered product displays, bustling crowds, and handcarts of wholesale markets, we clearly see four words: "distribution platform." Wholesale markets do B2B business: upstream are manufacturers, downstream are dealers, retailers, and other corporate clients. Essentially, they carry the "distribution" function in the supply chain. Since it is a distribution system, wholesale markets compete with other distribution systems in terms of "circulation efficiency" and are substitutive. Only by comparing "circulation efficiency" can we see the long-term trend of physical wholesale markets.

Other major distribution systems include:

(1) Brand chain franchise model (order-based) (2) Brand direct-operated model (3) Large specialized distributor systems (4) Online distribution platforms ...

In fact, the first impact on physical wholesale markets came from the brand chain franchise model that emerged in the late 1990s. For example, the Dongguan Humen clothing wholesale market, which rose in the late 1970s, initially operated on a "front store, back factory" model. It wasn't until around 2002 that the brand franchise agency model rose, shifting from allocation to order-based systems. The order-based system is similar to a futures system: what to produce and how much depends on agents' and dealers' inspection and ordering, essentially an expectation of market demand. The order-based system resulted from the strengthening of market-side forces, balancing the relationship between producers and distributors. Objectively, the chain franchise model dealt the first blow to physical wholesale.

Because brand companies can bypass wholesale markets and distribute products directly. For example, "Yishion" clothing had only one stall in Dongguan Humen Fumin Fashion City in 1999, but by 2004, it had become a strong enterprise with thousands of specialty stores nationwide. Over a decade, thousands of chain franchise brands emerged from major wholesale markets. If a large number of brand companies all adopted the chain franchise model, wholesale markets would be "marginalized." But later it was found that this worry was unnecessary. On one hand, China's market is huge with diverse demand levels; most goods still exist as generic or white-label products, relying on wholesale markets—a giant distribution system. On the other hand, brand companies also need image display, and well-known wholesale malls are a good choice. At the same time, physical markets can still attract traffic and bring in new customers.

Therefore, many brand companies, even after leaving wholesale and adopting agency franchise models, still open flagship stores in wholesale markets. This phenomenon is common in Hangzhou Sijiqing, Guangzhou Baima, etc. Essentially, the order meeting system under chain franchising is still a wholesale model, with the biggest drawback being the inability to accurately control terminal store operating strategies and market data, thus preventing thorough supply chain optimization.

The "direct-operated model," where brand owners directly manage distribution and retail systems, fully internalizes the distribution system, unlike the socialized distribution system of chain franchising. The direct-operated model can achieve integrated optimization of production, supply, and sales, but it requires high supply chain management and IT system capabilities. Fast fashion brands like Zara, GAP, Muji, and Belle adopt this model. In recent years, the SAP model (brand owners fully participate in design, production, logistics, and retail) characterized by "direct operation" has shown a winning trend, with companies like Cosmo Lady, Anta, and recently Li Ning shifting from wholesale to direct operation.

Abroad, the emergence of large specialized distributors has effectively replaced physical wholesale markets. Examples include Grainger in industrial products, NAPA in auto parts, Fastenal in fasteners, and Sysco in food. In developed countries, the only true wholesale markets left are for agricultural products. In the US and Europe, even large food distribution groups, after a hundred years of development, cannot fully internalize fresh food distribution channels within one company. The fundamental reason is the high dispersion of agricultural supply and the increasing demand for food diversity and personalization among urban residents.

Due to the lagging development of China's circulation system, there are no modern large-scale distributors in most fields. Under the planned economy, rural supply and marketing cooperatives (dealing in agricultural materials) and urban materials bureaus (hardware and electromechanical) were similar to large distributors in agricultural and industrial products. These China-specific large distributors transformed after market reforms, and a few gained strong market competitiveness, such as Zhejiang Materials Group, transformed from the former Zhejiang Provincial Materials Bureau, mainly distributing bulk commodities like automobiles, coal, and steel, and was selected into the Fortune Global 500 in 2014.

Online distribution platforms (online supply, online wholesale) can be seen as the second impact on physical wholesale markets. Online distribution is a company's internet-based online distribution and wholesale behavior, using the internet to complete distribution, channel construction, and distributor management. In reality, the first batch of online merchants almost all emerged around major physical wholesale markets because wholesale markets are the source of goods. Ali Research Institute research found that large numbers of online supply clusters appeared in Hangzhou Sijiqing, Hebei Baigou, Tongxiang Puyuan, Yiwu Commodity City, etc. According to research by Dr. Shi Qi of Zhejiang University, a scholar at Ali Research Institute, the e-commerce supply participation rate in Tongxiang Puyuan sweater market rose from 58.1% in 2011 to 80.2% in 2014. This means the vast majority of traditional wholesale households are already supplying e-commerce.

Currently, most wholesale market managers realize that e-commerce is the trend. On one hand, they provide merchants with e-commerce training to help them transform; on the other hand, they open dedicated online supply zones to retain customers and introduce e-commerce services such as graphic design, photography, agency operations, model agencies, and e-commerce express delivery. To some extent, some wholesale markets have evolved into "e-commerce industrial parks." At the same time, a large number of domestic B2B platforms focusing on online distribution and wholesale are emerging, such as Zhaogang.com, My Plastic Web, Yilianwang, Songxiaocai, Zhanghe Tianxia, Yiwu Gou, etc.

Figure: E-commerce evolution of Dongguan Humen clothing market Figure: "Data package" in the online supply zone of Sijiqing China Textile City

2. The existence of wholesale markets is based on complete product categories and small-lot wholesale, which is a more efficient distribution model than order-based systems

The market structure with highly dispersed supply and demand is the industrial foundation for wholesale markets, but it is not their foothold. Rather, complete product categories and small-lot wholesale are the main reasons for the existence of physical wholesale markets. First, categories and varieties are complete. A large wholesale market brings together thousands of merchants, with dense and rich SKUs in the same category, making one-stop shopping easy. This is an advantage over single-brand specialty stores, order meetings, and even large wholesalers. For retail customers, there is more room for selecting and assembling goods; for industrial customers purchasing production inputs, it is easier to complete a one-stop purchase for complex SKU lists.

For example, Hangzhou Sijiqing market specializes in Hangzhou-style women's clothing. In one building, about 800 merchants all sell women's clothing, with tens of thousands of styles, almost equivalent to the total annual styles of the world's largest fast fashion brand Zara. Another example is Guangdong's Xintang denim clothing city. Xintang town itself is the largest denim production base in the country, with over 3,000 denim clothing and related supporting enterprises and over 1,000 registered brands.

Second, small-lot wholesale in wholesale markets is a more efficient distribution behavior. Since wholesale does distribution work, it should bear the responsibilities of the supply chain.

A perfect distribution function should achieve: 1. For categories like textiles, clothing, and daily necessities, wholesale customers are mainly retailers; the mission of wholesale is to ensure retailers are never out of stock while minimizing inventory; 2. For categories like hardware, building materials, and industrial MRO, customers are mainly producers; the responsibility of wholesale is to ensure customers don't stop work due to material shortages while reducing capital occupation.

Small-batch, high-frequency wholesale can well achieve the above functions. The biggest advantage of wholesale markets is small-lot wholesale, small-lot mixed batches, and spot supply. In most wholesale markets, regardless of category, purchasing 3-5 times the retail quantity qualifies for wholesale service. In contrast, order meetings for major brands generally require large batch sizes and are held only a few times a year. Large-batch, long-cycle ordering most easily leads to inventory backlog and capital occupation, and products lack freshness.

3. The internet will partially solve the "breadth and depth" dilemma in wholesale markets

Although wholesale markets have many merchants, rich products, and spot transactions, there are two long-standing "pain points" for purchasing customers:

First, there is no precise, detailed SKU catalog index in the market, making product search and assembly time-consuming and laborious. Merchants mostly use manual ledgers, rarely use ERP or other IT systems, warehouse management is chaotic, inventory quantities cannot be accurately controlled, and stockouts are common. For popular and best-selling items, almost every store has them, with categories heavily duplicated, but when purchasing long-tail or niche products, they often cannot be found. Traditional wholesale markets have recognized this and tried to alleviate it. For example, wholesale markets set up service desks with shopping guides, and floor merchant classification and zoning management. Another example is the "Smart Market" app developed by Yongkang Technology Hardware City: to buy saws, water heaters, etc., just enter these keywords in the search, and relevant merchants and product information will appear, even indicating how many meters away they are.

Grainger, the largest MRO supplier in North America, stocks 900,000 SKUs and solves the problem of finding products through catalog marketing. Grainger's product catalog has been published in over 400 editions, a 1,200-page "industrial encyclopedia" covering 12 product lines and 500,000 MRO products. Grainger's product line breadth is evident. Corresponding to the product catalog is a huge, efficient ERP system that enables inventory management for each individual SKU. From customer ordering, warehouse staff picking, to logistics shipping, everything relies on ERP system support.

Second, the "unreliability" of wholesale markets is also reflected in quality, delivery, and replenishment capabilities. Merchants in wholesale markets have diverse backgrounds (both factories and wholesalers), product quality varies (same style, different raw materials and workmanship), prices fluctuate, and there are practices like speculation, forced bundling (wrong styles, specifications, colors, quantities), and various unspoken rules, causing customers to spend significant search, research, comparison, and negotiation transaction costs. At the same time, replenishment capabilities are poor, and popular items often sell out. These problems lead to unstable supply-demand relationships, often resulting in one-time transactions, deviating from the stability and repeatability required in B2B transactions.

Let's see how the internet solves these two problems: on one hand, online wholesale platforms break physical space limits, enabling massive product listings and easy search and sourcing through category indexes and search. On the other hand, online transactions establish evaluation and credit systems, forcing merchants to improve quality and delivery. Blue Lake Capital has made an excellent argument and drew a "Blue Lake Efficiency Curve" that accurately describes the internet's impact on wholesale markets. We borrow it here with slight modifications:

In China, the B2B market is huge and complex: on the supply side, there are large enterprises and brand owners, as well as tens of millions of small and medium manufacturers offering generic and white-label products. Therefore, various distribution systems—wholesale markets, internal distribution systems, and specialized distributors—each have their own living space, positioned at different points on the efficiency curve. When the internet appears, the situation changes, and the efficiency curve shifts upward overall, placing the original roles on the curve in the "death zone." Companies like Grainger recognized the internet's huge value early on, starting e-commerce operations in 1996. Ali Research Institute believes that the internet partially improves the "breadth and depth" dilemma in the supply chain, but not completely. Reaching the ideal position B requires more than just wholesale markets.

4. The internet will drive the gradual separation of functions carried by physical wholesale markets

Wholesale markets are essentially a marketplace. They specifically undertake three functions of a "market": physical product display and handling (logistics), information aggregation and price discovery (information flow), and transaction (capital flow). These three functions will significantly diverge under the influence of the internet.

First, wholesale markets bring together many buyers and sellers, forming a pattern similar to "perfect competition," thus forming market equilibrium prices. For example, Guangzhou has established "South China Grain Sales Price Index," "Steel Index," "Xintang Denim Price Index," "Shiling Leather Goods Price Index," "Yuzhu Wood Price Index," etc., based on major wholesale markets. In the future, as B2B transactions further migrate online, online trading markets will be established. As long as there are enough buyers and sellers, an effective price discovery mechanism can be formed based on B2B trading platforms. The functions of information aggregation and price discovery will be replaced by the internet first. For example, third-party platforms like 1688, HC360, Zhaogang.com, and Cogobuy.

Second, transactions and payments are also gradually moving to internet platforms. Since 2012, major B2B platforms have collectively transformed from information platforms to trading platforms. For example, Cogobuy, which deals in IC electronic components, has annual online GMV exceeding 5 billion yuan; 1688, the largest domestic trade platform, has hundreds of billions of yuan in online transactions, but compared to the nearly 10 trillion yuan B2B market, it's just the beginning. Although online transactions are just starting and the scale and proportion are still very small, it is a long-term trend for B2B business. Only through online transactions can data be accumulated, and based on data, corporate credit evaluation systems can be built, then value-added services like supply chain finance can be provided, forming a complete business loop. Therefore, the gradual expansion of online transactions means that on-site and cash transactions in wholesale markets may be replaced, and merchants have one less reason to go to wholesale markets.

Finally, only the issue of commercial flow remains. For some non-standard products, such as textiles and clothing, jewelry, and handicrafts, relying solely on online images and text descriptions is insufficient; some require on-site display and inspection, checking raw materials, style, quality, and craftsmanship, requiring on-site viewing, selection, and assembly. For building materials, hardware, and industrial products with uniform specifications and high standardization, on-site display is almost unnecessary; the key is to establish an internet-based credit system to distinguish good from bad.

Additionally, when transactions move entirely online, even offline display and services only require a small number of samples, and the main spot inventory can be moved to specialized warehouses in suburbs away from city centers. This means wholesale markets don't need as much space, and it can effectively solve the current "three on-site transactions" (on-site, spot, cash) problems of dirtiness and disorder.

For example, in clothing wholesale markets, shops in the market only display styles, transactions are handled via mobile "cloud market," and ordered goods are shipped directly from e-commerce warehouses a few kilometers away. In auto parts cities, merchants only keep regular inventory, provide on-site installation and maintenance services, and after daily retail, parts are dispatched from a central warehouse. To achieve logistics separation, it is necessary to establish unified, specialized e-commerce warehousing for all merchants in the wholesale market, with bulk goods stored centrally in a main warehouse, managed through unified standardized information systems, with all products shelved and numbered.

This can achieve: display and negotiation in the store, online payment, bulk pickup coordinated from the main warehouse, or direct logistics from the main warehouse to customers, safe and fast, improving transaction efficiency. Currently, many wholesale markets in Guangzhou are implementing the "city exhibition, suburban warehouse" method of separating people and goods, with initial results.

Figure: Separation of "information flow, logistics, and commercial flow" in physical wholesale markets

5. Overall, wholesale markets will significantly decrease. Those closely integrated with industrial clusters and able to radiate globally/nationally ("origin-type" markets) are themselves evolving; pure distribution hubs and second/third-tier markets will polarize based on product category (volatility of end demand): some transform into retail, others into logistics parks

Let's make a judgment on the industry endgame of wholesale markets. As information and transactions complete their migration online, spot inventory and supporting services become the main basis for the existence of wholesale markets. Spot inventory is essentially a protection against demand uncertainty. Due to production cycles and batch issues, spot inventory is necessary. This situation determines the necessity and rationality of "origin-type" wholesale markets supported by surrounding manufacturing. They are not only exhibition halls but also have spot inventory for immediate pickup. Such markets include Yongkang hardware market, Shanghai steel market, Guangxi Pingxiang rosewood market, Anhui Bozhou Chinese herbal medicine market, Shiling leather goods market, Huludao swimwear market, etc.

However, as analyzed earlier, these wholesale markets themselves are constantly upgrading and evolving: on one hand, the rise of online markets drives the continuous separation of "information flow, transaction, and logistics"; on the other hand, online supply rises within the market, e-commerce service ecosystems become increasingly prosperous, and multi-format operations become the norm for merchants. For managers of such wholesale markets, what needs to be done is to adapt to technological development trends, provide top-level design and careful implementation in market planning, business environment, supporting facilities, technical support, and knowledge training to ensure long-term attractiveness.

But overall, the number and scale of wholesale markets will significantly decrease.

What is the future fate of pure distribution hubs, sales-area markets, and wholesale markets in second, third, and fourth-tier cities without industrial support? Ali Research Institute believes that depending on the product category, considering demand volatility, logistics costs as a proportion of product value, the core question to consider is: Is it necessary to aggregate goods locally to form "spot inventory" to protect against local demand uncertainty? Answering this question clearly reveals the industry endgame for such wholesale markets.

(1) For goods with stable demand (where relatively accurate demand forecasts can be made based on data) and where logistics costs account for a high proportion of product value, such as grain and oil, vegetables and fruits, bulk raw materials, industrial products, hardware and building materials, and daily necessities, it is economically rational to aggregate goods and maintain spot inventory at demand locations. Therefore, such wholesale markets will continue to exist, forming a pattern of national central warehouse (first-level wholesale) + regional sub-warehouses (second-level wholesale) + retail points.

In practice, there are several specialized markets for such goods in major demand areas. For steel, which has stable demand and high standardization, almost every coastal city with significant demand has steel markets with spot inventory to meet daily production needs. For example, Changshu, Jiangsu alone has three large steel markets: Sunan Steel Trade City, Changshu Port Steel Market, and Jinshi Steel City; around Hangzhou, there are over a dozen steel markets of various sizes; even remote Nanning, Qinzhou, and Liuzhou in Guangxi have their own steel markets. Hardware markets, besides the largest Yongkang hardware market (origin), almost every city has various hardware cities, which can be seen as second-level wholesale markets serving local demand.

As for grain, oil, vegetable, and fruit wholesale markets, basically every medium-sized city has one or more. Because demand for these is more stable. For such second-level wholesale markets, those with higher standardization will transform into logistics parks, such as steel, building materials, grain and oil; some will transform into retail or smaller-lot wholesale, such as hardware, fresh produce. The biggest risk for these markets is not internet impact but commercial real estate oversupply.

For example, in Tianjin, due to the development of the Binhai New Area, four major hardware specialized markets formed after 2003: International Hardware Electromechanical City, Xin Nanmalu Hardware City, North Hardware City, and Zhujiang Hardware City, with business area exceeding one million square meters. Changsha's Gaogiao Market, the fourth-largest comprehensive wholesale market in the country, is planned for 3 million square meters, almost equivalent to three-quarters of Yiwu International Trade City. Even Yiwu wholesale market, the origin, now faces commercial real estate oversupply; phases one and two barely hold up, phases three and four are sparsely populated, and stall fees have dropped significantly in recent years.

(2) For goods with low standardization and high demand volatility (difficult to predict accurately for a small local market), and where logistics costs account for a low proportion of product value, such as textiles and clothing, shoes, hats, bags, toys, jewelry, handicrafts, and seafood, a national first-level wholesale market (central warehouse) and a few large regional wholesale markets (sub-warehouses) are sufficient; others will gradually disappear, some turning to retail, forming a pattern of "national central warehouse + a few second-level wholesale markets + retail points." For example, Zhengzhou Yinji Trade City, as a large second-level wholesale market, hosts general agents and distributors of many Guangdong, Zhejiang, and Shanghai clothing brands, becoming a regional wholesale center radiating Henan Province.

In recent years, Yinji has consciously built a rapid logistics system covering all counties and cities in the province with next-day delivery to implement distribution services. Besides a few regional center markets adding logistics functions, more are transforming into retail. For example, Beijing Bairong World Trade Center was originally built as a wholesale market and was once one of the "Top Ten National Clothing Specialized Markets," but now retail accounts for 80%. In fact, in recent years, many specialized markets relying on large urban consumer bases have improved business environments, introduced dining and leisure facilities, and vigorously promoted retail transformation, such as Shanghai Qipu Road clothing city, Haining Leather City, Guangzhou Liuhua business district, Zhengzhou Yinji Trade City, Changsha Gaogiao Market, etc., with most retail proportions exceeding 50%.

Wholesale markets, as a shared sales network for many small and medium industrial enterprises, have their inevitability and rationality, but under internet conditions, they also face urgent needs for transformation and upgrading: either upgrade in place to comprehensive service complexes, or transform into logistics parks and retail stores. Ali Research Institute believes that large specialized wholesale distribution platforms based on industrial clusters, adopting a "quasi-self-operated" model—with both the breadth of "complete categories, one-stop shopping" and the depth of "reliable delivery and quality, rapid replenishment"—may be the most efficient business form in the future. We look forward to it.

(This article is from "Ali Business Review")

A Quick Look at B2B Entrepreneurial Opportunities: Many Wholesale Markets Still Have Room for Transformation with IT and Capital

Presenter: Lu Yi, Blue Lake Capital

Core Summary:

  1. Blue Lake Capital's core views on B2B supply chains are encapsulated in three words: change factors, efficiency improvement, and scale advantages.
  2. The proliferation of smartphones has become the biggest change factor in how business is done.
  3. Many forms of wholesale markets still have opportunities for transformation with information technology and capital.
  4. For the restaurant fresh food supply chain, the US mainly relies on broad-line service providers; the top three broad-line service providers in the US hold 70-75% market share, but China lacks such broad-line service providers.
  5. With the advent of mobile internet, a time window has emerged to scale the demand side. There are three benefits: rapid penetration, pricing, and product sourcing.
  6. B2B industries are broadly divided into three categories: 1. Bulk standardized products with relatively few SKUs and high standardization; 2. Bulk non-standard products with a large number of SKUs, in the millions; 3. More broadly defined consumer goods, possibly ready-made products. Detailed explanation of how the gameplay differs for these three types of B2B.

Currently, the core of various commodity circulation in China, from manufacturers to final retail or end users, is various wholesale markets. Wholesale markets are rare in developed countries but play a core role in China. China's wholesale markets play more of a role in pricing and matching transactions, improving commodity liquidity and reducing transaction costs.

But from Blue Lake Capital's observation, many forms of wholesale markets still have opportunities for transformation with information technology and capital.

Observations on Agricultural Wholesale Markets

Let me share a case: Meicai, a company Blue Lake Capital invested millions of dollars in during its Series A in 2014.

Meicai is a B2B platform for fresh food supply chain delivery to small restaurants. Meicai's upstream is agricultural wholesale markets. It sounds like a typical matching platform for non-standard goods.

Selling agricultural products in wholesale markets incurs high losses. Why do current buyers, including small restaurant owners, have to buy from wholesale markets rather than locking in long-term relationships with farms and cooperatives?

The reason is that farms and cooperatives, due to planting seasons, climate, pests, and diseases, cannot guarantee long-term stable supply. Even the same cooperative may have different batches of goods, and the quality within the same batch may vary.

So agricultural wholesale markets provide more sellers during your fixed procurement time, allowing all buyers to inspect on-site and complete transactions on the spot.

How do smartphones solve this problem? Blue Lake Capital found that the answer lies not in technology but in scale. Because we can look at comparable companies in the US. In an era when the internet was not well developed, American consumers had already abandoned farmers' markets and chose to shop at chain supermarkets.

For the restaurant industry, it also mainly relies on leading broad-line service providers. A broad-line provider can supply many goods needed downstream and achieve one-stop procurement.

In the US, the three largest broad-line service providers hold about 70-75% market share. The leader is two to three times larger than the second, and the second is twice as large as the third, indicating clear scale effects. Moreover, the leader not only has scale but also higher profit margins than the third.

Why doesn't China have such broad-line service providers? In China, due to geographical and political reasons, supply is too dispersed and unstable, and the entire circulation chain lacks the soil for scale.

But when the mobile internet and smartphone era arrived, the opportunity emerged. With mobile internet as a terminal form, the demand side can be scaled.

The first benefit is rapid penetration:

For small restaurant owners, they can now easily use mobile ordering to quickly integrate the procurement scale of small restaurants. For B2B trading platforms, by integrating the scale of small restaurants, they can move from consumer wholesale markets to product wholesale markets, gradually penetrating to the source.

Huge procurement scale allows circulation enterprises to more accurately obtain upstream data on product output and quality, forcing upstream to improve production forecasting and grade differentiation. At the same time, this process reduces the number of times goods are handled. The efficiency of the entire circulation chain naturally improves, and with scale, it can also promote the construction of cold chain logistics systems, reducing logistics losses and further improving efficiency.

For agricultural markets, the upstream is highly dispersed, and the downstream is equally dispersed. When a B2B trading platform achieves sufficient scale in the middle circulation link, it gains significant bargaining power. For agricultural products, the gross margin from source to end is high enough. There is a possibility that as long as I improve the supply chain, the huge cost reductions can be converted into company profits, presenting business opportunities.

The second benefit is pricing:

Let me give another example of flower B2B. We researched the flower market. The source of China's flower market is mainly Yunnan. Sellers are flower farmers and brokers at the origin, and buyers are wholesalers at the sales destination. For flowers, communication costs are high, and prices are affected by festivals and large events. Additionally, flower cultivation is difficult to scale; each farmer has limited capacity, and unsold flowers wither and are wasted.

For upstream, having stable sales expectations is crucial. The upstream flower market can quickly adjust prices based on daily market sentiment. You can simply think of such a wholesale market as an auction, with transparent market prices. But this method has drawbacks; it doesn't fully leverage downstream demand to guide upstream.

On-site transaction costs are still very high, and this is where the internet can play a role in scale integration. Blue Lake Capital observed Japanese and European/American markets and found that for flower markets, pre-ordering and contract trading have become mainstream, with early-stage flowers accounting for only 20-30% in developed markets.

Upstream flower growers hope for stable purchases and don't want their flowers to be sold at flower markets.

How is stable purchasing achieved in offline agricultural and flower markets?

The most primitive way relies on a group of diligent small business owners in the wholesale market. If a downstream buyer can purchase stably long-term, these flower farmers (upstream) are willing to prioritize meeting the quality standards of these small business owners. When farmers have insufficient capacity, they also prioritize supplying long-term buyers. At this point, a matching platform has huge value.

For downstream wholesale markets, they know that when using this platform to sell flowers, they can always buy upstream flowers that meet their standards at the best price and most stably. For upstream, they know that through this platform, they can always sell their goods to downstream at a price that meets their expectations and most stably. As long as I can sell my goods, I don't need to worry about anything else. This process is a better experience for both upstream and downstream, so there is an opportunity here.

The third benefit is product sourcing:

The core function of wholesale markets is product sourcing, especially for markets with very long-tail SKUs and many types, such as auto parts, clothing, ready-made garments, and hardware.

These markets have two major characteristics: first, the number of SKUs is very large, possibly in the millions. Second, the demand for goods is often urgent. For example, if you need auto parts to repair a car, or a nut for hardware, without that nut, the machine cannot start.

How is this done? It relies on many small business owners in the wholesale market. In their minds, there is an index of SKUs in the market, guiding them on how to find the right person in the fastest way—maybe Boss Zhang or Boss Li—to get the item. The entire wholesale market basically relies on these small business owners' mental indexes to transfer goods among themselves and meet customer needs.

When I know what I need, I call, QQ, or WeChat to inquire about prices. Due to unstable demand, it's hard for both sides to form stable relationships, leading to low participation and breeding dishonesty like passing off inferior goods and shortchanging.

What might happen in this market? If a company has sufficient capital reserves, it can build a complete central warehouse and establish a complete SKU index and list, making it very reliable to find everything it needs. At the same time, if there is a reliable logistics system in the market that can deliver goods to downstream customers in the fastest way, that would definitely be a better experience.

For example, NAPA, the world's largest auto parts company, and Grainger, which does office supplies, are companies with sales of over ten billion dollars, and their market values also exceed ten billion dollars.

These large companies build warehouses of different sizes to provide comprehensive, fast, and reliable SKU services. Smaller companies that want to survive must either choose very niche categories and achieve more complete coverage and better service efficiency than the big companies in that niche, or they will find it hard to survive.

Efficiency Curve

Here is a B2B efficiency curve. How to understand this chart?

When the efficiency curve shifts to the right, the small players in wholesale markets enter the death zone for several reasons:

First, mobile internet makes it easier for downstream demand to search and find products. In China, Alibaba's e-commerce system has matured socialized logistics; our logistics speed is now ranked first globally.

This system allows upstream suppliers to have a much larger service radius, increasing competition. At the same time, mobile terminals integrate supply-side products and information, improving upstream service response capabilities.

For example, in auto parts, hardware, fabric, and clothing markets, all small merchants provide customers with consultation and quotes, and use WeChat groups to transfer goods among themselves. So mobile internet has already crudely increased the speed of information flow. We can see that Grainger in the US closed one-third of its offline stores this year, and online sales now account for one-third of total sales. It is now the 15th largest e-commerce company in the world. Through the internet, it increased its inventory from less than 100,000 SKUs to 600,000, better serving its downstream customers.

Is Grainger's self-operated model the only answer? Not necessarily. There is another Japanese company called Misumi that offers 10 million SKUs and can deliver within 1-3 days, but it doesn't own inventory. It finds a large number of inventories from below. This company has also seen rapid growth over the past decade, with a market value close to 4-5 billion dollars, which is quite impressive.

When discussing B2B supply chain opportunities, there are three core questions that must be considered. First, what are the change factors in my industry? Second, does my business model have room and points for efficiency improvement in the entire industry chain? Third, once my efficiency improvement points and business model are proven, will it generate scale advantages that help us grow quickly and build barriers? This is very core.

Compared to traditional wholesale markets, B2B trading platforms in China's current context bring three major core advantages, which are also the main aspects to consider when seeking efficiency improvement points: first, they can accelerate the matching of non-standard transactions. Second, they can quickly increase and complete transactions on the platform. Third, they can increase the richness of a single supplier's product handling and speed up downstream product sourcing. This is the most direct source of B2B supply chain efficiency improvement points under China's current conditions.

B2B Entrepreneurial Logic:

Today I will share about B2B, mainly limited to B2B trading platforms and corresponding supply chains. Enterprise services and SaaS are not in today's scope.

Blue Lake Capital's core views on B2B supply chains are three keywords:

1. Change Factors 2. Efficiency Improvement 3. Scale Advantages.

I. Change Factors:

The wave of To C internet and mobile internet began to explode in 2009 and 2010. After 2010, consumers gradually increased their acceptance of new services provided by mobile apps like Meituan, Ele.me, and Didi Chuxing.

Users have formed many new usage habits through apps. But traditional B2B business methods remain stuck 10 or even 20 years in the past. Twenty years ago, B2B transactions were simply wholesale markets. Fifteen years ago, Jack Ma founded Alibaba, a B2B e-commerce company.

The first generation of B2B trading platforms, more accurately information platforms, was represented by Alibaba. There were also vertical portals in many niche fields using classified ad or yellow pages models, aiming to help people do business better. But these platforms had a problem: they only solved where to find and whom to find, but couldn't solve the following:

  1. The types of products offered by the other party were unknown. Early merchants, to gain more opportunities, would exaggerate and claim to have all kinds of products, but whether they actually had them and in what quantities was hard for buyers to know.
  2. Ad-driven classified ad and yellow pages models sacrifice customer experience. Platforms pursue more information display; if they publish more information, they attract more traffic, meaning more money for the platform. But this is at the expense of customer experience and cannot guarantee the authenticity of displayed information. Over time, the time cost for merchants to browse this information increases.

These are the reasons why classified ad and yellow pages models hit bottlenecks 10 years ago. That's why Alibaba's stock performance was mediocre when it listed in Hong Kong.

The internet and mobile internet waves have brought revolutionary changes to B2B transactions: 20 years ago, business was done by phone; 10 years ago, by computer and internet; 3 years ago, by mobile smartphones.

The proliferation of smartphones has become the biggest change factor in how business is done. Ten years ago, it was very difficult for less-educated bosses in noisy wholesale markets to negotiate business on PCs. Today, smartphones have become part of the body; anyone can use mobile phones to chat on QQ and WeChat, greatly lowering the barrier to doing business on mobile terminals.

II. Efficiency Improvement:

When a company in a B2B trading platform creates a new product form to serve customers, as investors, we consider whether this will improve the efficiency of the entire industry chain. This is also caused by change factors.

For example, because many users order food through apps like Ele.me and Meituan, small restaurant owners, to do better business, need to adopt smartphones faster and learn to use app features faster. This wave forces small restaurant owners, their suppliers, and delivery personnel to quickly learn how to use smartphones and app features.

This is how an industry, when driven by downstream changes, also drives upstream changes, creating efficiency improvements in between.

III. Scale Advantages:

Usually, a good business model has obvious scale advantages. That is, the larger the scale, the better the customer experience, which increases customer stickiness on your platform, leading to continued scale growth, forming a virtuous cycle. If it's not such a model, your business won't grow big.

When we look at a specific segment of B2B trading platforms, the above three factors are important indicators for Blue Lake Capital. Are there industry change factors? Under the push of new change factors, is there supply chain industry-level efficiency improvement? After efficiency improvement, can it have scale effects?

If all three answers are "yes," it's a very good niche market, worth digging into for investment opportunities.

B2B industries are broadly divided into three categories:

The first category is bulk standardized products with relatively few SKUs and high standardization. The second is bulk non-standard products with a large number of SKUs, in the millions. The third is more broadly defined consumer goods, possibly ready-made products.

The gameplay for these three different B2B verticals is also different.

For the first type, when talking about bulk standardized goods, think of steel, oil, coal. For such fields, traders have very limited profit margins, and upstream production is highly concentrated, often monopolistic. For this vertical, a feasible business model is to become a traffic entry point, using accumulated transaction data and trading counterparties on the platform to provide data and supply chain finance services.

For the second type, bulk non-standard products with a large number of SKUs. Such companies include auto parts, hardware, fabrics, clothing, even pharmaceuticals, with hundreds of thousands of SKUs. For this market, upstream and downstream are often dispersed, and the platform actually accelerates transaction matching, during which the platform gains pricing power.

The platform just needs to do well in customer experience and service, allowing transactions to happen on the platform. At this point, the platform should take a cut of the transaction, whether through commission or service models. But because the platform has strong bargaining power over both upstream and downstream, a platform with high bargaining power can charge trade fees in the middle.

For the third type, broadly defined consumer goods, including cosmetics or FMCG. The core experience is not about product selection but logistics construction.

First, for downstream, product information is relatively transparent, no extra education needed, but it is standardized. In the long run, we can imagine that 50-100 years later, there will be two ways for such products to reach consumers: like B2B e-commerce, from B2B to JD.com, to Tmall, directly to consumers, without intermediate platforms.

Second, if going offline, it heavily relies on retail terminals. Consumers need to experience products at retail terminals, and retail terminals can directly connect with factories or large upstream suppliers. Because the degree of information opacity is relatively low, people doing this business need to think about how to use the information asymmetry between downstream retailers and upstream manufacturers, how to use the time window to quickly scale up, make the platform indispensable, and immediately build core capabilities.

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