Deep-diving into Alibaba’s “New Retail” grocery stores

Friday 12 April 2019 | News

The “omni-channel” buzz word has been omnipresent in most retailers’ annual reports and press releases in recent years. A majority of them are painstakingly trying to integrate multiple online and offline touchpoints from discovery to purchase and services into a seamless and convenient journey for the customer, which is often a costly and difficult job.

Then in 2017, in a letter to shareholders, Jack Ma announced the “end of E-Commerce as we know it” and the emergence of “new Retail”, thereby introducing a new buzz word to the world.

Is “new retail” just another avatar of “omni-channel” or is it something more profoundly different? What is it exactly? How does it address customer needs? How does it work? Does it make economic sense? How is it likely to impact our retail environment (if at all)?

To try to answer these questions we took a deep-dive into Alibaba’s “new retail” mothership, the Hema grocery supermarket chain launched in 2016, with its familiar Hippo face. Hema’s concept was developed from scratch by Hou Yi, a brilliant logistics expert hired from rival Jing Dong.

The Hema store value proposition is built on three pillars:

1. Superb quality fresh food – particularly seafood – at an attractive price, that you can pick and have cooked to dine in the store or to go, 2. A completely integrated smartphone centric experience, from product information (by scanning QR codes on product labels) to automated check-out enabled by RFID tags, to payment through Alipay (although Alibaba was recently forced by regulators to accept other payment platforms and cash), 3. An extended shopping experience with the download of an application that allows online ordering and free home delivery within 30 min. in a 3km radius around each store.

Hema has already opened 88 stores nationwide in 14 cities and acquired more than 10 million customers, generating an average daily revenue per store of RMB 0.8 to 1 Million.

The first thing we checked in our deep-dive was whether customers liked the Hema experience. In a nationwide survey of grocery store customers across multiple grocery retailers, we found that the answer was a loud and clear “yes”: They rate Hema above every other grocery chain on almost all criteria: freshness, quality, choice, convenience, service (including in-store cooking/dining), and….price. A lot of this perception is the result of Hema’s smart positioning. A typical Hema’s product range is in fact quite limited compared to other groceries, but it is very broad in fresh food, particularly in seafood. Also, Hema is a price leader only in fresh (although still 15% higher than RT-Mart), which they have positioned as their customer acquisition weapon focused on health-conscious affluent families, but Hema is more expensive in almost every other category. But once a customer is “hooked” on affordable fresh and downloads the Hema application, he becomes a regular online customer including for dry food and “long-tail” products (those products that customers don’t buy on a daily basis but often replenish between longer intervals), which are delivered through Hema’s cloud supermarket platform.

And customers love it! Hema wins in repeat purchase intention and preference, online and offline, against every competitor. To probe this, we asked a group of customers without Hema experience where they buy their grocery: their responses included a mix of various online and offline retailers, without any dominant option. Then we asked the same group after a Hema experience to tell us where they intend to shop for grocery going forward: the answer was an overwhelming 50%+ share for Hema. Of course, we should be careful that these are self-declared intentions and there may be gaps between intentions and reality. But the message is quite clear… With extended deployment, Hema seems to have the potential to grab massive market share in China’s grocery market.

How do they achieve such an overwhelming appeal?

First, a Hema store layout is very particular: 50% of the space is dedicated to the “back office” vs. only about 10% in a traditional grocery store. This back office supports the “front end” store and most importantly the fulfilment of online orders delivered in the 3km radius around the store. The “front end” itself is split between a regular retail space and the cooking and in-store dining space, which occupies a third of it.

Then, there is Hema’s “Cloud Supermarket” accessible through the Hema application, which gives customers an access to a much broader range of products (20,000+ SKUs including dry food, non-food, appliances, etc..) than those available in the store, but with a next day delivery promise instead of the 30-40 minutes from the Hema store’s stock, through a “classic” remote warehouse centred E-Commerce logistics approach similar to Tmall.

With this configuration, online is absolutely key to the Hema business model. Based on our analysis, best performing Hema stores generate close to 70% of their revenue online, whereas the average store is at about 50%. What is also interesting is that, based on our estimates, very few customers remain in an offline-only shopping mode after experiencing a Hema store. Most of them become “omni-channel” shoppers and a hefty 25% online-only shoppers. This is quite an amazing outcome compared to any retail category: A dream come true, where you acquire customers with a limited physical footprint and nurture them online?

How about the ability to leverage data in order to customise offerings depending on regional preferences or customer buying patterns? In theory, with all the digital integration happening along the Hema value chain, we should see a lot of this…and we were disappointed: No significant differences in ranging between stores in different regions, almost no changes in suggested products to online customers with different basket habits. It is one thing to generate a lot of data, it takes a lot more to dig into it efficiently to create value.

Thanks to this hybrid business model, Hema has created a very broad range of revenue sources: Beyond in-store and online retail, Hema generates revenue from processing fresh food, which partially compensates for low margins resulting from its attractive price position. Hema is also offering cooked food and ready-to-eat meals under its private label. It is also generating commission fees from inviting 3rd party F&B brands to operate small stalls on its premises. Hema is already collaborating in this way with 200+ restaurant brands, including Starbucks Coffee.

Beyond retail, Hema has started to leverage its integrated supply chains from farm to store, for example in seafood and pork meat, to become a B2B supplier to restaurant businesses.

Finally, Hema may also start to exploit its comprehensive set of capabilities – cloud computing, software, DC network, ultra-fast delivery, integrated supply chains, access to data to enable better forecasting and planning, etc… to market them to other retailers anxious to enter the “new retail” world.

But how does this stack up? How is Hema performing vs. other grocery retailers? Are they making any money?

Based on our analysis, Hema’s best stores are more than two times more productive than RT-Mart’s best stores, and about 50% more productive on average. Admittedly this is achieved with a different business mix, which includes in-store dining and a large percentage of online sales generated by the store customers.

However, profitability is still a challenge. Based on our estimates, most of the stores are loss making before application of any depreciation and amortization. Even best-in-class stores do not generate enough operating margin to absorb overhead costs.

One of the main reasons is that Hema’s hybrid online/offline business model implies high rent and high labor cost. High rent because you are basically operating a back-office warehouse for 50% of Hema space in expensive residential locations. High labor cost because you need all the staff to operate a premium retail environment + online fulfillment logistics with a high variable component for deliveries.

Scale economics apply: The bigger the online revenue the better the profitability. As customer density increases within each store’s 3km radius, delivery routes will be able to serve a higher number of customers each time, thereby reducing cost per delivery. But one must bet that this customer “densification” will happen at a faster pace than labour cost inflation, which is highly speculative. This is the old question of the “last mile” delivery challenge.

It will be interesting to see how Alibaba and Hema will address this challenge, through a combination of revenue lift, scaling down of store size, shifting a higher share of fulfillment to lower rent warehouses, charging for delivery, and sharing the CAPEX burden with other retailers through licensing and partnerships.

We should assume that Alibaba’s formidable technology and capital power will overcome these hurdles and make “New Retail” the new standard for retail.

There a few useful lessons to learn from the Hema experience:

1. “Omni-channel” success does not come from just adding more channels to existing ones. It comes from creating a distinctive value proposition – including a multi-touchpoint purchasing journey – that truly meets customer needs.
2. It takes a lot of investment and costs to run an “omni-channel” operation. Better do the math carefully and have a clear roadmap to build scale rapidly.
3. Online giants will be hard to beat at this game because for now their pockets are the deepest. Therefore, rather than try to beat them, it makes more sense to partner with them and leverage their technologies and infrastructure. They need the income from these partnerships as much as you do to progress as a wannabe “new retailer”.

This article first appeared in Inside Retail Asia, February 2019.