Pascal Martin and Jack Chuang, partners at OC&C Strategy Consultants, take a look at Alibaba’s Hema business model and ask: is it making money yet?
The omnichannel buzz word has been omnipresent in most retailers’ vocabulary 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 an entirely new buzz word to the world.
Is New Retail just another avatar of omnichannel or is it something profoundly different? What exactly is New Retail? 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 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 logo.
The Hema concept was developed from scratch by Hou Yi, a brilliant logistics expert hired from rival Jing Dong.
The Hema store’s 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 minutes within a 3km radius of each store.
Hema has already opened 88 stores in 14 Mainland China cities and built a customer base exceeding 10 million, generating an average daily revenue per store of RMB800,000 to 1 million.
Customers love it
The first thing we looked into was whether customers like 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 and dining), and…. price.
A lot of this perception is the result of Hema’s smart positioning. A typical Hema store product range is in fact quite limited compared to other grocers, but it is broad in fresh food, particularly in seafood. Also, Hema is a price leader only in fresh (although still 15 per cent higher than at RT-Mart). The company has chosen that as their customer-acquisition weapon focused on health-conscious affluent families.
Hema is more expensive in almost every other category, yet once a customer is “hooked” on affordable fresh food and downloads the Hema application, they become 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), delivered through Hema’s cloud supermarket platform.
Customers love that! Hema wins in repeat purchase intention and preference, online and offline, against every competitor. To understand this, we asked a group of customers without Hema experience where they buy their grocery: they nominated a mixture of online and offline retailers, without any one destination standing out.
Then we asked the same group after a Hema experience to tell us where they intend to shop for groceries going forward: the answer was an overwhelming 50 per cent-plus favouring Hema. Such is the nature of market research, we note these are self-declared intentions and there may be gaps between intent and action. But the message is quite clear: with extended deployment, Hema seems to have the potential to grab massive market share of China’s grocery market.
The secret to success
How do they achieve such an overwhelming appeal?
First, a Hema store layout is very particular: 50 per cent of the store space is dedicated to the “back office” – a huge proportion compared with the 10 per cent or so of a traditional grocery store. This back office supports the “front end” store and most importantly the fulfilment of online orders delivered to the local neighbourhood. The front end is split between a regular retail space and the cooking and in-store dining space, which takes up a third of it.
Then, there is Hema’s Cloud Supermarket accessible through the Hema application, which gives customers access to a much broader range of products – 20,000+ SKUs, including dry food, non-food and appliances in addition to the stock available in the store. Hema has a next-day delivery promise for these goods, compared with the 30-40 minutes estimate of deliveries from in-store range. Goods from the Cloud Supermarket are shipped from a traditional-style remote warehouse using a similar approach to e-commerce logistics to Tmall’s.
With this configuration, online is absolutely key to the Hema business model. Based on our analysis, the best-performing Hema stores generate close to 70 per cent of their revenue online, compared with about 50 per cent for a traditional store.
Tellingly, based on our estimates, few customers retain an offline-only shopping attitude after experiencing a Hema store. Most of them become omnichannel shoppers and a hefty 25 per cent become online-only shoppers. This is an amazing outcome in any retail category: to a retailer, it is a dream come true where you acquire customers using a limited physical footprint and nurture them online!
A disappointing feature of the Hema concept is in the area of leveraging data in order to customise a store offer based on differing 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… yet we did not. There are no significant differences in stock ranging between stores in different regions, and almost no changes in the products recommended to customers online who adopt 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.
Many revenue sources
Thanks to its hybrid business model, Hema has created a 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. And it is generating commission fees from inviting third-party food and beverage brands to operate small stalls on its premises. Already, Hema has collaborated this way with more than 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, it has become a B2B supplier to restaurant businesses.
In future, Alibaba may also start to exploit its comprehensive set of capabilities – cloud computing, software, DC network, ultra-fast delivery, integrated supply chains and access to data to enable better forecasting and planning, etc… then start marketing them to other retailers anxious to enter the New Retail era.
The profit conundrum
But how does this all stack up financially? How is Hema performing versus other grocery retailers? And is it making money?
Based on our analysis, Hema’s best stores are more than twice as productive as RT-Mart’s best-performing stores, and about 50 per cent more productive than the average one. 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 remains a challenge. Based on our estimates, most of the stores are making a loss before the application of any depreciation and amortisation costs. Even best-in-class stores do not generate enough operating margin to absorb their high overheads.
One of the main reasons is that Hema’s hybrid online-offline business model implies high rent and high labour cost. The rent is high rent because they are basically operating a back-office warehouse in 50 per cent of what would otherwise be prime retail space in expensive residential areas. High labour costs because you need a lot of staff to operate a premium retail environment as well as online fulfillment logistics, with a high variable component for deliveries.
Economies of scale come into play: the larger 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 trip, thereby reducing the per-delivery cost. But one must expect this customer “densification” will happen at a faster pace than the inflation of labour costs, which is highly speculative. This is an old challenge of last-mile delivery economics.
It will be interesting to see how Alibaba and Hema will address this challenge, through a combination of revenue lift, a scaling down of store size, shifting a higher share of fulfillment to warehouses in lower-rent locations, charging for delivery, and sharing the capital expenditure burden with other retailers through licensing and partnerships.
That said, we should assume that Alibaba’s formidable technology and capital power will overcome these hurdles and make New Retail the new standard for retail.
Three lessons from Hema
There are several useful lessons to learn from the Hema experience…
Omnichannel 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.
It takes a lot of investment and costs to run an omnichannel operation. It is essential to do the mathematics carefully and have a clear roadmap to build scale rapidly.
Online giants will be hard to beat at this game because – for now – their pockets are the deepest. Therefore, it makes more sense for retailers to partner with them rather than try to beat them, and to leverage their technologies and infrastructure. The online companies need the income from these partnerships as much as the retailers need to progress as wannabe New Retailers.
The interior of Alibaba’s Hema retail stores was designed by Malherbe Paris, which describes the outlets as “urban supermarkets offering a strategy online to offline” with “surprising purified design”.
The design highlights the fresh credentials of the retail brand and its in-store eating space, both aimed at capturing a premium clientele.
- Pascal Martin and Jack Chuang are partners at OC&C Strategy Consultants. Pascal Martin presented at Retail’s Cutting Edge 2019 on the success of Hema and its implications in the New Retail era.