One of the biggest customers of China’s white spirits industry (which includes sales of vodka, gin, rum, tequila and other liquors) has been government and state undertakings. Since the new administration came to power, however, there have been policy measures to control unbridled spending on entertainment. But in no country does the industry thrive on government patronage, says Hongfeng Hao, founder and chairman of Jiuxian.com, an online liquor sales platform.
In the past three years, Beijing-based Jiuxian has seen sales grow 300% every year. Founded in 2009, it has around 6,000 spirits varieties for sale on its platform, which has captured half of the online sales market for spirits in China. Jiuxian is also offering online one-stop sales and marketing solutions for branded spirits manufacturers. As of today, the company has raised six rounds of financing for a total of 930 million yuan ($150 million).
Before starting his new venture, Hao was a traditional offline dealer for white spirits in Shan Xi province for more than a decade. In this interview with Knowledge at Wharton, he talks about the industry, his own success, his new online to offline and consumer to business strategies and his view of the future.
An edited version of the conversation appears below.
Knowledge at Wharton: What made you set up Jiuxian.com?
Hongfeng Hao: We had been planning to expand into retail from our original wholesale business as I thought there was a lot of potential in retail. We investigated the offline spirits chains and found that it was not a remunerative business model as property rentals were too high and single-store sales too low. I attended a university lecture where I learned that selling spirits online doesn’t [require] rental fees and it can reach nationwide consumers more efficiently by stepping over the many levels of dealers and agents. This inspired me to start Jiuxian.com.
Knowledge at Wharton: What is your main business model?
Hao: Our business is selling spirits. We hope to reach consumers through whatever channels they are buying spirits from. Revenue from our official website and mobile orders is 60% of total sales. The other 40% comes from China’s major e-commerce third party platforms (including Tmall, JingDong, Yihaodian and Dangdang). We are very important partners for them in spirits sales.
There are many ways to sell spirits. Jiuxian.com is a business to consumer (B2C) model. To serve customers better, we have this year launched new business units — online to offline (O2O) and consumer to business (C2B) models. The B2C business mainly serves the demand to buy spirits [in a way] that is planned in advance. The O2O strategy is for the more impulsive. Our mobile app called Jiu Kuai Dao allows you to buy spirits to serve instant demand. [O2O is a strategy of traditional retailers; marketing and payments are online, while the actual delivery is at a store or restaurant.] Our C2B strategy meets consumers’ demand for a different and customized product. [The customer designs the product and the merchant implements the design and sells it.] Meanwhile, we offer a one-stop e-commerce solution for branded spirits manufacturers to weather the tough time in the industry.
Knowledge at Wharton: How do you think the Internet has changed the industry?
Hao: The biggest advantage of the online platform is that it brings spirits to the consumers’ hands faster and at a lower cost. There are many levels in the traditional sales network and it might take five to 10 years to launch a new brand. But in e-commerce, you can connect with nationwide consumers overnight and at a lower cost. We have helped many regional brands to go national. For example, Song He Spiri in Henan province was a regional brand available only there; it can now be delivered across China.
“In the online space, consumers have higher expectations. And it is nationwide competition from the very beginning.”
But e-commerce has its own challenges. Competition in the traditional spirits market is not very intense. In the online space, consumers have higher expectations. And it is nationwide competition from the very beginning. Any small innovation or mistake can be magnified very quickly; we therefore need to be more careful.
Knowledge at Wharton: You have expanded very quickly in the past few years. What explains the speed?
Hao: There are no miracles in this industry. You cannot just set up an online platform and expect to stand out in the market. You need strong consolidation abilities on upstream resources. Our core members have worked in the spirits industry for more than a decade. This gave us a strong advantage in resource consolidation. I have worked for 13 years in the spirits agent business and I have been No.1 in sales in Shan Xi province. We have strategic cooperation agreements with more than 500 spirits producers in China. In sales channels, we have worked with a dozen open e-commerce platforms, which helps complement resources. We have more than 2,000 people in the company.
Meanwhile, our business model is quite unique in the industry. We are not only selling spirits to consumers, but we also offer one-stop e-commerce solutions for spirits producers by providing branding, marketing, sales, logistics and other services.
In addition, we have received a total of 930 million yuan in financing. This has helped us set up very high entry barriers for competitors.
Knowledge at Wharton: Many of the e-commerce players are spending a significant amount of money, but are still in the red. Jiuxian has achieved profits after just three years. How did you do it?
Hao: Our average gross margin in online retail is around 10%. The other revenue stream is the service fees for value-added services for branded spirits producers.
How do we make profits? First, the overall environment for spirits e-commerce is relatively healthy, not like other verticals where competitors are fighting against each other for market share and sales volumes at the cost of bottom lines. As a major player in the market, we will not destroy the pricing structure in the industry. Our gross margin has stabilized at 10% and our revenue is growing at more than 300% every year.
Secondly, we are very cautious about spending on marketing and business expansion. When most e-commerce companies splurged on advertisements, we didn’t waste too much on promotions. As an e-commerce vertical, we have not expanded into other categories. Some e-commerce companies have nearly half a million SKUs (stock keeping units), but we have only 5,000 to 6,000 SKUs today.
“In retail, saving cost is crucial to make money.”
Thirdly, as businessmen from Shanxi province, we have inherited a thrifty style. Others rent offices at a daily rent of 10 yuan/sqm. But our office in suburban Beijing costs only 1 yuan/sqm. So we save millions of yuan on rent every year. In retail, saving cost is crucial to make money.
Knowledge at Wharton: If you are in a good financial position, why do you still need the sixth round of financing?
Hao: Up to now, we have raised six rounds of finance. Spirits suppliers, especially the big brands, insist on cash on delivery. Our sales are several billion yuan every year and our largest warehouse has more than 200 million units. This requires a huge amount of money to be pre-paid.
Secondly, the financing has set up a very high entry barrier. We have spent more than one billion yuan. If any competitor wants to achieve our scale, he will need to spend five billion yuan or more. But if someone has five billion yuan at his disposal, there would be a lot of other opportunities to invest and he might not choose to sell spirits.
Knowledge at Wharton: What is the profile of your typical consumer? The younger generation is quite conservative in drinking white spirits. Is that a concern?
Hao: What we have witnessed is that individual consumption has been stable. When the government spending is restrained, it is time for consumers to buy.
For Jiuxian, 80% of our buyers are 25-40-year-old individuals. Average spending is around 300-400 yuan. So the purchases are really for their own consumption. The best-selling items are spirits costing between 100 yuan and 200 yuan. Spirits that cost below 200 yuan account for 50% of total sales. On our platform, sales of white spirits account for 70%; wine accounts for 15%-20%.
In every country, consumption is closely related to culture. Chinese culture will not survive without white spirits. Korea and Japan are both very Westernized countries, but Koreans still drink distilleries (distilled rice liquor Soju) and the Japanese love Saki (a kind of rice spirit). In social events in China, the main offering must be white spirits. Young people don’t drink white spirits because they have not yet stepped into the mainstream. They will like white spirits once they are in. The whole market for spirits in China is around one trillion yuan. E-commerce players will get 10% which translates to a 100 billion yuan market. The number of consumers does not bother me.
Knowledge at Wharton: How did you get the idea for your mobile app, Jiu Kuai Dao?
Hao: I got the inspiration when I was drinking white spirits. It also draws from the newly-popular app [for summoning taxis]. With [our] app, users can find nearby offline spirit stores within five kilometers, and enjoy fast delivery. We insist these stores deliver fast; if they can’t deliver in nine minutes, they have to compensate 50 yuan to customers. Most customers can’t wait too long as they usually use this app when they begin to order at a restaurant.
People buy 10 boxes (around 60-100 bottles) of spirits for one wedding. We have six centers nationwide to handle logistics. But if you are going to have dinner in a restaurant and need a certain spirit soon, what can you do? Do you have to buy high-priced spirits in hotels and restaurants? Our app is consolidating offline spirits retailers to offer instant service for consumers.
Meanwhile, Jiuxian can help spirits companies manage their retail end more efficiently by using this app. The management system can support order-taking, client feedback, information push, etc. to make online sales and offline stores complement each other. The branded spirits companies can realize zero-distance interaction with consumers using this app instead of investing huge financial and human resources in dealing with the restaurants.
“In every country, consumption is closely related to culture. Chinese culture will not survive without white spirits.”
Knowledge at Wharton: Since 2012, the white spirits industry has suffered a lot due to the policy to control government spending on entertainment. Industry has been adjusting for two years; is the slowdown over?
Hao: The slowdown can be attributed to three factors. First, policy. But there is no spirits industry in the world that is growing on government spending. There will be no opportunities for government spending in the future. Secondly, the economic environment. The macro environment is slowing down and income growth is declining dramatically. Thirdly, excess capacity. From 2010 to 2011, many spirits producers expanded capacity, some by more than 100,000 tons. The whole industry has expanded [by] several million tons. When the downward cycle comes, there will be no way to digest so much capacity. Some companies will have to die so that the rest can survive.
In my view, the adjustment period for the white spirits industry has just started. I think that this round of adjustment will not be V shaped, but L shaped. We are still in a downward channel. It may become worse. In the past, the gross and net margins for white spirits companies were very high. Other mature industries usually see gross margin at 20%-25%, and net margin at 5%. This is normal and healthy.
I estimate that the industry will need another two-to-three years to recover. We are not at the bottom yet; there is still half the way to go. The real tragic time has not come yet.
Knowledge at Wharton: The whole industry is facing a slowdown. But you feel the advantages for Jiuxian outweigh the disadvantages. Why?
Hao: The industry was in a crazy phase before 2012. It was very difficult to buy a bottle of a big brand. It was also very tough to work with big brands. But in the past two years, prices have been cut almost by half. More than 90% of the spirits companies have seen their performance decline dramatically; in some cases, profits dropped 60%-70%.
When the market is so tough, the relationships overturn. In the past, we went to talk to the spirits manufacturers. Now, they come to talk to us. In the past, you would probably not get your spirits delivered even though you had paid the money half-a-year ago. Now, delivery is guaranteed. In addition, the government spending control mainly targets the traditional companies, which thrive on special connections and private kickbacks. We, as an e-commerce player, do not have these; we don’t offer illegal kickbacks. The shrinking government spending market is not our target anyway.
Knowledge at Wharton: How do you view the efforts of branded spirits companies to explore their own online sales channels?
Hao: They have had too much of the good life in the past and didn’t focus on e-commerce. Today, when the traditional sales channels have been blocked and e-commerce is growing rapidly, these companies are trying to catch up. Some have opened online stores on TMall or set up their own e-commerce platforms. As of now, their online performance has not been brilliant.
Traditional spirits producers have strengths in brand management and production. Their sales strength is mainly in managing dealers and agents. But the nature of e-commerce is retail, which is a totally different concept from wholesalers. E-commerce is a lot of hard work. It requires professional experience in online marketing, consumer research, logistics management and after-sales management. Some brands priced their spirits very high online, which was not for sales, but for branding. However, I expect them to catch up more quickly in the future on pricing and operational strategy.
Knowledge at Wharton: This year Jiuxian has worked with producers to launch customized spirits bottles. Why is that?
Hao: I think there is a lot of potential for spirits to be better priced. However, in order to avoid conflicts with offline sales channels, we have launched customized spirits to ensure our consumers can be satisfied.
We have experimented a lot. One new project is San Ren Xuan — a spirit launched jointly with Luzhou Laojiao [a famous spirits brand based in Luzhou, Sichuan province]. We invited a famous artist to design a special bottle, logo and packaging. The producer is responsible for the quality of the spirit. And the price is 139 yuan per bottle of 1 kilogram. This product is especially made for Jiuxian customers. We sold around 40 tons in the first few days after its launch.
We now have similar agreements with Fen Jiu and Wu Liang Ye [both famous brands of white spirits in China] to launch low-price and good-quality packaged spirits. We wish to gain market advantage through our scale and shortcut channels to reach consumers. There is a lot of potential for online sales platforms to build up Internet spirits brands.