When retail entrepreneurs Yu Gang and Liu Junling decided to give up their multinational expat lives in the U.S. and go into business together back home in China in 2007, they were sure about just three things: The sacrifices would be many, the hours grueling and nothing was going to be easy. Fast forward to today and they're the proud owners of Shanghai-based Yihaodian (or “The No. 1 Store,” in English), a booming online supermarket that sells everything from disposable diapers to digital cameras to laundry detergent and is aiming to give the country's offline supermarkets a run for their money.

In a recent interview with China Knowledge at Wharton, Yu discussed why the Yihaodian venture is, in fact, a return to his entrepreneurial roots. Originally from Yichang in central China, Yu headed to the U.S. to study in the 80s last century and later juggled an academic career at University of Texas's McCombs School of Business — publishing more than 80 articles and four books, and filing three patents — and the launch a software company, which he sold to consulting firm Accenture in 2002. Then, a stint teaching at Tsinghua, Peking University and other business schools in China was followed by a move to supply chains and procurement at multinationals Amazon and Dell. 

It was at Dell that Yu and Liu met and began hatching their plan to develop Yihaodian, China’s first large-scale online supermarket. Going live on July 11, 2008, Yihaodian now has eight million registered users across the country and sells hundreds of products from its virtual shop, while growing revenue from RMB 4.17 million (US$640,000) in 2008 to RMB 805 million (US$123 million) in 2010. As he revealed to China Knowledge at Wharton, he believes that the long hours are paying off as he turns Yihaodian into an online Wal-Mart for China's shoppers.

The following is an edited transcript of the conversation.

China Knowledge at Wharton: How did you get the idea of starting Yihaodian.com?

Yu Gang: Junling came up the idea of starting a company. It was in 2007, when both of us were expatriate executives at Dell — he was China president and I was vice president of global procurement. But being an entrepreneur wasn't something new to me. I had the experience of being one when I started a company from my basement in Austin, which grew to a team of more than 100 people developing a management system for almost all the major airlines in the U.S. As a first-generation Chinese in the U.S., there was a lot of hardship. However, my effort paid off.

Using experience gained then and as executives at multinationals, both Junling and I were able to look at many issues from a sophisticated commercial mindset and from all perspectives. Both of us got along well with each other in the past, and given all that, we were determined to do a bigger thing together.

When he brought up the idea of starting a new business in China, my entrepreneurial DNA was stirred. We did tons of market research and analyzed many companies, including Best Buy, Staples, Lianhua and Carrefour, and home improvement sector. Then it was my idea to start an e-commerce company. When I worked at Amazon, I was involved in its acquisition of [Chinese shopping web site] Joyo.com, which made me aware of the huge potential of China’s e-commerce market. We then spent four months in a 10-square-meter room writing the business plan and there was a lot of debate and analysis.

China Knowledge at Wharton: What was the biggest debate at that time?

Yu: When we analyzed the market, we found that most e-commerce companies were vertical, targeting a single product line. For example, 360buy mainly sellsdigital products, Redbaby focuses on baby-care products and Dangdang mainly books. Few companies were selling a full range of products online. So we had to ask ourselves whether it would be feasible to offering a full range of products right from the beginning.

We also found that when the vertical companies wanted to expand, they always hit bottlenecks. Some companies tried being an online supermarket, but failed. We analyzed their failures too, and our conclusion was that their problem lie mainly in their supply chain management systems, which happens to be what I had been dealing with a number of years.

I learned operational management in Wharton, taught more than a decade of operational management, and practiced supply chain management at Amazon and Dell. So we were confident that we could beat these challenges. What's more, having no established competitors also meant huge opportunities ahead. Although our research showed us that it was going to be hard, we found that at a certain point, things became easier.

China Knowledge at Wharton: What was the biggest challenge in the beginning?

Yu: The biggest was not money. Both of us invested our own money before raising financing from others. As mentioned, the biggest challenge was supply chain management. At the beginning, we had 3,000 SKUs [stock-keeping units] and hundreds of suppliers; now we have 70,000 SKUs and 2,000 suppliers. Managing the products, including quality control, inventory, online marketing and pricing, were all challenges. Inventory management was especially important — if you underestimate inventory, you won't be able to deliver anything; if you overestimate it, you have too much, which sucks up your capital.

In the beginning, we spent a huge amount of time developing system software. We developed all our systems, apart from the financial software. The whole system has more than 10 modules, including customer, warehouse, distribution and marketing management. We started with a systems-development team in February 2008, which worked day and night, and yihaodian.com went live on July 11, 2008.

China Knowledge at Wharton: How did you attract staff?

Yu: We recruited people one by one, all by ourselves. Entrepreneurs have to do everything. We don’t have big salaries, but we attract people with our passion and vision. What else could attract these young men? Junling and I have given up everything. As expatriate executives, we used to have luxury houses, cars, drivers and so on. At Yihaodian, we didn’t even pay ourselves salaries in the beginning.

Being an executive at a multinational means having a big crew in a big machine. Now, we are the engines. We have to drive this company with our passion, leadership and experience. We have to think of every means possible to solve problems and continuously create value. We were the first online supermarket, so there was no business model to copy, or regulation, process or institutions. But I really enjoy this process. It’s like watching a baby being born and then grow up. The whole process is really exciting and rewarding.

The company has grown astoundingly fast. We had around 180 employees at the beginning of last year; now, it’s 1,800. This year, we will recruit 3,000 more people. At the same time, such rapid expansion brings huge challenges, from culture to internal systems, from stock to service. There are a lot of bottlenecks. I have to solve many issues every day, but I am not scared. I call these problems “happy pains."

China Knowledge at Wharton: From your blog, I can see you are especially optimistic about many things.

Yu: I am an optimistic person. I am not afraid of difficulties; they are part of the game. It was so much harder back in the U.S. to start a company, but I managed. We had to look on the bright side of everything. It's a very important attitude if you want to be an entrepreneur.

Today, I can accept hardships and meet challenges with a very mature mentality. I am very clear about the process I have to go through. First, I have to take myself back to zero, and forget about all the past glories. When I was a senior executive at Dell and Amazon, suppliers would be at my beck and call. Now, I have to call them. If once is not enough, then I have to call them twice, or until it works.

At the start of Yihaodian, I put promotional catalogs in my neighbors’ mailboxes in Shanghai. I had asked a friend, an American professor, to help me. We waited until it was dark and then went out with our backpacks full of catalogs. When a security guard stopped us and said we weren't allowed to do that in the apartment complex, we just kept on going. He didn't stop following me until I got back home.

I also go to the warehouse myself to pick up orders and check on inventory. No problem. Many people could not make the transition from luxury to the basics, but it doesn't bother me. If you are going to start a company, you have to put yourself on the front line. People don’t remember your past. The past glory belongs to the past. You have to create your future.

We once talked to a venture capitalist, who said point blank, "Executives from multinationals do well moving from one to 10, but you don't do well moving from zero to one.” I am determined to move from zero to one, and then one to 10.

China Knowledge at Wharton: Many offline retailers in China have tried to start online channels, including department stores Yintai and Lotus, the supermarket. What are the major differences between the two?

Yu: Offline and online retail are very different, from supply chain structure to human capital structure to marketing.

For example, the supply chain is different. Offline retailers have suppliers deliver goods to different stores, without having to go the “last mile” and deliver those to customers, which is especially important for online retailers like us.

Of course, offline retailers already have a wealth of procurement resources and advantages through their big supplier networks. However, that leads to the question: What do you do about pricing? Customers expect online prices to be lower than those offline, but if you price products cheaper online, you can “cannibalize” yourself and your offline business will be seriously threatened.

China Knowledge at Wharton: What are the most important performance metrics for an online retailer?

Yu: The most important is customer experience, which is a complex process involving many things — the richness of your offering, attractiveness of your price, the flow of the purchasing process, deliveries being on time, and what about the quality of your after-sales service? The customers' experience is a comprehensive measurement of your performance.

Yihaodian has outperformed the [e-commerce] industry in several metrics. First, the conversion rate — what percentage of a site's visitors place an order? The industry average is between 1% and 2%; we have 4%. Of course, that has to do with the nature of our business and target customers, who tend to have a shopping list to hand when they go online. A second metric, customer stickiness — how many of them would come back to buy again? Up to 70% of our customers are repeat buyers. And the average page views of each visitor is 12; the industry average is around 8. The number of products bought per order is around 12.7, and volume per order keeps rising.

China Knowledge at Wharton: What is Yihaodian's core competence?

Yu: Our biggest one is our five modules. First is the platform. We have dozens of software systems, some of them under patent. Second, our procurement system. We have a big procurement team to manage our suppliers from certification to product quality control. Third, the logistic system, which includes three distribution centers in Beijing, Shanghai and Guangzhou, and will new centers opening in Wuhan, Chengdu, Xi’an and Shenyang this year. Fourth is our distribution system. We have more than 50 distribution stations in 10 cities and will open hundreds in 30 cities this year — 70% of our distribution service is built in-house. The last module is the customer relationship management system. We do a lot of data analysis based on customer online behavior to recommend new products for individual customers.

What’s especially important is that all five systems are scalable basis.

China Knowledge at Wharton: How do you view the competition between Yihaodian and offline retailers?

Yu: We focus continuously on improving ourselves — how can we lower costs, be more efficient, scale our business, expand our offering and improve our service. Our price is lower than offline channels by around 3% to 5%. We use an automated price intelligence system to adjust our pricing in real time according to our competitors’ pricing.

Online retailers have many advantages over offline retailers, including a wider selection of goods. Generally, a mid-sized offline supermarket can only manage 20,000 SKUs; we already have 70,000 SKUs. Meanwhile, online prices are lower and home delivery is convenient. On top of that, online shopping can provide customers more information and more fun. For example, if you buy wine, you can read stories about the world's top wineries and learn how to distinguish good and bad wines.

China Knowledge at Wharton: How are you dealing with the challenges of managing talent amid such rapid expansion?

Yu: Talent management is indeed a big challenge right now. We continuously have new people coming in, who are like shock waves to older staff and the corporate culture. We have developed some strategies to attract, train, motivate and retain people, but more importantly, we hope current employees have a good attitude about accepting new hires and new hires have a good attitude about accepting our corporate culture.

Our corporate culture is defined in four words: Integrity, customers, execution and innovation. Integrity is first because it’s the most important. Integrity means doing what you say, saying what you do. We have to have integrity when dealing with our customers, suppliers and employees. When I started a company in the U.S., as a first generation Chinese, clients were willing to close billion-dollar deals just because they felt I was trustworthy and do my best to do what I promise to do.

Our co-operation with [U.S. consumer goods multinational] P&G started from this. When we met one of its vice presidents for the first time, we had a PowerPoint presentation about our business, and a small line at the bottom of the slides said, "Integrity is our corporate culture." He got really excited, and said we are a perfect match because P&G put integrity first as well. From that moment, our communication kicked off and all has gone well.

One saying I've shared in my blog is: Be a person with integrity and not being successful is temporary; be a person without integrity and being successful is temporary.

China Knowledge at Wharton: What's on the company's five-year horizon? Do you have plans for a stock market listing?

Yu: Going public will be a milestone, but not an ultimate goal. It’s only a way of accessing financing. Our plan is to grow step by step, according to our business plan, and create a new business model and new value and eventually change people's lifestyles. We will continue to expand our offerings and improve our service. Our aim is to build Yihaodian into a sound, respected company for the long term.

China Knowledge at Wharton: What qualities do all entrepreneurs need?

Yu: You have to be optimistic, and have the courage to go back and start from zero again. How far you can go depends on the depth of your vision. Too many people focus too much on the benefits directly before their eyes, which prevent them from seeing a bigger future. Only by giving up the benefits now, can you build a long-lasting course for the future.