In recent months, it became clear that China’s tech giants were retreating from new (physical) retail, once hailed as the future of omnichannel consumer experience.
At Alibaba, Hema’s founder has been retired, while Sun Art retail’s CEO has been replaced. Alibaba Group Chairman Joe Tsai said in the latest earnings call that they will ‘continue to work on (exit physical retail businesses)”.
For a long time, Hema was able to hire the best tech talent in China in a mission to transform one of the largest, and most traditional, industries. What has gone wrong?
A recent article in China by consumer-focused writer Dong Jie (董洁) has been widely circulated amongst Friends of Momentum Works. The article, titled “After an eight year dream of new retail, it turns out the winner is Sam’s Club”, synthesised interviews with seasoned executives in retail but also those in tech majors’ efforts of new retail.
The original article is long, detailed, and with a lot of context which might not be straightforward for non-Chinese professionals. We have put some summary plus context below:
- In 2017, at the beginning of the hype of new retail, Chen Zhiyu went against the current by leaving Alibaba to join Walmart China to head ecommerce. At that time, traditional retail was in dire state while ecommerce giants were confident of conquering offline. Chen, however, believed that “having a model alone is not enough, and it is difficult to achieve sufficient scale in the short term. A business with substantial scale determined to innovate internally has a greater chance of success“;
- Eight years on, new retail is in retreat, and traditional retail is advancing. Experts believed that Sam’s Club had a CAGR of >30% in the last 3 years, reaching RMB 80 billion (US$11.1 billion) sales in 2023. An average member contributed RMB 14k (US$1.94k) per year, 1.6 times that of Taobao – Alibaba’s largest online marketplace;
- At the end of 2023, Hema had >360 stores with RMB 60 billion in sales, while Sam’s Club’s RMB 80 billion revenue came from just 47 stores. Sam’s Club has also actively learnt and poached people from Alibaba and JD on digital marketing and fulfilment. However, when it comes to “goods”, the core of retail, Sam’s Club only fears Costco, another “traditional retail” player;
- Sam’s Club entered China in 1996, and only opened 4 stores eight years on. In 2004, Walmart paused Sam’s Club’s expansion plan in China because of “lack of sufficient members”. A key challenge was convincing Chinese consumers to pay a membership fee before they could shop. Some in Walmart’s global management wanted to shut down Sam’s Club in China, while then chairman Robson Walton (son of the original founder) gave Sam’s Club more time – they needed to wait for the middle class in China to grow from the meagre 4% back then;
- Since 2010, Walmart’s hypermarket business has experienced a lot of turbulence with the rapid expansion of ecommerce in China. However, Sam’s Club’s fortunes started to change in 2012, when British executive Andrew Miles joined as COO for Sam’s Club China. His track record had been expanding Watson’s footprint in Asia from 400 stores to 1500 between 2003 and 2008;
- One of Mile’s first major challenges was that the staff’s understanding of the “membership store” concept was unclear, heavily influenced by Walmart’s hypermarket mindset. However, the key to success of a membership’s store is the member fees – margins from sales should only contribute to a smaller percentage of the profits;
- Miles implemented two important operational reforms: 1) Cut SKUs from 10,000 to about half of that, allowing a high turnover rate and better price negotiations with suppliers; 2) Raise membership fee, which had remained RMB 150 for almost 20 years, to RMB 260;
- The membership fee hike was controversial. Amid a lot of customer complaints, Miles provided a reason internally: “If someone doesn’t accept this figure, then they are not our target customer.” The decision turned out to be right, helping Sam’s Club filter for ‘precise’ users: urban middle-class individuals with sufficient purchasing power and a pursuit of quality of life’. This is different from the user base of major ecommerce platforms;
- However, cutting SKUs and raising membership fees were only tactics, a deeper reason for Sam’s Club’s success was to make good products. Sam’s Club looked for “novelty” and “uniqueness” in their products. They relied on the global supply chain only for a few selected categories such as dry goods, while most of the goods were sourced from domestic supply chains, often developed from scratch;
- Chief Merchandise Officer Zhang Qing once said “If Sam’s Club’s products are the same as those available through other channels, why would members pay to shop with us?” Sam’s Club believed internally that if new products had too high a success rate, they were not taking enough risk to create true “hero products”.
- To ensure selection is unaffected by external influences, Sam’s purchasing tends to deal more with suppliers’ R&D rather than sales teams. “If a supplier starts by arranging their sales team to talk about sales volume, profits, rebates, and deductions, there’s a high chance they’ll be passed over,” Zhang Qing once said;
- Another core principle of Sam’s product strategy is to offer the best quality within the same price range or the lowest price for the same quality. For example, Sam’s Club spent a few months negotiating with suppliers, and finally chose one. They required ” pure natural vegetable oil, higher purity mochi flour and milk powder, and crucially, doing all these without raising the product price;”
- Few suppliers could gain an upper hand in negotiations with Sam’s Club. However, they accept Sam’s terms because it is a strong endorsement of their capabilities, which often leads to much more other business opportunities. Walmart essentially achieved quality and pricing of its products through: 1) exclusive supplies; 2) customising the products; and 3) scale to negotiate down prices;
- Hema actually took a similar core product strategy compared to Sam’s Club. Hema’s initial model of business was to use online orders to expand sales volume, supporting stores to profit sooner. However, this required a sufficiently large volume of online orders (a former Hema employee stated that the internal critical point was “an average of 3,000 orders per store per day”), otherwise both the stores and online would lose money;
- Sam’s Club’s approach to online sales was entirely different. It started merely as a supplement to store business but unexpectedly grew to a significant volume.By Q4 2023, more than 50% of Sam’s Club China’s orders came from online. Compared to most competitors which ran on-demand groceries, Sam’s Club did not need to invest in acquiring new customers, but leverage their members who became loyal through offline channels;
- In fact, Sam’s Club’s online experience was poor for a long time. This changed during the pandemic, when they were forced to accelerate online channels. Miles provided the crucial decision of only making 1,000 SKUs (out of 4,000+) online, to protect the offline shopping experience;
- Hou Yi, the founder of Hema, made no secret that Sam’s Club was the only retailer worth learning from, and aggressively marketing against. A price war in Shanghai between Walmart’s local store and Hema, however, led to the Sam’s Club store manager being advised to leave. Senior management reminded that dynamic promotions were a major taboo for the membership model. Christina Zhu, CEO of Walmart China, once explained that the reason why Sam’s Club does not do promotions was “because every promotion adds complexity to the business model, and the complexity of each product model increases costs, which ultimately are passed on to members;”
- Miles also talked about what “discipline” means in a membership store: “We don’t focus much on store design, fancy shelves, lighting, or complex promotion models. We care more about a stable pricing system”;
- In the current downturn in consumer sentiment and competitive landscape, both new and traditional retail made their own strategic choices. In 2023, Sam’s Club invested 1 billion yuan to permanently lower the prices of its best-selling dozen products; Hema, on the other hand, started a drastic strategic transformation;
- Sam’s Club is very cautious about a new competitor – Costco in China. When Costco entered China in 2019, Sam’s Club started a team of 8-10 whose main job was tracking Costco’s operations, including products, supply chain, membership, services and actual sales data. In Shenzhen, Sam’s Club also doused metro stations near the Costco store with their own ads to divert traffic. Costco responded with frequent rounds to Sam’s Club stores, often stopped by the latter’s staff;
- Sam’s Club China has been following some of the core practices in Walmart, such as frequent inspections of the stores by the CEO, Walmart cheers, and frugal culture of senior executives. Global CEO Doug McMillon once said during a speech at Beijing’s Tsinghua University: “I think for veterans in the retail industry, new concepts are constantly emerging, but fundamentally, retail is about three elements: price, products, and experience, which never change.”