MORE FROM KrASIA

Venture Matters | The siege of consumer brands: Winning China’s final B2C battle (Part 2)

Within a few short years, consumer brand unicorns with high valuations have emerged amidst shifting market dynamics in China.

This is the sequel to a two-part series chronicling investors’ renewed focus in consumer brands, a long-neglected sector in China’s B2C investment circles. Part 1 examined the growing interest in consumer brands among venture capitalists (VCs) in China. In this release, we look at shifting market dynamics that make consumer brands attractive and how VCs are securing their spots in this unexpectedly crowded sector.    

Around 2010, Consumer-to-Consumer (C2C) e-commerce platform Taobao launched its own in-house brands, such as snack food brand Three Squirrels and fashion brand Other Mix. These were original internet consumer brands that were developed exclusively for, and sold on, Taobao Mall, Taobao’s new business-to-consumer (B2C) marketplace that eventually became Tmall in 2012.

Well-loved by consumers, the two brands garnered a decent amount of investor attention due to their internet-first nature. Legend Capital invested RMB 100 million (USD 14.6 million) in Other Mix, while Capital Today and IDG Capital had stakes in Three Squirrels.

Other Mix and Three Squirrels were part of a line of products released by Taobao, known as “Taobao Brands”. Apart from a handful of star brands that have grown over time, the majority of these products have today faded into oblivion.

Despite the availability of capital, many of these brands failed to sustain growth, which was driven solely by online traffic. Without sufficient brand, product, and supply chain management capacity, they were not able to compete against larger domestic and international labels that later populated Tmall. Unlike Taobao’s C2C sellers who could cater to niche markets, B2C’s Taobao products that failed to scale within their categories went out of business quickly.

A decade since the introduction of Taobao Brands, VCs are once again buzzing with excitement at the potential of the internet to quickly scale consumer-facing businesses, which traditionally take years to build. Several shifts in market dynamics are renewing investors’ confidence in funding and building these kinds of companies in their portfolios.

China digest

Market dynamics spur interest in consumer brands

The post-95 generation is a formidable force behind China’s rising consumer sector. These young consumers do not blindly follow international brands but are drawn to cost-effective emerging domestic ones with an attitude, prompting investors like Yuan Lingyun of China Renaissance (CR) to explore five critical areas driving this trend—new demography, new media, new channels, new supply chains, and new technology.

“China is not going through a consumption upgrade. But rather, it is segmenting consumption. The country’s huge consumption market and complex structure have created a diverse consumer market. To build a brand in China will entail a comprehensive understanding of each unique market, in order to deliver differentiated products for finely segmented target audiences. Thinking along this line, there is plenty of room for imagination for future homegrown Chinese brands,” said Yuan.

Young consumers are also largely tech and mobile-savvy, driving new sales and brand-building opportunities online through e-commerce, social media, and livestreaming sites, which greatly reduce the distance between brands and consumers.

Ye Chunyan, a partner at Loyal Valley Capital, explained that “online channels are helping emerging brands to scale quickly. To achieve RMB 100 million (USD 14.6 million) in sales, they can do it within a year while traditional brands would take three to five years. Therefore, our future investment focus will be on leading consumer brands with the twin strengths of young consumers and online capabilities.”

pop mart
A Pop Mart store in Shenzen, where customers can buy designer toys and mystery boxes. Photo: Wikipedia Commons

Online sales channels are supported by China’s increasingly sophisticated and flexible supply chain, built on years of experience as the “factory of the world”. Not only can online sales channels meet the explosive demand from livestreaming sales, but manufacturers with quick turnaround time often run on zero inventory, fulfilling the exact number of orders generated during livestreams efficiently.

“In five to ten years’ time, top consumer brands will share these unique characteristics—the integration of brand and channel, as well as the integration of product and service,” Han Rui, a partner at Gaorong Capital, predicted.

Investment prospects of consumer brands

Within a few years, consumer brand unicorns with high valuations have emerged amidst these shifting market dynamics—Pop Mart’s post-funding valuation stands at USD 2.6 billion, HeyTea at USD 2.5 billion, and Perfect Diary at USD 2 billion. With VC interest running high, a curious question surfaces: Can these expensive brands still fetch high returns on investment?

“When we invest in high valuation consumer brands like Pop Mart, we are confident of their long-term potential. Pop Mart is continuously upgrading its business model—from IP incubation, to design, production, omnichannel sales, or even an open source system that lets other IP owners produce according to Pop Mart’s method, which is a good monetization vehicle,” Ye said. “There are many possibilities, as we believe Pop Mart can be a truly global brand.”

Other investors offer a word of caution. Apart from a handful of top projects, which are still generating healthy net profits and capable of offering good returns on investment, many brands are facing slowing growth and a diminishing value curve.

“The consumer investment scene is very vibrant now. Some organizations are using the Telecommunications, Media, Technology (TMT)  valuation method to price consumer brands, based on growth indicators like Gross Merchandise Value (GMV),” Yin Linyi, the managing director of Befor Capital, explained.

“This actually creates a pricing bubble because if the brand fails to achieve a relatively high growth rate, it will eventually take a very long time to digest the valuation.”

kr asia community

VCs are not averse to risky projects, regardless of their value. Often, investors thrive on being “anti-consensus”, securing emerging, high growth projects before others could see the potential.

“To seize the ‘anti-consensus’ time frame, we need to run in-depth research early. While the market is still wavering, we will be able to make sound decisions to invest in potential brands at a good price,” Han explained.

This could mean investing in small and niche brands, which are cheaper than top projects. Sun Wei, a partner at Meridian Capital, who has invested in outdoor sports brand EDCO, shared that these brands could achieve annual sales of up to RMB 500 million (USD 73 million), with a net profit in the tens of millions. Investors will likely not lose money funding these brands but instead, stand to gain from their potential growth.

To be anti-consensus also means constantly seeking new opportunity areas. As consumer brands become a competitive battleground, Befor Capital is starting to migrate investment dollars into new fertile fields—the suppliers of raw material for top consumer brands—to gain a first mover advantage before everyone else.

VCs should also build strong relationships with brands during pre-funding and post-funding stages to establish mutual trust and drive growth. For over a year, while waiting for Pop Mart to release their shares to external investors, Ye had unconditionally offered research and resources to Pop Mart’s CEO Wang Ning. When the long-awaited opportunity came, Loyal Valley Capital managed to secure 3.5% of Pop Mart’s shares and became the only institutional investor with preferred shares.

Meanwhile, Black Ant Capital‘s services for its invested brands are structured into six stages, including pre-investment analysis, strategic advice, as well as plans for 100 days and 365 days after investment. The 365-day post-funding service covers channel expansion, supply chain construction, capital management and budgeting, talent acquisition and incentives, among others.

If VCs and brands are mutually supportive in their long-term collaboration to create sustainable growth paths capable of weathering the storms of a volatile consumer market, emerging brands could avoid the fate of Taobao Brands

The original article was written by Chen Zhiyan for 36Kr, KrASIA’s parent company.