Kathy XU rarely appears in public. She gives speeches once in a while, but rarely does interviews. However, stories about her abound.
She is one of China’s first-generation VC investors. In 1995, Kathy XU invested in Wahaha, betting that the Chinese would develop a liking to the then “faddy” bottled drinks as foreigners did. She was then working at Peregrine, a private bank in Hong Kong. That might have been the first consumption upgrade China’s VC investors ever betted on. Kathy XU won. Wahaha, which was worth 300 million yuan back then, is now valued at more than 100 billion.
She was the first to invest in NetEase in 1999. Then in the year 2000, the internet bubble burst. It began a “hell-like” period for Kathy XU and Ding Lei, founder of NetEase. At its worst, NetEase was rated as a junk stock. All the investors on the board insisted selling NetEase at a low price. Kathy XU was the only one who opposed it. Her reason was simple: We already hit rock bottom, and from now on, things will become a little better with every step we take.
The stories that followed are more widely known. In 2007, after being turned down by dozens of investors, Richard LIU met Kathy XU, who, on that very night, signed a letter of intent that involved a $10 million investment in JD.com. Intuition told her that Richard LIU was a dark horse, whom she could not afford let him meet other investors.
Also in Kathy XU’s investment portfolio are Tudou, Dianping, Ctrip, Ganji (赶集), Vipshop, Three Squirrels, Xiaozhu, Meituan, Zhihu, and Guazi. In late 2016, bullish on the growth prospects of new retail, Kathy XU invested in Yonghui Life, a chain of community-based fresh produce stores under Yonghui Superstores, although the chain had only 20 outlets then and an average daily sales value of less than 4,000 yuan. A year later, Yonghui Life grew to more than 200 outlets with sales rising ten-fold and then went on to raise funds from Tencent.
This following is Part 1 of a 3-part interview with Kathy XU done by 36Kr, our parent company. Read Part 2 and Part 3 here.
If only one question could be asked of Kathy XU, it would be: How did you, as an investor, develop the acumen to keep identifying promising companies for the past 23 years?
On new retail
- I gain a lot of weight every time I finish a project survey.
- Failing to see the forest for the trees is a no-no. Don’t waste your money on things that won’t pay off.
Q: How much time do you normally spend making decisions before investing in a project?
A: It turned out that the right decisions were those I made in an instant. After a brief chat with the founder, if I have a strong feeling that this could be a dark horse, I would act fast. I know I can’t afford to send him to other investors.
Q: Who was the latest person to give you such a feeling?
A: ZHANG Xuanning, founder of Yonghui Group. When he came to me, Yonghui Life, a community-based convenience store under Yonghui Superstores, was more than one year into operation, but had only 20 outlets. It was losing money and struggling to keep afloat. He had just fired his CEO and planned to take charge himself, but employee morale was low. He told me that, as a listed company, it was not money they lacked; he was looking for a morale booster; as a traditional business, his company could use a VC investor who “knows both the internet sector and retail business well” to help with due diligence.
We talked in front of a bunch of fruits and vegetables in a community store in Shanghai for less than three hours. Eventually, I said yes.
Q: An oral agreement?
A: We shook on it. But later it was I who was urging him to get the deal done. I was like “Hurry up! I’m transferring the money!”
Q: What was it about him that impressed you the most?
A: Xuanning kept telling me that he wanted to establish a “partner + horse racing” system. The company puts money in the shops, and employees are given a stake in them. They receive a base salary and split the profit 50-50 with the company. In this way, employees become the company’s partners who have shares in the shops. Each store is led by a democratically elected manager.
Horse racing means the stores are evaluated every 6 months and managers who are ranked among the bottom 20 percent are displaced. You’ll be given a second chance, but if you still can’t prove yourself, you will be out for good.
I thought the system would work the moment I heard it. Xuanning was amazing, he had an insight into human nature.
Q: Turn each shop into a self-organization?
A: The management cost fell sharply. They used to hire those who were less competent than themselves, out of fear that they might be replaced. Now they are all partners, which means that if their shops fare poorly, they will all lose their jobs. This system ensures that employees are always motivated and devoted to their work.
Another thing that impressed me was the store where we met. The shelves were all wood-made, packed with fruits and vegetables. It was a cozy environment. There was also a small wooden table around which you can sit. Xuanning told me that he hopes children can do their homework here after school. I was touched. It was different from the cold world of the internet.
Q: It sounds like you value user experience a lot.
A: Of course. I’m quite sensitive when it comes to retail shops and I like visiting them. Sometimes you don’t even need to see the founder first. Go to their shop and see what they have to offer. I gain a lot of weight each time I finish a due diligence. The Yonghui Life shop really made me excited.
What happened after the investment was really a miracle. The average daily sales per shop increased fourfold, and the number of stores increased fivefold. The company generated a sales revenue of 50 million yuan in 2016. The number surged to 600 million yuan in 2017 and is expected to grow by another tenfold to 6 billion yuan this year.
Q: Why was it able to grow faster than even an e-commerce business?
A: I thought about this myself. E-commerce businesses may achieve an annual growth of 300% at best. I think the root cause of Yonghui Life’s increase is that community convenience stores offer items that are necessities and are purchased on a frequent basis. You don’t buy home appliances or clothes on an e-commerce platform every day, but you do buy fresh food two to three times a week. Fresh produce is a 5-6 trillion yuan market. It’s huge but also difficult to crack because fresh produce are not standard products. Fresh produce is the last traditional retail segment that has yet to be affected by e-commerce.
Q: You invested in Yonghui Life in 2016, and in 2017, new retail became the hottest investment trend in China. Is it just a coincidence that you were one step ahead of others?
A: We have long been researching this sector. In 2014, everyone was talking about speculative shipping and O2O. We were interested too because we had invested in Meituan Dianping. I wondered why did speculative warehouses and O2O, despite the huge investment, generate limited number of orders? You have to place advertisements to appeal to even old customers because people must be constantly reminded of your existence.
If you want people to be aware of your existence all the time, you have to open stores on the streets, which consumers can see every day. That was when I realized that online and offline retail are inseparable. But that was just the “trees”, I still hadn’t seen the “forest”.
So, we spent a lot of time deep studying. I asked my team to study all retailers, online and offline, and come up with a winning pattern. We studied Amazon, JD.com, Alibaba, Wal-Mart, Costco, 7-11, and ALDI. We read biographies, interviews, and annual reports, and watched all their videos.
Q: And you saw the “forest”?
A: Yes, we did. A common mistake made by investors is that they see the trees but not the forest. They become preoccupied with certain trees and have no idea what the forest looks like. It will be too late when they do see the forest. The money is already gone. Ha-ha!
Q: Does Yonghui Life fit perfectly into your winning pattern?
A: Actually the winning pattern is simple: When it comes to retail, what matters is the control of goods, stores and minds.
Regarding control of goods, Costco’s self-developed brands take up 30% of the total, while for Aldi the figure is 90%. They act as both sales channels and goods suppliers. By branching out into the supply chain, they gain control of the processes of building product portfolios, selecting raw materials and quality control. Only in this way can they deliver superior quality at low cost and consequently set up barriers against their competitors.
As for channels, e-commerce channels are restricted to Alibaba, JD.com and perhaps the likes of Vipshop and Pinduoduo (拼多多), which are increasingly monopolizing the market. You can’t rely on online channels only. You must be able to obtain customers offline too.
Control of minds means you have to open stores everywhere. We have this saying that a brand cannot be called a brand unless it’s a common sight for 20% of a city’s population. You must have a 20% coverage in a city. It is rather pointless to expand to new regions if you haven’t yet reached a significant scale in your current market.
After figuring these out, we are confident that the so-called new retail is about owning your own brands and stores because that’s the only way to deliver good quality at low cost. You have to open new stores at a fast pace to increase your brand awareness. The replacement of the old by the new depends on whether the defects of the old are pressing enough, plus timing.
Yonghui Life is a chain of community-based fresh food convenience stores, which are taking the place of traditional farm markets. The disadvantage of traditional markets is that they are far, inconvenient, filthy and expensive. In contrast, Yonghui Life’s stores are located in communities. People can buy things conveniently after work on their way home or use home delivery service that delivers merchandise to their doors in half an hour if the distance is within 3 kilometers.
Q: What do you think will the proportion of online retail be?
A: Above 50%. Half-hour home delivery service is now our trump card, and it will one day become an integral part of what’s deemed as “convenient”. People are becoming lazier these days and are sometimes even unwilling to go downstairs, so the proportion of online retail may reach 70%.
Q: Why are you not bullish on unmanned shelves or stores? They generated much buzz last year.
A: I think they fail to take into consideration the core fact that fresh food and the instant food, the staple of convenience stores, must be served hot. Chinese people want food to be served hot, be it coffee, soybean milk, breakfast, lunch, or afternoon tea. Unmanned convenience stores cannot meet the demand. It’s hardly possible for you to take unmanned shelves as your sole business. Although you save on rent and labor cost, you have to cover the cost of replenishment and deal with complex logistics and supply chain operations. Low sales per store and difficulty in scaling are also problems.
For investors, the more profitable a business, the better. If I can invest in a convenience store with a daily sales of 20,000 yuan, why would I be interested in shelves with a daily sales of 100 to 200 yuan?