This article is reproduced with permission from “The Catcher“, the author: Sophia Li Zhao
N5Capital Partner Qian Kun
Online and offline traffic changes alternately, and the continuous capture and use of traffic dividends is the key to the rise of consumer companies. How to maintain sustained growth in this process rather than just a flash has become a question that consumer companies and investors must think about. In the past two years, companies represented by KK Group and HARMAY have developed rapidly, and they have received great attention and have also triggered industry discussions.
Today, THE COLORIST, a subsidiary of KK Group, occupies the first place in the makeup store, and HARMAY has become the most efficient channel brand for high-end cosmetics, and both have the same investment institution and investor- N5Capital Qian Kun, partner of N5Capital.
This time, The Catcher asked Qian Kun to talk about the logic behind his investment in KK and HARMAY, which involved his perception of consumer investment in the past 10 years, his understanding of offline shopping malls, and his profound thinking about the nature of retail and the value of retail enterprises.
Review Investment in KK Group
Qian Kun: At present, KK Group has three brands: KK Pavilion, KKV and THE COLORIST. When I was investing, the company had only one brand: KK Pavilion. KK Pavilion is a collection store of imported goods, with a standard store of 200-300 square meters, all of which are located in shopping centers. During its birth and growth, it did not enjoy the dividends of category and shopping center but relied on operation to win.
KKV is a new brand iterated by the company itself. It has a large collection store of 800-2000 square meters, positioned as a main shop in shopping center. It has enjoyed the bonus of shopping center format adjustment. Because of the overall economic downturn in 2019, major stores such as GAP, ZARA, HM,etc. are in the process of dismantling shops, most standard shops to upgrade to sub-main stores and main stores ended in failure due to a too much drop in floor efficiency. As a result, the main store’s suppliers were lacking. KKV took this to make up for it. On the other hand, the COLORIST gets a category bonus.
Li Zhao: THE COLORIST has achieved the first place in offline makeup collection store. What is the specific category dividend that it enjoys?
Qian Kun: I have been paying attention to the trends of the cosmetics category since 2017. Last year, I found that some cosmetics companies I saw before were growing rapidly. Apart from the good operation of the company itself, it was a systematic opportunity.
This opportunity comes from two points. The first point is the push caused by social media, especially short videos. In the era of Weibo and official accounts, it seems powerless to recommend and introduce makeup with pictures and texts, but the rise of short videos makes makeup easy to learn and become popular. The second point is that China has outstanding manufacturing capabilities and a well-developed supply chain, providing many cost-effective products at affordable prices. On one hand, the demand has doubled, and on the other hand, the supply is abundant, which together create a big market.
These two points have broadened the make-up crowd. Previously, makeup users were 25 to 40 years old, but now the demand of 15 to 25 years old has also been stimulated, bringing growth opportunities to the whole category.
Li Zhao: There are quite a few people in the industry questioned the collection store model. How do you think of online and offline collection stores?
Qian Kun: The success of the collection shop model depends on two things:
First, China’s superior manufacturing capabilities and abundant product supply have led to the emergence of new brands. Consumers tend to diverge rather than concentrate in brand selection, and consumers’ disloyalty leads to shorter and shorter brand life cycle.
Online traffic is naturally concentrated and easily controlled by channels, and channel controllers want to distribute traffic to more brands, so there is an obvious ceiling for online sales. While offline, the sales volume of most cosmetics brands cannot afford an independent store, and the original offline channels are very old. For new brands, there is a lack of good offline channels.
Second, offline brands must bear a large amount of pressure from inventory, product design and production cycle, while the selection mode of collection stores is anti-cyclical, and the adjustment ability of product portfolio and inventory management is far beyond that of single brand companies.
However, the logic of online collection stores does not hold. Taobao, JD.com and Pinduoduo are the largest collection stores, and opening collection shops within collection shops is a selling business without core value. These e-commerce platforms have the advantages of user scale, broad categories and SKU. Brand companies will directly set up shops directly on different e-commerce platforms, and do not need to sell goods through online collection stores. An online collection store channel has no advantages, which is why there is no vertical e-commerce platform in China.
The offline shopping experience is different from the online shopping experience. Although the offline consumption scene is also price-oriented, for young consumers, the demand for “instant access” is stronger than the demand for a few yuan cheaper. If you choose a product with a low unit price, you will have a higher sales conversion rate, and the online price difference will not be too large. The price of a single product of the Colorist is not high, but the order rate will be relatively high. It is normal to buy three or four products at a time. Moreover, the offline collection store has a good brand trial experience, a wide selection of products, fast update iterations, and full of freshness.
Li Zhao: Collective stores do have stronger adjustment capabilities, but they also face a more complex business environment. In what way does KK achieve faster adjustments?
Qian Kun: All channel businesses have to go through the process of first paying and then getting. Channels must be scaled to have bargaining power for suppliers. However, for collection stores, there is nothing at the beginning. Products belong to suppliers and consumers belong to shopping centers, which is a multi-party game relationship.
KK started with the supplier first. I will give you good terms and you will give me a low price. As long as the product is good and the price is low, consumers will buy it. This is one of the easiest factors to grasp. It is a positive cycle to deal with suppliers first, combine good products, consumers buy in large quantities, and then go to get the shopping mall. After completing the shopping mall, the sales scale of a large number of shops will increase significantly, and then we will strive for better business conditions from suppliers.
Li Zhao: What is the biggest insight when reviewing the investment in KK?
Qian Kun: Recalling that when I invested in KK, my understanding of the shopping mall format was very insufficient. It seems today that I was like a fool who didn’t understand anything, but I thought I understood. For example, my understanding of the investment logic of offline shopping malls is not thorough enough, and my understanding of the role of franchisees is not clear. The entire shopping mall is an ecology, not as simple as finding a location for rent.
To a large extent, I also ignore the game relationship of the whole external business environment. From the results of KK, the core reason for meeting our investment expectations lies in the team, which keeps upgrading its cognition and products. During the two years I invested, I communicated frequently with the founder. Every time I communicate, I can feel that he is making progress and I have learned a lot.
Review Investment in HARMAY
Qian Kun: Offline shopping mall chain will produce large companies, while online shopping is difficult. Because there is always a game relationship between channels and brands. The bigger the channel companies are, the smaller the brand companies will be. Take Taobao Tmall, the largest channel in China, for example, the largest brand born on this platform with a turnover of 5 trillion RMB is less than 1% of the transaction volume, and the brands with a turnover of more than 0.1% can be counted by fingers. Therefore, new brands with Taobao as the main channel have no bargaining power over Taobao in the long run, and the ceiling is quite obvious.
As of the end of 2019, there were 7,199 shopping centers in the country, each of which can accommodate more than 300 brands, and a single shopping center has an annual traffic of 10 to 30 million, because there are so many shopping centers that are mutually exclusive. There is competition between them, so high-quality brand independent stores have certain bargaining power over shopping centers.
At the same time, the adjustment of e-commerce traffic entrance is very flexible and the cost is very low. Today, there are dozens of sellers in the main venue of the cosmetics festival, and these dozens of businesses are very good. But tomorrow, the traffic entrance can be adjusted to other sellers. However, offline traffic, especially in shopping malls, is relatively stable. Unless the mall is closed for renovation, the store at the door always has the best traffic. The traffic on the first floor and subway floors is definitely higher than that on the second and third floors. Even if there is a problem in a single field, there are still many fields to spread the risk. As long as it reaches a certain scale, it will enter a virtuous circle, and the overall anti-risk ability will be strong, so I only need to invest in the categories needed by the shopping center.
Li Zhao: HARMAY is also an offline collection store. What experience did you learn from in investing KK in its investment?
Qian Kun: I understand the pain point of shopping malls. Investing in the categories they want, shopping malls will offer good business conditions, even rent-free and decoration subsidies. This is unimaginable on e-commerce platforms, where things are scarce and expensive.
The shopping mall’s floor efficiency is classified. Good locations are given to those with the highest floor efficiency and higher rents can be received. High-end cosmetics have the attributes of high customer unit price and high repurchase, which can bring transaction volume and passenger flow to shopping malls and are the king of shopping malls. The shopping center is willing to provide various subsidies for a well-done high-end makeup brand. However, many shopping malls cannot support independent brand stores and can only attract collection stores.
The collection stores bring great challenges to brand owners. First, they will discount, and brands cannot control prices. Second, they will place multiple brands in confined spaces for comparison. Not only will brands face competition, brands that are different from their own brand positioning are sold together. Many brands believe that this approach will reduce their brand power. Therefore, several major cosmetics groups do not directly supply offline collection stores, and their channels are either directly operated stores or department stores.
Therefore, many high-end cosmetics collection stores have little living space in the market. Sephora is the only large-scale chain collection store in China, but Sephora is too strong in offline shopping centers. This is the pain of offline shopping centers and there are opportunities in the market.
HARMAY has a lot of innovations, such as independent stores in the business circles instead of shopping malls, display by category instead of brand, no BA (beauty consultant). It emphasizes the integration with the Internet, etc. Besides, its stores are bigger, with more complete categories and lower prices. We believe that HARMAY has the opportunity to seize this part of the market.
Li Zhao: What is the whole process of investing in HARMAY?
Qian Kun: In March last year I had met with Junchao Wang, founder of HARMAY. Since, we have maintained a good relationship. They opened their Sanlitun store opened on September 3rd, and he sent WeChat messages on September 5th to me said the store is “on fire”. After I came back from a business trip, I went to talk with him immediately, and then actively researched to determine whether the popularity was temporary or sustainable. In mid-September, I confirmed the investment in HARMAY.
In the process of determining investment, we face unprecedented competitive pressure. Every day six or seven funds come to visit HARMAY store, many of them are leaders of top funds. When others were still worried about whether the popularity of HARMAY was short-lived, we quickly decided to lock it in, it can be said that the experience of investing in KK made us dare to bet.
Subsequent developments also proved the judgment at the time. In October, it increased by 50% month-on-month, and in November it increased by 50% month-on-month. This is a store with more than 400 square meters and not in any shopping mall. Both the monthly efficiency and the single store sales are the highest in this category in China, even reaching the level of luxury goods. Moreover, without promotion, the single store sales volume of more than 1 million yuan in a single day set a record.
Li Zhao: Many people say that N5Capital is low-key. In summary, low-key, and fast betting are your styles?
Qian Kun: Yes, the three partners adhere to the investment principle of being optimistic and quick decision making. Optimistic is based on “scarcity, top, and the market size of one billion”. In addition, we insist on frequent communication with entrepreneurs to learn from each other, and accompany the company’s growth over a long period of time.
Li Zhao: What is the reason why you did not push the investment immediately after the first exchange?
Qian Kun: They didn’t have a relatively large store to support them. For the shopping mall format, the logic of opening a standard store and a main store is very different, and the commercial format it faces will undergo fundamental changes. The opening of stores over 500 square meters has a huge threshold and risks, because it is faced with the risk of loss and insufficient capital turnover.
There are many stores like Sephora all over the country, and they can only open stores within 100 square meters. This type of store has no traffic effect, so it cannot compete with Sephora, and it is also dispensable for shopping center managers.
I have seen several companies that do offline cosmetics chains before, but the core reason for not investing is that their area is not large enough, they will face Sephora’s exclusion, and they will not be able to enter high-quality shopping malls. The national excellent shopping center is limited. If you cannot get in, you won’t be able to form traffic and brand scale, you won’t be able to compete with shopping centers, and you won’t be able to form bargaining power.
Other investors see the HARMAY continue to fire a few months, and we see letter ten days, rapid decision-making behind is that we really understand HARMAY value, the process we also asked the founder KK Wu Yuening opinions, such as category, and shopping center of relation, the problem such as sustainability, finally, we combined with previous experience has carried on the comprehensive judgment, yue is HARMAY first institutional investors.
Other investors saw HARMAY continue to be popular for a few months before they believed, but we believed it for ten days. Behind the fast decision is that we really understand the value of HARMAY. During the process, we also asked KK Group founder Wu Yuening’s opinions, and we have made a comprehensive judgment based on the category, the game relationship with the shopping center, and the continuity. Finally, we made a comprehensive judgment based on our previous experience. N5Capital is the first institutional investor of HARMAY.
Li Zhao: Was there some data to help you make decisions?
Qian Kun: What we do is not just looking at the data. We only have ten days’ data from the opening of the Sanlitun store to our decision making, which is of little significance. We do consumer insights and research: how consumers come, why they buy, whether the reasons for buying can be sustained, and there are some indicators that others don’t look at but we pay attention to.
In the first 10 days of opening, consumers mainly came from social media, so we went to read the comments on social media and did on-site interviews. There were three reasons for the popularity: the store was beautiful and interesting; Full of goods, there are many high-end goods, cheaper than the counter, but more expensive than duty-free shops; the shopping experience is good, and there are no shopping guides who keep selling.
We analyzed whether the three reasons above can support its sustainable growth, beautiful and interesting shops will be regarded as attractions by consumers, this is difficult to continue, but cheap and good goods are sustainable, and the larger the scale, the cheaper the price given by the supplier, the more brands it attracts, and the longer it takes consumers to shop with enough brands. If consumers are satisfied to go to a place for more than 40 minutes, they can make a special trip for this store.
This will allow the store to form a traffic advantage, and the customer acquisition cost is lower than others, and it will be able to obtain shopping center support and subsidies, and high-end cosmetics also have category advantages in the shopping center. The success of HARMAY’s Sanlitun store has changed its game relationship with offline stores, users, and supply chains.
Li Zhao: In our communication, you have always emphasized the game relationship. What is its importance in retail?
Qian Kun: Now there are many articles about the changes in the three elements of retail: people, goods, and markets, and what are the opportunities of the times brought by these changes. And I judge the value of the company more from the game relationship between these three elements. We have to clarify what kind of value a retail business provides, whose money it can make, whether it is consumers, suppliers, or stores. money. All the money is paid by consumers, so what does it mean to make money? It depends on who paid the premium on both sides of the transaction.
For example, suppliers are more profitable. As long as the retail business can scale up, they can get low prices from suppliers, and the purchase costs are lower than competitors, which can be interpreted as making suppliers’ money. Consumers’ money mainly depends on whether consumers pay you a premium or a discount. The money for commercial real estate is mainly obtained through low-cost rent or decoration subsidies through brand and traffic.
Take Taobao as an example. Taobao cannot make money from consumers. It has to make every effort to sell it cheaper than other channels to attract consumers. Taobao also cannot make money from the shopping malls, because no matter how big Taobao is, it has to pay traffic fees to other Internet traffic parties without any discount. Taobao can only make money from suppliers, because of its huge scale and market share, it is enough to make money from suppliers.
Similarly, consumer goods like Estee Lauder and Zhong Xuegao earn money from consumers; Channels like KK and HARMAY make money from suppliers and commercial real estate, but not from consumers. While the high quality offline consumer brands represented by Xi Cha and IKEA earn money from consumers, suppliers and commercial real estate, which is the most difficult.
Through the analysis of the game relationship, we can know the core value of an enterprise, and the value created by a retail enterprise is the core factor for its long-term development. If the team has a clear understanding of its value and has the ability to execute it for a long time, the consumer enterprise can continue to grow.
The status quo and opportunities of consumption investment
Qian Kun: In fact, there have been three consumer investment booms in the past decade or so:
The first was from 2007 to 2008, when PC Internet was a foregone conclusion and offline shopping malls were being built in large quantities, which led to a lot of investment in consumption and catering brands; the second time was 2012-2013 with the formation of e-commerce platform, many Taobao brands have won the favor of capital; the third time was the unprecedented prosperity of social media in 2016-2017, which led to the rapid growth of new consumer products and services.
We will find that every consumer investment boom is at the stage when Internet platform companies are beginning to take shape, on the one hand, technology companies have fewer investment targets, and on the other hand, when Internet platform companies start to monetize traffic, consumers’ attention is shifting. Many new brands and new services have been born, and consumer investment is the process of investing in targets that can grow rapidly and form brand recognition.
The reason why many people think that the threshold of investment and consumption is low is because each of us is a consumer and can form the evaluation of the target company’s products and services. But in fact, it is very difficult to invest in the consumer sector. The biggest challenge is how to judge its ceiling and how the company can continue to grow and improve its brand capability and form its own barriers.
It’s easy to judge a consumer brand from 0 to 1 or from 1 to 10. There is great uncertainty from 10 to 100. It’s possible to invest in a certain company this year, but it’s hard to grow next year. This uncertainty comes from the intense competition in the market and the pressure of sales growth from how the team faces and handles changes in traffic. There are thousands of consumer projects seeking financing every year, but 90-95% of them cannot form the core value and are not worth investing in. However, the reality is that 20% to 30% of the projects can get investment.
Li Zhao: How do you judge the sustainability of the company’s growth in your investment?
Qian Kun: First of all, we must identify what the company’s core value is and whether it can be strengthened in the fierce competition. At a lower level, I will look at what constitutes its growth. There are two specific indicators.
First of all, the percentage of sales accounted for by sales promotion or live broadcast which is very popular now is low efficiency growth. However, the inefficient growth is not completely meaningless. If in order to gain customers and market share in the short term, the effect of re-purchase after obtaining customers should be re-evaluated. Simply hitting sales amounts to working for social media or to fool investors’ money.
The second is to see the rate of repurchase and repurchase reasons. The repurchase rate is the core indicator. If the reason for the repurchase is sustainable, the growth of the company will be relatively stable.
On the larger side, the most important thing is to see whether the company can adapt to the rapid changes in traffic. There are many companies in China that can achieve revenues of 300 million and 500 million. When they reach 800 million to 1 billion, the annual growth rate will drop from 200% to 30% to 50% per year, and even stagnant growth. In addition, Chinese consumers are not that loyal, the efficiency of repurchase and customer acquisition will decrease according to advertising and products. There are very few products that are truly capable of acquiring customers and forming brand traffic. So the products and services that have their own traffic attributes can become a big company sooner or later.
Li Zhao: There are many understandings of “brand”. How do you understand it?
Qian Kun: The key to brand recognition is whether consumers are willing to pay a premium or generate a higher sales conversion rate for your product or service. The premium has at least two dimensions: whether consumers are willing to pay more, and whether they spend more time, such as waiting in line. Most companies are not brands, they just have a brand name to sell through the channel.
Li Zhao: Can you extract some methodologies for branding from your experience?
Qian Kun: First of all, I think products with unclear functional indicators or weak user experience perception are more likely to form a brand. If the subjective experience of the product is not obvious, such as cosmetics, brand endorsement is required, and differentiation is required without brand endorsement, which will lead to strong uncertainty.
Brand companies have to keep reinforcing their perceptions in the minds of consumers, and too few have done so in the long run. Many companies that took investors’ money had to succumb to increased sales and ended up in a box-carrying business. At the same time, we should pay attention to the change of traffic and channel in practice, especially the change of traffic.
Li Zhao: In terms of investment, both KK and HARMAY are very successful, but the most difficult challenge of making investment is to replicate success, so how do you invest in the next KK or HARMAY?
Qian Kun: KK and HARMAY both grew out of shopping malls, and shopping malls are the most replicating scenes offline. After casting them, I forced myself to make changes and visit the shopping malls every week. It turns out that I am a person who does not like to go shopping, and my sense of consumption and fashion is not enough. Then I will not judge the quality of products by my own shopping concept.
There are also some young women in our team who are sensitive to fashion consumption. They can understand the ideas of the post-90s and post-95s very well and strengthen my weak points.
In addition, I also deliberately come into contact with various roles in the shopping mall ecosystem. At present, I maintain a very good relationship with powerful franchisees and many shopping malls across the country. Therefore, once entrepreneurs accept our investment, we will help him get good position in some benchmark shopping malls and really help the company develop its business.