COVID has changed how Chinese consumers buy fresh food, especially in lower-tier cities. People are embracing bulk-buying online, with an association of shoppers working with an appointed leader to find items and take delivery. It is called community buying, and S&P Global Ratings believes it may alter e-commerce in China.
We estimate community buying reached Chinese renminbi (RMB) 130 billion in 2020--a pittance compared with total Chinese retail spending in the year that likely hit RMB39 trillion. But we anticipate such sales will grow 50%-60% in 2021, referencing current sales momentum and recent investment trends. And it represents another opportunity for e-commerce firms to crack China's US$770 billion (2020 sales) grocery market.
The shift will likely contribute strong revenue growth. It will also require heavy investment while chipping away at margins. Rated entities such as JD.com Inc. and Meituan are spending aggressively to get into this segment. The fundamental credit question for investors is whether this is the beginning of an explosive new market, or a fad that will lead to diminished margins and wasted capital.
Here we address investors' frequently asked questions about this phenomenon, which we expect to be neutral to slightly credit negative for large e-commerce players for the next 12 months.
Chart 1
Frequently Asked Questions
What is community buying?
Essentially, bulk-buying online. There is an important social aspect, however, which is why we describe it as a "community" activity.
A designated leader in a network collects the food and arranges for collection. The leader knows the participants in the group, understands their daily shopping needs, and can recommend items. It is a form of low-cost personal shopping, for groceries.
The practice took off during the COVID outbreak in China when people avoided entering public spaces, and many markets and grocery stores were shut. The trend continues. People realize that such group purchases are convenient and cheap, as they involve bulk discounts.
Chart 2
The rise of community buying has also raised use of the internet to buy groceries. This is an enormous market and a kind of last frontier for online shopping in China. Consumers till now have largely resisted buying food online. If the e-commerce can crack this market, it might dramatically raise sales.
Will community buying continue after the pandemic ends?
We believe so, given clear benefits for buyers and platforms. Community buying will likely co-exist with other purchasing channels. Platforms and retailers will want to capture demand from every possible mode of distribution.
The pandemic has broadly lifted e-commerce penetration rates. This was particularly the case in lower-tier cities in China where residents have dealt with stringent restrictions on movement during lockdowns. JD.com says 70%-80% of its new active customers added in the first nine months of 2020 came from lower-tier cities, while we estimate 60% of community buying comes from lower-tier cities.
Compared with other online channels, community buying involves less range and longer delivery times. However, consumers appreciate the on-target shopping choices. The leader personally knows what goods buyers want, and can substitute another item if it's on sale. Users give immediate feedback to the leader, which may be quickly reflected in product offerings.
While we believe that community buying will continue to gain traction, we acknowledge the trend is untested. Consumers might revert to old habits, such as eating out more and cooking less. Price wars may flare up. We note that some operators are already discounting aggressively to win market share.
Should irrational competition emerge, resulting in persistent losses, we may see platform operators exiting the business, writing off their investments in the process. This was the case for previous consumer fads in China, such as karaoke booths (popular in 2017) and bike sharing (2018).
Regulators are urging internet giants to not compete too aggressively for customers. This suggests market share will stay fragmented, and that no single large player will dominate.
In December 2020, China's State Administration for Market Regulation (SAMR) met representatives from Alibaba Group Holding Ltd., Tencent Holdings Ltd., JD.com, Meituan, Pinduoduo Inc., and Didi Chuxing Technology Co. to discuss community buying. Increased regulation of the sector would be consistent with China's recent moves to strengthen oversight of its big tech firms.
What is the potential of community buying?
While e-commerce should account for just 5% of fresh-food sales by 2022, such sales China should be the second largest online retail category by that year. This points to the very large size of this segment and the potential for sales gains.
Chart 3
How profitable is community buying compared with other online channels?
Historically, online grocery sales have been barely profitable. Fresh food has a gross profit margin of 20%-30% (before selling, general and administrative expenses including logistics and marketing costs).
That said, we believe community buying may fare better as a business model than the traditional online grocery channel. The logistics costs are lower in that they involve bulk deliveries to a single buyer (the group leader). This compares favorably with existing models that require delivery to a consumer's doorstop. It also minimizes perishable waste.
Customer acquisitions costs are also low. Community leaders are incentivized to expand their network, which means they find the new clients. We believe customers can be acquired through community buying channels at RMB5 a head, while traditional online retailers pay about RMB200 to acquire each new customer.
We estimate the EBITDA margins of community buying at 2% to 5%. This compares favorably to existing online retail EBITDA margins of negative 9% to negative 6%.
Chart 4
Why are operators interested in this market if margins are slim?
There are several reasons. Most significantly, it gives e-commerce players entry into China's RMB5 trillion grocery market (2020 turnover), which has proven till now to be highly resistant to online sales.
It offers entities access to tier-three cities (and lower), which is helpful as growth slows in higher-tier cities. Chinese cities are informally ranked according to their size, wealth, and political ties to the central government. Tier-three designates poorer and more peripheral cities.
Once community buyers are locked into a channel, vendors have many opportunities to cross-sell to them. Community buyers a have high purchasing frequency (about three to four times a week), solidifying the vendors' relationship to the customer and assisting data collection and profiling.
Chart 5
What is the effect on credit?
We see this trend as neutral to slightly credit negative over the next 12 months, even as sales expand. This is due to the weak or negative EBITDA contribution and entities' need to invest in more complex supply chains to handle wide distribution of fresh food.
We remain cautious on the sustainability of the trend given that Chinese consumers are susceptible to fads that quickly fizzle. We are also mindful of potential for market-share battles that may dent margins.
Table 1
| What Is The Effect Of Community Buying On Rated Entities? | ||||||
|---|---|---|---|---|---|---|
| Rating | Comments | |||||
|
JD.com Inc. |
BBB/Positive/-- | JD.com announced in December 2020 two investments: a US$700 million investment in community buying platform Xingsheng and a US$102.7 million investment in agriculture product circulation service provider Dili Group. Both stakes were aimed at strengthening its online grocery presence. It also has exposure in JD Daojia, 7Fresh, and Yonghui Superstores. We anticipate the pace of investments could exceed our base case but that JD.com has sufficient rating buffer to absorb the extra expenditure. This entity's strong discretionary cashflow backed by solid growth in multiple categories provide this buffer. | ||||
| Meituan | BBB-/Stable/-- | Meituan's spending on this segment saw its operating loss enlarge to RMB2 billion in the third quarter of 2020, from a loss of RMB1.2 billion in the third quarter of 2019. This was largely due to the cost of buying its own community buying platform, Meituan Select. We expect segment losses to continue over the next 12 months, with income from food delivery, in-store shopping, and the hotel and travel segments sufficient to cover the losses. The entity's ongoing investment needs and sizable losses from the community shopping segment weigh on ratings. | ||||
| Alibaba Group Holding Ltd. | A+/Stable/-- | Alibaba's mobile-app Freshippo covers a spectrum of online/offline channels. This allows the entity to spread its bets, to make sure it's invested in whatever channel that may take off. It is also leveraging on its online food delivery subsidiary, Ele.me Inc. and its supermarket partner, Sun Art Retail Group, to improve sourcing, delivery, and inventory management. We see the community buying trend as credit neutral to Alibaba given the minimal EBITDA contribution relative to the total. Meanwhile, cross-selling gains should offset the cost of building out its community shopping platform, as customers can be channeled into the entity's many services. | ||||
|
Tencent Holdings Ltd. |
A+/Stable/-- | Tencent is exposed to community shopping through its investments in a front-end warehouse company, MissFresh, a platform delivery company, Dmall, and its 18% stake in JD.com. It helps that the entity owns WeChat, the dominant messaging channel for community leaders to reach consumers. | ||||
|
Inner Mongolia Yili Industrial Group Co. Ltd. |
A-/Stable/-- | China's top two dairy companies established a community buying channel at the start of China's COVID outbreak. They have seen a rapid growth in online-to-offline sales with a combination of targeted online community marketing. As supply chains return, the dairy companies find the channel effective in reaching out to consumers and to get product reviews. This channel is credit neutral for the dairy names as it brings in good volume on top of its existing distribution network, which makes up for the channel's slightly lower selling price. Selling and distribution costs may be lowered when volumes increase. | ||||
|
China Mengniu Dairy Co. Ltd. |
BBB+/Stable/-- | China's top two dairy companies established a community buying channel at the start of China's COVID outbreak. They have seen a rapid growth in online-to-offline sales with a combination of targeted online community marketing. As supply chains return, the dairy companies find the channel effective in reaching out to consumers and to get product reviews. This channel is credit neutral for the dairy names as it brings in good volume on top of its existing distribution network, which makes up for the channel's slightly lower selling price. Selling and distribution costs may be lowered when volumes increase. | ||||
| RMB--Chinese renminbi. Source: S&P Global Ratings. | ||||||
Appendix
Table 2
| Community Buying Is Drawing Heavy Investment | ||||||||
|---|---|---|---|---|---|---|---|---|
| Investments made in 2020 | ||||||||
| Target platform | Timing | Amount | Investor(s) | |||||
| Nice Tuan | January 2020 | US$88.3 million | Alibaba, ZhenFund, Qiming Venture, China Growth Capital, and others | |||||
| May 2020 | US$81.4 million | GGV Capital, Joy Capital, Qiming Venture, INCE Capital | ||||||
| July 2020 | US$80 million | CDH Investments, GGV Capital, INCE Capital, CMBC Capital | ||||||
| November 2020 | US$196 million | Alibaba, Jeneration Capital, Kunlun Capital, a fund under CICC Capital, CDH Investments | ||||||
| Xingsheng Youxuan | November 2020 | US$800 million | KKR, Sequoia Capital, Tencent, Capital Today, Huaxing Growth Capital, Eastern bell Capital, and others | |||||
| December 2020 | US$700 million | JD.com | ||||||
| TongCheng Life | June 2020 | US$200 million | Joyy, Engage Capital, Legend Capital, Bertelsmann Asia Investments, SR Ventures, Suzhou Oriza Holdings, Welight Capital, Tongcheng-Elong Group | |||||
| July 2020 | Less than US$100 million | Xiang He Capital, Bertelsmann Asia Investments, Suzhou Oriza Holdings, and others | ||||||
| Liancaiwang | June 2020 | RMB155 million | Meicai, State-owned capital in Henan province | |||||
| Kaola Maicai | June 2020 | N.A. | Yancheng High-tech Zone Investment Group, Yancheng Innovation and Venture Capital Investments | |||||
| Missfresh | July 2020 | US$495 million | CICC Capital, ICBC, Tencent, Abu Dhabi Capital Group, Suzhou Changshu Government Industry Fund, Tiger Global, and others | |||||
| Yipin Fresh | August 2020 | RMB2.5 billion | Tencent, Capital Today, Eastern Bell Capital | |||||
| N.A.--Not available. RMB--Chinese renminbi. Sources: Tianyancha, Lanjing TMT, S&P Global Ratings. | ||||||||
Table 3
| Many Platforms Are Springing Up To Service The Fresh-Food Segment, With No Model Or Entity Yet Achieving Dominance | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Traditional e-commerce | Recently established e-commerce models | |||||||||||
| Third-party marketplace | Front-end warehouse | Community buying | Omnichallel (including O2O) | |||||||||
| Business model | Delivers fresh food directly to consumers using self-owned or third-party logistics. | Platforms collaborate with offline retailers and convenience stores to provide fresh food delivery service | Establishing distribution centers near consumers to shorten distribution chain and lower delivery costs | Community buying platforms provide product distribution chain and after-sales services, while community leaders are responsible for operation of the community group and users pick up products at their community | Combines physical store purchases, online purchases, and quick delivery to provide integrated online-to-offline shopping experience | |||||||
| Geographic focus | Nationwide | First- and second-tier cities | First- and second-tier cities | Third- and fourth-tier cities | First- and second-tier cities | |||||||
| Delivery coverage | Greater than 10km | 1km-3km | 1km-3km | 500m-1km | 1km-3km | |||||||
| Delivery time | 1-2 days | 1-2 hours | Within 1 hour | 1-2 days | 30 minutes | |||||||
| Advantages | Low customer acquisition costs due to established user habits. Strong brand reputation and trust. | Satisfies demand for quick delivery as retailers are physically close to their customers | Short delivery time due to proximity to users. The use of distribution centers also lowers the chances of product damage and lowers the cost of cold-chain delivery | Low customer acquisition costs. Light capital requirements make business model highly scalable | Gives consumers choice of multiple shopping channels | |||||||
| Weaknesses | Long delivery times and high potential for products to be damaged during delivery. High capital requirements to manage supply chains | Difficulty to get help of offline retailers to ensure product quality | Higher upfront capital requirement to build distribution centers and supply chains | Limited product range. Community leaders typically lack retail experience | Model requires heavy capital costs, with additional expense of maintaining physical stores and large staff payroll | |||||||
| Examples | Tmall Fresh, Fruitday, JD Fresh | JD Daojia, Meituan, Ele.me | Missfresh, Dingdong Maicai | Xingsheng Youxuan, Shixianghui | Freshippo, 7 Fresh | |||||||
| O2O--Online to offline. Sources: iResearch, S&P Global Ratings. | ||||||||||||
Related Research
- JD.com Inc., Dec. 16, 2020
- Alibaba Group Holding Ltd., Dec. 7, 2020
- Asia-Pacific Forecasts Stabilize, Risks Now Balanced, Nov. 30, 2020
- China's Tight Financial Conditions Start To Bite, Nov. 19, 2020
- Inner Mongolia Yili Industrial Group Co. Ltd., Nov. 10, 2020
- China's Careful Stimulus Dims Outlook For 2021, Oct. 19, 2020
- Meituan, Oct. 18, 2020
- China Mengniu Dairy Co. Ltd., July 29, 2020
- Tencent Holdings Ltd., June 11, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Sandy Lim, CFA, Hong Kong + 852 2533 3578; sandy.lim@spglobal.com |
| Secondary Contacts: | Ava Chang, Hong Kong + 602 3530; ava.chang@spglobal.com |
| Clifford Kurz, Hong Kong + 852 2533 3534; Clifford.Kurz@spglobal.com | |
| Flora Chang, Hong Kong + 852 2533 3545; flora.chang@spglobal.com |
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