Corporate watch: Vipshop’s in fashion

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Small can be beautiful. Just ask Yang Donghao, chief financial officer of Vipshop, a US-listed Chinese online discount retailer.

In a country where e-commerce is dominated by Alibaba’s Taobao online marketplace (through which small merchants can hawk their wares directly to buyers), Vipshop has found success by tapping into the hunger among those living in China’s smaller cities for branded fashion.

Based in Guangzhou, Vipshop is an online flash sales retailer. Like Vente Privée in France and Gilt in the US, the company teams up with western and domestic brands and helps them offload their excess inventories at steep discounts via limited-time sales events.

Founded in 2008, the company made just $2.8m in revenues and a net loss of $1.4m in its first full year of operation. But as the concept of flash sales gained traction in China and Vipshop became better at managing its logistics and distribution, sales grew to $692m last year.

Of this, 60 per cent came from customers living in China’s in second- and third-tier cities. Sales from first-tier cities like Beijing, Shanghai, Shenzhen and Guangzhou accounted for just 14-15 per cent of revenues. with fourth-tier cities making up the rest.

“The biggest growth is coming from Tier 2 and Tier 3 cities,” said Yang (pictured left). “People there have decent purchasing power but shopping choices are still very limited. They also have less exposure to foreign brands. This helps our business because they can’t tell if the designs that we are selling are from this year or from two years ago.”

Interestingly, in a country known for its obsession with luxury goods, Vipshop, unlike its western counterparts, is decidedly mass market in the brands it sells. High-end goods are rare. Instead, users will find Nike, Vans, Estée Lauder or Esprit.

“There is too much risk when it comes selling luxury goods online,” said Yang. “On the one hand buyers will not trust that we are selling the real thing, and on the other hand there is the risk that people will buy a genuine article online only to return a knock-off to our centres.”

“That is less of a problem with mass-market brands. People in China are now wealthy enough that there is no need to knock off Nike.”

But while e-commerce in China is booming – a recent report from McKinsey reckons the country’s online retail sales hit $190bn last year, making it the second largest e-tailing market in the world after the US – it’s not without its challenges.

The biggest one is probably logistics and delivery troubles. Unlike the US, Chinese customers, particularly those from big cities, expect next-day delivery. Given the country’s size and relatively weak transport and logistics infrastructures, this can be extremely costly.

Vipshop offers free shipping on all orders over Rmb288 and charges Rmb10 for all orders under that. The amount barely begins to cover Vipshop’s shipping expenses, Yang admits.

“It’s a loss-leader,” he said. “I would say it costs us on average Rmb30-40 to ship a dress and Rmb100 to ship bigger items like bedding. It would be even more of course if the destination is far west like in Tibet.”

Frustration with the shipping situation has even prompted 360buy, the country’s second-largest online retail firm after Alibaba, to invest in its own trucking fleet.

Nonetheless, Vipshop – whose investors include venture capital firms DCM and Sequoia Capital – says the money that can be made from helping companies get rid of their unwanted inventory – helps take the sting out of the shipping losses.

Like many start-ups, Vipshop has yet to start generating big profits on its rapid sales growth. But the company finally made its way into the black in Q4 last year, when it posted $6.3m in net profit. It continued the streak in Q1 this year, reporting $5.8m in net profit.

And after a dismal debut on the New York Stock Exchange last March – in which its share fell 15 per cent on the first day of trading – Vipshop has been on a tear. The stock has jumped 475 per cent over the past 12 months to trade at $33.31. This compares with its debut price of $6.50.

But this being a Chinese company – the surge seen in Vipshop’s performance and share prices has not been without controversy.

Last month, shortseller Greenwich Research accused the company of publishing “misleading financials”. As it wrote in a lengthy report:

[Vipshop]‘s recent IPO had little street credibility. The price for the deal was reduced from 10.50 down to 6.50 and the size was reduced to 11.2 million shares. In other words, just 12 months ago, there was very little institutional investor interest in the company. Then suddenly in September 2012 everything changed. Now the stock trades at sky-high multiples – Price/Book Value is 11x, Price to 2013 Estimated Earnings is 78.0x (JP Morgan Report). Why the sudden sky-high valuation with the stock price accelerating from 5 to 37? VIPS “reported” phenomenal growth of 24,700% over four years. In the ultra-competitive E-commerce retail industry in China, it begs the question – Are the numbers real?

The accusations were refuted by Vipshop, which said the report contained numerous errors, unsupported speculation and a general misunderstanding of the company’s business model.

In this argument, one thing both sides can agree on is this: competition in China’s e-commerce space is getting fiercer by the day. While marketplaces like Alibaba’s Taobao and Tencent’s Paipai account for 90 per cent of all e-commerce transaction in 2011, according to the McKinsey report, a number of retailers are also looking to get into the direct selling (or business to consumer) space that Vipshop operates in.

Aside from Alibaba’s Tmall and buy360, which are the two biggest players in the B2C space, Spain’s Zara and the US’s Neiman Marcus for example have set up online shops in China. Locally Vancl, which sells its own branded clothing online, said it is on the prowl to add other brands to its site.

Which brings us to the cyclical nature of the flash sales business model. The model is dependent on suppliers having excess inventories. While sudden downturns in the economy (like what we saw in the post Lehman years) tend to be a boon for flash sales retailer because of the huge glut of unsold inventories, retailers, aided by technology are quick to adjust their order to minimise excess stock. Separately, as more big brands look to set up their own sites and sell directly to customers in China, it will lessen the need for third-parties like Vipshop to act as the middleman.

It’s something that management must be thinking about.

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