Vipshop Holdings Ltd (NYSE:VIPS) was a standout in a group of Chinese internet companies traded in the United States seeing gains reminiscent of the dot-com boom during 2012-2015. Vipshop saw its stock rise over 65X during a 3-year period between April 2012 to April 2015, earning a place on traders' watchlists during a time when Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) weren't yet publicly listed.
Traders and Investors dove in head first, trying to find the next VIPS, filling their watchlists with names like DangDang (NYSE:DANG), Jumie (NYSE:JMEI), and LightInTheBox (NYSE:LITB). Even Renren (NYSE:RENN) made the list as they had made some investments in e-commerce, even though their core business was a social network.
It was clear Chinese consumers were taking to shopping online faster than just about anybody. During a time before Alibaba, investors were looking to get exposure to Chinese e-commerce any way they could. After a while I'm not sure people even knew what they were buying, the names were unique, momentum was rolling and all the charts seemed to go from the bottom left to the upper right.
There was a Chinese version of just about every US internet company. The US had Netflix (NASDAQ:NFLX) China has Youku (NYSE:YOKU), Angie's List (NASDAQ:ANGI) vs. 58.com (NYSE:WUBA) even CarMax (NYSE:KMX) had a Chinese counterpart, Autohome (NYSE:ATHM). Chinese entrepreneurs used the Chinese great internet wall to their advantage. Vipshop took something that wasn't new, to US consumers at least. They took the flash sale model offered by Groupon (NASDAQ:GRPN) and Living Social that US consumers initially fell in love with, put their twist on it, and shipped it off to China.
Vipshop flash sales focus on apparel, accessories, home goods, lifestyle products, cosmetics and affordable luxury goods. The company has struck a chord with Chinese consumers, carrying Western brands such as Nike, Adidas, Hanes and Lee to eager consumers wanting a modern look at deep discounts. Flash sales tickle a human instinct many of us possess, fear of missing out, or FOMO.
Because each flash sale has a set number of the items to be sold, once they are all sold at the discounted price, they are gone for good. If a consumer were in the market for a jacket, he or she would typically search the internet or brick and mortar store and either choose to make the purchase or hold off. He or she might also compare the price of the item they are looking at in a physical store to prices offered by e-commerce sites, ultimately choosing to make the purchase online with the store's competitor in their actual store!
This behavior has become so prevalent it's gotten its own term: "Showrooming" as it's known, was added to the Oxford Dictionary in 2013. E-commerce websites are not without issues of their own, "Shopping Cart Abandonment" is the term used when consumers leave before purchasing the items in their online shopping carts. Cart abandonment is a big deal for e-commerce sites; the Baymard Institute estimated 67.45% of shopping carts are abandoned (source: shopify.com).
As I'm sure the reader is quite aware, leaving an online shopping cart is an easy thing to do. You know Amazon, Target or whatever online store you're visiting will still have those same goods tomorrow, likely at the same price, perhaps cheaper. E-commerce has taken away the experience of finding a shirt you like, finding there is only one left in your size, and making the purchase as your viewed the shirt as a scarce resource. Flash sales generate that same human emotion multiples times a day when there is seemingly a finite amount of something it becomes, at least mentally, scarce. Flash sales are nothing new, with literally hundreds of companies offering various products utilizing this model. Why has Vipshop been so dominant in the space? Much of their segment domination stems from some strengths in their business where management hangs its hat.
First Mover Advantage. Vipshop was launched in China in 2008, just a year after American's became accustomed to flash sales from players such as Groupon. Flash sales had been around since 2004 by some accounts with Woot.com bringing the idea to market. Groupon sunk its teeth into services early on, switching to products later in its existence. Regardless of who started what, selling what and who sold what better, the model moved to the top of the retail food chain quickly. Vipshop knew the model would probably work well with new consumers in China looking for a deal; they just needed to find the right products to push to these consumers. At the time, the Chinese were more interested in acquiring physical goods than going on a kayak ride or getting a massage. The consumer driven market the Chinese government wanted to push so aggressively started to look much the same as the US's "keeping up with the Jones." Chinese people didn't have McMansions or flashy condos to show off their monetary triumphs. Chinese people tended to live in apartments, how the Chinese have decided to show off their wealth was with designer clothes right on their backs. Vipshop offered big names like Levi jeans at low prices if you could buy quickly. They took a populous, eager to get decked out in name brand apparel and offered them that product at a discount, as long as they bought in groups. They were successful, incredibly successful actually, Forbes estimated they had over 90% market share of the "special offers" category (source: forbes.com). To have 90% of a market is nearly unheard of in low moat internet businesses. Vipshop had a huge running start, a running start they ran with for over 6 years now. Such deep penetration is rare, not only did they have it but they knew how to keep it, Vipshop was the most well-known Chinese flash sale company in 2008, and it remains so 8 years later.
Availability. Vipshop's discount model, doesn't have the same competition the flash sale model has in the US. Nordstrom, Macys, and Saks all have their own discount stores to unload merchandise not sold in their flagship stores. Nordstrom Racks, TJ Maxx's and Marshalls dot strip malls in sufficient numbers making high fashion available to all budgets. If those stores can't move the merchandise, there is a host of outlet malls ready to take the product to sell to deep bargain hunters. If both those avenues don't sell the product, they can sell it or list it with hundreds of available internet discount portals. In China, the former, Nordstrom Rack's or TJ Maxx's simply don't exist. In fact, brick and mortar retail stores, in general, don't exist on the scale they do in the US. The US on average has 45.2 square feet of retail space per capita vs. China at 12.9 square feet per capita. There is just not as much brick and mortar retail per person in China as there is in the US. There are also few outlet malls in China vs. the US. The lack of outlets means fewer bargain bins for consumers to rifle through to get that smoking deal so many desire. Bailan Outlet Plaza and Beijing Scitech company are the two big names in this space, the combined space of those malls are equivalent to approximately four Tangier malls, for comparison, there are 40 Tangier malls in the US alone. And these are outlets to serve just two of the top four cities in China. There is not a big outlet mall footprint in the 2nd -5th tier cities in China. This lack of physical infrastructure makes Vipshop the dominant discount store and often their only option for many Chinese consumers.
Product. The most exciting product category for retailers selling into China has been "affordable luxuries." Luxury products that are affordable are a product category Chinese consumers are most interested. Much like pitching Macau in early 2008 because "Chinese like to gamble" one must tread carefully in 2016 with statements like "Chinese like Gucci and Versace." The fact of the matter is China is a highly aspirational culture that values wealth and prosperity. Status symbols like Gucci handbags and Christian Dior cosmetics are viewed favorably by Chinese consumers. Vipshop allows consumers that typically might be priced out of such brands an avenue to afford such luxury products. Handbag flash sales are one of the hottest items for Vipshop, allowing scores of women to wear brands they would have typically be priced out. Many times a product offered at a discount on Vipshop might be the first time a consumer purchases that brand, whether it was unknown to them in the past or just unobtainable. This benefits both Vipshop and the luxury brands sold on the portal, Vipshop is getting a customer and the luxury brand is as well. The difference is that consumer remembers that it was Vipshop that allowed them exposure to that brand they couldn't afford before. These brands have complained about Vipshop's practices, stating Vipshop doesn't give them the access to the end consumer so they might foster a better relationship. These complaints seem to be nothing but hot air as the number of brands partnered with Vipshop have only increased over time. Luxury brands might want more ownership of the process, but there doesn't appear to be any risk of them pulling out of Vipshop channels.
Mobile. Vipshop generates over 70% of its revenue by consumers using their phones to make purchases unlike many American's who tend to use a desktop or laptop. High mobile use makes sense when you think about it; consumers have to be plugged into flash sale offers, or they could just pass you by. Being so focused on mobile in China has another benefit. Tens of millions of Chinese people are getting their first technology and internet experience with smartphones. It's not uncommon for a citizen of the 3rd, 4th, and 5th tier cities to have never used a computer. However, they still own a smartphone. In addition to these consumers, the Chinese millennials are more comfortable making purchases on mobile. These millennials are a demographic Vipshop has been aggressively targeting and will likely become a huge growth driver for the company. Chinese millennials often have more disposable income than even their American counterparts. The one child policy has produced many three person households, in the US we have the single child syndrome, i.e. spoiled brats. In China, nearly all millennials are single children, because of this many of their parents pay a lot of their expenses well into their adulthood. Chinese millennials are often flush with disposable income with much of their basic needs already provided. There is a lot of millennials, by 2020 there is expected to be over 300mm Chinese millennials vs. 80mm in the US (source: Forbes.com). That's a lot of people comfortable shopping with a smartphone and they are the demographic Vipshop intends to target to power their next growth cycle.
Repeat customers. Flash sales in the US tended to be a shopping medium a consumer used sporadically. They certainly wouldn't think to deck out their whole wardrobe by piecing together items from various flash sales. You might buy a massage on Groupon, stick the receipt in a drawer and never end up using it. The item you bought would inevitably expire, causing you to swear you would never use such a site again. Due to factors such as inventory, mobile penetration and the sheer number of sales, Vipshop has seen amazing levels of repeat customers vs. its peers. Vipshop has seen over 75% of users QoQ come from repeat customers and over 90% of sales QoQ again from repeat buyers.ir.vip.com) These repeat customers represent an incredible level of loyalty for a company whose business competes very much on price. In a study, done by Utpal Dholakia at Rice University found that only 20% of customers become repeat buyers in the US equivalent flash sale sites like Groupon, Living Social and OpenTable (source: fortune.com). Vipshop's ability to command repeat customer levels over 3X those levels shows that the Chinese are likely much more receptive to this form of shopping and value the products Vipshop is selling and their platform a great deal more.
Logistics. It's not easy to run flash sales on the scale and with the numbers of SKUs that Vipshop offers. In fact, it's a great deal more complicated than traditional e-commerce sites, with faster processing times, higher volumes and a higher percentage of returns. Its IT infrastructure needs to be able to handle huge volume spikes if a few sales at the same time are resonating with consumers. It also has to keep a massive customer database so it can figure which consumer would be most likely to purchase the item going on their next flash sale and market to them. Vipshop has recently added another 500k square foot of warehouse space to help relieve some of the growing pains there were experiencing in late 2015/early 2016. They utilize a JIT (Just in Time) warehousing methodology as best they can, but they need warehouse space to take advantage of deals they might encounter and due to simple time management. In a perfect world, some brand made too many jackets, it's cold outside, they call up Vipshop. Vipshop would agree to sell those jackets, instructing the brand to have to jackets delivered to their warehouse on day X. Day X would be the day the flash sale began, and in the best case scenario, i.e. the flash sale sold out, the jackets wouldn't even need to go into the warehouse for storage. They would go straight to fulfillment and out the door. In actual practice, it's hard to get deals that work that smoothly. When the stars aren't aligned if you will, is where the added warehouse space comes in; its gives them time for transportation issues, or maybe they feel the sale might do better two weeks from now because it's warm outside and nobody is buying jackets. Vipshop's logistics is best in class; it's one of the reasons it's been able to deliver such high margins in the hyper-competitive discount retail space.
One of the main arguments regarding Groupon being a poor investment centered on the fact the business had very little moat. Vipshop is in a similar situation as Groupon is, but after looking at the facts, it becomes apparent that the moat around Vipshop's business is likely deeper than most think. Maybe Vipshop just had the right product mix and hit the ground running first, but after looking at their strengths, I think it is apparent there is more going on. Some of the metrics Vipshop possess would be extraordinary just 3 years ago, i.e. having 70% of all purchases done with a smartphone. They have been active in future proofing their business. Vipshop had some growing pains, not surprising as its grown revenue the last 3 years by over 90% CAGR.
Vipshop was tactical; they identified these issues rather quickly and moved to fix them so someone else nimbler couldn't jump in and take share. Vipshop's new focus on millennials looks as it could be a growth driver for the next 3 years. The days of 100% growth are likely behind Vipshop, but 40% is nothing to be ashamed. On my next article, I will be talking about the competition that everybody is so afraid. Comparing Vipshop to some of the other Chinese e-commerce plays and look at new possible issues going forward.
If you found this article useful and look forward to my next articles regarding Vipshop, scroll to the top of the page and hit the follow button. You'll be the first to know when my next article comes out, and it helps me to determine if people are finding my work of value. Thanks again.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VIPS, JD, BABA over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.