Author: Di Wu
Convenience stores have been developing for over 20 years in mainland China. At present, these Chinese equivalents of 7-Eleven are embracing unique opportunities brought by the trend of new retail. How should investors and entrepreneurs view the current opportunities and perceive the challenges faced by the industry? This is Source Code’s take on this topic, and based on thorough research and analysis, we exclusively present Source Code Research Report Issue No. 5.
- East Asia and Southeast Asia are currently some of the best markets for convenience stores. Mainland China, in particular, may be home to several giants like 7-Eleven in the future.
- It is easy to run a convenience store, and yet it is difficult to make it a competitive one. The core factors of competitiveness can sometimes be invisible. Hence, local Chinese brands must go through numerous trials and intense evolution before they can become market leaders.
1. Great Potential for Chinese-Born “7-Eleven’s”
The earliest prototype of the convenience store came out in 1927, when U.S.-based Southland Corporation launched a series of convenience stores called Tote’m stores in Dallas, selling eggs, milk, and ice products. Since then, the convenience store industry has been developing for nearly a century. Yet, it was not until four decades ago that the industry began to see years of vigorous growth.
7-Eleven and Lawson, two U.S.-born brands, failed to grow strong in their homeland in their early development stages. After travelling across the Pacific Ocean, they succeeded in dominating the East Asia market.
“There are only two types of convenience stores in the world: 7-Eleven, and the others.”
By mid-2017, 7-Eleven had opened 19,588 stores in Japan, generating an annual sales volume of 4.5 trillion yen (about USD $45 billion). The brand is also proactively expanding beyond Japan: by mid-2017, there were 62,935 stores in 17 countries and regions, and the number continues to grow by over 3,000 per year. These efforts have made 7-Eleven an undoubted retail giant worldwide.
In developed economies such as the U.S. and Europe, chain convenience stores have never become the most popular retail format. According to the statistics released by the Association for Convenience & Fuel Retailing (NACS), by the end of 2015, there were approximately 154,000 convenience stores in the U.S., and their compound annual growth rate over the past 13 years was only 1.2%.
Among them, 63% are non-chain stores.
More interestingly, 80% of gasoline in the U.S. was purchased at convenience stores (most U.S. convenience stores have refueling equipment). That is to say, most convenience stores in the U.S. are gas-station-type convenience stores.
Looking at the history of convenience stores in major countries and regions across the world, it can be concluded that East Asia and Southeast Asia are some of the most suitable markets for convenience stores.
(1) Four Key Elements: Population Density, Economic Development, Culture, and Eating Habits
Population density: In general, the growth of small-scale convenience stores (c-stores) must be supported by a relatively high population density. Over half of U.S. c-stores are located along the more densely populated East Coast region. Many countries fall short in terms of population density, while East Asia and Southeast Asia are some of the most densely populated regions in the world.
Economic development: Today, the common understanding is that the c-store industry can flourish if the per capita GDP of a region is no less than USD $7,000 . The reason is simply that prices of goods in c-stores are higher than those in larger supermarkets. Hence, as consumers in less developed areas have limited purchasing power, they may not buy into the “price premium” associated with “convenience.”
Culture: Pace of life and the abundance of nightlife are the two key cultural factors impacting the development of c-stores (both are more generally reflected in big cities). The faster the pace of life, the more consumers demand for “convenience.” In cities with abundant nightlife activities, only 24-hour convenience stores can satisfy people’s late-night consumption needs. These two phenomena can be evidenced by Japan and Taiwan in the late 1970s and early 1980s.
Eating habits: There are two dimensions for this element: diet structure and the culture of eating out. One of the main characteristics of modern c-stores is that the sales volume of food (especially fresh food) accounts for a considerable proportion of the total sales volume. In countries and regions with diversified diets (snacks in particular) and a popular culture of eating out (which is usually a result of the development of mega-cities), convenience stores tend to grow vigorously.
(2) City Clusters in China Satisfy All Four Elements at the Same Time
As China makes sound progress in urbanization, McKinsey predicts that there will be 22 city clusters in China, surrounded by one or two “hub” cities.
When reviewing many of these new-retail companies, Source Code has researched into and investigated a dozen Tier 1 and Tier 2 cities onsite, most of which are already equipped with all four elements mentioned above. Several of them are already home to one or more chain c-store brands (of various scale, ranging from a few dozen stores to over a thousand stores).
The macro statistics show that both the population and GDP per capita in central hub cities are growing year over year.
According to our onsite due diligence, central hub cities (mostly provincial capitals) are absorbing population from neighboring cities. The urbanization process has led to a faster pace of life. Nowadays, the post-1985 generation is less likely to cook at home. Meanwhile, the entertainment industry is thriving and leisure consumption is on the rise, all of which are beneficial to the development of convenience stores.
Mainland China is a gigantic country. Both its population and land area are many times larger than those of Japan and Taiwan. The history of convenience stores in Japan and Taiwan suggests that one convenience store requires 2,000 to 2,500 people to sustain it. All of China’s Tier 1 and 2 core cities have thousands of convenience stores, which alludes to great market potential.
In accordance with the principle of “running closely-located stores on a regional basis,” each region has an opportunity to have their own “7-Eleven” before nationwide market consolidation occurs.
2. Strengths of Chinese Convenience Stores
A successful convenience store system typically has three key success factors: system, supply chain, and franchise model.
System: The convenience store industry is characterized by low profit margins. A typical store’s operating margin usually ranges from 3% to 5%, which means that the fault tolerance ratio is quite low.
Meanwhile, convenience stores are very much an operations-oriented business. As the lifecycles of goods continue to shorten and consumer demands diversify, a passive sales model is unable to adapt to the changes in the overall climate. Now more than ever, data-based precise operations across three dimensions (people, goods, and scenes) are necessary to help convenience stores improve their operations and management efficiency.
A convenience store’s IT system needs to be connected with its headquarters, store managers, suppliers, warehousing and logistics providers, as well as consumers, in order to effectively address the flow of goods, capital, and information.
A solid IT system can serve as the brains of convenience stores, as it can coordinate tens of thousands of stores and substantially improve system efficiency with precise operation. Since 1978, 7-Eleven has introduced six generations of its integrated IT system, and the total R&D cost has reached USD $1 billion – clear evidence that 7-Eleven has always placed great emphasis on technology and IT systems.
Traditional Japanese convenience stores may fall short in terms of customer relationship management (CRM) on the customer-end.
China naturally provides a favorable environment for mobile internet to flourish. The effect of good CRM has been evidenced in traditional sectors such as catering. We believe that 7-Eleven may not represent the ultimate business model of the convenience store industry, and that a model integrating both online and offline traffic is expected to take shape.
Data-based precise operations across three dimensions, i.e., people, goods, and environment, can help the convenience store system significantly improve its operation and management efficiency. Today’s convenience stores must feature a model integrating both online and offline operations, in order to expand their physical boundaries and SKUs, better satisfy user demand, and improve sales volume per staff member and per unit area.
Supply chain: Generally, a convenience store stocks between 2,000 to 3,000 SKUs. Hence, store managers need to select items with higher shelf sales ratios or greater gross margins.
In addition to regular goods, the most important SKUs in convenience stores are fresh food and private brand labels.
Delicious fresh food not only brings a stable customer flow, but also lifts the store’s gross margins. The history of three major convenience store brands in Japan shows that the differentiation of fresh food appears to be a critical factor in the competition of the convenience store industry, and that brands compete fiercely to attract customers with enticing fresh food selections. However, the supply chain of fresh food is very complicated, for which R&D capabilities are key. As customer tastes become ever more particular, consumers may soon get tired of the same items.
Each year, 7-Eleven replaces 70% of its SKUs with new items, aiming to satisfy customers’ ever-changing demands.
R&D work involves not only new menus and recipes, but also new ingredients and cooking techniques. When working on the R&D of fresh food, Japan-based 7-Eleven stores collaborated with suppliers of food ingredients and kitchen appliances. Every step along the process should be controlled, from planning for a specific product to implementing the plan.
Localization is another challenge in the R&D of fresh food. 7-Eleven Japan divides the country into nine regions, and develops diversified goods catering to different tastes. As a heavily-populated country with vast territory, China has distinct food cultures, refined food customs, and diversified tastes across different regions. While researching 7-Eleven’s in China, Source Code found that certain bento boxes that sold very well in store A may be unmarketable in store B.
Many convenience stores are actively exploring ways to develop supply chains for fresh food, as well as establish their own fresh food factories or central kitchens. We believe that in the long run, the fresh food supply chain will become very important to the core competitiveness of convenience stores and it may be worth investing into related capital and resources.
A fresh food factory should not only ensure food safety with a sound production system, but also deliver substantive R&D results, which is not easy.
The key talents required by fresh food factories are scarce. Therefore, companies determined to develop fresh food supply chain should consider investing more into talent acquisition.
Franchise model: The franchise model is suitable for convenience stores. Nearly 80% of 7-Eleven stores are franchise units, and the proportion is growing. On one hand, chain stores are an asset-heavy business – it generally takes longer to open self-operated stores (a large number of stores, plus decorations and facilities are expensive). However, since gross margins are low, store managers are greatly relied upon to improve operational efficiency. Compared with managers of self-operated stores, those of franchisees tend to work harder.
A sustainable operation of stores can only be achieved by good partnership between franchisees and headquarters. A good franchise model can properly identify the responsibilities of headquarters and franchisees, and thus determine how to split profits reasonably.
Although more and more Chinese are becoming franchisees of convenience store brands, overall the industry is still in its infancy. Most franchisees are still inexperienced in business operations. It is also a huge challenge for headquarters to adequately train franchisees to follow good standards and run stores properly.
In recent years, huge changes have taken place in offline retail businesses: as large-scale stores have been hit hard, small-scale chain stores are attempting to grasp golden opportunities.
Each hub city has accommodated the rise of several regional chain c-store brands with dozens to hundreds of stores. They are gradually establishing their brands as well as improving their systems and supply chains. Some of them have begun to try the franchise model.
People have been talking about the opportunities for convenience stores for years, and yet it seems that the opportunities never materialized.
As the saying goes, Rome was not built in a day. It requires significant investment to establish standards and operations. The goal is to build a world-class system, a comprehensive supply chain, and a solid franchise model. The convenience industry is a tough egg to crack: to lay a solid foundation at the initial stage, one must first endure numerous hardships. It took 7-Eleven six years to open its first 1,000 stores, but today, the number of 7-Eleven stores is growing by 3,000 per year. We believe that it is time for the best regional convenience stores to use their first-mover advantages – attracting as many consumers as possible, snapping up the best prime locations, and hopefully one day becoming the Chinese equivalents of 7-Eleven!