NetEase Inc. (网易) is primarily known in China for its online gaming apps, a worthy competitor to other digital entertainment companies such as Tencent. However, another strong growth driver is the company’s e-commerce branch, specifically NetEase Kaola (网易考拉) and NetEase Yeation (网易严选).

According to NetEase Inc. latest financial report, its e-commerce services made up of 33% of the company’s net revenues for the fourth quarter of 2018, second to its online game services. Willing DING, Chief Executive Officer and Director of NetEase, mentioned in the report that they see “huge potential in ecommerce”, and it will be a “primary focus of [their] business strategy in 2019.”

Dominant e-commerce platforms like Alibaba (阿里巴巴) and JD.com (京东) and strong brand competitors like Xiaomi’s MI Store are already notable players in China’s e-commerce market. According to a study conducted by Jiguang, users preferred to use JD.com rather than NetEase Yeation.

Specifically, 88.8% of survey respondents prefer to use NetEase Yeation and 90.15% prefer JD.com.

However, this doesn’t mean they will use other apps on their phones. While Alibaba and Xiaomi’s MI Store wasn’t mentioned, it still raises the question of how NetEase’s e-commerce arm can strengthen its app appeal. Currently, NetEase Yeation is more of a brand than a platform. In a reported Chinese interview with Yeation’s brand director, he mentioned that brand premium and the brand location is not important.

However, as Yeation is teetering between an e-commerce brand and an e-commerce platform, how can it differentiate itself from the players mentioned above? Or, how can it increase its app attractiveness? Furthermore, what does the future look like for this e-commerce brand in such a saturated market?

Note: Jiguang’s analysis result is from utilizing big data. The company provides SDK (software development kit) to app developers to reduce its time cost. For application developers, the data can be extracted from push notifications or data statistic tools.

Once the developer uses Jiguang, the data will be shared with the company. Based on the data the company receives, they conducted an analysis of the industry. This is how their brand preference index is calculated: by calculating how many users open a specific app after its downloaded.

However, preference can also be calculated by comparing how often it’s used (i.e. time spent in the app) with similar apps in the same category. There are many different ways to calculate a brand preference index. Though Jiguang didn’t specify how they calculated its brand preference index in its report, they are a trustable data source. They provide clients (Starbucks, Sina, etc.) with big data solutions in China.

NetEase Yeation Business Overview

As China’s middle class gets richer, their preferences have begun to change. They have upgraded their consumption expenditures by focusing on quality rather than price. According to the Global Times, this gave birth to a “new e-commerce niche.” According to an EO Intelligence report, consumers are also taking the brand and their experience into consideration when making a purchase decision.

Launched in April 2016, NetEase Yeation uses an original design manufacturing (ODM) business model. They partner with big manufacturers in China who are also the original producers for global brands to provide quality goods for a lower cost. For example, according to Caixin Global, an original pair of UGG ankle boots may be found on JD.com and Tmall for USD 200. However, on Yeation an identical pair made by a “Ugg manufacturer” using a Yeation label is priced at USD 45.

This, of course, is an easy target for infringement claims. However, it provides an incentive for prospective consumers to use their platform and buy from them than from other pricy competitors. Their slogan literally means “good life consumption”

However, while profitable, its e-commerce branch is seeing a decrease in its gross profit margin. According to their latest financial report, their e-commerce gross profit margin for the fourth quarter of 2018 dropped to 4.5% while the preceding quarter and the fourth quarter of 2017 was 10% and 7.4% respectively. The report cites “larger-scale promotions and certain sales discounts” as the reason for their decrease. This decrease may be correlated to user preferences as mentioned above.

Increase its Network Effect

Their gross profit margin decrease may be a sign of NetEase Yeation’s lack of network effect. However, a strong network effect needs strong user stickiness. Chinese social platforms, WeChat and Weibo, are two examples of strong user stickiness with 1 billion and 313 million MAU.

While WeChat is a general social platform and isn’t involved in doing any specific business, numerous companies use it to strengthen their network effect. HeyTea (喜茶), a Chinese tea start-up, is a great example of how it saves in marketing costs by effectively using WeChat.

In South China Morning Post’s article, it details how HeyTea uses its “non-traditional tea drinks” and “long queues” as a marketing tactic as its frequently discussed on large Chinese social media platforms.

However, Yeation’s weak network effect may be related to its supply chain. Implementing a different supply chain from traditional retailers. As their user base grows, their product numbers and staff must grow simultaneously. Otherwise, it becomes saturated and provides less value to its users.

According to Deloitte, the new retail supply chain management should be data-driven and ideally be customer oriented rather than product oriented. In a report published by CITIC Securities, NetEase Yeation’s expansion is slow as every product has to cooperate with the manufacturer to produce. Therefore, from this alone, the speed of the supply chain has already been reduced.

Recently, the company addressed its layoff rumours, clarifying that only 8% of its employees are leaving. Additionally, half of its programmers received the short end of the stick. The reason for the layoff is apparently due to internal management reorganization. As IT specialists are crucial in managing a new retail supply chain, hopefully, NetEase Yeation won’t slack when it comes to talent. Without a strong network effect and user stickiness, it can be difficult for Yeation to survive.

Strengthen Their Brand

NetEase Yeation strictly focuses on home supplies, specifically cleansing products. As such, compared to Tmall, JD.com, and Pingduoduo, their main advantage is in their numerous options. While it’s possible for Yeation to focus on a specific user base first and gradually branch into other categories, the platforms mentioned above are already dominant players.

This makes differentiation much more important as consumers need an incentive to switch which can come from strengthening Yeation’s brand to make them known in a specific category. This can also attract more quality manufacturers to work with them which simultaneously attracts more users or vice versa.

Furthermore, it can also control SKU proliferation. Assuming NetEase Yeation decides to expand their categories and become more platform-oriented than brand-oriented like JD.com, new products may eventually steal demand from existing products. Therefore, the overall sales haven’t increased but shifted from one product to another.

Additionally, adding more categories requires better supply management and efficiency. Again, if we assume Yeation adds more categories, but cannot keep up with demand or lack demand, the potential consumer will likely switch to a competitor.

According to Deloitte, Wan’s study on SKU proliferation “requires a delicate balance. Variety can be good, but it’s possible to have too much of a good thing.” While NetYease Yeation did not reveal their SKU count, EO Intelligence’s 2018 report reveals that the company had 20,000 SKUs. This was confirmed by SHI Wenyi (石闻一), NetEase’s vice president, in ebrun’s report.

In 2017, CITIC Securities indicated Yeation had 7,000 SKUs. During this period, it can be deduced that Yeation saw significant growth as they included more products, simultaneously working with more manufacturers and increasing their userbase.

According to Jiguang, Yeation’s daily new users in the last six months at the time the report was written in Nov 2017 was 13,000. Its retention rate was 52.6%, but 40% of new users uninstall the app within a month. Therefore, it can be argued that Yeation has a strong existing userbase but lacks in maintaining new users which makes strengthening their brand all the more important.

While Yeation’s GMV nor its growth was disclosed, it missed its CNY 20 billion target in 2018. On the other hand, JD.com reported its GMV increase: a 59% growth rate from 2015 to 2016 and a 38% growth rate from 2016 to 2017.

There were rumors flying about regarding Yeation focusing too much on GMV. SHI Wenyi addressed the problem by saying the company’s model is to be a “well-stocked company.” However, large inventory and no sales lead to increased costs which is obviously a problem. Again, this correlates back to how brand strength is critical in a saturated market environment.

Online-Offline Integration

NetEase Yeation launched its first brick-and-mortar store in Hangzhou in 2018. It would be valuable to integrate its products with artificial intelligence that can reach new customers and collect valuable data on their shopping behaviours, a similar strategy that Alibaba has already executed and what JD.com strived to do, according to Quartz. Therefore, NetEase Yeation could implement a system that allows users to order their desired products online and pick up at the offline store if it's more convenient for the customer.

This can save delivery costs for the consumer and allows for better product transparency. It also provides a reason for customers to visit Yeation’s offline store. According to China Knowledge, prices on NetEase Yeation’s app and its brick-and-mortar store are the same.

NetEase Yeation Vs. Xiaomi MI Store

Two different companies are competing for the same market. One is predominantly an online gaming company while the other specializes in cellphones. However, a large chunk of Xiaomi’s revenue comes from its IoT and lifestyle products. Its MI app aims to “bring e-commerce to the population of many emerging market countries,” according to SeekingAlpha and it is Yeation’s direct competitor as Xiaomi also markets low price and good quality to consumers.

According to iResearch, Xiaomi applies an F2C (factory to customer) model, another term for ODM. Similar to Yeation, the business model “removes unnecessary layers between manufacturers and end customers.”

The Best of Both Worlds

Currently, Xiaomi’s IoT/Lifestyle business has 90+ “aspiring ecosystem partners.” It’s interesting to note the key difference between Yeation and Xiaomi in this regard: Xiaomi combines two growing demands while Yeation remains in a single sector.

iResearch notes “[Xiaomi’s] proprietary AI assistant can control 118 IoT product models on its platform as of 1Q2018” and “[has] been installed on more than 23 mln smart devices as 1Q2018.” According to company filings, IoT generated revenue has been increasing. 

In the past, Xiaomi launched various small appliance products including air purifiers, rice cookers, and robot vacuum cleaners, all of which rank number one in global shipment. This is part of Xiaomi’s strategy: it focuses its efforts on a fragmented sub-sector of consumer goods were offering high-quality products at affordable prices can quickly gain market share.

As Xiaomi is notably known for its smartphones, TVs, and routers, it uses that to facilitate the sales of other products such as rice cookers, water purifiers, air purifiers, and much more. According to Xiaomi, the company does not get involved in operational management with other categories.

Therefore, Xiaomi understands where its strengths lie and make up for their weaknesses by investing in other companies. This way, companies can take advantage of using Xiaomi's brand while Xiaomi can effectively expand their business. However, as seen in the first graph of this section, companies have to accommodate for Xiaomi's lower profit margin and prevent over-dependence on the brand. On the other hand, Xiaomi must be confident in the company's management as they do not get involved. 

MI Offline Stores

iResearch conducted a survey to analyze how many Xiaomi users have visited its offline Mi Home stores. While 86% of respondents said they have visited Mi Home Stores, over 50% visited “[try] products to support a purchase decision.”

According to the survey, the results indicate that customers visit Mi Home Stores to experience its products and its after-sales service. As NetYease Yeation is planning to open more physical stores in 2019 and “introduce flagship stores.” However, its stores may ultimately become a showroom without adding further incentive to visit. Additionally, opening brick-and-mortar stores are costly and ideally should provide is own revenue stream or added value.

Strategic Integration

Both Xiaomi and NetEase Yeation are able to control their supply chain which ensures product quality. Despite this influencing the speed that consumers receive the product, it helps to improve their brand. However, Xiaomi’s main advantages lie in its integration between lifestyle and IoT products without deviating from what they do best. They first use their strengths as an anchor to provide an incentive for other companies to work with them. 

NetEase Yeation's Shaky Business Model?

While consumers are attaching increasing importance to quality, authenticity is proving to be a winning factor in China’s online shopping market. According to a survey conducted by iResearch, 54.09% of users will choose to buy from a platform with a higher authenticity guarantee. In addition, nearly 60% of users are willing to pay a premium. This reflects how important it is to be in control of the supply chain.

As NetEase Yeation doubles down on internal management, the company may benefit from looking to integrate with products of its mother company if possible. Additionally, as Chinese consumers shop online frequently (30.9% shop once every 2-3 days and 26.1% shop once a week according to iResearch), more and more brands will be looking to get a slice of the market. 

As it becomes increasingly more competitive, consumers need a strong incentive to choose NetEase Yeation. The company has been embroiled in controversial issues before such as being too identical to multinational goods. Again, as consumers place more value on authenticity, Yeation's business model in the future is starting to look a little shaky.