Transcript:
If you are here, I assume you have already heard of SheIn, the mysterious Chinese e-commerce giant which is said to have more downloads than Amazon in 2020. Also, according to publicly reported numbers, SheIn, after its latest massive funding, is now a new member of the hectocorn club, meaning the company's valuation reached $100 billion. Today, in this episode, I want to share with you, however, what's not covered by most mainstream media after researching SheIn. In particular, why I don't think SheIn's model can be or should be replicated by DTC (Direct to Consumer) startups and other cross-border e-commerce companies, whether they're in the U.S. or inside China. Welcome to Tech and Borders, the intersection of tech, capital, and geopolitics.
Our typical DTC company is like Everlane or Warby Parker. Sometimes they are also called category killers because they typically start with a very specific merchant category and go viral by developing intimately followed fans who are loyal customers. Everlane, for example, started with a viral white cotton T-shirt, and Warby Parker started with $99 per pair of prescription eyeglasses with only one style, the retro style. A typical cross-border e-commerce platform is like Wish App. It doesn't own any inventory but instead consolidates vendors from China to give them direct access to overseas fast consumer goods markets. Wish, or similar platforms, competes with Walmart and Amazon.
SheIn is not just a DTC direct-to-consumer company nor a mere cross-border e-commerce platform. I consider SheIn a supply chain company. A supply chain company, on the other hand, is the one who has the ability to dictate the terms with factories. Conventionally, it is giant corporations such as Walmart that have the say; they are also called incumbents. SheIn did it as a startup in barely a 10-year span for multiple reasons. First, the founder started out as one of the earliest SEO experts in China. The timing seems perfect because he could quickly navigate the overseas consumer market, knowing the consumers' preferences for clothing manufactures, particularly the smaller ones. The smaller factories, who would otherwise be clueless about what and whom to sell to, also, according to what SheIn told the Chinese press, was an early adopter for the smaller orders, more frequent orders trend in supply chain, meaning that they place much fewer orders per SKU, but they have a higher returning order frequency. Because the smaller order allows them to test out the consumer's interests more sweetly, therefore, SheIn can increase viral pieces and reduce unsold items.
For example, SheIn claims that for every 3000 pieces ordered, Zara can only test one up to six styles, while SheIn can test 30 styles. This is because Zara's average order per SKU is about 500 pieces, while SheIn can lower it to 100 pieces per SKU. This is a significant cost reduction given that unsold inventory eats away a large portion of fast fashion's profit. Of course, this could be PR narratives of SheIn's, but from what I learned, smaller orders, more frequent orders, was initially rejected by many Chinese factories but eventually being widely accepted, partially due to the economic cycle wasn't very friendly to smaller factories in the past few years in China.
The fact that today SheIn was able to demand its suppliers to be a two-hour driving distance from its headquarters in the city of A'fanui, a suburb town near Canton, the world's most famous clothing manufacturing and distribution hub, that means SheIn has skinned an upper hand in picking suppliers on their favorable terms. How did it do it? By harnessing Chinese factories' existing big data power. For example, the popular C2M (Consumer to Manufacturers) model. This concept is believed to create production on demand and now it is adopted by many of China's e-commerce players such as Pindul. The market size of consumer to manufacturer e-commerce in China reached 2.5 billion in 2018 and is estimated to grow to 6 billion in 2020, according to Statista. With such adoption, that means SheIn doesn't need to reinvent the gear to retrain factories to be big data savvy. Instead, it takes data-driven play to the next level that it allows faster turnaround, more precise prediction on styles, and volume. Therefore, fast fashion just becomes faster and cheaper.
Secondly, as said earlier, the economic climate in China wasn't friendly to factories, and many brands eventually moved their supply chain out of China, moved to Southeast Asia, such as Vietnam. It created unoccupied manufacturing capacity for factories who were unable to adapt to the down cycle. They will, of course, take orders, however small. Thirdly, according to some of SheIn's suppliers, SheIn subsidized certain costs to convince factories to get on board with them who were initially unwilling to take SheIn's smaller orders. As we know in manufacturing, there is a fixed cost once the production streamline is activated, however small or big the order is. SheIn made sure factories don't lose money by taking their smaller orders, not only by subsidizing some of the activation costs but also by paying them on time, which, believe it or not, is a big favor to win over factories because what is factories' and OEM's worst nightmares? Unpaid invoices, which sometimes could bankrupt the factory.
If you ever dealt with Chinese factories, you probably know the client and the factories always have an intimate yet manipulative relationship. Both sides need to constantly engage in economic climate and to stay ahead of the fierce price competition. You win some, you lose some; that's a game. And because not every factory is able to supply big-name brands from the West, there are many smaller ones. Dealing with such uncertainties is part of the cost of being smaller players in the manufacturing game. SheIn, in a way, stabilized the relationship by giving stable orders. It won over factories' trust and eventually was able to dictate the terms in such a relationship. That is how a supply chain company is capable of.
With that said, I want to go back to my earlier point: why SheIn's model can hardly be replicated by other e-commerce startups. For American DTC startups, aside from SheIn's proximity to the factories, there are several other reasons. First is the tax incentives created by the Chinese government. Chinese factories, once qualified as an exporter, enjoy certain subsidization or so-called tax reform from the government because their manufactured goods exchanged for U.S. dollars for the government, therefore helping increase China's dollar-based foreign currency reserve. This is why you see during the China-U.S. trade war, manufacturers kept their machines running even after the 15% tariff increase, and many of them were left near zero profit margin because they will get a percentage of the invoice as a cash-based tax refund from the government. This is quite a nuanced issue that probably needs another episode to explain, but long story short, to get back to what we're talking about here, western DTC brands are customers, clients to those factories. They are treated as a counterpart on the other side of the trade table, while SheIn, on the other hand, is considered a catalyst to help enhance the supply chain efficiency, somewhat a partner to those factories. Therefore, a pure western style of DTC e-commerce company can hardly dictate the terms like SheIn could to cut the overall costs.
Secondly, on the international tariffs front, SheIn could further lower its cost basis by taking advantage of free tariffs as an overseas vendor. For example, by law in the U.S., if a package contains consumer goods and is delivered by an international courier such as FedEx, and the good has less than an $800 value per piece, the import tax is waived. Such policies have gained SheIn some backlashes from the western market. For example, in the UK, the media considers such policies a threat to other British fast fashion brands such as Oasis and Boohoo. This is another cost reduction a western DTC brand can hardly enjoy.
Thirdly, the current political climate is playing to SheIn's favor. SheIn, as a Chinese private fashion company, is not subject to political schooling like many western fashions brands would do. For example, I have not verified, but I believe even as small as a brand like Everlane, it will not procure Xinjiang cotton nowadays. Zara has been constantly scooted for using materials that could be harmful to the human body. Currently, it seems SheIn's sales strategy has not been affected by such exclusivity at all. More so, as we mentioned earlier, when other clothing brands publicly announced they are not using Xinjiang cotton all because of the tariff increase during the trade war when they are reselecting their suppliers, sometimes outside of China, such a situation played to SheIn's advantage because many factories were left out of business in China. They took SheIn's orders just to keep the lights on.
As for Chinese DTC brands or other so-called cross-border e-commerce companies, I also suggest they factor in the following circumstances before they aspire to become the next SheIn. As we know, fast fashion is a saturated consumer segment. Brands compete on the razor-thin margin. Not only I don't think there are more cost reductions can be done from the supply chain front, but also, as we know, cross-border e-commerce companies like SheIn allocate 20 to 30 percent of their budget on advertisement. I actually think it could be much higher, say 40 percent, just to gain customers. SheIn, as we know, its advertisement budget knowledge went to TikTok. So if you look at the game, you are actually enlarging the pie of social media platforms or total advertisement income, and you will find the customer acquisition costs going higher and higher by having more players competing for the same pie. And that brings us to my next point: who are the real winners in SheIn's phenomena? Surprise, the answer is neither Chinese factory exporters nor TikTok. The real winner is Facebook or Google. As we know, in its early days, TikTok for a while was the largest ad customer to YouTube, aka Google, and now TikTok is one of the largest advertisement customers of Facebook. There is a Chinese YouTuber who shares insider stories from the Chinese tech industry daily. He estimates TikTok spends several billion dollars a year on Facebook advertisements just to keep its user growth. By the way, if you understand Chinese and are interested in China's tech business, I highly recommend listening to his channel. I will include a link in the show notes. In one of his recent episodes, he explained why Facebook and TikTok have a love and hate relationship. Despite the press being filled with head noise about how these two are constantly getting on each other's nerves, the fact is TikTok is one of Facebook's biggest customers.
So back to SheIn, if there are three or four more aspiring next SheIns to be, it only increases Facebook or Google's ad revenue. And lastly, why I don't think Chinese factories and exporters will gain much from SheIn's game either. Remember Xiaomi, the Chinese mobile giant who is also a dominant brand in the Chinese smart home and other consumer electronic segments? If you are a Chinese entrepreneur in such a space, you probably have heard, a few years back, Xiaomi created a smart home ecosystem inside China and incubated many sister brands off which Xiaomi is the essential stakeholder. Those brands are called members of the Mi Family. The Mi Family Suites encourages such brands to work with the factories exclusively to avoid copycats or to gain market dominance, buoyed by Xiaomi's branding power. Many factories joined the suites. Sadly, many factories also end up with zero profit, and some filed for bankruptcy because they just couldn't drive down the costs like the Mi Family demands, and they don't have the venture capital type of investment to back them up. It was a hard lesson learned by many electronics factories in China.
I'm not saying SheIn has such demanding terms as Xiaomi did. In fact, I heard SheIn is flexible in terms of exclusivity, but my point is that there is not much margin to manipulate in the fast fashion segment or in any other fast-moving consumer goods sectors. It will be a zero-sum game for factories. Recently, there is a buzzword trending in China. It is called "Lēi Juǎn" or, in English, "involution." It captures the current generation's frustration, particularly among young Chinese, who see limited career growth opportunities. Some describe themselves as the "involution generation." SheIn's story somehow reminds me of this buzzword. In some ways, SheIn is not a revolution but an involution. It doesn't increase the overall innovation nor the productivity in Chinese manufacturing but instead is driving down the already thin profit margin which eventually will come back to bite factories and exporters.
And that concludes my research on SheIn. What do you think of SheIn? Feel free to leave a comment below or contact me directly, and stay tuned for the next episode.