In Part 1 – and in Podcast 90 (Can Dingdong Win in Groceries and Specialty Ecommerce?), I teed up questions about how specialty ecommerce companies win and lose. It’s a really useful strategy question to think about. Here’s why.

• Imagine a small ecommerce company emerges and gets some traction with a clever product. Or in an interesting niche. This happens regularly in Asia.
• The company shows growth but is still operating profit negative.
• The ecommerce giants are looming potential threats to the new specialty player.

Is the company going win? Is it going to get crushed? Is it just going to struggle along? Do you invest?

That’s the situation with Dingdong and many specialty ecommerce companies. What if you could predict confidently whether it was going to succeed or not? That’s a real investment opportunity.

It’s why I focus a lot on emerging ecommerce companies. And why I’m trying to come up with a reliable framework for this scenario.

• I got it wrong for post-IPO Meituan. They had exactly the above scenario post-IPO and I thought they would not be able to get to operating profits in food delivery. Especially not with Alibaba and ele.me openly stating their intentions to take their business. But a year after IPO, Meituan reached operating profitability.
• I got it right for Shopee. But that wasn’t really a specialty ecommerce play. Just a well-thought out and well-executed plan for SE Asian ecommerce.
• Cross-border DTC retailer Shein has burst onto the scene this year. It is a promising specialty ecommerce company. I’m keeping an eye on it.
• Farfetch and Secoo are both viable specialty ecommerce companies that focus on luxury. But they appear a bit stuck in no man’s land. I’m not sure about these long-term.
• Vipshop got a lot of traction based on flash sales. It’s unclear to me what the long-term trajectory is for Vipshop.

And now there is Dingdong, a specialty ecommerce company focused on fresh groceries and on-demand (i.e., under 30 minute) fulfilment. So what is going to happen?

Here are my 5 questions for assessing the viability of a specialty ecommerce company. This is a work in progress so any feedback would be appreciated.

1) Is the company sufficiently differentiated in the user experience?

Ecommerce is mostly a demand-side game. Yes, Alibaba and others are building out infrastructure but that is a game for the ecommerce giants. A specialty ecommerce player will never get growth without sufficient user attention, engagement AND retention. So you have to have a differentiated service in something users really care about. And, fortunately, there are lots of opportunities to do that in ecommerce.

We actually see this fairly frequently. There are ecommerce companies that focus only on new moms. Others are for consumers who really care about sports and exercise (and related fashion). Ecommerce companies are currently emerging with great digital tools for make-up and beauty.

There are actually quite a lot of options that makes sense. Go into any shopping mall and you will see lots of creativity in retail. It’s a fairly vibrant and interesting space.

A specialty ecommerce company can definitely differentiate by types of products. However, I think that is fairly easy to copy.

I like specialty ecommerce companies that combine products with something else, like entertainment and content. Live streaming naturally combines content about subjects like fashion and make-up with ecommerce. That combination can really differentiate the company.

Experiential retail is another interesting approach. Nike China is offering mobile apps for training and running. So they are combining content with commerce. But they also offer running events you can participate in. That’s experience plus commerce. If the product has an experiential component, like trying out a sofa or clothes, you can really differentiate. Partnerships with physical retailers could be an interesting approach here.

But ecommerce plus community is the gold standard for specialty ecommerce. Companies that have a community that is always talking online about the subject really last. It creates relationships. It creates a group identity and a feeling of in versus out. It can tie the product and community to certain values. Consumers will even tie their identity to the group. We can see that in gaming communities.

In all of these, you want to expand the relationship and user experience beyond just a product transaction. Otherwise the company is not much more than a list of products in a mobile app.

In Part 1, I wrote about Oriental Trading (OTC), an ecommerce company that specializes in party supplies. OTC ships packages with assortments of small, mostly low-cost items for parties. So lots of small rubber ducks, party hats, streamers, markers, banners, pens and so on. OTC primarily sells wholesale to businesses (especially schools and hospitals) and the company describes itself as the “nation’s largest direct retailer of value-priced party supplies, arts and crafts, school supplies, toys and novelties.”

That is some real differentiation. It’s weird. Had you ever heard about something like that before I mentioned it?

2) Can the company compete and/or differentiate in logistics or infrastructure without ongoing spending?

Having unique logistics that are optimized for a specific consumer or product niche can be valuable. Dingdong makes this point many times in its IPO filing. It argues its fulfilment grid model lets it better deliver fresh groceries in 30 minutes. And its entire system is based on cold chain and refrigerated trucks so they can ensure end-to-end quality.

Ok. Maybe its differentiated logistics enables it to better serve consumers in its specialty niche. I’m not a total believer but it’s certainly possible.

But China’s ecommerce giants are also doing fresh groceries and rapid delivery. And they keep investing year after year. Is Dingdong really going to be able to keep up with their spending on logistics and infrastructure?

I think differentiated logistics or infrastructure can be a strength. But not if it gets the company into a long-term spending fight with the major players. The logistics or infrastructure spending for a specialty ecommerce company needs to be limited. And certainly not open-ended.

I think Oriental Trading actually has this. OTC has a large logistics facility in Omaha where the primary activity is assembling lots of small, low-cost party products into custom combinations for shipping. Their system is good at assembling things like rubber ducks and streamers (mostly from China). That is something a standard logistics facility at Amazon couldn’t do very well. So it is differentiated.

But it is also contained. They don’t have to build 50 of these facilities. They don’t have to keep investing in new infrastructure and technology. They are not in an arms race in infrastructure with Amazon.

I like cross-border ecommerce companies for this reason. That is what Shein is doing. That is what Farfetch does. Going cross-border means unique logistics requirements that most ecommerce companies don’t have. And it is not an arms race. An ecommerce company in cross-border luxury (Farfetch) is going to have very different logistics than a typical domestic ecommerce company. But it is pretty limited.

3) Does the company have a strong competitive advantage in a circumscribed market?

Obviously, I look for competitive advantages. And they need to be really strong here. A specialty ecommerce company, by definition, is smaller than its competitors. So the company needs a clear strong advantage to protect itself and to scare of new entrants.

OTC has this, as discussed in Part 1. It has economies of scale in logistics, mostly in assembling. And these are in a circumscribed and slow-growing market.

You’ll notice I didn’t ask about market size or growth in these questions. I am looking for strong differentiation in something that users care about. I am looking for a depth of relationship and uniqueness. That is probably going to be a niche. That is probably going to be in a smaller opportunity. And, as I will mention in Question 4, a small and slowly growing market is probably not going to attract the big players.

4) Is there a clear path to significant operational cash flow?

This is critical.

Most ecommerce companies are operating cash flow negative for many years. It is expensive to build out the logistics and other infrastructure. And onboarding a new group of merchants usually takes a lot of time, education and money.

But a specialty ecommerce company absolutely needs to be on a clear path to operating cash flow. The company must generate enough cash to be viable as a stand-alone company. And it needs enough cash flow to defend its niche from new entrants. A dominant company in an ecommerce niche with no cash flow is not a threat to a new entrant.

5) Has the company avoided markets and situations that are attractive or strategic for the major ecommerce companies?

Ultimately, if Alibaba or Amazon want your specialty ecommerce business they can probably take it. It’s all a matter of how expensive and difficult it would be for them. You can fortify. But it’s better if they just don’t want your space that much. If it’s a small space without a large growth opportunity, they will probably not bother. That’s the OTC situation. That’s the best scenario.

And you really don’t want to be in a space that the ecommerce giants view as strategically important. You don’t want to be doing something that they would keep doing even at a loss. Or that they would pay a very high price to capture.

That is what Dingdong looks like to me. They are in the fresh groceries and on-demand delivery business. That is exactly the space that Alibaba, JD, Walmart China and Sun Art Retail all view as both a big opportunity and strategically important. Alibaba CEO Daniel Zhang has referred to on-demand delivery as the “infrastructure of new retail”.

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Based on these questions, I think you can get a reasonable assessment of the viability of a specialty ecommerce company.

• Is it going to be viable financially?
• Can it build up its defenses?
• Is it going to attract lots of serious competitors?
• Can it grow fast enough to actually compete with the majors and survive
• Does it need to sell?

Last Question: Is Dingdong viable long-term?

I think Dingdong has a solid answer to #1. It is nicely differentiated in the delivery of fresh groceries and daily necessities. Their guaranteed delivery in 30 minutes and assured quality are valuable to consumers.

I don’t think the logistics matter (#2) that much.

And then it gets bad.

• They are losing money (#4). The gross profits (20%) are still quite a bit smaller than their fulfilment costs (35%).
• They are competing with Alibaba and others in a large attractive space that the ecommerce giants consider strategic (#5). That’s bad.

That’s where I end up. Any feedback would be appreciated. We are definitely going to see more of these specialty ecommerce companies.

Cheers, jeff

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