Softbank-backed Dingdong and Tencent-backed Missfresh have both gone public, to minimal investor enthusiasm. Both companies were launched:
- To solve the difficulties of selling perishable and difficult to transport groceries online.
- To tackle some of the pain points for both Chinese families and farmers.
- To capture a massive opportunity.
- And to get to operating profitability.
They are both specialty ecommerce plays. Their argument is that groceries are unique ecommerce markets where a specialty approach:
- Is superior for meeting unique customer needs.
- Benefits from specialized logistics systems.
However, the financials of both companies are problematic. And the competitive dynamics versus Alibaba, Tencent and JD are daunting. I will discuss this in Part 2.
Keep in mind, we have seen quite a few specialty ecommerce players.
- Vipshop is a specialty ecommerce company based on flash sales. This sales approach provided consumers an opportunity to buy branded apparel at discounts and it enabled brands to dispose of last season’s inventory as needed.
- Farfetch is a specialty ecommerce company based on connecting small and medium luxury brands (located around the world) with similarly distributed around the world luxury consumers.
- Chinese Secoo is a specialty ecommerce company focused on connecting Chinese luxury consumers with mostly international luxury brands.
- Shein is a specialty ecommerce company doing direct-to-consumer, low-cost, ultra-fast fashion by connecting international consumers with Chinese manufacturing.
This raises an important investor question:
How do you tell the specialty ecommerce winners from the losers?
In each case, we hear the same story.
- There are unique customer needs that enable specialty ecommerce to provide a superior value proposition.
- There are challenges on the supply and logistics side than benefit a specialized player.
To answer his question, I turn to Warren Buffett. And why he bought a specialty ecommerce company that nobody really knows about.
Introduction to Oriental Trading Company
Oriental Trading Company (OTC) is an Omaha-based ecommerce company that specializes in party supplies. Yes, you heard that right.
From its logistics facility, OTC basically assembles and ships packages with assortments of small, mostly low-cost items for parties. Lots of small rubber ducks, party hats, streamers, markers, banners, pens and so on. They primarily sell 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.” It’s really kind of a strange business.
Imagine you work at a real estate company in Florida and the company is throwing a Friday event to celebrate the 5-year anniversary of the company. Three hundred staff will be in the office, and you need lots of party-type supplies. You need hundreds of streamers, tons of balloons, maybe some signs and a whole bunch of other random small fun things for everyone. You probably don’t even really know what you need. And where do you go?
You go on OTC and scan their +40,000 SKUs of cheap, fun party supplies. You fill your shopping cart with tons of different things. OTC ships it all to you in a few days.
This company can be a bit confusing, so it helps to know the background.
- OTC was founded in Omaha in 1932 by a Harry Watanabe, a Japanese immigrant. It was one of the first wholesalers of “value-priced novelties and gifts.” They initially were a major supplier to US carnivals in the 1950’s (what do you sell to carnivals?). They later expanded into catalogs and direct marketing.
- In the 1970’s, the founder’s son took over and added some retail to the wholesale business.
- In the 1980’s, they started selling more to schools, hospitals and businesses.
- In the 1990’s, they moved online.
By 2018, the company handled 40,000 SKUS in +50 categories with 4 fulfillment centers. They appear to generate sales mostly by catalogs, but the orders are placed and fulfilled online (90% of orders). But this is being driven more and more purely online now.
- Their biggest selling categories are party supplies (#1), toys and novelties (#2), crafts, school supplies (#4), and weddings.
- The average price per item is $8, far below what you would see on Amazon. But the average order size is $75.
Berkshire Hathaway got involved in 2012, after the company emerged from bankruptcy.
- In 2000, the company had been sold to a PE firm, under which it grew from $150M to $300M in revenue.
- In 2006, it was acquired by the Carlyle Group and significant debt was added. That debt, plus the financial crisis, resulted in bankruptcy from which it emerged in 2011.
- Berkshire then bought the company in 2012.
Not long after coming out of bankruptcy, the CEO sent an email to Warren Buffett on a Friday at around 10am asking if he was interested in buying. He got a call from Buffett directly about two hours later. They had a basic deal within a few days and the whole thing was closed within 45 days. The CEO tells this story to show how fast Buffett makes decisions. But it is also likely Buffett had been aware of this Omaha-based company for a long time.
Today, the company has four businesses with +70% of revenue still coming from party supplies. They are still mostly a B2B wholesale operations focused selling party-suppliers to hospitals, businesses and educational institutions.
If you look at their webpage, you can see they sell a huge number of weird items, such as costumes, banners, candy, Easter eggs, etc. They do weddings, school, events and such. It’s worth going to the site and starting to put stuff in a shopping cart.
Management says they sell a huge number of rubber ducks. When I visited, they gave our group Warren and Charlie ducks (below).
Now as a Berkshire company, OTC can use its cash for things other than paying down debt. They have done several acquisitions in recent years. These included Fun Express, Mindware (games and puzzles) and SmileMakers (mostly stickers for companies like hospitals). And while these deals were small for Berkshire, Warren was involved in each of them directly. OTC has also launched new internal brands such as Learn 65, MarryMe and Fun365.
So why is this specialty ecommerce company successful?
Big Surprise. OTC has Big Competitive Advantages.
If Berkshire buys a company outright, I assume it has a competitive advantage and try to figure out what it is. Like Nebraska Furniture Mart and Borsheims jewelry, OTC dominates a circumscribed, niche market with unique needs.
- Buffett’s company Nebraska Furniture Mart has a market is circumscribed by geography and the cost of moving (and storing) furniture.
- Hi jewelry store Borsheims has a market circumscribed by geography and the need to see, touch and feel expensive jewelry (which is fading).
But OTC’s market is circumscribed more by its unique products and order types. They offer a huge assortment of strange little party favors that companies buy for events. That is a unique customer need. And OTC has very specialized logistics in order to fulfill these orders. Think about the type of warehouses and packaging systems you need to combine all these little items into specific packages for customers. Their warehouses are good at assembling lots of unusual, low-cost items into custom assortments. They are able to do this more efficiently and more cheaply than a company like Amazon, which has big general purposes warehouses.
And having a circumscribed market is critical if your competitive advantage is about being larger than a competitor and having economies of scale. Economies of scale means a lower cost per unit based on greater scale than competitors against fixed costs. You need the scale differential to keep your cost advantage. So you need a limited market without room for your competitor to grow to match your size. You want local dominance of a circumscribed market.
I think it is the logistics fixed cost that matters for OTC. According to the OTC CEO, the “lynchpin is fulfilment”.
I think the key number to know would be what percent revenue per order is the fulfillment cost. Given their higher volume in this unique, circumscribed market (plus their specially designed facility), they should have the largest assortment of products and should be the lowest cost provider. That gives customers no reason to ever go anywhere else.
OTC’s business appears to depend on three assets:
- An installed customer base of customers and businesses that make these types of unusual orders. OTC has a big volume in a small, strange market with unique needs. That’s a great strategy.
- An ordering system that allows users to find, discover and assemble from a wide spectrum of fun items – that do change frequently with tastes. Ducks are very popular in general. But spinners were the most popular item in 2018. OTC originally accomplished this via print catalogs. Now it is more through an online portal.
- A fulfillment center designed for assembling these types of orders. They handle about 6-7M orders per year.
Touring the Facility
A few years ago, I did take a tour of OTC’s La Vista fulfillment center (no photos allowed). It is basically a big Amazon-like facility for assembling orders and shipping out packages. It’s a building completely full of chutes, conveyor belts and assembly points with picking trays and staff with scan guns. Basically, it’s an e-commerce logistics facility – where the main activity is assembly.
The primary activity is assembling lots of small, low-cost party products in strange combinations in shipping boxes. That unusual activity is the key to understanding the business.
On one side, OTC receives thousands of small, mostly cheap items like rubber ducks and streamers (mostly from China). Then their facility assembles these into shipments for parties and events. And the metric that probably matters is the assembly cost as a percentage of unit sales. If this were e-commerce for consumer electronics, that assembly cost would be a pretty small percentage. But for combining lots of different cheap items into complicated combinations, the assembly cost is probably a significant percentage.
As mentioned, this is about scale in assembly costs that are uniquely large in this strange, niche market. Plus, there is the capital cost of building a big facility for this single activity. OTC handled 67M units in 2017, with 400-500 employees working 3 shifts / 5 days per week. It has 500,000 square feet of storage and 250,000 square feet for fulfilment. They say they could host 12 simultaneous football games in the facility.
Again, we see a Berkshire company with a circumscribed niche market with special characteristics and a dominant company with operational scale against it, giving it lower costs and greater product selection.
So that’s a winning specialty ecommerce play, with:
- A competitive advantage. Mostly economies of scale related to assembly costs.
- Positive unit economics (assumed). It’s an established company with significant fixed costs and operating leverage.
- A small market with unique requirements and limited growth.
Think about that last point.
Now imagine you are going to take them on as a competitor.
- Can local physical retailers do what they do? No. It’s a national business.
- Can a national retailer do what they do? Yes. But they would have to put +40k little items in their stores that virtually no other customers would want.
- Can catalogs companies do what they do? Yes. That was their traditional business. They moved online from there.
- Can an ecommerce giant like Amazon do what they do? Yes. Amazon could easily move into this space. But they could not beat OTC on selection or price. They best they could do is to match them.
How likely is Amazon to enter? Not likely.
- It would require a new specialized facility.
- It’s a small market with limited growth.
- There is an entrenched incumbent they can’t beat on either price or selection.
That’s a good playbook for winning as a specialized ecommerce company. It’s not the only one but it’s a nice clear one.
In Part 2, I’ll compare that to Dingdong, the newest specialty ecommerce company in China. It is one of the most fascinating companies to look at for digital strategy. Their F-1 is fantastic reading.
Thanks for reading, Jeff
- Dingdong and 5 Questions for Assessing Specialty Ecommerce Companies (2 of 2) (Asia Tech Strategy – Daily Lesson / Update)
- The Pros and Cons of Farfetch’s Global Luxury Marketplace (Jeff’s Asia Tech Class – Daily Update)
- Will Farfetch or Secoo Win in Luxury Ecommerce in China? (Jeff’s Asia Tech Class – Podcast 38)
From the Concept Library, concepts for this article are:
- Specialty Ecommerce
- Economies of Scale
From the Company Library, companies for this article are:
- Oriental Trading
I write, speak and consult about digital strategy and transformation.
My book Moats and Marathons details how to measure competitive advantage in digital businesses.
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This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.