Yihaodian - The No.

1 Store
On July 11, 2009, the Chinese Internet retailer Yihaodian celebrated its first birthday. It had been exactly one year since the July 11, 2008 date when their website first went live and they began to fulfill customer orders from their Shanghai distribution center (DC). And what a celebration it was! Yihaodian cofounders Gang Yu (Chairman) and Junling Liu (CEO) were interviewed on Boss Town, one of Chinas most popular TV programs and the impact so dramatic that Yihaodian's servers actually crashed during the program due to suddenly multiplied traffic. When they reached the end of July, they found that sales in July had doubled from June. Now the celebrating was over and it was time to get back to business and to resolving three important issues facing Yihaodian: 1) formulating the right strategy for expanding geographically beyond their current Shanghai base 2) whether to continue to use outsourced package carriers or to create their own delivery fleet that would allow them to make deliveries directly to a customers home and 3) whether their product assortment should be broad or narrow and focused. Gang Yu and Junling Liu After receiving his doctorate from Wharton Schools Decision Sciences Department (renamed in 2002 to be the Operations and Information Management Department) in 1990, Gang Yu joined the faculty of University of Texas at Austin. He taught for fifteen years at the McCombs School of Business there and rose through the ranks from Assistant Professor to eventually become a Chaired Professor. As an academic researcher, he published over 80 journal articles, four books, issued three patents, and won the prestigious Franz Edelman Management Science Achievement Award in 2002. During his tenure at the University of Texas, he founded CALEB Technologies Corp. and served as Chairman/CEO. CALEB developed a complex software system that would allow an airline to recover from disruption caused by delayed flights. This system supported decisions on revising crew schedules, cancelling flights and rescheduling other flight and was adopted by almost all the major airlines in the US including American Airlines, Delta Air Lines, Continental, Northwest, Southwest, AirTran, and JetBlue. Accenture acquired CALEB in 2002. Gang then spent a sabbatical year during 2002-2003 in China teaching executive MBAs at Tsinghua University, Peking University, Shanghai Jiaotong University, CEIBS, HKUST. In 2004 he was recruited by Amazon to be Vice President of Worldwide Supply Chain in charge of procurement, distribution, inventory, and distribution center capacity. His team built the next generation
Professor Marshall Fisher of the Wharton School prepared this case. 3 November 2010

Amazon supply chain system, significantly lowering inventory while improving service levels. He also participated in the acquisition of the Joyo, a Chinese Internet retailer that became Amazon.cn. His role was mainly to evaluate and recommend reorganization of Joyos top management. Gang was recruited by Dell in 2006 to serve as its VP of Worldwide Procurement responsible for its $18 Billion annual procurement spend in Asia as well as inbound logistics from OEM/ODMs to Dells factories. Junling Liu was born and raised in China, but lived and worked in Australia, Singapore, Hong Kong, and the United States, including earning a Masters degree in International Business from Flinders University in Australia. Junling had extensive experience in the Information Technology and Telecommunications industries, including serving as Managing Director of Avaya China and then President of Dell China, where he had responsibility for Dells over $2 billion annual sales in China and Hong Kong. Numerous awards including being named one of Chinas Top 10 IT Figures in 2005 and Computer Worlds Top 10 Figures in 2006 had recognized his career accomplishments. A lunch meeting leads to a new direction As colleagues at Dell, Gang and Junling had monthly lunch meetings to update each other on business status. In late February 2007, Junling invited Gang to have lunch at a Hubei (Gangs hometown) restaurant. During lunch, Junling brought up the idea of entrepreneurship. Gangs past entrepreneurship experience brought him cherished memories and the prospect of partnering with Junling intrigued him. They believed that they could do big things if they worked together. They explored various ideas, including creating a pad-like low-cost computer that can access Internet but with very limited local functions and creating a platform to sell home improvement products. Finally, they focused on the e-commerce space. They were struck that relative to other countries, Internet use in China was current low relative to other countries (Exhibit 1), but had been growing quickly and was projected to grow even more quickly in the future (Exhibits 2 and 3). This represented a great potential for e-commerce, especially B2C. In the C2C space, there was already Taobao with an over 85% market share and in the B2B space, Alibaba dominated. But B2C was on the rise with many players, but no one dominated the market. Also, the obstacles that had been blocking growth of ecommerce in China, including payment and logistics, were diminishing. Credit cards were already a popular means of payment. Rapid highway constructions and the improved last-mile delivery in the big cities make logistics a lesser issue. Gang also remembered the acquisition of Joyo and believed that a B2C e-commerce venture would have a great chance to succeed. Finally, supply chain management is arguably the most critical factor for the success of B2C e-commerce and Gangs 20 years of experience in this field and his Amazons experience would certainly enable them to start with a high standard.

Creating a business plan Before they made the decision to quit Dell and launch the business, they assembled a small team to conduct market research and the two started to draft a business plan. They rented a 100 square foot office with a single shared table. They sat face to face for four months writing a business plan, with numerous rounds of debates on the business model, corporate culture, core values, and financing. One question they faced is what products to offer. Should they have a narrow, vertical product line or a broad, comprehensive one that would enable one-stopshopping for customers? And in either case, were fast-moving consumer goods (FMCG) good products with which to start? To answer these questions they conducted market research and analyzed existing top Chinese e-commerce companies. They also visited many stores, including supermarkets, department stores, and flea market for home improvement materials. They found that many e-commerce companies started with a narrow, vertical product line. For example, Joyo and Dangdang both started with books and Redbaby started with mother/baby products. But after a few years, all of these companies faced a barrier when they attempted to expand the categories of products they offered. They all launched a tremendous marketing effort over a lengthy period in an attempt to change their customers' perception that they only offered products in their original categories. And despite the high cost, these efforts were not always successful. For example, Redbaby (www.redbaby.com.cn) was still regarded as a website that only sold mother/baby products despite having expanded its offering to eight different product categories. Certainly, the simplicity and other benefits of starting with a single product category were appealing. However, category and selection expansion is inevitable for e-commerce companies due to the advantages of e-commerce -- unlimited shelf space and easy scalability. Thus they decided to choose a tough road -- a broad range of categories from the very beginning. They called themselves an online supermarket and centered their product categories around the concept of 'The Home.' One appeal of The Home concept is its expandability; it can be as broad as what's offered from a hypermarket or as small as that from a convenience store, so it removed the category expansion bottleneck they would have otherwise faced. However, starting with a large selection spanning many different product categories (food/drinks, cosmetics, kitchenware, mother/baby, home appliances) had its challenges, especially from supply chain point of view. Major difficulties came from sourcing, supplier management, inventory control, product quality management, and front-end/back-end systems. However, overcoming these difficulties would create a barrier to potential competitors entering, thus affording a first-mover advantage. Including the FMCG category from the start had important advantages - large traffic and high customer stickiness. Because FMCG products meet customers' daily repeated needs, they need to visit the site frequently, thus. Thus, enabling The Store to quickly build a loyal customer base.

Consumers demand one-stop shopping for FMCG products, and have high quality requirements, so customer trust is an important factor. C2C e-commerce business models such as Taobao do not fulfill these two requirements and thus do poorly on FMCG, leaving room for B2C to dominate this space. For example, the average basket size for Yihaodian customers turned out to be 16.7 items, while that for Taobao was less than 3. This implies that a customer needs to buy from 5-6 sellers on Taobao to get all the items he/she can get from Yihaodian in one purchase. Yihaodian is born The founders considered over 200 candidate names before choosing Yihaodian. The name translates to English as The No. 1 Store or simply The Store, and is thus reflective of the ambition Gang and Junling had for their new company. When the complete business plan was finalized, the founders were extremely excited with the market potential and their business model. The two families got together to celebrate. They resigned from Dell to officially launch the business. The business plan was over 40 pages long and included a checklist of 36 items to be implemented for their front-end/back-end systems. When they examined this checklist they were pleased to discover that over 95% of these items had been accomplished. However, while The Store existing as a business entity, there was much work to be done before the website would go live and they would begin delivering orders. They needed to raise capital, find a distribution center to serve their initial Shanghai market and build the software system that would control all of their operations, including order taking, scheduling deliveries and managing inventory. Raising capital Junling and Gang invested the initial seed capital, which was used was to hire an initial IT team to build the website and backend systems. They needed more capital to lease a distribution center in Shanghai and to build a product team that to manage the various product lines they planned to carry. When they presented their ideas to venture capitalists, the response was cool; no VC in China was willing to invest in a company that had only an unproven concept. Many VCs claimed that the most important factor for making their investment decision was the founding team, but they informed Junling and Gang that their track record as professional managers showed they were capable of growing an existing business but would have a high chance of failing when building a company from scratch. Gang pointed out his prior successful entrepreneurship experience in the US, but the response was that business in China is completely different from that in the US. Having failed to obtain VC funding, Junling and Gang sought angel investors. Thanks to the Executive MBA teaching experience Gang had had in 2002-2003, he quickly identified a few potential investors who might be interested in helping them. They contacted three of them and gave one-hour pitch to each. Due to the prior trust that had been created, the investment decisions were quickly made and money was wired to the companys account within a month.
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Establishing the first site in Shanghai They then searched for the site of their first distribution center, which would serve the Shanghai market. Since rental rates are high in Shanghai, they sought sites on the outskirts of Shanghai, but within a one-hour drive from the center of Shanghai to allow the potential for same-day delivery. They made a table for comparison purposes with rows as the potential sites and columns as rental unit price, expandability, property quality, travel-time to Shanghai, labor availability, and other factors. After several rounds of negotiations and internal discussions they chose one that met their then current and future needs. However, after they signed the contract and started to prepare to move in, the owner withdrew from his commitment, apparently because he had received a better quote from another renter. Junling and Gang eventually found a Shanghai distribution center location, and along the way they learned a valuable lesson. They decided in the future to work only with more reputable international logistics companies such as Prologis and ARMB. Building the software support system The first employee Junling and Gang hired was The Stores Chief Technology Officer Jason. Jason had previously been the CTO of 51job.com, a Nasdaq listed online HR company. Jason was quite excited with The Store concept, but his wife was cool about the prospect of his leaving amore secure job. So Junling and Gang got the three families together for dinner to convince Jasons wife of the merits of their venture. Jason officially joined the company in late January, 2008. During the long Chinese Spring Festival, Gang and Jason spent countless hours discussing system specifications and finalizing the front-end/back-end system functional requirements. The function requirements specified the following properties for the system. Integration

All modules would share the same data; results obtained from one module should be communicated to all other modules and change behaviors of those modules accordingly. Different users have different access rights to different modules. Real time

The system would be event driven and fully transparent, allowing the status of all of resources, customer orders, inventory, and payment flow to be monitored in real time. Automated

Decisions are as automated as possible. For example, procurement decisions are automatically made; when inventory drops below a defined safety stock, a purchase order is automatically issued and sent to the supplier. When the order is filled by the supplier, the system tracks the delivery time, receiving and shelving information, and processes payment.

Optimized

All processes and resource usages should be optimized. For example, the Warehouse Management System (WMS) optimizes where products are shelved in the distribution center and the route followed in picking orders, and the Transportation Management System (TMS) the routes followed in delivering orders. Advanced Customer Relationship Management (CRM)

The CRM system records customer entry, search, and purchase behaviors. Data mining is then used to construct a customer behavior model, which is used in making customized referrals. Facing decisions in July 2009 With the Shanghai distribution center in place and their enterprise software system completed, The Stores website went live on July 11, 2008 and they began delivering customer orders. Initial traffic was low, but grew steadily as they discovered literally dozens of marketing tools for attracting customers. The one-year anniversary celebration in July 2009 was a great success and featured an entire month of celebration with various promotional events, many of which were sponsored by The Stores suppliers. The Store gave out 100 million loyalty points to reward their supportive customers, offered deep discounts for their 30 most popular brands and hosted events on popular Chinese websites like Tianya and Sina. Renowned Chinese business tycoons sent their congratulations and these were shown on The Stores website. And of course there was the server crashing appearance of Gang and Junling on Chinese television. Now they needed to resolve three important issues. The first was how to expand geographically. Of course there was the decision of which cities to expand to, but they also needed to decide whether to use a centralized or decentralized model in managing multiple distribution centers. In the decentralized model, each distribution center serving a major city market would maintain an independent sub-website and control its own product selection, pricing, marketing, and inventory. In the centralized model would have a common website and all decisions about product selection, pricing, marketing and inventory would be made centrally by The Store Corporation. The second decision was whether to continue to use outsourced package carriers or to create their own delivery fleet that would allow them to make deliveries directly to a customers home. Finally, the wondered whether their product assortment should be broad or focused more narrowly on products where they had a competitive advantage. Geographic expansion The acceptance of The Store customers made Junling and Gang consider a more rapid geographical expansion than they had originally planned. As they considered in which cities they should open additional distribution centers, they collected the data on Internet usage shown in Exhibit 4. Candidate cities for an additional DC were
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Beijing, Chengdu, Guangzhou Wuhan, and Xian. Exhibit 5 shows the location of these cities as well as Shanghai, the location of their current DC. Beijing and Guangzhou were strategically located cities with the largest population. Moreover, Beijing can easily cover another big city, Tianjin. Guangzhou can cover important provinces including Guangdong, Guangxi, and Fujian. Having been the test bed for Deng Xiaoping's socialist capitalism, Guangdong also had the highest online purchase population. The decision of whether to use a centralized or decentralized model in managing multiple distribution centers was of great concern. Both business models existed in the e-commerce industry; representative for the centralized model is Joyo, and that for the distributed model is Redbaby. Joyo almost entirely copied Amazon's business model and controlled all decisions from its headquarter. Joyo does not have local branch offices except distribution centers. Meanwhile, Redbaby had branch offices in 12 different cities each of which makes its own decisions including sourcing, marketing, inventory. Each business model has its own pros and cons as illustrated by the following table.

Pros Centralized model

- Organizational structure is simple without local branch offices except distribution centers. - Financial structure is simple with taxes paid by the headquarters. - Centralized sourcing is easier and with more bargaining chips due to larger volume. Better supplier management. - Lower overall inventory due to risk pooling effect.

Cons
- Difficult in addressing local needs. - Worse availability. - High inventory transfer cost.

Decentralized - Easier for local inventory management model

- Can address local customer needs

- More inventory - High procurement and operations cost

Should The Store have their own delivery fleet? In the beginning, delivering products from their DC to customer homes was a constant struggle for The Store. Unlike in the US where a few delivery companies such as UPS, Fedex, and DHL are household names, in China, the delivery business is very fragmented with thousands of local delivery companies, many of which are mom and pop operations. No delivery company could cover all of China and very few had sophisticated TMS (transportation management systems).

When The Store started in Shanghai, they chose three delivery companies as partners and distributed orders to them based on customer location, payment method (for example, only one company could use a POS system), and product type in the orders. They also used three other companies to deliver outside of Shanghai. They established Key Performance Indicators (KPIs) to measure the performance of these delivery companies and conducted weekly meetings to review performance with them. The delivery companies had never used systematic KPIs to gauge their performance and thus it took a few months for them to get used to this process. The initial delivery performance was horrible with massive customer complaints, late deliveries, missing orders, missing items, and damaged products. For example, the initial on-time delivery was only 90% and customer returns reached over 3%. In an effort to improve performance, The Store sent their customer service staff to provide training to the delivery companies, and they shared with them their customers complaints. They also had numerous meetings with the owners/presidents of the delivery companies. After over a half-year of effort, they started to see significant improvement. For instance, on-time delivery reached 98% and customer returned orders dropped to below 1%. Although the performance of the delivery companies started to meet expectations, scalability became a critical issue. Orders had increased by a factor of 27 over the last year and the delivery companies were struggling to keep up with this rapid growth. The Store could in part cope with this by adding more delivery companies, but this added to complexity. They also realized that in e-commerce the last-mile delivery was the only human touch point with customers and thus could be important in enhancing the customer experience. They were thus forced to consider whether the time had come to consider creating their own delivery fleet. While the investment and complexity of creating their own UPS or Fed Ex was daunting, especially for a company barely a year old, they felt they needed to at least consider this option.

Should the product line be broad or focused on selections where The Store had a have competitive advantage? The diagrams in Exhibits 6 and 7 describe the Stores business model and order fulfillment model. At the beginning, their assortment was influenced by the highly successful Germany discount grocery retailer Aldi. Aldi had the narrowest assortment in the grocery industry, comprised of just the bare essentials, yet Aldi was also one of the most successful grocery retailers. Thus at launch, The Store carried only 3000 SKUs versus a typical supermarket which carried 20,000 25,000 SKUs. And of course hypermarkets had an even broader assortment, comprised of both food and non-food products like home appliances and consumer electronics. Not surprisingly, the most common feedback from customers was the lack of products they wanted to buy.

As they reflected on successful e-commerce retailers such as Amazon, they realized that the Aldi model might fit offline retailers where the physical size of the store is a hard limitation. But the important characteristics of e-commerce are almost unlimited shelf space, 7x24 services and the ability to offer both physical and virtual products, such as services. This left them wondering by how much they should expand their product assortment (for example, should they move outside of food and start selling products like TVs and computers) and what process they should follow in adding and deleting SKUs from their assortment.

Exhibit 1 Percentage Internet use in selected countries

Source: 2009 APRIA comparation report Exhibit 2 Projected B2C usage in China

Source: Zero2IPO research 2010.06

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Exhibit 3 E-commerce in the U.S. and China: 2005-2008

Source: 2009 iResearch &JP Morgan Exhibit 4 Percentage of population using the Internet for provinces with the highest usage

Source: gongchang.com data research center

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Exhibit 5 Potential locations for additional warehouses

Source: Google Maps

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Exhibit 6 The Store business model

Exhibit 7 Inventory Management

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