Why Was NetEase the One to Build Yanxuan?

Brand-name suppliers, a mature e-commerce infrastructure, consumer demand moving upmarket — the opening was there for almost everyone. Why did NetEase take it?

NetEase is one of China's oldest internet companies, but the part it plays is always the follower's.

From the outside, it doesn't chase whatever is hot, and it rarely burns money on sweeping mergers and investments. It paces around the edge of an opportunity, waits for a market to mature, then enters from the margins. NetEase once caught the portal news site and the online game at exactly the right moment. Its latest smart move is a product called NetEase Yanxuan.

By GMV — the number every big e-commerce player likes to quote, though it doesn't really show how a business is doing — NetEase Yanxuan hovers around 10th place among Chinese e-commerce platforms. Alibaba, JD.com, Suning.com and even the delisted Dangdang are all ahead of it. But it is growing three times as fast as the industry, and may soon pass Xiaohongshu and Mogujie, both of which have slowed.

It steered clear of sprawling, sell-everything rivals like Taobao and JD.com and aimed squarely at city dwellers aged 25 to 35, with one pitch: value for money. The Yanxuan home page is laid out with plenty of white space, and most of the display slots go to goods supplied direct by brand-name manufacturers. These knockoffs of famous-brand products were the platform's first hook, priced at a third — sometimes a tenth — of what the original brands charge.

William Ding, anointed "the internet's man of taste," has spent the past two years writing a column called "Brother Sanshi's Personal Picks" on NetEase's Kaola. What he recommends there tends to reappear on Yanxuan in a cheaper version: a French Le Creuset pot that sells for more than 3,000 yuan has a manufacturer-direct Yanxuan twin at just over 300 yuan. A MUJI four-piece bedding set that costs more than 1,000 yuan sells for just over 200 yuan on Yanxuan.

Besides using price to tell you that "a good life doesn't have to be expensive," Yanxuan's in-house editors also gather goods from lesser-known manufacturers into themed recommendations, wrapped in the language of lifestyle aesthetics.

Six months after launch, NetEase Yanxuan claimed 30 million registered users and monthly sales above 60 million yuan. It began its trial run with a few dozen household items, mostly towels and slippers; it now carries more than 10 categories — kitchenware, food, clothing, personal care, accessories — and close to 7,000 SKUs.

In NetEase's just-released second-quarter 2017 results, the email and e-commerce businesses brought in 3.35 billion yuan, up 68.9% from a year earlier — a quarter of the company's total revenue.

On an earnings call at the start of the year, William Ding set Yanxuan a target of 7 billion yuan in GMV for 2017, and said he hoped to "build a second NetEase in three to five years through e-commerce businesses like Kaola and Yanxuan."

Yanxuan has yet to build a second NetEase. What it has built is a queue of imitators:

• On March 23, Tencent launched a self-media e-commerce platform, Penguin Youpin.
• In early April, Xiaomi launched its lifestyle e-commerce app, Mijia Youpin.
• On May 26, Alibaba opened its first self-operated store, Taobao Xinxuan.
• On June 2, Mia.com introduced its own brand for mother-and-baby goods, Tutou Mama Zhenxuan.

These lifestyle e-commerce ventures, all built on "lifestyle aesthetics" and "curation," copy NetEase's sales model down to the letter, and none has come close to matching it. Several of them command far more resources and far bigger audiences than NetEase does. So why is Yanxuan the one in front?

Is It Really About the Goods and the Suppliers?

NetEase Yanxuan says its core advantage lies in how it picks products and manufacturers.

It now sells across every category, but it started with a handful of plainly styled household items — a canny choice. Demand for them is as steady and as frequent as demand for clothing, without clothing's need for brand cachet or a constant refresh of fashion. The average order value sits in the middle: high enough to tempt a shopper into trying something new, and high enough to support keeping stock in one place rather than bleeding money on long-distance distribution.

Its suppliers, meanwhile, had mostly been trained in design and manufacturing by foreign brands, and already worked at a respectable "Made in China" standard.

Yanxuan arrived just as manufacturing orders were flowing back into China. In the past, most of these suppliers took only foreign orders and had no patience for the small, frequent batches that domestic e-commerce requires. Then the global downturn cut foreign orders sharply, competition among contract manufacturers grew fiercer, and Chinese factories came under pressure to change.

NetEase looked like the more dependable partner. It carried the inventory risk itself, and at a Yanxuan supplier conference William Ding said every partnership would run three to five years, that the company would never leave a supplier short of cash, and that it paid all partner suppliers interest on withheld payments at the bank's time-deposit rate.

Yicai once quoted a Nike supplier: "Contract manufacturing for international brands gives you a gross margin of about 10% to 15%. Supplying Yanxuan can reach 20%."

"Frankly, e-commerce doesn't take much experience. It takes deep pockets and good taste," Ding said. "A buyer's store lives or dies on the quality of its buyers. Deep pockets guarantee a bigger order."

William Ding and NetEase Yanxuan are glad to help popularize the term "ODM," short for original design manufacturer. It differs from the OEM production once known simply as contract manufacturing: under ODM the manufacturer usually owns the design, and the client picks from those in-house designs.

Yanxuan pushes harder than ordinary ODM. Liu Xiaogang, who runs Yanxuan, says its buying team deals with manufacturers directly and helps specify everything from materials to features, then sells the result under Yanxuan's own brand.

The trouble is that none of this is exclusive. If Yanxuan can do it, so can any comparable brand. Taobao in fact saw the value of export manufacturers earlier. Taobao Xinxuan, the self-operated store it opened this May, grew out of its "Made in China, Quality-Made" channel, which predates Yanxuan and drew on the same pool of companies turning from exports to the home market.

So why is Yanxuan the only one that got big?

Email: The Cheapest and Most Effective Way to Get Users

If someone tells you Yanxuan's success comes out of NetEase Mail, don't be surprised.

Yanxuan was assembled inside NetEase's email division, at first a team of about 10. Email and e-commerce look like different worlds, but "NetEase's email division doesn't only run a mailbox; it also has a background in supply chain, technology and sales." Yiyuan Duobao, the "One Yuan Wins" shopping site once attacked as close to gambling, and the budgeting app NetEase Youqian came out of the same division.

Its staff had dealt with factories before. From 2014 they surveyed the market while scouting plants, found the Chinese manufacturer behind a well-known Japanese towel brand, and ran an internal test inside NetEase at close to cost.

The email division is one of NetEase's top-level departments. The product was founded in January 1998, China's first free email system, written by William Ding and his colleagues over seven months. Since 2003 NetEase Mail has held first place in China's internet email market without interruption — the only NetEase product that has never lost the lead.

As one of the internet's earliest forms, email is a major source of traffic. Gmail is the classic case: the free storage it offered was larger than what paid mailboxes gave at the time, which reshaped most webmail services and turned email into an even bigger gateway.

WeChat, as it happens, was also born in the QQ Mail team. "WeChat started out as a mailbox. WeChat really is email — fast client-side email — only so fast that you don't think of it as email." Pony Ma described WeChat's birth at the 2016 Tsinghua Global Management Forum.

Webmail has inevitably been pushed to the margins by the instant messaging of the mobile era, but Liu Xiaogang says email is still the most effective channel for getting users — so much so that Yanxuan's earliest customers were essentially NetEase Mail's: business people, mostly men, with high order values and strong loyalty.

Yanxuan mattered enough to be treated as a major project. It began in early 2015, took about a year to prepare, and went live in April 2016. In the first internal test, the team sent 250 internal emails and took in 300,000 yuan in sales. That unexpected result led William Ding to promote Yanxuan from a departmental experiment to a company project.

During the three-month trial run before launch, Yanxuan sent its first promotional email to every NetEase Mail user. It carried only a dozen or so household items then, scarves and bedding among them, but they still went out to users' family-and-friends circles under the name "Yanxuan New Year Goods Festival," with the lowest prices — a twentieth of what the market charged — in the most prominent slot.

After the official launch, the emails that went out at irregular intervals each month mostly sold "gifts," "perks" or "claim your coupon," or flagged new arrivals with a note about which brand-name product they matched. The message never changed: look at the gap between the original brand's price and Yanxuan's. Beyond email, Yanxuan promotions turn up in the menu bar at the top of the mailbox home page and in pop-ups at the bottom of the web version.

Once you register as a Yanxuan customer, it keeps you spending by sending coupons, then reminders that the coupons are about to expire. If you use NetEase Mail, this stream of promotion is hard to ignore.

Email this frequent could easily wear on people, but the layouts and color schemes are pretty enough that nobody has been driven to dump them in the spam folder.

Getting Users Isn't Enough. Where Was the Opening?

Yanxuan's smooth run depended on payment and logistics — the infrastructure of e-commerce — already being in place.

When NetEase launched a coupon platform in 2011, it played the middleman: merchants at one end, users at the other. It had understood for years that its channels were its best asset, but it stayed out of the parts of e-commerce that were already settled, and put no serious money into the business.

By now WeChat and Alipay have built out mobile payments, and the Tongda couriers (ZTO, YTO, STO, Yunda) have laid down dense delivery routes. Yanxuan did not have to train shoppers through sheer transaction volume the way Alibaba did, nor pour money into logistics the way JD.com did. By the time it walked in, the market was already built.

"I don't think the Yanxuan model could have worked five years ago," Liu Xiaogang said. Shifting attitudes among consumers, and their growing worry about air and food safety, were preconditions for the consumption upgrade too: "It's precisely the accumulation of the past few years that gives quality-focused e-commerce a fairly broad base now."

NetEase is good at catching openings like this.

In 1997 Charles Zhang founded Internet Technologies China, and the next year launched Sohu in imitation of the search engine Yahoo. Stone Rich Sight, Sina's predecessor, became the country's first IT company to take venture capital after Wang Zhidong brought investors in. William Ding quit the Ningbo Telecom Bureau and headed south, founding NetEase in Guangzhou, where he built China's earliest email service and its first homegrown online games.

China's internet portal era had arrived. The three big portals — Sina, NetEase and Sohu — all set IPO plans in motion in 1999, and went on to rule the internet for nearly a decade.

Then came 2001, and a run of blows: false financial reports, management turmoil, a trading halt on Nasdaq. Text messaging and online games rescued a company that had come close to delisting, and gradually turned it into a "games company."

At one point William Ding considered selling NetEase. But after asking Duan Yongping of BBK for advice, he worked out where to go next: "I've been thinking about what the next version of the Chinese internet looks like. The way in is wireless internet and online games. NetEase is taking the path of extending the internet model."

By then the old NSS order — NetEase, Sohu, Sina — had long since given way to BAT: Baidu, Alibaba, Tencent. NetEase trailed behind, propped up by a market value of 10 billion yuan built on highly profitable games. Now it had found itself another engine: e-commerce.

Liu Xiaogang likes to tell an old story: "Back when Alibaba was small, around 2002, Jack Ma came to Guangzhou to see Mr. Ding, and the two of them talked about the e-commerce business. They got on well, which is why we later bought land together with Alibaba, in Binjiang, Hangzhou. We've been watching this industry all along."

But it was not until Taobao and JD.com had divided up most of the broad, sell-everything market that Yanxuan pried open a corner and stepped in.

"A lot of things happen because the timing, the ground and the people are all right," Ding said. A former director of NetEase's website products department who writes under the name Chunyin once called Ding a businessman with "little taste for gambling": "He stayed out of the group-buying war in 2008, the video war in 2009 and the cloud-storage war in 2011 — every time because Ding thought the cash burn was too fierce and profit too far off."

Judged by the result, it was NetEase's oldest product, and the only one that has always stayed out in front — email — that made its e-commerce business work.

Who Buys From NetEase Yanxuan?

As Yanxuan has added activity online and off, the picture of its users has kept changing.

One clear sign: the fresh, MUJI-like palette it started with has grown busier. Among the sharply expanded SKUs you will now find close to a hundred T-shirts printed with game characters, filed under a category called "Interests." Almost all of them come from NetEase's own game IP.

This follows from Yanxuan's own positioning. Because nothing costs much, the average order currently runs to only about 200 yuan. To reach 7 billion yuan in GMV, it has to widen its selection, add users, and push them to buy as often as possible.

"We didn't lose money last year, and this year we don't plan to make any," Liu Xiaogang said. "We hope that after another year we'll have reached deeper into the consumer market, and our marketing spending will grow to match."

Like NetEase's other products, Yanxuan markets itself with some wit. In 2016 a song its own employees made and posted on NetEase Cloud Music, 《网易严选打折了》 ("NetEase Yanxuan Is Having a Sale"), was named by Zhihu one of the year's outstanding marketing efforts. The comments were almost all teasing praise: "Never underestimate people who make music. When they sell you something, they sing about it."

Around the same time, Yanxuan ran a purchase-limit promotion for Double 11 called "Three Pieces of Lifestyle Aesthetics," gradually widening its target beyond the business people it started with. Young students and white-collar workers hungry for novelty — short of money, but the most willing to spread the word for nothing — became the engine of its growth.

Women matter more and more to Yanxuan. Its in-house design brand, Hei Fengli ("Black Pineapple"), has done a crossover with the Jiangsu TV reality show We Are in Love, and in the second half of 2017 it will keep opening offline outlets such as cafés and bookstores.

Hei Fengli's brand colors are mostly black, pink and gold, and its range covers pajamas, bedding, snacks and cosmetics. Prices sit a level above the rest of Yanxuan. William Ding has described the Yanxuan model as "a crane among chickens," and said Taobao Xinxuan may fail because it contradicts Taobao's own business model.

"Its merchants are a flock of chickens. If it turns itself into a crane, the chickens are finished," Ding told Bloomberg Businessweek.

Outsiders, though, also call Yanxuan "an upgraded ten-yuan store" and "an affordable shop for the middle class." One phrase stands for consumption upgrading; the other is regularly offered as proof of the fashionable term "consumption downgrading." The contradiction between them measures exactly how well NetEase has read the middle-class shopper.

Yanxuan's customers may be people like this: swept along by the consumption upgrade, they have seen a model of the ideal life and want out of the rough-and-ready standard they grew up with, but cannot necessarily afford to move up a tier. Or they are people buried in work, who understand the sunk cost of time and would rather not hunt down a household item that might be cheaper on Taobao.

Their appetite for value for money almost certainly runs deeper than any curiosity about what NetEase's "ODM model" involves.

On August 8 the Atour x NetEase Yanxuan hotel opened in Hangzhou. A Yanxuan room is on average 6 square meters bigger than a standard one, cost 30,000 yuan more to fit out, and is priced 200 to 400 yuan higher. Yanxuan says the extra cost comes mainly from floor area, layout, furnishings and "the many Yanxuan products supplied for the guest experience," adding that "the real extra cost is more than 30,000 yuan."

In QDaily's report that day, a user going by Mou Kuan commented: "Yanxuan isn't expensive to begin with. Why does fitting out a single room cost 30,000 yuan more? Is the scale just too small?"

Cover and in-article images: NetEase Yanxuan