By Tim Burroughs
Various PE firms have found success supporting Taiwan consumer brands in mainland China. But the food and beverage segment is an example of how picking the team, theme and time can make all the difference
Starting from a single store in Taipei in the 1970s, restaurant chain Din Tai Fung has taken its brand across Asia and into the US. Shanghai is home to one third of the 18 mainland China outlets. In carving a niche in that city, the company has done what some doubted was possible – sell xiaolongbao, a soup dumpling closely associated with Shanghai, to the Shanghai people.
“When they first went there I didn't think they could be successful,” says Susan Lin, managing partner at EverYi Capital, a China consumer-focused GP that spun out of AEA Investors. “Xiaolongbao is like mom and pop store food – it is sold everywhere at one third of the price of Din Tai Fung. But go into the restaurant in Shanghai today and the majority of customers are locals.”
Din Tai Fung is not a private equity story, but an object lesson in how a Taiwan consumer brand can establish itself in China. The company picked the right price point to leverage rising domestic consumption, and persuade customers that it worth paying a premium to eat a quality product, served by attentive wait staff, in a pleasant environment.
“For historical and geographical reasons, Taiwan has a much better service mindset than mainland China, and this is what differentiates Taiwanese restaurants,” says Ken Chen, a partner at LEK Consulting. “But it's also a challenge. Individual stores do well because the owner is there. Once you develop a chain, though, it is hard to maintain that level of service.”
Plenty of Taiwan consumer brands have established themselves in China, in the food and beverage (F&B) space and beyond. Private equity sees an opportunity in helping them realize these ambitions. It is, however, never easy to get the best management team into the most attractive market segment, at the right time. China's consumer sector is evolving almost as fast as the ideas shaping it.
James Roy, associate principal at China Market Research Group, notes that mainland consumers most readily associate Taiwan with electronics and snack foods. “In food services and food retail, they tend to have fresher ideas that are suitable to Chinese palettes all over the place because they never have flavors that are too strong, – not too salty, not too spicy,” he says.
This combination of taste and service helped the likes of Tingyi Holding get traction in the 1990s. More recently, in the casual dining space, it formed the basis of investments by Actis and General Atlantic in the now-listed Xiabu Xiabu, by Actis again in Bellagio, and by Headland Capital Partners in 85C Bakery Café. Given mainland China's fast food market was worth $120 billion in 2014 – 33 times larger than Taiwan's – according to Euromonitor International, winning a small slice can mean a huge pay off.
These investments fell between 2008 and 2012. During this period, Chris Tay was looking for another brand to fill the space in between fast food and fine dining. He settled on Taiwan over Southeast Asia, in part because the thought the mainland wasn't quite ready for a Southeast Asian player.
“The barrier for Taiwan brands to get into China at that time was low,” Tay adds. “The concept, the genre, the food type and pricing were acceptable to the local Chinese consumers, but it was also a little bit foreign, so they were willing to pay a premium for it. At the time, if you looked at most of the local brands, they weren't charging high prices.”
Tay, who had previously worked for a string of Chinese F&B groups, received some seed capital from Qiming Venture Partners and went to Taiwan to talk to brand owners, accompanied by Hans Tung, then of Qiming but now a managing partner at GGV Capital. They agreed a technology transfer deal with Cloud 9 and got the recipes to core dishes. The chain that emerged under the operating company YPX Cayman was a modified version of the original Taiwanese format, in terms of menu and store layout.
Following Qiming's initial $5 million, YPX received three more rounds of funding worth a combined $51.5 million. When the Series D came in 2014, the Cloud 9 network had grown to 40 outlets and the company was building scale by creating sub-franchises to complement its self-owned restaurants.
Nevertheless, talking to Tay and Tung, there is a clear sense of then versus now. While Tay recently left YPX, Tung remains an investor in a personal capacity, and he admits the move into fast casual dining was very much of its time.
“The investment thesis was that Chinese economic growth was 10% a year, so in an offline sector that was fast-growing you could do 20% a year, and if you are among the category leaders you might be able to grow 40% a year. You didn't have to be in internet back then, and you could also pick up assets relatively cheaply,” Tung says. “What has become more obvious over the past five years is the impact of e-commerce on the offline economy.”
As such, the earlier model no longer applies. If China's “new normal” is 5% annual GDP growth, Tung suggests, a consumer brand that outperforms its category might expand at a rate of 20%, but there is unlikely to be a discount on entry. Venture capital investors are obviously drawn to the larger potential returns of e-commerce and online-to-offline (O2O) services.
Most offline retailers, irrespective of their territory of origin, have been hit by the rise of e-commerce. Shopping malls now have greater food and beverage representation than before as consumer goods retailers struggle, but LEK's Chen notes that rental rates for these premises have yet to fall. Restaurants are seeing reduced foot traffic but little moderation in cost.
They must also cope with two specific O2O threats. The first is online food delivery platforms that take ownership of the consumer relationship through free delivery and loyalty programs. The second are listings and group-buying sites that also insert themselves between the consumer and the restaurant. “It's less damaging to the restaurant because you still get to see the customer, but you have to pay for discounts and promotions,” Chen says. “Parts of the value chain are being disrupted.”
None of these pressures faced Xiabu Xiabu, 85C or Bellagio when they arrived in China, but digitally-enabled disruption is just one challenge presented by a modernizing mainland consumer sector. Customers that Tay concluded were not ready for Southeast Asian cuisine in 2009 are now spending increasing amounts of money on a wider variety of dining options. “It's hard to be loyal to one brand when you have so many choices,” Tay observes.
The commercial environment is therefore highly competitive and Taiwan brands no longer have as much of an edge in terms of appeal to local taste buds or service standards. Caught up in a battle between stronger local brands and the growing number of international players entering the market, they also face a chicken-and-egg conundrum when trying to build scale.
Most fast casual dining business models have at their core the concept of a central kitchen: serving a string of outlets, it delivers economies of scale and allows greater consistency in food quality and service. According to research conducted by LEK, the regulatory requirements in Taiwan make a central kitchen economically viable only once a chain crosses the 50-outlet threshold. In mainland China, with its allegedly more lax regime, the threshold is 8-10 locations.
It makes it harder to squeeze smaller players out of the game and gain sustainable market share. These mom-and-pop establishments are said to compound their advantage by ignoring tax obligations. A private equity-backed group that is ultimately targeting an IPO or trade sale has no such luxury, which means lower margins and much less margin for error.
Chen estimates that a quick service restaurant chain needs to reach 200-300 outlets before it is large enough to withstand the undercuts of these smaller players and have the power to dictate terms to the O2O platforms.
Taiwanese food and beverage brands retain numerous advantages – “their local market is small and competitive, so if you are not innovative you end up in a price war,” says Y.R. Cheng, a partner at China mid-market buyout firm Lunar Capital – and several continue to thrive within China despite the challenges facing the industry as a whole. If Din Tai Fung is an example of success at a higher price point then Xiabu Xiabu is the mid-range poster child; as of June it had 499 restaurants and six-month revenue was up 10% year-on-year at RMB1.12 billion ($175.7 million) with net profit increasing 42.7% to RMB117.5 million.
However, not all brands are suited to a private equity-backed mainland expansion strategy. Paul Yang, chairman of CDIB Capital, identifies two key factors. First, he believes that most Taiwan consumer brands are light on franchise equity – i.e. their ability to change consumer behavior – and those that are not often don't have a large enough addressable market. “There are some famous pineapple cake brands in Taiwan, but how big is that industry?” he asks.
Second, Taiwan entrepreneurs are not necessarily open to the value-add that private equity can bring, being of the opinion that they have the language skills and cultural affinity to crack the mainland market on their own. Yang and EverYi's Lin are united in identifying an operational gap between Taiwanese and international brands in this respect.
EverYi recently invested in Belgian chocolate brand Pierre Marcolini with a view to helping it access China's middle class consumer market. The company has a systematic approach to entering new markets, honing in on its target segment and drawing up plans to build exposure across multiple channels.
“Many Taiwanese entpreneurs don't think that way,” Lin explains. “Mid-cap companies tend to look at China the same way they look at Taiwan, which is a key mistake. They are often reluctant to spend money on branding, marketing and promotion, and that is the one area that is very different if you want to come to China.”
Then vs. now
Again, comparisons are drawn between the China of 10 years ago and the China of today. Brands used to feel their way into the market by picking a city – perhaps because a friend was willing to offer them a cheap deal on rental – opening a shop and seeing how consumers responded. If the response was favorable, capital could be raised for further expansion.
Fast forward to the present, and the immediate costs, in terms of real estate and labor alone, are far higher. Local brands have deeper on-the-ground networks and insights, while international consumer brands enter with seemingly limitless marketing budgets. The greater capital requirements come hand-in-hand with a more substantial time commitment; mainland expansion is rarely a strategy that can be coordinated from Taipei by remote control.
“Six years ago, the bar for investing in a Taiwanese food and beverage brand was a lot lower and people would pay more. Now that China is maturing you have to up your game,” Lin adds. “If an entrepreneur says, ‘I have a great brand, I can be successful; just give me the money and don't worry about the rest – I'm going to a small city to open up a shop and try it out,' that is not enough for me. They need to be open-minded enough to sit down with us and work out a strategy.”
Tay, for his part, lays some of blame with the PE firms for investments failing to deliver. He says there is a tendency to hire executives from the big fast food chains in China, who come into an “ex-family run business and immediately try to systemize it and change everybody.” Rather, PE firms should target ex-entrepreneurs or people who have experience of smaller, localized companies as well as large operators.
This underlines not only the challenge to find the right management team, but also the traditional venture capital credentials – a bet on an entrepreneur with an idea – of the original YPX deal.
Most PE investors that spoke to AVCJ expressed reservations at the prospect of rolling out a greenfield business. Strait Capital, for example, almost exclusively targets companies that were set up by Taiwanese entrepreneurs in China. Jack Lee, a partner with the firm, says he values management teams' experience dealing with local governments and suppliers. Expanding a Taiwanese brand in China when there is no pre-existing footprint involves a high execution risk.
Similarly, Lunar's Cheng notes that Tingyi Holding, best known for the Master Kong instant noodle brand, was founded in Tianjin by four Taiwanese brothers who had no existing business in their home territory. Lunar's preference is for strong existing brands in China – in the consumer goods space rather than restaurants – and most of the sellers are inevitably mainland founders.
“Some Taiwan-based brands overlap with our focus, but we have to consider how easy it is to take them into China. These days the cost of expansion for consumer products is very high,” Cheng says.