Finally, we may get some sane marketing in China?

In November 2020, China’s tech giants should have been celebrating the runaway success of the year’s Singles’ Day festival. Yet the mood in their offices was sombre. A day before the festival had concluded, Beijing released its draft antitrust rules, aimed at rooting out monopolistic practices among China’s Internet companies.

The months that followed were brutal. The announcement gave license to the Government, courts, consumer associations and consumers in their quest against the tech gorillas. Fines and other penalties peppered weekly news bulletins, and within a few months, $240 billion of value had been wiped off Alibaba’s stock price.

China’s seemingly unstoppable tech industry, which for years had attracted the lion’s share of its equity capital markets, saw investments abruptly halt. The money folk were spooked. But it was the loose years of the pandemic when finance was cheap and China’s private equity and venture capital firms had plenty of cash sloshing around looking for a home. With tech off the table, the money flowed elsewhere, much of it to the consumer goods category.

The enviable growth of China’s middle class, who were quick to return after its short and sharp lockdown in early 2020, became the focus of many investors. With China’s borders closed and many foreign brands’ decision makers locked out of the country, Chinese brands were able to adapt much faster to the swiftly evolving market. On top of that, peak-nationalism saw Chinese brands gain further advantage, and investors took note.

Much like the dot-com boom of the late 90s in North America, consumer companies with feeble strategies and no genuine point of difference, were being showered with cash like never before. Investors were attracted to acquisition and sales growth, with little consideration to the sustainability of business strategies. Attracting new customers became the main focus of cashed-up consumer brands, seeking ever-higher valuations in the next round of financing.

Consumer companies followed the playbook of former darling brands such as Perfect Diary - the company that spent over two-thirds of revenue on marketing. Much of that marketing was transactional directed towards KOLs and livestreaming. With Perfect Diary and many other brands spending so much on KOLs, their fees shot up. The costs of KOLs on platforms such as RED has increased by as much as 50% in a year.

When a brand is already spending 70% of revenue on marketing and a large portion of that cost increases by 50%, the strategy becomes unsustainable. It also upsets the apple cart, with other brands having to increase their spending just to get mindshare amongst brands who are feeding every KOL and KOC from Harbin to Haikou. 

Fortunately, both investors and companies are increasingly waking up to the fact that these strategies defy business sense in the medium term. As a result, brands are increasingly diversifying their strategies from the transactional approach of just dropping prices and throwing money at KOLs. This has been achieved by initiatives such as brand-owned channels.

Based on some news we’ve heard this month, we think that this trend will accelerate. Why? Because funding from the equity firms feeding KOL spending sprees over the past few years is drying up.

Despite China’s last quarter’s 5.3% annual GDP growth exceeding forecasts and adding almost a trillion dollars to its economy over the past 12 months, the capital markets are less rosy. Chinese companies have raised just $6.4 billion on mainland IPOs, follow-on and convertible share offerings this year – the lowest level on record. Fund raising in offshore markets is its lowest in decades. Similarly, pay at China’s private equity (PE) and venture capital (VC) firms plunged by as much as two-fifths year-on-year last year.

This isn’t great news for Chinese companies hoping to raise money, but the silver lining is that we expect the market to become a little more real now. It will still be fiercely competitive, but there should be less heavily-funded brands unbalancing the market by over-spending on marketing. It will be the smart brands, not necessarily the cashed-up ones, who will win. Contact China Skinny to ensure that you are among the smartest ones.