Established in June 2002, Home Inn's business model is very simple. It operates small hotels in big cities that are painted in a warm, yellow color. Each hotel has approximately 120 tidy and clean rooms. Yet none of the first few venture capital (VC) investors Ji Qi, Home Inn's founder, approached wanted to invest in his business. At that time, VC investors' focus was on the Internet, and Home Inn was completely different from the investment projects they had in mind. Many believed there was no investment value in what Ji proposed.
Ji eventually found someone who saw potential in his business. Zhang Suyang, General Partner of IDG Technology Venture Investment, clearly understood the market potential of budget hotel chains in China, although they had yet to take off. The concept had been proven in the United States in the 1960s. "People have the demand and the market doesn't supply it," Zhang said. "Let's place a bet on it." After Home Inn was listed on the U.S. stock market in 2006, IDG's investment payback was more than 40-fold.
Because of this, Zhang became known as one of the first investors in China to favor traditional businesses. Apart from Home Inn, traditional businesses IDG has invested in include supermarket chain Wu Mart, Chatea and Kanghui Medical. Wu Mart has been listed in Hong Kong.
Consumer spending spurs opportunities
Five years later, VC investors have switched their investments in China to traditional businesses as similar success stories have multiplied. More than one VC investor has indicated that retail chains are now their top priority. As a result, consumer chain enterprises such as Inner Mongolia Little Sheep Catering Chain Co. Ltd. and Chatea have been able to raise capital successfully.
Sun Wenhai, Executive Director of Eplanet Ventures, believes the difference between the markets in China and the United States is that the U.S. market is technology-driven. As long as an enterprise has advanced technologies, the chance of success is very high. On the other hand, the market in China is consumer-driven. The model that might succeed may not be the one with the most advanced technologies, but the one the people want most.
The consumption structure in China has completely changed from the survival consumption of the past to today's pleasure consumption that favors fashion, sports, traveling and socializing. Brand-name chains can now better satisfy consumer requirements. During the transition, new consumption concepts will be born to offer increasing business opportunities.
Due to the rapid GDP increases, accelerated urbanization, and continuous expansion of the middle class in China, Shao Jun, Managing Partner of DT Capital Partners, believes many VC investors, not just IDG, see the gold mine that awaits in providing products and services related to the spending escalation in China.
"Not all businesses can be operated as chains," said Liu Yongju, chief planning consultant with Beijing Fortune Marking Consulting Co. "A chain business must first of all consider the connection between public consumption and the product or service offered. A year-round consumer market must exist for the business to survive nationwide. Then, it must consider how to cope with consumer characteristics in different regions by improving the product or service so as to establish a long-standing attachment to the consumers."
Restaurant chains line up for listing
Compared with razor-thin margins of other traditional businesses and the worthless Internet bubble, net profits of more than 50 percent in the restaurant industry are tempting to VC investors.
On June 13, the hot-pot chain Chongqing Little Swan Hot Pot announced it had obtained an investment of $20-25 million from Sequoia China and SAI. In the next three to five years, Chongqing Little Swan plans to open 150 corporate and 200 franchise restaurants domestically and overseas. This is expected to help it realize total sales of 4 billion yuan as well as to get it listed in Hong Kong by 2010.
Chongqing Little Swan Hot Pot is the second largest overseas VC investment in China's hot-pot industry. In July 2006, Inner Mongolia Little Sheep Catering Chain Co. Ltd. formed an alliance with 3i Group, the largest investment organization in Europe, and renowned investor Prax Capital, bringing in $25 million. Inner Mongolia Little Sheep Catering Chain Co. Ltd. has set a listing target for 2008.
In 2006, China's top 100 restaurant enterprises had combined sales of 83.21 billion yuan, an increase of 24.4 percent over the previous year. As far as the capital market goes, originally indifferent domestic restaurant entrepreneurs are getting excited about the possibility of listing on the stock market.
However, everybody will be overwhelmed when the restaurant industry expands to embrace group management.
"Sales and market share are surging but, on the other hand, the restaurant industry is quietly biting the bullet," said an industry leader. "After opening the standard store and the flagship store, everybody, including the leaders, will be wavering between direct and franchise operations."
Faced with the choice between direct or franchise operational models and a myriad of operating problems, more and more restaurant heavyweights are having "growing pains." After recruiting people and marking the territories for expansion, the restaurant giants, who are relatively weak in modern management concepts, must face and resolve problems such as their huge cash flows being eaten up by resource integration, costs of research and development (R&D) for service and production standardization, costs for staff management and training, and skyrocketing rents due to shortage of prime restaurant sites.
"After entering the expansion phase, the chain restaurant enterprises must consider changes to the management system following changes in strategies, and get prepared for this," said Tang Hua, partner of Alliance PKU Management Consultants Ltd. "Irrational expansion is the biggest sudden killer of restaurant chain enterprises."