Only 4 franchise stores in 2 months, is Heytea's expansion "cooling down"? | Insight Research

Nai Xue's Tea released its first performance report after opening up franchising this week.

In the third quarter, the group added a net of 166 directly operated stores and closed 5 Nai Xue's Tea directly operated stores. As of the end of September, there were a total of 1,360 Nai Xue's Tea directly operated stores. This net increase far exceeds the net increase of 69 stores in the same period last year, and even exceeds the total number of newly added directly operated stores in the first and second quarters of this year.

However, in the more than 2 months since the opening of franchising, only 4 new stores have been added, which is in stark contrast to the practice of other tea brands that focus on franchising expansion.

In mid-August, Cha Bai Dao sprinted for a Hong Kong IPO, and its prospectus disclosed that it had opened nearly 6,000 stores in 3 years, with a revenue of nearly 9 billion and a net profit margin of over 22%. This once again proves the "money-printing machine" business model of franchising, following the prospectus of Mi Xue Bing Cheng.

It is reported that Mi Xue Bing Cheng, Shanghai Auntie, Gu Ming, Xin Shi Qi Milk Tea, and Ba Wang Cha Ji are also on the road to IPO in Hong Kong/USA.

Nai Xue, which has always insisted on heavy asset self-operation, could not resist the temptation and opened up franchising in July this year. However, the speed of opening 4 franchised stores in 2 months has raised doubts, how can a high-end brand "let go of its posture" and adapt to the franchising model.

Is Nai Xue really so incompatible with the sinking market?

A profit margin of over 20% gives franchisees a "peace of mind"

There was a time when the directly operated store model was the proud business model of brands, and "high-end" and "fashionable" were the labels of directly operated stores.

However, with the drastic changes in the milk tea market environment, "high-end" directly operated stores cannot bring more "profit". The rapid sinking brought by the franchising model has become the new industry profit model.

The prospectus of Mi Xue Bing Cheng and Cha Bai Dao vividly illustrate this franchising, sinking, and profit model. High-end directly operated stores can no longer be the exclusive synonym of the milk tea industry.

In the face of market changes, brands that have insisted on directly operated stores, such as Hey Tea and Nai Xue, have gradually turned to the franchising camp, and the market's view of the franchising model has completely reversed. Currently, only Cha Yan Yue Se among the popular tea brands has not opened up franchising.

With more and more brands opening up franchising and releasing more aggressive store expansion targets, from the perspective of franchisees, the choices have become more diverse.

The status of franchisees has changed from "seeking franchising" to "in high demand". Franchisees with rich store opening experience and their own high-quality resources and locations have become scarce resources and the objects that major brands compete for.

How to attract more high-quality franchisees has become the most important issue for brands to consider.

In the eyes of franchisees, the payback period and profit margin are undoubtedly the two most important indicators. It is generally believed in the industry that the operating profit margin of a general store should be above 20% in order to attract franchisees' attention.

Nai Xue's large store model has always been criticized for its high costs and insufficient profitability.

However, from the "unit economic model changes" disclosed by Nai Xue for the first time in its semi-annual report, this situation has changed. In the past, Nayuki focused on promoting the first type of tea shop, which had high rent and was located in high-end commercial areas, in order to attract customers. However, Nayuki has now shifted its focus to the second type of tea shop, which has flexible locations and lower rent. According to the semi-annual report, the proportion of the second type of tea shop has increased to 18%, and this proportion will continue to rise. It may become the main way for Nayuki to adjust its store structure and optimize the profitability of individual stores.

The "cost reduction" brought about by the adjustment of the store structure has also shown results in the semi-annual report. The proportion of rent costs and labor costs, which are strongly related to store size and location, has significantly decreased. This has directly led to a double-digit increase in the overall store profit margin, achieving the target of a 20% store profit margin that was difficult to achieve in the past.

This is undoubtedly welcomed by franchisees, as the "cost reduction" in terms of labor and rent has also reduced the actual operational pressure on franchisees. A store profit margin of over 20% is also equivalent to a reassurance for franchisees.

High Threshold ≠ Difficult to Join

However, the first report card after opening up franchising seems to have not satisfied the market, as opening 4 franchise stores in 2 months is not considered fast enough.

Compared with competitors, HEYTEA opened franchising at the end of last year and announced that the number of franchise stores exceeded 1,000 in July this year, which is equivalent to opening over 100 stores in a month.

Milksha, which is famous for its franchise model, had 19,986 franchise stores at the end of 2021. By the end of March 2022, this number had reached 21,582, with an average monthly increase of 532 franchise stores.

Compared with other brands that open hundreds of stores in a month, Nayuki's store opening pace is relatively slow. The controversy lies in the high threshold. Since the announcement of the franchising policy in July, Nayuki's franchising requirements have been criticized as the "strictest" partner program in history.

Not only does the large store model result in higher fixed costs for store decoration, equipment, and props compared to other brands, Nayuki also requires franchisees to provide proof of 1.5 million yuan in liquid capital for a single store and 4.5 million yuan for regional cooperation.

In contrast, most franchise brands such as Milksha and Yihetang only require an area of about 20 square meters and a basic capital requirement of less than 500,000 yuan.

In terms of store size and capital requirements, Nayuki's entry threshold can be considered the highest in the industry.

Jianzhi Research believes that the high threshold restricts the entry of a large number of franchisees with limited capital, resulting in a limited number of qualified franchisees, which may hinder Nayuki's store expansion speed. However, it is too early to judge the franchising effect based on only 2 months of franchise numbers. Considering that some stores are still under renovation and have not officially opened, it is normal for some franchisees to adopt a wait-and-see attitude during the initial opening period.

The high threshold and the difficulty of joining should not be equated directly. From one perspective, a high threshold may limit the number of franchisees, but from another perspective, it also reflects the brand's value in the market and future return expectations. Only when it can bring substantial returns to franchisees will they be willing to invest a high price.

According to Dolphin Research, which has many years of experience in opening new tea beverage shops, in the past two years, new tea beverage brands have been expanding rapidly, and some advantageous locations have been taken. The competition has become more intense. For example, Heytea and Bawang Tea now require an actual investment of up to 1 million yuan for franchise applications, but there are still many people applying.

On the other hand, some fast recruitment companies offer free franchise opportunities, as long as franchisees purchase their materials and equipment, but these brands have no reputation and no one is interested.

From this, it can also be seen that franchisees with strength value brand value more and are willing to pay a high price for the expected substantial returns. In the case of increasingly scarce advantageous locations in the future, they want to secure good locations first.

According to Naixue's Tea, in the future, franchisees will maintain a gross profit of at least 60% and a net profit of about 20%, which is a reasonable level for franchisees.

The 9.9 yuan price war has been effective, targeting third- and fourth-tier cities.

From the franchise situation, Naixue's first batch of franchisees are mainly concentrated in cities such as Yangzhou, Taizhou, Suqian, and Taizhou in the eastern region of China. Starting from the Jiangsu and Zhejiang regions, Naixue gradually expands to third- and fourth-tier cities nationwide.

Third- and fourth-tier cities will be Naixue's focus in the future. Firstly, Naixue's market share in third-tier and below cities is still not high, and even the share of self-operated stores is less than 10%, indicating great growth potential.

Secondly, as of June 30th this year, Naixue's third-tier store operating profit margin reached 21.7%, the highest among all levels, and is considered an important growth driver to improve the overall store profit margin.

Naixue has also made a lot of efforts to expand its brand in lower-tier cities.

Not long ago, Naixue also started a price war in the coffee field, offering a 9.9 yuan "fresh milk tea with original tea leaves" promotion. According to research by Tianfeng Shangshe, the sales proportion of Naixue's fresh milk tea has significantly increased in the third quarter, indicating that the 9.9 yuan price strategy has been effective.

Although this move has led to a decrease in average transaction value and has affected daily sales, appropriately lowering prices can expand the appeal of Naixue's products among the mass consumer group, which is beneficial for Naixue's franchise business to adapt to the lower-tier market more quickly.

Obviously, for Naixue at this stage, average transaction value is not the focus of attention, but rather the transaction volume. It needs to open up the lower-tier market first by relying on quantity.

In terms of franchise layout, Naixue still adheres to its consistent large store model. From Naixue's perspective, it hopes to differentiate itself from competitors through a "third space" offline experiential scene similar to Starbucks. However, according to Dolphin Research, the essence of franchising is still to expand store presence more flexibly and make quick profits from franchisees. If the high entry barriers affect the franchise rate, Naixue should also make dynamic adjustments. For example, in key commercial areas, Naixue can first occupy prime locations with large stores, and for flexible and small locations, it can use a small store model to increase density.

In conclusion, as a newcomer in the franchising field, Naixue Tea needs to prove to high-quality franchisees that after adjusting its store structure, it can ensure a reasonable profit margin in the franchise model and help them quickly enter the sinking market, which is already saturated with franchising brands.

As the "leading stock of new tea drinks," Naixue has enjoyed great popularity and is synonymous with "high-end" and "quality" in consumer circles.

Next, Naixue still needs to continue optimizing its profit model and find the best balance between user experience and operational efficiency. By providing consumers with a great experience and showing franchisees tangible returns, they will truly "vote with their hands."

Only then can Naixue truly make money and put it in their pockets.