China's leading tech-enabled healthcare platform committed to efficiently managing the pharmaceutical supply chain by digitally connecting the key stakeholders in the supply chain, from drug manufacturers through to distributors, pharmacies, and ultimately consumers. 111 trades on the Nasdaq under the ticker YI. For 111's safe harbor statements, please refer to the company's filings with the SEC. So let me start by first welcoming Dr. Yu. Thank you for joining us today.
Pleasure.
Before we get into our main discussion topic, which will focus on 111's supply chain logistics network and capabilities, which is a critical part of your growth strategy, it will be helpful if you could give us some background about yourself.
Thank you, Robert. I'd be glad to. I hold a master's in physics from Cornell University and a PhD in operations research and operations management from the Wharton School at the University of Pennsylvania. Over the past three decades, my career has spanned academia, corporate leadership, and entrepreneurship. I've held a role as vice president of worldwide supply chain at Amazon, responsible for procurement, fulfillment, inventory control, and logistics network design. I've also served as vice president of global procurement at Dell. Additionally, I founded and co-founded three companies in the U.S. and China: Caleb Technologies in the U.S., later acquired by Accenture, Yihaodian in China, later acquired by Walmart, and 111, Inc., now listed on Nasdaq. Now, back to you, Robert.
Thank you very much for that. That's a very nice introduction. Let me start with a general question. What do you see as the major shortfalls that exist today in China's pharmaceutical supply chain that need to be addressed, and why you believe 111 has the capacity to fulfill that role?
That's an excellent question. I see three major challenges in China's pharmaceutical supply chain. Number one is the fragmentation, which might be the root of many other problems. China has a highly fragmented market with over 6,000 pharmaceutical companies, more than 14,000 distributors, and more than 600,000 drug stores. Half of them are chain stores, and the other half independent stores or mom-and-pop shops. Unlike the U.S., where three main distributors control over 90% of the market and three large chains, now consolidating into two, CVS, Walgreens, and Rite Aid, dominate over 80% market share, and in comparison, the largest pharmacy chain in China holds less than 3% market share. This fragmentation limits economy of scale and drives inefficiencies everywhere across the system. Number two is the lack of digitization and transparency. The pharmaceutical industry in China is probably one of the least digitized.
For instance, the CFDA, which stands for China Food and Drug Administration, its policy mandates that every transaction, I mean, every transaction between parties requires the exchange of copies, physical permits with fresh stamps. This creates significant friction. Imagine that our platform alone would handle thousands of suppliers, up to nearly 500,000 drug stores downstream. Think about how many changes that must be made. This alone can be extremely cumbersome and a huge barrier. Additionally, this industry has more than 100 different ERP systems currently in use. Integration with these systems becomes a major obstacle, making it very difficult to track and manage the flow of goods, not to mention transparency. The third is very limited supply chain optimization. Only a very handful of major pharmacy chains can afford sophisticated supply chain management systems for optimizing their selection, pricing, and inventory.
As a result, inefficiencies like excess stock, high stock- out rate, and slow inventory turns are very common. At 111, we tackle these main pain points using our advanced Keystone Technology and integrate supply chain solutions. As I mentioned, both the downstream and upstream are extremely fragmented. Even with 14,000 distributors in the country, no one can provide a one-stop shopping experience. Pharmacies have to go to dozens of distributors to replenish their stock. What 111 has been doing is to leverage its supply chain capabilities to offer the downstream customers with the richest selection and one-stop shopping experience.
Right.
We probably have set an industry benchmark for that. We've developed over 30-some proprietary systems, mainly focused on supply chain management, including the demand forecasting, smart sourcing, selection optimization, which we call the Boyi system , S&OP, WMS, TMS, PIS. PIS stands for Price Intelligence System , et cetera, many.
Right.
These systems allow us to forecast demand, optimize selection, make data-driven procurement and inventory decisions, and efficiently manage our procurement. Give you some numbers. Over the past five years, these innovations have reduced our procurement costs from over 5% down to 2.6% of our revenue, establishing our supply chain as one of the most efficient in the industry. We are not only building these capabilities for internal use. We also extend the digital capabilities to help our partners, both upstream and downstream. Let me give you a few examples. We offer so-called Telescope systems to pharmaceutical companies, provide them full visibility into their product flow. In the past, once their product was out of their door, they probably lose track. But now they have full visibility on where these products flow into, what distribution channels, what retail stores, and what price.
We also offer downstream pharmacies a host of supply chain solutions. For example, we help them to make decisions on assortment management, on pricing, optimization of their inventory. So through these efforts, we have achieved a competitive edge in both supply chain efficiency and transparency. Hope that addressed your question.
That's a very full answer. Thank you very much. I think that it's given us a lot of information to internalize. Now, earlier this month, 111 announced expansion of its supply chain network with the addition of two new fulfillment centers to the network. Can you describe to us the scale of the network as it stands today, how expansive the network is geographically within China, and explain the business models that are deployed across that network?
Thank you, Robert. Currently, we operate 13 fulfillment centers covering the entire China. Among all the cities we serve, over 1,000 we can deliver within 24 hours. Among our 13 fulfillment centers, five of them are central hubs. We call them super hubs, with each hosting more than a few hundred thousand SKUs. These are located in Shanghai, Tianjin, Guangzhou, Wuhan, and Chongqing. The rest, we call forward-deployed fulfillment centers. This extensive coverage is essential. For example, we have more than 60% of pharmacies in our customer base are in China's third- to sixth-tier cities. We can penetrate deep down to every corner of the country. Let me also emphasize that establishing fulfillment centers for pharmaceuticals is far more complex than traditional e-commerce. We have experience with Yihaodian, an e-commerce company.
We could easily build a fully functional FC fulfillment center in three to six months. But now, on average, it takes about two years to build a new fulfillment center from inception to full operation, including receiving all the required CFDA approvals. To accelerate our expansion, we shifted our model from building fulfillment centers from the ground up to collaborating with partners by transforming existing warehouses into full-fledged fulfillment centers, but with 100% adoption of our existing systems and processes. This way, we reduce FC setup time by 70%. We are actively establishing additional FCs to enhance both customer reach and service quality. Hope that answers.
And you mentioned partnerships. They come in the form of joint ventures which you control. Is that the case?
Some are co-founded. Some are just affiliates.
Right. And one of your recent expansions was particularly, I think, in Guangzhou, Guangdong, sorry. You actually entered into a different type of model, a franchise model. Can you explain that a little bit?
Right. We have three different models. Some are in franchise model. Some are we partner through a capital arrangement.
Right. Okay.
But with 100% usage of our systems and our processes, our quality control. So that's very essential.
Right. That's right. That's important to remember. Okay. So let's go on from that and delve into the capabilities of these fulfillment assets. How do they improve your capabilities? Can you give us an idea of how they improve your procurement and last-mile delivery capabilities?
Okay, so given China's vast geography, each new fulfillment center reduces fulfillment time for local customers covered by that FC by approximately from half a day, sometimes to two days. So we use our proprietary Ping Pong Logistics Network, which we mentioned in our press release before. We use that proprietary logistics network for cross FC inventory transfers. We follow a rigorous transshipment model that allows for flexible, efficient movement of goods across our network. With each additional FC, we're able to reduce fulfillment costs for local customers within its coverage by 15%-20%. That's the logistics cost. Another key advantage is the reduction in product damage due to transportation. For instance, by using our own Ping Pong network, we cut the damage rate by 55%, really enhancing the overall customer experience through more reliable and intact deliveries, so those are the benefits we get.
Right. Thank you. So your closest competitor is YSB. Now, YSB operates many more warehouses nationwide, about 22, I believe, including two smart sub-warehouses. However, I did the sort of crude math. It does seem that based on reported numbers for the first half of 2024, 111 generates significantly more revenue on average per center than does YSB. So how do you explain the difference, and how do you correlate a fulfillment center in your network to sales?
I really think the efficiency is the key of the fully utilized capacity. I mentioned that we have five super hubs with each hosting more than a few hundred thousand SKUs. The scale economy exemplifies. For each FC, we focus on maximizing throughput and inventory turns, which requires a strong commitment to optimization modeling and algorithms. So we made continuous efforts to improve operational efficiency within each FC. For example, over just the past year alone, we've increased the efficiency of shelving and replenishment by 11% through modeling and optimization algorithms. Additionally, by optimizing order consolidation, we reduce picking and sorting time by 15%, further enhancing fulfillment efficiency. So these efforts allow us to handle more inventory than the original capacity designed for each FC, making each FC more productive and fuller utilization. These directly contribute to higher revenues per FC.
So that's a key factor in competitive advantage, really.
Yes. Yeah. How do we make full usage of the existing FCs?
Right. Thank you for that answer. Now, aside from feeding your ability to scale up, can you lay out the impact, the build-out of your fulfillment network has on 111's operating cost structure?
Okay. Let me explain our cost structure so aside from general administrative expenses, our costs are mainly divided into two categories. One is the sales and marketing expenses. The other is fulfillment costs and the latter, the fulfillment costs includes warehousing costs and logistics costs. From a logistics perspective, it's more economical to serve local customers locally through regional fulfillment centers, where the cost savings can be, I mentioned, reach up to 20%. However, we must balance the logistics cost savings with warehousing expenses because you have an additional warehouse but each new FC comes with additional operational costs and inventory costs so fortunately, we have optimization models and algorithms we rely on so those models and the algorithm guide these decisions. We only establish a fulfillment center in a specific region if our model and analysts confirm that we will definitely reduce overall fulfillment costs by enhancing customer experience.
So these are the conditions. We cannot deteriorate customer experience, but we have to reduce overall fulfillment costs, including logistics costs and the warehousing costs. Adding more FCs requires a careful balance between logistics and inventory costs. So it's a global organization with multi-factors in play. Hope that explains.
I think that's a real thanks for that answer. So can you now tell us more about your network expansion plans going forward, and what are the key determinants as to where you locate the new centers and which operating model you adopt?
Certainly. The key factors are customer distribution, inbound, outbound logistics, warehousing and inventory costs, overall customer experience, et cetera. So those are the factors we must consider. So we will continue to optimize our supply chain network based on demand distribution, customer experience, operational efficiency, et cetera. But with our current lighter-based model for adding new fulfillment centers and the more standardized systems we have now, which can adapt to different partnership schemes or setups, we anticipate acceleration of our network expansion. Over the next year, we plan to add at least five new fulfillment centers.
Okay. Across the country still?
Across the country.
Yeah. Okay. That's good. So finally, just to follow up on that question, how many centers nationwide do you need, do you think, to cross that RMB 20 billion revenue threshold, which the company's been talking about in recent quarterly earnings calls?
Earnings calls, right. Yeah. With our new fulfillment center models and developing our own proprietary Ping Pong Logistics Network, fulfillment center setup is no longer our growth bottleneck. Our current supply chain expansion plan is on track to carry us across the RMB 20 billion threshold. Our primary focus remains on delivering an exceptional customer experience.
Right. Yeah. Okay. Thank you very much for that. I think we'll wrap it up there. You've given us a much better understanding about really the heartbeat of the supply chain management business, especially as it's attributed to 111. If you have any other questions, I'm talking to our audience here, if you have any other further questions for Dr. Yu, please send them to me, and I'll be sure to pass them on. For analysis of 111, please refer to our open access website, www.watertowerresearch.com. The views expressed, I want to add that the views expressed in this fireside chat may not necessarily reflect the views of Water Tower Research and are provided for informational purposes only. Finally, I'd like to thank Dr. Yu for helping us with that better understanding of the logistics and network capabilities of 111.
Thank you for all of you for joining us on this fireside chat, and have a great day.