So-Young finds beauty in growing economies of scale

The company’s revenue rose 33% in the second quarter, as aesthetic treatment services from its growing chain of self-operated clinics jumped 130%

Key Takeaways:

• So-Young’s revenue rose 33% in the second quarter, as its chain of cosmetic treatment clinics recorded triple-digit growth
• The company’s clinic network more than doubled year-on-year to 65 facilities at the end of June, as gross margin for that business improved by 3.8 percentage points

By Doug Young

Cosmetic treatment provider So-Young International Inc. (SY.US) is quickly proving the old business truth that there’s beauty in economies of scale. The company wowed investors this week with a 10^th straight quarter of triple-digit growth for the self-operated aesthetic treatment services that have become its core business since the pandemic.

On top of that, it also showed notably improving gross margins for the aesthetic treatment services, which it provides through its fast-growing network of self-branded centers. That network reached 65 centers by the end of June, up by 11 from three months earlier and more than double the 29 it had a year ago.

The centers are also showing a remarkable ability to achieve profitability very quickly. Of the 65 centers, 47 were profitable in the second quarter, while 51 achieved positive operating cash flow. So-Young is also leveraging those centers to sell cosmetic products to its customers through a partnership with a major manufacturer.

If there’s one small cloud in the company’s latest earnings report, released on Monday, it was So-Young’s forecast that its triple-digit revenue growth streak for the aesthetic treatment services business will come to an end in the current quarter. The company forecast that business would generate between 352 million yuan ($52.4 million) and 362 million yuan in the three months through September, which would be up 91.7% to 97.2%. But if there’s any downside to achieving economies of scale, it’s that growth rates inevitably slow as a company gets bigger, so we can’t fault So-Young too much on its inability to maintain triple-digit growth.

Investors didn’t seem to mind the imminent end of that streak either, with So-Young’s stock rising 21.3% the day of the results announcement.

So-Young’s stock was one of a small group we called “Chinese Easter eggs” last year, as investors suddenly took interest in their shares after years of neglect. So-Young’s was one of the best performers, as its shares rose sevenfold in the space of just a few weeks. But unlike most of those companies, whose shares later fell back to earth, So-Youngs’ stock has managed to retain some of its gains. The shares are still about triple from where they were before the rally that began in June last year, indicating genuine investor interest in the company’s ongoing transformation.

So-Young started out operating an online community for people interested in cosmetic surgery, earning most of its money from referral services from third-party clinic operators and product sellers. That business is extremely high margin, as its asset-light nature requires very little capital investment.

But So-Young also discovered the business comes with a big downside, namely, quality control. Quality varied widely among the many third-party clinic operators on the platform, exposing So-Young to reputational risk, as well as loss of customers when China embarked on periodic crackdowns on subpar clinics and product sellers.  

The company discovered quality is much easier to control, and business is far more stable, when it operates its own clinics. It opened its first self-operated clinic at its headquarters in Beijing in August 2023, and has rapidly expanded the concept since then.

Eroding margins

The biggest downside to the new business model is profit margins, which dropped rapidly due to the far higher costs of building and operating clinics compared with merely providing referral services. So-Young’s gross margin has fallen steadily over the last three years, dropping from 63.6% in 2023 to just 47.9% last year.

Officials said the company’s gross margin for aesthetic treatment services stood at just 28.1% in the second quarter, well below its overall gross margin of 44.1% for the quarter. But it also pointed out the latest treatment services gross margin improved by 3.8 percentage points from a year earlier, showing the treatment center business is becoming more profitable as it gains scale.

Most of the company’s major metrics reflect that improving efficiency that comes with growing scale. So-Young’s overall revenue rose 33.4% year-on-year to 505.2 million yuan in the second quarter from 378.7 million yuan a year earlier. But aesthetic treatment services grew by a far faster 129.5% year-on-year to 331.4 million yuan, expanding to two-thirds of total revenue from 38% a year earlier.

Revenue from its older information and reservation services fell 35% to 87.9 million yuan from 135.2 million yuan a year earlier, while sales of medical products and maintenance services fell 2.8% year-on-year to 73.9 million yuan.

Most of the metrics for its aesthetic treatment services tell a similar story of rapid scaling. Verified treatment service visits to its branded centers during the quarter rose 145% year-on-year to 165,200, while active users of its centers in the 12 months through June rose 154% to more than 255,300 from the previous 12-month period.

Significantly, the company said that about half of the new business to its clinic network came from referrals, reflecting its growing ability to attract new clients without heavy costs. Reflecting that, its sales and marketing expenses rose just 16.8% year-on-year during the quarter to 153.5 million yuan, far slower than its revenue growth rate, dropping sales and marketing expenses to 30% of its overall revenues from 35% a year earlier.

The company is also using its clinics to cross-sell products to customers through a partnership with Jinbo Bio-Pharmaceutical. It disclosed that one product from the partnership, Miracle Collagen, has sold over 66,000 units since its launch in April, while another, WeaveCol, launched in June, helps “fill the eye and midface areas while promoting ongoing collagen regeneration for a natural look.”

The improving profitability metrics filtered down to So-Young’s bottom line, as its net loss narrowed to 22.7 million yuan from 36 million yuan a year earlier. “Looking ahead, we see a clear path toward profitability as our industry leadership solidifies and economies of scale continue to unfold,” said CFO Shannon Shen.

The company hasn’t given specific targets for its new clinic openings for the next year, though it has said it will expand at a “measured pace,” while focusing on increased operational efficiency. That could be an important factor to watch, as overly aggressive expansion often undermines this type of brick-and-mortar service company if it starts to open outlets in less desirable locations simply to keep growing.

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