Meemi O.
Sep 22, 202111 min
Updated: Mar 12, 2022
Previously, we introduced Pinduoduo's company's history and business model in Part 1, and dissected the company's performance and marketing strategies in Part 2. In the latter half of our Pinduoduo series, we explore Pinduoduo's long term future business strategies, including developing Pinduoduo's role as an AgriTech (i.e. agriculture and technology) platform in Part 3, and boosting user trust and satisfaction in this fourth and final installment. Specifically, in this article, we summarize the strategies Pinduoduo has implemented to increase user confidence and spending on the platform, as well as analyze their efficacies. We also take a look at Pinduoduo's monetization rate and explore the implications of this statistic, before concluding our four-part series on the company.
Enhancing User Confidence and Spending
While high user confidence and satisfaction is undoubtedly vital to any successful, growing business, boosting these factors is particularly important to Pinduoduo as the company's user growth begins to slow down. With 850 million annual active buyers as of the end of Q2 2021, it would be, as management also acknowledges, very difficult for the platform to continue to maintain its rapid historical growth rate of tripling the annual active buyer count over a period of only four years. Consequently, while we expect that Pinduoduo will undoubtedly continue to try and attract new (and particularly higher income) users going forward, we anticipate the company to place greater emphasis on increasing monetization from existing users going forward.
For the sake of comparison, during the year ended June 2021, Alibaba recorded 828 million annual active users for its China retail platforms (i.e. T-Mall and Taobao), while JD recorded 532 million annual active users.
As discussed in Part 3, Pinduoduo's revenues are, for the most part, a function of GMV, meaning that the company can generate more profit by encouraging users to spend more frequently and/or purchase higher premium products on the platform. To do so, Pinduoduo has launched a series of strategies under an umbrella theme which we call "platform upgrading", which involves overcoming the company's existing reputation as a platform for cheap, lower quality, and oftentimes counterfeit products, by broadening Pinduoduo's brand image to also be associated with higher quality, genuine, branded merchandise. The strategies implemented by Pinduoduo to foster consumer confidence and spending target different sections of the income and price spectrum, as follows.
At the low to medium end of the price spectrum, Pinduoduo launched the New Brand initiative (see Part 1) at the end of 2018 to help manufacturers launch their own brands for merchandise in the consumer staples and household essentials categories. Branding arguably increases the legitimacy of products sold and enhances the credibility of Pinduoduo's e-commerce platform, which can encourage hesitant new users to try and start out by ordering lower value goods from Pinduoduo first, before moving up to higher premium products after consumer trust is established. Moreover, branding can also cultivate customer loyalty and promote user retention among price-sensitive, value-for-money users, as those who have made satisfactory purchases from Pinduoduo brands may return to order again if they view Pinduoduo to be a trustworthy place for affordable products of reasonable quality.
At the medium to high end of the price spectrum, Pinduoduo has been upgrading its product offerings to include high premium products from domestically and internationally renowned brands. To encourage new and existing users to purchase these relatively expensive items, Pinduoduo launched its10 Billion Subsidy Scheme (百亿补贴) in mid-2019 (see Part 2) where the platform provides concessions on higher premium, branded goods across all categories of merchandise, including typical discounts of at least 10% for more expensive items such as phones and laptops, and even higher discounts for lower value items. We think Pinduoduo's upgrade in product offerings is an attempt to compete with higher income market incumbents T-Mall or JD by attracting wealthier clientele and encouraging existing users to purchase more expensive items on the platform.
As mentioned in Part 1, Pinduoduo revived and modified its direct selling (i.e. 1P) business in 2020. The new 1P business involves identifying products for which there is consumer demand but for which there are no available products yet on the Pinduoduo platform. Pinduoduo then temporarily sources these products for consumers to purchase until similar items are made available by third-party merchants. Management emphasizes that products sourced as part of the 1P initiative are temporary consumer solutions that constitute an immaterial proportion (i.e. less than 1%) of GMV, so the 1P initiative is a small business segment which they have "no intention to grow". At the same time, management also, rather contradictorily, describes the 1P business as "another strategic priority" for the company.
Our view of these somewhat conflicting remarks is that Pinduoduo launched the 1P initiative as a supplementary business to generate additional profit, while direct selling itself has the accounting benefit of boosting (recorded) revenues in comparison to third-party selling, since each sold product's price would be counted towards total revenue as opposed to only the marketing and transaction fees earned and charged by the platform as a third-party intermediary. Nevertheless, we exclude the 1P initiative from our set of long term strategies for Pinduoduo. As of the present, we don't see long term commitment from management to seriously pursue and extend the 1P initiative, while direct selling is significantly more costly than third-party selling due to the requisite storage, delivery and other related costs. We feel that Pinduoduo currently lacks the financial flexibility to invest in the logistics and infrastructure necessary to support 1P selling, and it is unclear whether there will be a strong and consistent demand for Pinduoduo's 1P products.
Are Pinduoduo's Upgrading Efforts Working?
Previously in Part 2, we briefly analysed whether or not buyers have been spending more on the Pinduoduo platform by showing that even though each active buyer's level of spending on the Pinduoduo's platform has been increasing over the years, yet the average GMV per order placed increased only marginally during the same time period. In this section, we supplement the existing analysis by considering two additional revenue-based metrics.
The first metric we look at is the amount of revenue generated by each Pinduoduo buyer, calculated as the total revenue in each year (excluding direct merchandise sales) divided by the number of active buyers in that year. In order to provide consistency in terms of analysis and focus solely on Pinduoduo's core operations, we only consider the company's revenue from its third-party selling business, although we describe the effects of including 1P data below for interested readers.
As shown in the graph below, Pinduoduo's buyers generate an increasing amount of revenue over the years, from an average of RMB7.11 per buyer in 2017 to an average of RMB68.16 per buyer in 2020. Although the increasing trend is a positive sign, we feel that the raw monetary amounts are not very economically meaningful.
We point out that revenue per buyer and annual spending (i.e. GMV) per buyer (presented in Part 2) are related by the monetization rate (our second revenue-based metric of interest), which measures the proportion of GMV spent on the platform that is actually captured as revenue by Pinduoduo.
Including direct merchandise sales in total revenue increases the revenue/buyer ratio from RMB7.11 to RMB7.12 in 2017, does not affect the results for 2018 and 2019, and increases the revenue/buyer ratio from RMB68.16 to RMB75.46 in 2020. The effect of including direct merchandise sales is negligible in 2017 due to the extremely small volume of direct selling revenue that year as Pinduoduo phased out its direct selling business in the first quarter. The relatively large impact in 2020 is due to the comeback of 1P selling and the associated accounting where each entire product's selling price is recorded as revenue, as opposed to just the marketing and transaction fees earned by the platform as an intermediary.
The monetization rate captures how much revenue Pinduoduo can generate from each yuan of GMV sold, and can be defined for a given year as the total revenue (excluding direct merchandise sales) divided by the total GMV in that year. We note that total GMV includes the GMV of 1P products, but this amount is negligible and less than 1% of the total GMV. Since Pinduoduo's revenues primarily come from marketing fees, the monetization rate can also be interpreted as how much merchants are willing to pay for the platform's marketing services per each yuan of product sold.
Although the monetization rate does not directly capture whether or not Pinduoduo's upgrading strategies are effective, the metric does, nevertheless, offer related useful insights. According to the graph below, Pinduoduo's monetization rate increased sharply from 2017 to 2018, but barely changes henceforth. As a comparison, we approximate a monetization rate for Alibaba's China (as opposed to global) online retail segment that is also in the 2% to 3% range, though of course a direct comparison is not feasible since Alibaba's China retail business is much more diverse than Pinduoduo's with additional components such as offline supermarkets and hypermarkets. We exclude JD from this comparison analysis since JD primarily adopts a 1P model and thus has a different revenue structure.
Including direct merchandise sales in the computation of total revenue increases the monetization rate by 0.01% in 2017, has no impact in 2018 and 2019, and increases the monetization rate from 3.22% to 3.57% in 2020 due to the same reasons as for the revenue per buyer metric .
Pinduoduo's monetization rate is not low given Alibaba's approximation as a relatively mature industry benchmark. This indicates that merchants are willing to spend a fair amount on Pinduoduo's marketing services, reflecting perhaps that the platform's marketing solutions are effective. Nevertheless, it is also possible that Pinduoduo's marketing services are only seemingly effective because the company provides concessions and rewards to customers to induce browsing and spending. For example, merchants can pay to have their products advertised on Duo Duo Orchard (see Part 2), but Pinduoduo provides users with rewards for browsing these products so it may be that users are only looking at or purchasing advertised items in exchange for rewards from the platform. Moreover, it is possible that some advertised items may be experiencing high sales not because of the efficacy of Pinduoduo's paid marketing techniques, but rather because of cash concession discounts offered by the platform.
Irrespective of the driving factors, based on these numbers, we don't think that Pinduoduo will be able to significantly increase its monetization rate much further. This means that the platform will have to rely on increasing GMV in order to generate more revenues, though of course, a higher GMV does not necessarily translate to higher profits. Based on the company's historical performance as well as management's recent and various discussions over the years, Pinduoduo always had and will continue to rely heavily on sales and marketing investments. Even if Pinduoduo can continue to maintain a monetization rate of 3% and increase its GMV each year, we think that the company would still need to significantly cut down on such expenses in order to be profitable in the long run.
Concluding Pinduoduo
To wrap up this lengthy four-part series, we conclude with some final thoughts.
Pinduoduo is a pioneer in recognizing the unique opportunities that China's lower income and rural area markets present, just when the existing incumbents thought that the country's e-commerce landscape had already matured. To exploit the business opportunities embedded in this niche segment, Pinduoduo pursued a strategy that targets the needs of price-sensitive clientele, i.e. selling affordable fresh produce and value-for-money consumer products. The company was able to expand its user base very rapidly through the promotion of social buying because it understood the zhan xiao pianyi (Chinese: 占小便宜 - see Part 2) characteristic of lower income Chinese residents, where consumers are willing to sacrifice significant time and effort in sharing product links in order to get a discount.
One of the standout characteristics of Pinduoduo's business model is, undoubtedly, how much the company was willing to invest in marketing, and particularly cash concessions. Up until the end of 2020, Pinduoduo spent a total of RMB81 billion in sales and marketing expenses, averaging to RMB103 per active buyer. At its peak, annual sales and marketing expenses constituted 90% of Pinduoduo's total revenues. The marketing and cash concession strategies are intended to introduce new users to the platform, to encourage existing users to spend more time browsing the app, and to purchase higher premium products (see Part 2). While user acquisition is clearly not a problem, we strongly question Pinduoduo's potential to retain users without the use of heavy marketing subsidies.
To reduce its reliance on marketing concessions as a revenue generation driver, or perhaps in supplement to this, Pinduoduo has adopted a number of initiatives to upgrade its brand image. The platform upgrading initiatives are intended to promote user confidence and satisfaction, which can translate to more frequent spending and/or higher-value purchases. We think that brand upgrading is a rational business strategy for Pinduoduo to pursue that can potentially have a significant positive impact on the platform's profitability. However, as of the present, the results are not very convincing, although it is of course possible and likely that the outcome (good or otherwise) of Pinduoduo's upgrading efforts will take time to manifest.
In terms of core competency, Pinduoduo aims to distinguish itself from other e-commerce players as a leader in the specific field of agriculture technology (AgriTech), a sector that is highly aligned with the Chinese government's economic goal of common prosperity. The company is working to promote AgriTech at all levels of the agriculture value chain, with the platform's community buying program (Duo Duo Grocery) at the downstream consumption level being particularly noteworthy for its large market share in the niche area of community e-commerce. Pinduoduo is planning to invest heavily in AgriTech going forward, though we are quite skeptical and concerned as to how profitable a business focused on agriculture can really be in spite of the favourable regulatory aspect.
From a broader strategy perspective, we feel that management does not have a clear direction for the company, hence the vague and frequently contradictory statements made during discussions and the lack of clearly defined goals. In Q4 of 2020, management explained that they don't manage the business against quarterly GMV targets, as this metric is "increasingly less relevant" to evaluating [Pinduoduo's] business. Instead, it is suggested that investors should focus more on the company's P&L and cash flows, which we find to be an impractical suggestion given that Pinduoduo's revenues are, for the most part, a function of GMV, and that the company has been operating at a steep loss every year.
Without a strong and credible management to serve as the backbone for the company, and given Pinduoduo's ongoing and anticipated reliance on heavy cash subsidies going forward, we find it difficult to predict when the platform will finally reach a mature and stable state, or what the company's business model in that state would look like. Pinduoduo did finally breakeven and recored an operating profit of RMB2 billion in the second quarter of this year, although management explains that the profit was due to lower (than usual) sales and marketing expenses, since Q2 is typically a low season for retail. However, they do not suggest that Pinduoduo's positive profitability will be sustained going forward, as the company plans to invest heavily in agriculture for the foreseeable future.
In extremely concise terms, regardless of the platform's specific retail focus (e.g. agricultural produce or higher premium consumer products), we think that Pinduoduo's future profitability and success hinges on its potential to continue generating high revenues and promote GMV growth while cutting down significantly on the sales and marketing expenses that the company has relied on so heavily to stimulate consumer spending in the past. The biggest question is, will users continue to purchase from the platform (and perhaps upgrade their purchases or buy more frequently) without the cash concessions?
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An Overview and Timeline of China's E-Commerce Sector
Alibaba Series
Alibaba (Part 1): Introducing the Alibaba Ecosystem and Commerce Empire
Alibaba (Part 2): Alibaba Cloud, Digital Media, and Innovation Initiatives
Alibaba (Part 3): A Financial Overview of Alibaba Group
Alibaba (Part 4): The Future of Alibaba
Ant Group Series
Part 1 - What You Need to Know About History's Biggest IPO
Part 2 - How Big is Small? 7 Mind-Staggering Facts You Need to Know
What Happened to Ant Group's IPO? Interpreting the New Online Microlending Regulations in China
JD Series
Pinduoduo Series
Pinduoduo (Part 1): Targeting China's Forgotten Consumers
Pinduoduo (Part 2): Business Performance, Financial Snapshot, and Key Marketing Investments
Pinduoduo (Part 3): Pioneering AgriTech and Pinduoduo's Future
Pinduoduo (Part 4): Concluding Pinduoduo's Future
Comparing Alibaba, JD, and Pinduoduo
Glossary