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Pinduoduo (Part 2): Business Performance, Financial Snapshot, and Key Marketing Investments

In this second instalment of our Pinduoduo series, we examine Pinduoduo's overall business performance and financials, describe some of the company's well-known (and occasionally criticised) marketing strategies, and evaluate whether or not Pinduoduo's costly sales and marketing investments will pay off in the long run.

We recommend reading our first article (here) before continuing to gain familiarity with the company's history, evolution, and business model.

The future of Pinduoduo is discussed in Part 3 and Part 4.


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Business Performance

In this section, we provide a snapshot of Pinduoduo's overall business performance starting in 2017. We note again that Pinduoduo does not provide business performance data for its first two years of founding, although we argue that 2015 and 2016 data are not so significant in evaluating the company since Pinduoduo only completed the transition to its current business marketplace model in 2017.

#1: The Number of Active Buyers and Active Merchants on Pinduoduo's Platform Proliferated Over the Past 4 Years

The number of active buyers on the Pinduoduo platform has more than tripled over the past four years, from 244.8 million active buyers in 2017 to 788.4 million in 2020 and 823.8 million in the first quarter of 2021.

Pinduoduo Number of Active Buyers
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

Note: Pinduoduo defines the number of active buyers in a given period as the number of user accounts that placed one or more orders on the Pinduoduo mobile application or through social networks and other Pinduoduo access points (e.g. mini programs and weblinks) during the period.

The number of active merchants on the Pinduoduo platform grew 42-fold from 207,000 in the year ended June 2017 to 8.6 million in the year ended December 2020.

Pinduoduo Number of Active Merchants
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

Note: Pinduoduo defines the number of active merchants in a given period as the the number of merchant accounts that had one or more orders shipped to a buyer on the Pinduoduo mobile platform during that period.

#2: Pinduoduo's Users Have Become Increasingly Engaged with the Platform

Pinduoduo's number of monthly active users (MAUs) has grown in tandem with the platform's rapid growth in active buyers. The graph below shows Pinduoduo's quarterly average number of monthly active users during the Q1 2017 to Q1 2021 period. Pinduoduo experienced extremely rapid growth in monthly active users, from 15 million MAUs in the first quarter of 2017 to 724.6 million MAUs four years later.

Pinduoduo Monthly Active Users
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

Note: Pinduoduo defines the number of monthly active users as the number of user accounts that visited the Pinduoduo mobile application during a given month, excluding those who accessed the Pinduoduo platform through social networks and other access points (e.g. mini programs and weblinks) during the period.

To get a sense of whether the increase in number of monthly active users was purely driven by the overall increase in number of active buyers on the platform, or if a greater proportion of active buyers were actually shopping on the Pinduoduo platform monthly, we calculate the proportion of active buyers in each year that were also monthly active users. Since Pinduoduo reports the number of monthly active users on a quarterly basis but the number of active buyers is reported on an annual basis, we approximate the proportion of monthly active users each year by dividing the Q4 average of monthly active users by the same year's number of annual active buyers.

The reasons for choosing this approximation are:

(1) The number of active buyers counts the total number of buyers who placed at least one order during the year. Since the number of active buyers on the platform doesn't stay constant but rather increases over the year, we want an MAU figure that is as close as possible to year end to be comparable.

(2) The fourth quarter is when Chinese consumers are most active, with the October golden week holiday, 11.11 shopping event, as well as year-end and new year sales. Indeed, Pinduoduo mentions in their prospectus that the platform's sales volume is generally higher during the fourth quarter of each year. If a consumer were to be active on an e-commerce platform, we think that they would, at the very least, be active during the peak shopping period.

The graph below shows the percentage of each year's active buyers that were also monthly active users, which we refer to as the "MAU proportion". Pinduoduo's MAU proportion increased from 57.6% in 2017 to 91.31% in 2020, indicating that the platform not only attracted a significant number of new users during the past four years, but also effectively increased its users' engagement with the platform.

Note: according to Pinduoduo's earnings call reports, more than 90% and 88% of the platform's annual active buyers were MAUs in Q4 2020 and Q1 2020 respectively. Based on these figures, we think our MAU proportion approximations above should be reasonably accurate.

#3: The Pinduoduo Platform Witnessed Substantial Growth in Terms of Both GMV and the Total Number of Orders Placed

The total gross merchandise value (GMV) sold on Pinduoduo's platform grew at a CAGR of 85% during the 2017 to 2020 period, from RMB141.2 billion in 2017 to RMB1.67 trillion in 2020.

Pinduoduo Gross Merchandise Value
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

At the same time, the number of orders placed on Pinduoduo's platform grew almost 9 times, from 4.3 billion orders in 2017 to 38.3 billion orders in 2020.

Pinduoduo mentions that part of the large increase in number of orders from 2019 to 2020 is due to the launch of its next-day grocery initiative (Duo Duo Grocery) described in Part 1.

Pinduoduo Number of Orders Placed
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

#4: The Average Pinduoduo User Ordered More Frequently From the Platform Over the Past Four Years, But Did Not Upgrade Their Purchases

The average Pinduoduo user spent 3.67 times more money on the platform in 2020 than they did in 2017, from an average spending per active buyer of RMB576.9 in 2017 to an average spending per active buyer of RMB2,115.2 in 2020.

Pinduoduo Annual Spending Per Active Buyer
Data Sources: Pinduoduo Prospectus, Annual Reports, Quarterly Reports

To gauge whether users were buying higher premium products on the platform or simply making purchases more frequently, we calculate the average GMV per order placed as the annual GMV in each year divided by the number of orders placed during the same year, with results shown below.

As a whole, the average GMV per order placed on Pinduoduo's platform did not change significantly over the past four years. The average GMV per order placed on the Pinduoduo platform grew slightly from RMB32.84 in 2017 to RMB42.49 in 2018 and RMB51.10 in 2019, before dropping to RMB43.54 in 2020. Management clarifies that the drop in 2020 is partly due to the inception of Duo Duo Grocery where users make more frequent purchases that are of a lower value each time.

(Pinduoduo states that they do not disclose separate results for Duo Duo Grocery)

We conclude that the increase in spending per active buyer over time is predominantly due to more frequent purchases (that are partly driven by grocery spending in the most recent year) rather than a significant upgrading in the types of products purchased. This is consistent with the increase in MAU proportion discussed above, where more users are becoming frequent monthly buyers on the platform. These results also suggest that Pinduoduo's strategy of upgrading their platform to sell higher premium goods (which we alluded to in Part 1) is perhaps not so effective thus far.

Financial Snapshot

In this section, we present key highlights from Pinduoduo's annual reports and financial statements. As mentioned before, Pinduoduo initially relied on direct sales of merchandise during its first two years of business in 2015 and 2016, before fully switching to a marketplace model in 2017. Going forward, we include 2016 data where available for the sake of completeness, although our discussion primarily pertains to Pinduoduo's performance starting in 2017.

#1: Pinduoduo's Total Revenues Grew at a CAGR of 142% Over the 2017-2020 Period

Pinduoduo's revenues grew extremely rapidly over the past four years, from RMB1.74 billion in 2017 to RMB59.49 billion in 2020.

Pinduoduo Total Revenues
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

#2: Pinduoduo's Revenues are Dominated by Services Provided on its Online Marketplace

Pinduoduo has two main revenue sources: (1) the services it provides in operating the company's online marketplace platform, and (2) direct sales of merchandise.

Direct merchandise sales in 2020 and 2021 correspond to Pinduoduo's 1P initiative described in Part 1, where Pinduoduo sources specific in-demand but under-supplied products to sell directly to consumers on its platform. According to the company's management, these products are sourced as temporary solutions until other third-party merchants start selling the same items on the Pinduoduo platform.

As shown below, the overwhelming majority of Pinduoduo's revenues come from its online marketplace services.

Pinduoduo Revenue Breakdown
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

We note that revenues from direct selling and revenues from online marketplace services should not be considered as directly comparable, since the entire price of a product sold would be recorded as revenue under direct selling, whereas with online marketplace services for which Pinduoduo serves as an intermediary, only transaction fees and marketing fees are recorded as revenue. This explains why, according to management, sales from Pinduoduo's 1P initiative account for a negligible proportion of total GMV (less than 1% in Q4 2020), yet constitute a more significant percentage of total revenues earned.

#3: Online Marketing Services are Pinduoduo's Main Revenue Driver

We further breakdown Pinduoduo's revenue sources, where Online Marketplace Services can be broken down into Online Marketing Services and Transaction Services. Online Marketing Services include services whereby merchants can bid for keywords that match product listings in order to have their products appear first in search results, as well as display marketing services where merchants can pay to have advertisements posted on the Pinduoduo platform. Transaction Services refer to sales transactions completed on the Pinduoduo platform, which Pinduoduo charges a transaction fee for. The transaction fee does not represent commission to Pinduoduo and is only used to cover payment processing fees incurred through the use of third-party payment processors such as WeChat Pay.

(Pinduoduo has a zero-commission policy, but is planning to charge a small commission fee for certain branded products which the platform is selling at a discount in order to attract users and boost sales)

As shown in the graph below, online marketing services constitute the majority of Pinduoduo's revenues. We discuss more about the specifics of Pinduoduo's marketing services further in this article.

Pinduoduo Revenue Breakdown by Segment
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

*the 9.5% in 2016 refers to revenue earned from transaction services

#4: Pinduoduo's Services-Based Revenue Model Commands a Higher Gross Profit Margin

Pinduoduo's level of gross profit margin is highly correlated with its business mix, where greater emphasis on services-based revenue (as opposed to revenue from direct selling) leads to a higher gross profit margin. This is due to the higher costs of goods sold associated with direct selling.

Pinduoduo Gross Profit Margin
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

#5: Pinduoduo Operated at an Annual Loss of About RMB10bn the Past 3 Years

Pinduoduo has operated at a financially significant loss since its inception, with annual operating losses reaching a peak of RMB10.8 billion in 2018 and staying close to that level since. During the first quarter of 2021, the company recorded an operating loss of RMB4.15 billion.

Pinduoduo Operating Loss
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

#6: Pinduoduo's Losses are Driven by Extremely High Operating Expenses

Pinduoduo's large and growing losses predominantly stem from the company's high operating expenses relative to total revenues.

Pinduoduo Total Revenues vs. Operating Expenses
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

#7: Sales and Marketing Expenses Dominate

Taking a closer look at Pinduoduo's operating expenses, it is clear that sales and marketing expenses dominate. We note that these expenses include both advertising expenditures and incentive programs such as price concessions that are intended to encourage consumption. Pinduoduo does not provide a detailed breakdown of its sales and marketing expenses, although the company is known for heavily investing in cash concessions which we discuss further in the subsequent section.

Pinduoduo Operating Expense Breakdown
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

Pinduoduo's Addictive Cash Concession Strategies

Pinduoduo's marketing strategy relies heavily on incentive programs that give cash concessions to customers in order to attract new users and promote consumption. Over its short history, Pinduoduo has developed numerous marketing games that require users to spend a lot of time browsing the application or excessively reach out to their contacts in return for small cash rewards. These games are designed to appeal to users based on a common Chinese obsession with zhan xiao pianyi (Chinese: 占小便宜), which refers to the habit of devoting potentially substantial time and effort in order to obtain an extra discount, no matter how small. Pinduoduo's marketing games are highly addictive to many of its platform users, as most Pinduoduo users are price-sensitive rural residents with a fair amount of free time and a well-sized social circle of contacts who share a similar drive to zhan xiao pianyi.

We describe some of Pinduoduo's major marketing tactics below.

#1: 10 Billion Subsidy Scheme (百亿补贴) to Build Consumer Trust and Boost Consumption

In order to attract higher income clientele to the platform and increase consumer trust, Pinduoduo launched a RMB10 billion subsidy program in mid-2019 to provide concessions on higher premium, branded goods across all categories of merchandise. Specifically, Pinduoduo claims that the company will spend a total of RMB10 billion as cash concessions on various products for customers to buy, with each product typically having a discount of at least 10% for more expensive items (e.g. phones and laptops) or even higher for lower priced items (e.g. fast-moving consumer goods). The range of eligible merchandise under the 10 Billion Subsidy scheme has also expanded to include agricultural products and fresh produce.

We think there are two key motives behind the 10 Billion Subsidy scheme. The first is to expand the user base by attracting customers with higher consumption power (such as those who typically shop on Taobao or JD), since Pinduoduo traditionally has a brand image that appeals mostly to lower income consumers who compromise quality for price. The second motive is to enhance user trust in the platform by proving that Pinduoduo also has authentic, high-quality branded goods in addition to the lower quality (and occasionally counterfeit products) listed on the platform. The goal here is to ultimately boost each user's level of consumption by encouraging users to purchase higher value merchandise.

#2: Red Packet Rewards and Lottery Games to Fuel User Growth

Pinduoduo is widely known for using red packets as a way to incentivize existing users to refer and bring in new users. The exact rules for Pinduoduo's red packet program(s) are constantly evolving, while there have been user complaints of the company's rules being too deceiving in recent times. We describe such an example below.

A Never-Ending Lottery Game

During the second quarter of 2021, Pinduoduo made the headlines for its deceiving referral lottery game. Specifically, users were able to participate in a lottery game where each user could spin a lucky wheel and obtain a cash reward transferred to their digital wallet account. The caveat is that Pinduoduo has a set minimum withdrawal amount that must be reached before any reward can be transferred from the platform to the user's digital wallet, and in most cases, users were only given rewards of a lower value than the stated mininum withdrawal amount. Users did have the chance to spin the wheel repeatedly and accumulate the rewards they earned in each round by inviting new contacts to the Pinduoduo platform, where each friend invitation granted one free spin. However, the majority of Pinduoduo's lottery game participants reported never being able to accumulate sufficient rewards to reach the minimum amount required for withdrawal, even in spite of significant devoted time and effort.

We walk through a real example below.

At the start of the game, each user can spin the lucky wheel for free and win an amount slightly less than RMB500 (say, for example, RMB495). However, Pinduoduo has set a minimum withdrawal amount of RMB500, and the user must accumulate enough rewards to reach this threshold first before being able to withdraw the cash to their digital wallet. Since the user is RMB5 away from reaching the RMB500 required minimum withdrawal amount, they can invite their friends to sign up on Pinduoduo in order to spin the lucky wheel again and win additional rewards. The user is rewarded with RMB1 from the lucky wheel for each additional friend they invite to the Pinduoduo platform, until the user's accumulated reward balance reaches RMB499 after inviting four friends. With only RMB1 left to reach RMB500, the user invites one final friend to Pinduoduo, only to find that the lucky wheel rewards them with RMB0.1 instead of RMB1.

Now that the user has an accumulated reward balance of RMB499.1, they invite eight new friends to Pinduoduo to reach a balance of RMB499.9. With high hopes, the user invites one last friend to Pinduoduo to reach the RMB500 mark, only to find again that the lucky wheel has decreased its reward, this time to RMB0.01. The user continues to persist and invites eight more friends to the platform to reach an accumulated reward balance of RMB499.99. Being only RMB0.01 away from the RMB500 withdrawal threshold, the user invites a final friend to the platform. As is perhaps predictable by now, the lucky wheel decreases its reward yet again, this time to a "Duo Duo coin" worth RMB0.001. The story continues, as the lucky wheel decreases its reward to 0.1 Duo Duo coin (worth RMB0.0001), and then to a Lucky Star (worth 0.01 Duo Duo Coin, wequivalent to RMB0.00001). Eventually, once the user is 0.1 Lucky Star away (or RMB0.000001) from the minimum withdrawal threshold, inviting new friends and spinning the lucky wheel would earn them no new monetary rewards, but rather tips on how to reach the withdrawal threshold, such as "try harder!".

A few users probably would be able to reach the minimum withdrawal amount of RMB500 in the end, but for most users, this game was a deceptive marketing tactic meant for them to introduce new users to Pinduoduo without receiving anything in return (of course, Pinduoduo did not make the declining reward system clear from the beginning).

Note: Pinduoduo varies the minimum withdrawal threshold and corresonding rewards given out over time, but the mechanics is the same as in the case we just described.

#3: Duo Duo Orchard and Duo Duo Factory to Foster Platform Engagement

Duo Duo Orchard is a game where users can start off by selecting a fruit seed and subsequently performing specified daily tasks in order to grow the seed into a proper fruit tree over time. These tasks can include browsing certain product categories, inviting friends to join the game, or purchasing certain flash sale products in exchange for virtual water and fertilizer that are required for the Duo Duo Orchard tree to grow. Once the fruit tree is ready to be harvested, the user will receive a box of real fruits sent by Pinduoduo.

Duo Duo Factory is similar to Duo Duo Orchard except that users operate a virtual factory instead and receive household goods sent by Pinduoduo once they complete the game. Both games are particularly popular among older generation users.

#4: Duo Duo Short Videos to Increase Application Usage Time

Pinduoduo recently launched a new reward scheme where Pinduoduo users can watch short videos to receive cash rewards, with Duo Duo Short Videos being featured on a top-level tab on the application home page. When a user first starts watching the videos, they will be immediately rewarded with a few cents (where RMB1 = 100 cents), with some of the money being transferred straight away to the user's WeChat Pay wallet and the rest of the money being kept on the Pinduoduo platform. The user will be able to withdraw the remaining money on the Pinduoduo platform once they have watched a sufficient number of videos in order to collect at least RMB20*.

*RMB20 is the minimum withdrawal threshold at the time of writing but may change according to the platform's rules

Note: Pinduoduo cooperates with WeChat Pay rather than AliPay since AliPay is essentially owned by Pinduoduo's competitor, Alibaba. In contrast, WeChat Pay is owned by Tencent, which has a 15.6% stake in Pinduoduo's shares as of Q1 2021.

Most of the featured videos are unrelated to Pinduoduo and are similar to short videos on other platforms such as Kuaishou or Douyin, although occasionally, there are promotional videos featured that advertise Pinduoduo's products and marketing campaigns.

We think this is Pinduoduo's response to a myriad of competitors who have been engaging in short video and live-streaming e-commerce. Over the past year or so, numerous internet companies across various sectors in China have started promoting the sale of products via short clips and live-streaming videos.

Examples include:

  • Pinduoduo's e-commerce competitors JD and Alibaba, both of which have short video and live-streaming capabilities

  • Chinese search engine Baidu, which has short videos featured on their mobile application

  • Traditional short video platforms ByteDance (the parent company of TikTok and Douyin) and Kuaishou

  • Video-sharing platform Bilibili, similar to a Chinese version of YouTube

  • Xiaohongshu, a Chinese version of Instagram that primarily targets a young female audience

  • Momo - a Chinese dating application which also has a multi-purpose live-streaming functionality

Evaluating Pinduoduo's Marketing Investments

Although Pinduoduo has been investing heavily in marketing (and indeed suffered huge operating losses partly or largely because of the company's sales and marketing expenses), the more important question is, are Pinduoduo's marketing investments paying off?

To gauge how effective Pinduoduo's marketing strategies are, we analyze the company's marketing expenses and associated outcomes. Pinduoduo does not provide a more granular breakdown of their marketing expenses beyond the Sales and Marketing Expenses line presented earlier, neither in the company's financial reports nor in management's discussions and earnings call updates. Consequently, we try our best to conduct our analysis with what little information there is available.

We note that Pinduoduo defines Sales and Marketing Expenses as "[consisting] primarily of online and offline advertising, promotion and coupon expenses, as well as payroll, employee benefits, share-based compensation expenses and other related expenses associated with sales and marketing". However, a dig through management's discussion over time reveals that past increases in Sales and Marketing Expenses have been primarily driven by additional spending on advertisements and promotions, where Pinduoduo continues to expect higher Sales and Marketing Expenses in absolute terms going forward as part of an effort to "increase [its] brand awareness, enhance user engagement and build scale".

(Going forward, we abbreviate Sales and Marketing Expenses as just Marketing Expense for the sake of brevity)

How Much is Pinduoduo Investing in Marketing?

We first define two metrics to capture how much Pinduoduo is investing in marketing:

1. Marketing Expense/Order - this metric captures, on average, how much marketing expenditure goes into generating each order.

This is calculated as Marketing Expense/Number of Orders Placed for each year.

2. Marketing Expense/Buyer - this metric captures, on average, how much marketing expenditure Pinduoduo invests in making each user an active buyer.

This is calculated as Marketing Expense/Number of Active Buyers for each year.

(A user is only an active buyer if they place at least one order on the Pinduoduo platform in a given year)

The two metrics are plotted on the graph below.

Pinduoduo Marketing Expense Ratios
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

We see that Pinduoduo has been investing a similar amount in terms of marketing on each order over time, with the slight drop in 2020 probably due to the launch of Duo Duo Grocery, which increases the frequency and number of user orders. Pinduoduo has also been investing an increasing amount of marketing expense on each buyer over time, in line with the trend of buyers making more frequent purchases on the platform.

What is Pinduoduo Gaining in Return for Its Marketing Investments?

To try and measure what Pinduoduo is gaining from its marketing investments, we consider two metrics:

1. GMV/Marketing Expense - this captures, on average, how much GMV is generated per one yuan of marketing expenditure.

This is calculated as GMV/Marketing Expense for each year.

2. Revenue/Marketing Expense - this captures, on average, how much revenue is generated for each yuan of marketing expenditure.

This is calculated as Total Revenues/Marketing Expense for each year.

The two metrics are plotted below.

Pinduoduo Returns on Marketing Investment
Data Sources: Pinduoduo Prospectus, Annual Reports, and Earnings Reports

As shown above, the GMV generated per yuan of marketing expense went up by RMB5.4 since 2018. At the same time, the average volume of revenue generated for each yuan of marketing expense increased ever so slightly, from generating a net loss in 2018 (i.e. each yuan spent on marketing caused Pinduoduo to lose RMB0.02 in revenue) to bringing in RMB0.11 and RMB0.44 of revenue for each yuan of marketing expense in 2019 and 2020 respectively.

(GMV/Marketing Expense in 2017 is an outlier due to the substantially lower marketing expense in that year as Pinduoduo had just transitioned its platform)

Are Pinduoduo's Marketing Investments Working?

As a whole, we are quite skeptical regarding how well Pinduoduo's marketing efforts are paying off. While the company has invested heavily in marketing expenditure over the past few years (management highlights that they have spent RMB81 billion on marketing from Pinduoduo's inception till the end of 2020), we feel that we are not seeing very significant results reflected in the company's financials. The amount of revenue that Pinduoduo is generating from each yuan of marketing expense, in particularly, seems to be almost negligible, while the increase in GMV per yuan of marketing expense is not much more substantial either.

Furthermore, the fact that Pinduoduo's marketing expense per buyer has been increasing along with the increased frequency of orders per buyer makes us question whether the company's marketing investment strategies only have an immediate short-term effect. Specifically, buyers could only be making purchases because Pinduoduo keeps on offering discounts and concessions on products, but if these consumer benefits were to be taken away, not so many buyers may be making purchases on the Pinduoduo platform. In a more ideal case, marketing expense per buyer should be relatively stable or even decreasing, as user stickiness is enhanced over time and buyers actively choose to come back to make purchases on the platform without the need for additional incentives.

The Future of Pinduoduo

In Part 3 and Part 4, we explore the future of Pinduoduo, including the company's strategies to pioneer AgriTech (agriculture technology) and enhance user confidence and satisfaction. We also analyze the feasibility and long run sustainability of Pinduoduo's business plans with regards to factors such as potential profitability and regulatory landscape.


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