In the final two instalments of our Pinduoduo series, we focus on the company's future prospects, with an overview of Pinduoduo's future business strategies and discussion of agriculture technology (AgriTech) here in Part 3, and an exploration of Pinduoduo's other strategies going forward in Part 4.
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Overview of Pinduoduo's Future Strategies
As a whole, we think that Pinduoduo's future is characterised by some overaching themes, a lot of experimentation, and significant uncertainty arising from management's lack of clear direction.
From our observations and understanding, Pinduoduo's management has identified two key strategic priorities for the company: (1) developing Pinduoduo's role as an AgriTech (i.e. agriculture and technology) platform, and (2) boosting user confidence and satisfaction in order to generate greater profitability from the platform's existing users. How exactly the company will go about achieving these goals is not entirely clear, and we think there will be a lot of trial and error involved as Pinduoduo continues to refine its business model.
In this article, we explore management's first strategic priority (i.e. the promotion of AgriTech) in further detail, while Pinduoduo's second strategic priority and other considerations are discussed in Part 4.
What is AgriTech?
To start our discussion on AgriTech, we first consider the question, "what is AgriTech"?
AgriTech refers to the intersection between agriculture and technology, which can also be thought of as the digitization of agriculture according to Pinduoduo.
AgriTech is an area of focus that has been receiving increasingly greater emphasis from Pinduoduo's management. Pinduoduo describes itself as "China's largest agriculture and interactive commerce platform", with the goals of becoming "China's largest agriculture producer" and hence "the largest grocer for the world". Management does not lay out a particularly specific plan as to how they intend to go about achieving these objectives, although, as we discuss in subsequent sections below, most of the company's discussions centre around expanding and modifying Pinduoduo's existing agricultural initiatives previously explained in Part 1.
The next question that undoubtedly rises is, "why does Pinduoduo choose to focus specifically on agriculture?"
We try to answer this question by examining two different points in time.
When Pinduoduo first launched... a key reason could be because the lower income clientele is a niche focus that the existing e-commerce incumbents (namely Alibaba and JD) had ignored when Pinduoduo first entered the market. Many of China's lower income residents have a penchant for sourcing daily fresh produce to eat and cook. Food is a very important part of Chinese culture, while China's lower income (and particularly rural area) residents have the time to go grocery shopping frequently and cook meals on a daily basis. Higher income residents in larger cities oftentimes prefer (or have to) order delivery in order to save time, even though food delivery is more costly than cooking.
Moreover, when Pinduoduo first started out as two separate platforms (see corporate history in Part 1), the company's fresh produce e-commerce business under the Pinhaohuo platform significantly outperformed its general merchandise business under the Pinduoduo platform. Although Pinhaohuo was subsequently absorbed by and became a subsidiary of Pinduoduo (before ultimately being discontinued), this merger reflects Pinduoduo's decision to fully adopt the marketplace model (Pinhaohuo involved direct selling to consumers, whereas Pinduoduo was a platform for third-party merchants to sell goods) rather than a decision to focus solely on selling general merchandise on the Pinduoduo platform. Even after Pinhaohuo and Pinduoduo were unified under one marketplace platform, Pinduoduo had always continued to maintain a substantial focus on agricultural produce, perhaps due to the popularity of such products.
In light of the recent regulatory developments... we think that Pinduoduo could be emphasizing and continuing its focus on agriculture because AgriTech is a form of e-commerce that would be perceived more favourably by the regulators. We discuss this further in a later subsection titled AgriTech and Common Prosperity.
How is Pinduoduo Pioneering AgriTech?
We now explore the various strategies and goals Pinduoduo has set in order to advance its position as an AgriTech e-commerce leader. From a broad perspective, Pinduoduo is pioneering AgriTech as an e-commerce platform by applying more advanced technology and business strategies (including the platform's traditional consumer-to-manufacturer model) to enhance the traditional agriculture value chain. The company has also made a pledge to contribute RMB10 billion to further its agricultural initiatives.
Enhancing the Agriculture Value Chain
Pinduoduo breaks down the agriculture value chain into three key levels: (1) upstream production, (2) midstream transportation, and (3) downstream consumption.
At the upstream level, Pinduoduo assists farmers and local partners in realising greater production efficiency and economies of scale through a variety of strategies, including re-organising small-scale farms into larger cooperatives and implementing effective precision farming management. Precision farming management refers to a farming approach where various tools and potentially new technology are utilised to maximise crop yields, while also minimising the input amounts required (e.g. fertiliser, water) in order to increase profitability.
As part of the company's efforts to improve the upstream production process, Pinduoduo collaborates with industry professionals and academic experts at top universities in China to sponsor agriculture-related competitions such as the Global Smart Agriculture Competition and the First China Agricultural Robot Innovation Competition. These competitions have attracted talented teams from around the globe who strive to generate innovative solutions that can enhance farming efficiency and generate produce with higher nutritional quality.
At the midstream level, Pinduoduo explores potential collaborations with third-party logistics companies to develop a nationwide logistics network optimised for the delivery of perishable agricultural goods. We emphasize that Pinduoduo does not use its own financial resources to invest in logistics infrastructure and delivery, and the net investing cash outflows (RMB7.5 billion in 2018, RMB28 billion in 2019, and RMB38 billion in 2020) reported on the company's financial statements are primarily due to the purchase of short-term and long-term investments for cash management purposes rather than due to investments in fixed capital assets.
Furthermore, Pinduoduo's management states that they "prefer to work with strategic partners" for logistics infrastructure, although the company is prepared to make equity investments in logistics development if and when necessary. We interpret "working with strategic partners" as referring to franchising, a common practice in China for most e-commerce and delivery companies with the notable exceptions of JD and Shunfeng. For example, an interested franchisee may hold a franchise to operate a regional or local distribution centre, pay a franchising fee to the franchisor e-commerce or delivery company, and pocket the rest of the profit from the franchisee's logistics operations.
It may seem odd that even though Pinduoduo as a company is, at least based on management's comments, highly committed to AgriTech, and given that success as an AgriTech platform hinges greatly on having an efficient and well-developed logistics infrastructure system, the company has yet to invest its own funds in infrastructure development.
We think this is due to two reasons:
(1) Management is not entirely sure whether AgriTech, and Duo Duo Grocery (see Downstream Consumption below) in particular, is something they definitely intend to pursue in the long run. This is presumably due to uncertainties with regards to the potential profitability of the AgriTech business, and perhaps the fact that management could be focusing heavily on AgriTech and Duo Duo Grocery in the mean time for lack of a better (i.e. more lucrative) business strategy to pursue.
(2) Pinduoduo cannot afford to invest in infrastructure projects given its current financial standing. The company has been operating at a loss of equal to or almost RMB10 billion each year since 2018, while also pledging to support its RMB10 billion Subsidy Scheme (see Part 2) and most recently the new RMB10 billion agricultural initiative.
At the downstream level, Pinduoduo facilitates the direct selling of agricultural products from farmers to end consumers, and also provides training to farmers on how to operate an online agriculture business. Pinduoduo's biggest contribution at this level is the launch of Duo Duo Grocery (also called Duo Duo Maicai - Chinese name: 多多买菜) (see Part 1), which was established in August 2020 to circumvent the difficulties of transporting large volumes of fresh produce that can perish or get damaged easily in the transportation process. The idea behind Duo Duo Grocery is to connect consumers with local farmers who can supply fresh fruits and vegetables on a daily basis, with Duo Duo Grocery having operations in over 300 Chinese cities as of the end of Q1 2021 and Pinduoduo as a whole connecting more than 16 million farmers to consumers as of the end of Q2 2021. We point out that management does not disclose the overlap between the general Pinduoduo platform and Duo Duo Grocery, including the specific number of Duo Duo Grocery farmers that are also regular merchants on the Pinduoduo platform, or the total GMV constituted by Duo Duo Grocery.
Whilst management has repeatedly stressed the importance of Duo Duo Grocery as a long term commitment and strategic priority for the company, at the same time, significant uncertainty surrounding the exact business model of Duo Duo Grocery is also acknowledged. Management emphasizes that the core focus of their decision making process is the idea of "serving users well" and thus making business decisions accordingly, including the (rather contradictory sounding) decision of whether consumers want to continue using Duo Duo Grocery or if they prefer to make purchases on the general Pinduoduo platform instead. From going through management's Q&A answers, we find that contradictory sounding statements are not an infrequent phenomenon for the company.
Applying Pinduoduo's C2M Model to Agriculture
Pinduoduo's AgriTech contribution at the downstream level is essentially an extension of its traditional consumer-to-manufacturer (C2M) e-commerce model. The C2M model is defined as a business model where consumers make purchases directly from manufacturers (or in this case, agricultural producers) rather than going through layers of intermediaries, while the e-commerce platform facilitating these direct transactions can accumulate, aggregate and analyse consumer spending data in order to provide manufacturers (or producers) with useful feedback on how they can better tailor products to meet consumer needs. Pinduoduo is known for being a key pioneer of the C2M model in China's e-commerce market, with the company having launched business initiatives such as the New Brand Initiative to aid manufacturers in developing their own brand for goods that have high consumer demand, or 1P Direct Selling to contract with manufacturers to produce niche products that have substantial consumer demand but currently lack supply (see Part 1).
When applied to agriculture, the C2M model can be advantageous to both farmers and end consumers. Under the C2M model, farmers can earn more by selling directly to end consumers without going through third-party intermediaries, while consumers can also realise price savings by making direct purchases. At the same time, Pinduoduo collects and analyzes data to provide farmers with constructive feedback such as information on which kinds of produce are in-demand or how to improve packaging in order to boost consumer appeal.
The RMB10 Billion Agriculture Initiative Pledge
According to the company's most recent Q2 earnings call, to supplement the platform's existing AgriTech business, Pinduoduo has launched a "dedicated RMB10 billion agriculture initiative". Whether or not this initiative overlaps with the previously launched 10 Billion Subsidy Scheme (Chinese name: 百亿补贴) (see Part 2) is unclear, and Pinduoduo does not provide any further clarifications as to how the RMB10 billion agriculture initiative will be implemented. However, management does emphasize that all profits from Q2 and any potential profits in future quarters will be allocated towards the RMB10 billion agriculture initiative first (as opposed to other alternative purposes or distributed to shareholders), until the total RMB10 billion commitment is fulfilled.
The Implications of AgriTech
Turning now to the implications of pursuing an AgriTech-focused business strategy, we discuss two key themes that may substantially affect the outcome of Pinduoduo's AgriTech business: (1) the relationship between AgriTech and the Chinese government's regulatory and economic goal of common prosperity, and (2) the questionable profitability of pursuing an AgriTech-based business strategy.
AgriTech and Common Prosperity
In our view, agriculture is a sector that is highly aligned with the Chinese government's long term development plans for the country, including the goal of common prosperity. A key component of common prosperity is the effort to distribute wealth more evenly across the vast spectrum of Chinese cities and socioeconomic classes, which includes the economic development of lower tier Chinese cities and the raising of income levels for China's rural area residents. We outline below how Pinduoduo's AgriTech initiatives help to promote common prosperity goals.
How Can AgriTech Fuel the Development of Lower Tier Cities?
As of January 2021, it is estimated that 500 million out of China's 1.4 billion population reside in rural areas, of which an approximate 250 million to 270 million are engaged in farming-related work. However, many Chinese rural area residents typically farm as a side-job, by planting crops that require less regular maintenance so that they can migrate to work in larger cities to earn more during growing season (e.g. by working at factories), and only returning home once their crops are ripe for harvest. The expansion of AgriTech to rural areas can attract more farmers to stay and work permanently in their hometowns, as Pinduoduo claims the company has contributed to over 100,000 new farmers returning home for work thus far. Pinduoduo is aiming to support another 100,000 potential farmers to return home to work over the next five years, while the expansion of e-commerce in general has fostered additional job creation (e.g. logistics management, customer and merchant support functions) in less developed areas.
Note: the benefit of infrastructure development would typically be associated with e-commerce expansion in less developed regions, however, since Pinduoduo does not invest in physical infrastructure itself, we don't mention this point in the paragraph above.
How Can AgriTech Improve Business for Farmers and Agricultural Merchants?
The digitization of agriculture can benefit both farmers and third-party agricultural merchants (i.e. merchants who source fresh produce from farmers and resell the products to end consumers) by providing them with a larger market for which to sell their goods. Farmers and agricultural merchants who typically sell at small local markets can now take the opportunity to advertise their products to Pinduoduo's 850 million annual active buyers (Q2 2021 data), while regions that specialise in growing certain kinds of crops can utilize Pinduoduo's platform to market their lesser-known specialty produce to the rest of the country. In terms of statistics, Pinduoduo highlights that the platform's recent "harvest festival" (a large online sale for agricultural products) featured more than 1,000 unique kinds of produce from 400 different agricultural production regions, and in the first quarter of 2021, the company recorded over 2,600 unique agricultural product stock keeping units (SKUs) that had more than 100,000 orders each.
The Questionable Profitability of AgriTech
As appealing as Pinduoduo's AgriTech goals may be from a regulatory perspective, we are nevertheless skeptical about the lucrativeness and long term sustainability of the company's agriculture-focused strategy. This is due to two main reasons: (1) the low gross merchandise values and profit margins of agricultural goods, and (2) the heavy financial burden of operating an AgriTech business.
#1: Agricultural Goods Have a Low Gross Merchandise Value (GMV)
According to management, agriculture comprises the core part of Pinduoduo's business, yet the GMV for agricultural products constituted only RMB270 billion (i.e. 16.2%) of Pinduoduo's RMB1,667.6 billion total GMV in 2020. Perhaps more importantly, Pinduoduo's revenues (and hence profits) are a function of GMV, with Pinduoduo deriving most of its revenues from online marketing services that merchants pay to the platform, in addition to a smaller revenue source generated from transaction services.
The amount merchants are willing to pay for online marketing depends, to some extent, on how effective Pinduoduo's marketing strategies (e.g. advertisements) are, but for the most part, merchants who sell higher value goods are able and willing to spend more on marketing. In this regard, we think it is unlikely that farmers or third-party agricultural merchants would have a very high willingness or ability to spend on marketing services. Although Pinduoduo could still earn reasonably high marketing revenues from lower value agricultural goods that have substantial order volumes, we doubt whether the order volumes of agricultural products sold on the platform would be large enough to compensate for the presumably low marketing expense per item sold (Pinduoduo does not release order volume details for agricultural products).
Pinduoduo's secondary revenue source, transaction services, is also an increasing function of GMV. However, as mentioned in Part 2, transaction fees do not represent commission to Pinduoduo and is only used to cover payment processing fees incurred through the use of third-party payment processors. Pinduoduo also generates service fees from Duo Duo Grocery transactions, although such revenue is predominantly used to cover warehousing, fulfillment, and other expenses related to the operations of the Duo Duo Grocery business. We emphasize that Pinduoduo maintains a zero-commission policy for agricultural produce, although of course, farmers and agricultural merchants can still choose to pay the platform marketing fees in order to further promote their products.
#2: AgriTech is an Operationally Heavy Business
AgriTech in general, and community buying programs such as Duo Duo Grocery in particular, is a relatively operationally heavy business due to the requisite logistics and infrastructure system to ensure that agricultural products can be transported quickly from place to place and that easily perishable goods will not go bad during the transportation process. Pinduoduo does not disclose the specific financials surrounding Duo Duo Grocery or its AgriTech business beyond what we have described earlier, however, we strongly question the extent to which AgriTech revenues can sufficiently cover the costs of operating the business.
With regards to community buying, Pinduoduo believes that Duo Duo Grocery has the benefit of lowering the costs of its AgriTech segment as a whole by reducing spoilage from storage and transportation (due to the shorter transportation time and distance), and by eliminating the need for last mile delivery (since consumers can pick up their groceries at designated pick-up points). Our question is whether or not the benefits from cost reduction would be replaced by perhaps even larger costs in operating the community buying program on a large scale. Given that the community buying clientele are typically price-sensitive, lower income consumers, and that there are still other competitors in the community e-commerce market (see the section below), we don't think that Pinduoduo would be able to significantly increase the profit margin for grocery products to cover for the additional costs of operating community e-commerce. Perhaps, in the long run, economies of scale may be reached, but we question whether or not Pinduoduo can continue to sustain large annual losses until then (see Part 2).
We discuss community e-commerce further in the subsequent section.
The Community E-Commerce Landscape
In this section, we provide a brief overview of the history of community e-commerce in China, and examine some of Pinduoduo's competitors in this specific industry.
As a recap, a community e-commerce (or community group purchase) program is a form of e-commerce where small sites are set up in each community for local residents to order groceries and other daily household items online via an e-commerce platform and pick their purchases up at the designated sites. Depending on the platform and community, some sites have community leads who take charge by finding discounted daily special products and encourage local residents to purchase by participating in WeChat groups. Pinduoduo's management claims that Duo Duo Grocery is not a community group purchase program because the company does not rely on community leads to attract users, however, we argue that the nature in which Duo Duo Grocery functions (see Part 1) is essentially the same as that of a generic community e-commerce business.
History and Overview
The first community e-commerce (i.e. community group buying) platform in China was founded in 2016 to serve the Changsha area. In the following years, the number of community group buying platforms in China quickly proliferated. Some platforms focused on a single city or a small regional area, while others expanded nationwide. The shaping process of the community e-commerce landscape was characterized by extreme price wars where companies were selling products at below-cost prices in order to attract typically price-sensitive customers (such practice has since been banned by the government since December 2020). Eventually, two main players emerged at the national level: Pinduoduo and food delivery platform Meituan.
A Primer on Meituan Select
Meituan's community group buying program, Meituan Select, is similar to Duo Duo Grocery except that Meituan primarily sources agricultural products indirectly (i.e. via third-party agricultural merchants) rather than directly from farmers. Meituan Select was launched in July 2020, only a month before the launch of Duo Duo Grocery, after which Meituan rapidly rolled out the program to over 2,000 (i.e. more than 90% of) cities and counties in China. The rapid expansion was possible due to Meituan's extensive food delivery network, where the company's existing merchant partners could easily sign up to participate as community leads.
Naturally, such an expansion necessarily comes at a large cost, especially given that Meituan made the decision to also invest in the related logistics and infrastructure rather than simply just franchising as Pinduoduo did. Meituan does not cite specific numbers for its Meituan Select operations, however the company's New Initiatives and Others segment recorded an operating loss of RMB6 billion (i.e. 64.9% of total revenues) during Q4 2020, primarily due to investments in Meituan Select but also Meituan Grocery (a grocery delivery service in Tier 1 cities where customers can place orders for items to be delivered in 30 minutes), as well as a bikesharing business. Meituan's management highlights that Meituan Select is not yet sufficiently developed enough to benefit from economies of scale, although they believe community group buying to be a big opportunity for the company to invest in (albeit at a loss) going forward.
What About Alibaba and JD?
Alibaba tried implementing community group buying through its different business units, including Cainiao, Lingshoutong, and Hema. Cainiao lets users place grocery purchases ahead of time and pick them up at local Cainiao post offices. Lingshoutong was founded as an application for local convenience store owners to make wholesale purchases of items that they would not normally be able to obtain through their regular distributors. A community buying function was added to the application where convenience store owners could sign up as community leads who are responsible for aggregating the demand for various products and placing orders for these items on the Lingshoutong app in order for customers to pick up their orders in-store at a later date. Hema is Alibaba's high-tech supermarket chain, which now offers a pre-ordering service for consumers to pre-order and pick up their purchases at various community lead stores. Currently, Alibaba is primarily focused on Lingshoutong and Hema for developing its community group buying business.
JD has a community group buying program, named Jingxi Pinpin, implemented through its Jingxi business segment that targets lower income consumers (see more information here). However, JD has withdrawn its Jingxi Pinpin business from several provinces over the past year or so due to slow user growth (and perhaps lower profitability). JD does not provide specific operating data for Jingxi, although its New Businesses segment as a whole (which consists of Jingxi, JD Property, and JD's Indonesian e-commerce arm) operated at a loss of RMB2.3 billion in Q1 2021.
Interestingly, DiDi, China's high profile ride-calling company, also has its own community buying program. However, the company laid off 30% of its community e-commerce employees in July 2021, and as of the time of writing, DiDi only has a community buying presence in nine provinces, down from a peak of 31 provinces.
Conclusions on Pinduoduo's AgriTech Future
Broadly speaking, we think that AgriTech is a promising business from a regulatory standpoint. Even without the officially announced theme of common prosperity, the Chinese government has always placed great emphasis on improving the lives of the average Chinese people. The term common prosperity is merely a way to reiterate and reaffirm this objective. As such, we think that the AgriTech sector may benefit from future central and/or local (i.e. provincial or city-level) government support, such as public-funded infrastructure and logistics development projects in less developed regions or tax incentives that encourage companies to expand their businesses in typically lower income areas. Of course, we anticipate that the Chinese government will tighten regulations over time to promote fair competition as the AgriTech industry evolves (and indeed, the central government did issue a number of laws to prevent acts of market distortion such as collusion or price manipulation for community e-commerce platforms in December 2020), although we think that the AgriTech sector as a whole will not have significant regulatory headwinds to contend with.
We are concerned, however, by how Pinduoduo can make long term, sustainable profits from AgriTech. By definition, agricultural products (for the most part) don't have high GMVs nor profit margins, and especially with Pinduoduo charging zero commission for agricultural products, it seems hard for AgriTech to be a very lucrative business. We think this is reflected in management's uncertainty with regards to a specific future business strategy for Pinduoduo. Going through management's discussion and earnings call Q&A answers, we find that Pinduoduo's management does not mention any clearly defined goals for the company's AgriTech business, and also gives evasive answers when faced with questions that touch on AgriTech specifics, such as a rough GMV estimate for Duo Duo Grocery or further details on the RMB10 billion agriculture initiative.
Finally, we emphasize that Pinduoduo's financial standing is of particular concern to us. As mentioned earlier, the company has been operating at a loss of equal to or almost RMB10 billion each year since 2018, while also pledging to support its RMB10 billion Subsidy Scheme (see Part 2) and the new RMB10 billion agricultural initiative. Although Pinduoduo is not in a dire financial situation, we feel that the large operating losses seem unsustainable, especially given that management does not seem to have a clear plan with a more lucrative strategy for the future. Pinduoduo did record an operating profit of RMB2 billion in Q2 of 2021, however management says that this was due to relatively low sales and marketing expenses, and that the positive operating income may not be sustained due to future investment in AgriTech as part of the RMB10 billion initiative.
We discuss other strategies and factors that shape the future of Pinduoduo further in Part 4.
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