Consumer Staples Author: Yue Liu Editor: Luke Sheehan, Zhiqing Chen Jan 22, 2021 10:22 AM (GMT+8)

The Chinese e-commerce industry still has room to grow.

pinduoduo

  • The rising disposable income of residents, the growing Internet penetration rate in lower-tier cities and small and medium-sized businesses outside of Alibaba and JD.com's networks will remain the main drivers of Pinduoduo's growth.

  • The company is carving out a niche in the Chinese e-commerce market by maintaining high WeChat traffic and is better than Alibaba and JD.com in terms of customer acquisition cost and retention rate.

  • The 'ten billion subsidy' program will transform the user structure and help Pinduoduo expand in first-tier and second-tier cities.

  • As Pinduoduo has built a well-performing agricultural product supply chain, community group buying is likely to boost its revenue growth.


The e-commerce industry is on the cusp of another surge. Alibaba's anti-monopoly investigation alarmed reigning e-commerce giants. On December 29, 2020, the sudden death of an employee spurred a probe into working conditions at Pinduoduo. On that day, its share prices immediately fell sharply, providing investors with a proper buying point. 

Pinduoduo rapidly developed over the past three years when Chinese shoppers have flocked to this online shopping platform. This company eventually became the most prominent competitor to Alibaba and JD.com in China. SMEs are the primary driving forces fending off sales volumes and revenues for Pinduoduo while heightening WeChat traffic through subsidized deals. 

By targeting low-tier cities with low Internet penetration, Pinduoduo unleashed rural markets by acknowledging the rising disposable income and diversification of spending behaviors. Unlike Alibaba and JD.com, Pinduoduo first targeted lower-tier cities, bridging the gap between the consumers and the e-commerce market with the advent of the digital economy and infrastructure.  

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Moreover, the Internet penetration rates between rural and metropolitan regions are progressively declined. By the end of June 2020, the Internet penetration rates in China's urban and rural areas were 76.4% and 52%, with the gap decreasing 12% compared to June 2019. With the consumption upgrade of e-commerce platforms, the low-income or price-sensitive group is emerging. Consumers are increasingly conscious of their purchase intention by preferring high-quality and low-priced products. This criterion fits into the product strategies of Pinduoduo composed of low-end market demand. 

Small and medium-sized businesses remain Pinduoduo’s key growth driver

When the war between e-commerce giants Alibaba and JD.com is in full swing, small and medium-sized businesses were mainly neglected by the e-commerce platforms. These two companies mainly focus on intuitive user experience and service quality. As a result, SMEs are shifting to Pinduoduo as a new online shopping platform. 

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Unlike Taobao, Alibaba's Tmall targets high-end markets. From 2012 to 2019, its proportion in GMV gradually increased from 23.5% to 48.6%. Moreover, the proportion of Tmall merchants to Taobao has increased from 1.9% in 2017 to 3.5% in 2020. Therefore, Pinduoduo gained a substantial inflow of small and medium-sized businesses. 

Regarding merchants' characteristics, Pinduoduo merchants enjoy low entry barriers and low fees. This platform has always adopted a policy of zero commission and zero platform service annual fees to reduce marketing costs and boost price advantages compared to other platforms. 

WeChat facilitates low acquisition costs and high retention rates for Pinduoduo

The group buying model in WeChat significantly helps Pinduoduo to maintain the lowest customer acquisition costs. This social e-commerce model compacts with the advantages of expanding brand recognition and consolidating consumers' trust. And the customer acquisition costs gap with Alibaba is gradually widening, from CNY 494 in the third quarter of 2019 to CNY 575 in 3Q 2020. The proportion of users from WeChat mini-programs navigating to the Pinduoduo app is also gradually increasing, from 38% at the end of 2018 to 58% in August 2020. In addition, Pinduoduo's per capita usage time is the highest among the three giants.

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As the traffic dividend fades, for Pinduoduo, it is pivotal to figure out how to acquire new users and increase user stickiness with the lowest cost. Compared with the other two players, Pinduoduo hits a growth momentum of these two aspects in the short-term.

Widening the moat to attract users from high-tier cities

In order to improve its brand power, Pinduoduo implemented 'ten billion subsidy version 1.0' – 3C electronics and home appliances – in September 2019 to attract potential users in first- and second-tier cities and increase ARPU (average revenue per user). In March 2020, the company launched another 'ten billion subsidy 2.0' – for mid-end brands in various fields, such as clothing, medicine, daily supplement, and food. By expanding into regular consumption goods, the company aims to increase the repurchase rate. The results are apparent. Specifically, the stock keeping units (SKU) increased from 8,183 at the end of 2019 to 23,700 at the end of July 2020.

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After experiencing four consecutive quarters of decline in the growth rate of new users, both campaigns have effectively increased new users and user stickiness starting in the second quarter of 2019. In addition, first and second-tier cities are new growth drivers for Pinduoduo. In June 2020, first-tier cities, such as Beijing and Shanghai, became the most popular regions for active registered users. 

Community group buying business empowers revenue growth

Since 2020, community group buying has been highlighted by Internet giants in terms of business strategy. Pinduoduo fits the user profile of community group buying, subsequently stimulating its growth. The main consumers of this model are the elders. and the social App used by these people is WeChat. Pinduoduo just happened to be able to get WeChat traffic support. 

At the current stage, community group buying mainly displays on products, including fresh food, agricultural products, and daily necessities. These products are widely promoted on Pinduoduo. This platform has much stronger control over the agricultural product supply chain than platforms such as Alibaba and JD.com. 

From another perspective, community group buying is a high-frequency and low-price business, similar to Meituan's food delivery business. Even if it cannot bring profits to Pinduoduo, the traffic can continue to increase revenue for the company's other businesses. If once the scale is large enough, Pinduoduo can profit from this model, it will have hit two birds with one stone.

Downside risks

1) With the expansion of Alibaba and JD.com in the sinking market, it is challenging for Pinduoduo to retain existing users as the other two giants have been in the e-commerce industry for longer periods and have more experience. 2) Although the ten billion subsidy program has attracted new users, brought higher repurchase rates, and levels of user stickiness to Pinduoduo, the losses caused by the continuous burning of money will gradually consume the enthusiasm of investors in the secondary market. 3) The Chinese government's supervision of community group buying is strengthening, which is likely to block Pinduoduo's pace of tapping new growth engines.

Bottom line

We hold a bullish opinion on Pinduoduo. The short-term investment will be paid off by long-term revenue as Pinduoduo focuses on rapidly developing low-tier cities. The company also serves as a medium platform for small and medium-sized businesses to thrive.