China social e-commerce: Saturated society

Is social e-commerce China’s next internet golden mine or an investment theme of the past? It seems odd asking this question about a phenomenon that is barely four years old, but the market moves quickly – as evidenced by the rise of social e-commerce’s most noted pioneer. Founded in 2015, Pinduoduo is already the country’s third-largest online marketplace after Alibaba Group’s Taobao and JD.com. Last week, it surpassed Baidu to become one of China’s top five most valuable listed technology companies.

Where Pinduoduo went, others followed. There was a flood of investment into the space, while the likes of JD.com, Taobao and Suning Commerce introduced group buying apps. With competition intensifying, the bullish mood is evaporating. VC commitments to social e-commerce businesses came to RMB41 billion ($5.7 billion) in the first six months of 2019, down from RMB105 billion a year ago, according to the E-Commerce Research Center, a local research group.

“For any e-commerce investment, you need to be fast. Entry barriers are low, so business models are copied quickly by others in China. If you don’t acquire a significant market share in a short period of time, your game is over,” one early-stage investor tells AVCJ. 

The notion that market has become saturated and the big opportunities are now gone is reinforced by Hans Tung, a managing partner with GGV Capital, which has previously backed social e-commerce players Little Red Book, Global Scanner and Xiangwushuo. “It is not realistic to want to invest in an early-stage social e-commerce company this year,” he says. 

Others, however, are not so downhearted. They argue that China’s e-commerce story is still in its early chapters and there is scope for companies to take the Pinduoduo model in different directions, perhaps becoming billion-dollar businesses in the process. “Everyone who invested in JD.com missed Pinduoduo,” he says. “We thought the game was over, but it’s not,” says Wei Zhou, founder of China Creation Ventures. 

Birth story

It is not wholly accurate to attribute social e-commerce innovation to Pinduoduo. As early as 2013, small merchants in China were posting products on WeChat Moments and selling to their friends. Over the next two years, WeChat Pay and WeShang, also known as WeChat Merchants, were launched, making e-commerce easier.

Tencent Holdings-owned WeChat was a natural outlet for those that lost visibility within the Alibaba empire. In 2018, Taobao and Tmall’s gross merchandise value (GMV) hit $947 billion, more than Amazon, JD.com and eBay combined. Until Pinduoudo and its peers came along, small players were lost in the crowd.

Helen Wong, a partner at Qiming Venture Partners, breaks down the evolution of social e-commerce into separate waves. The first involved micro-retailers selling low quality but high margin products. With no customer review system or oversight mechanism to protect customers, activity soon dried up. Many WeChat users started blocking friends that marketed products through WeChat Moments.

The void was filled by larger platforms like Pinduoduo or Yunji, which “offer better quality products and supply chain management,” says Wong, outlining the second wave. Social e-commerce transaction value saw year-on-year growth of 380%, 683% and 256% in 2015, 2016 and 2017, according to iResearch Consulting. In 2018, it reached RMB626.8 billion.

They employed innovative methods such as live broadcasting and key opinion leaders to spread the word about new products, but the basic premise – using social networks as sales channels – has historical archetypes. Pinduoduo and Yunji simply updated what already existed through reselling and group buying.

There are two broad social e-commerce models. First, Pinduoduo’s group buying approach: by teaming up and buying in bulk, consumers can purchase goods for lower prices. The innovation comes through the integration with social networking. WeChat users who post about Pinduoduo offers and achieve a critical mass of followers qualify for discounts or even free gifts. Groups are created within WeChat specifically to pursue discounts.

GGV’s Tung asserts that Pinduoduo was the right idea at the right time. Anyone looking to enter the social e-commerce space today faces much higher customer acquisition costs. “Many WeChat users are bound to certain social e-commerce platforms, persuading them to leave is a very expensive exercise,” Tung explains.

Indeed, newcomers have sought to avoid these costs by focusing on more concentrated geographical areas, typically residential developments. Community group buying is coordinated by individual residents, designed “team heads” who add their neighbors to WeChat groups and circulate special offers available through the platform. They aggregate orders, take delivery of goods, and handle distribution.

“None of the traditional retailers has really solved the issue of perishables like fruits or vegetables,” says CCV’s Zhou. “Community group buying does so through pre-orders. You see on WeChat that your next-door neighbor is looking to buy certain produce and you join the order.”

CCV is an investor in Shixianghui, a segment leader with monthly GMV of RMB200 million. A larger rival emerged last month with the merger of Shihuituan and  Niwonin, which have a combined GMV of RMB500 million. According to Ying Chen, founder of Shihuituan, taking the community approach has cut customer acquisition costs to RMB1-2 per head, while last-mile logistics fees have fallen from RMB15-25 per order to RMB1-2.

Pyramid problems

The second branch of social e-commerce is best exemplified by Yunji, which involves reselling or multi-level marketing. It is essentially a club: new members sign up to a flat-rate RMB398 membership package at the invitation of existing members. Most of the company’s business comes from flash sales, whereby items are offered at discounts for limited periods of time.

Yunji listed on NASDAQ in May, 11 months after Pinduoduo, but its evolution has not been smooth. In 2017, the company was fined for violating restrictions on pyramid selling and its official WeChat account was closed. Yunji then modified its model. Members who referred new customers received in-app credits rather than cash. Moreover, they no longer receive incentives for products sold via links shared by other members they had invited, only for sales on links they personally posted. In this way, the multi-level hierarchy was flattened.

“Reselling is a proven business model that has been around for decades,” says one early-stage investor. “The regulator defines a pyramid scheme as a reselling network with more than three levels. Yunji’s modified model reduces the number of levels, but it also reduces the incentives available to resellers and affects growth.”

Several companies launched near copies of the Yunji model, even the RMB398 membership package, but this means they must negotiate the same obstacles. In July, Weilaijishi saw its WeChat account abruptly terminated within 10 days of launch. Global Scanner falls within the same category as Yunji, but GGV’s Tung says he is not concerned about regulatory risk. “These companies will find a solution, together with the regulators,” he observes. “In China, the practice is to do it first, and then set a standard, just like the standardization of Taobao. The government encourages innovation.”

Other newcomers have already modified their business models. For example, Jingling doesn’t charge membership fees and has no multi-level hierarchy. Members with 10 followers become shop owners, eligible for commissions on sales arising from products to which they have linked. Commissions are capped at 16%, well below the industry average. However, the company has developed an algorithm that calculates each member’s impact on the community and bonuses are distributed accordingly. 

Jingling, which has 50 million users to Yunji’s 10 million, closed a $100 million round last month, led by Sky9 Capital. Qiming and Tencent re-upped. “Jingling has Tencent as an investor and this provides a safety net for us because we know that they will be close to any new policies that Tencent introduces,” Qiming’s Wong says. She adds that innovation is not necessarily a prerequisite for success; optimizing an existing model can prove just as lucrative in the long run. 

Be the backbone

It remains to be seen where the next breakthrough comes in consumer-facing platforms. Some investors have already refocused on the infrastructure behind these platforms, rationalizing that better returns can be extracted from e-commerce service providers than from the saturated e-commerce market itself. These start-ups stand to make money regardless of which e-commerce player wins out. 

Hong Kong-listed China Youzan develops a range of software-as-a-service (SaaS) products for online merchants, including third-party payment solutions and customer engagement tools. The VC-backed company has received funding from Baidu and Tencent in recent months. 

On the supply chain side, Xyb2b.com, a B2B platform that helps e-commerce companies source products from overseas, raised $100 million last month. It claims to serve more than 100 online e-commerce platforms, including Yunji, Pinduoduo, Little Red Book and Tmall.

Perhaps most interestingly, social e-commerce platforms are looking to become service providers themselves. Jingling recently launched Wantuanlianmeng, which helps individuals or traditional merchants develop their own social e-commerce platforms. 

Wu Qiangqiang, Jingling’s CEO tells AVCJ that it is an open platform strategy. “Many brands have yet to enter the social e-commerce space, the market has the potential to grow tenfold,” he says. “We can empower many decentralized platforms in the future.”   

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• Topics
• Greater China
• Consumer
• Technology
• China
• China Creation Ventures
• Qiming Venture Partners
• GGV Capital
• e-commerce
• Media
• TMT