China consumer: The low road

Pinduoduo has its share of critics. The Chinese social e-commerce platform has been pilloried by consumers for selling knockoffs that are every bit as unreliable as their low prices suggest and upbraided by investors for allowing costs to rise at a faster pace than revenue.

In a letter to shareholders accompanying the most recent annual report, founder Colin Huang compared Pinduoduo to Chinese basketball star Yao Ming during his elementary school years. Yao was tall for his age, but still young, and in need of nutrition, training and life experience. A parent or guardian might want to keep Yao grounded by encouraging him to save rather than spend his pocket money. But would denying Yao a new pair of basketball shoes in fact undermine the development of his talent? 

Addressing Pinduoduo’s profligate spending – sales and marketing expenses rose 87% quarter-on-quarter to reach RMB6 billion ($876 million) in the final three months of 2018, while revenue rose 68% to RMB5.65 billion – Huang argued that the company shouldn’t put its money “in the piggy bank” at this stage. He sees this spending as a long-term investment in meaningful continuous returns. If the company can carry on attracting and engaging users, it will be worth it.

Pinduoduo’s business model combines social networking and e-commerce, offering discounts for group purchases that result from users sharing product information with friends. It serves as a marketplace, brokering transactions for merchants and helping them achieve significant scale: the greater the number of buyers that signs up for an offer, the lower the price goes.

What the company has done is blaze a trail into China’s lower-tier cities that others are trying to follow. It has opened channels to consumers that were previously underserved, allowing them to buy and sell products without going through layers of resellers, all of whom took a cut. The key is value for money: Pinduoduo is selling small-ticket consumer staples – the average order is RMB6 compared to RMB60 for JD.com – and buyers are apparently willing to overlook the odd dud product if everything is cheap.

With growth slowing at national level, investors are increasingly looking for technologies that tap the lower-tier consumer base. “IT is really expanding into lower-tier cities and changing people’s lives. We’ve seen it with e-commerce – most community-based e-commerce platforms, including Etao, one of our portfolio companies, are focused on tier-three and tier-four cities – and with distribution,” Richard Peng, founder of Genesis Capital, told AVCJ when outlining key themes for his $850 million growth fund.

This view is echoed by GGV Capital’s Teck Loon Goh, who observed that Alibaba Group’s e-commerce transactions are continuing to grow for women in tier two, three and four cities, but stagnating in tier one cities. “The reason is that people in tier three and four cities have no mortgages – every dollar they earn goes into discretionary spending. In Beijing and Shanghai, higher costs in areas like property and education are holding back spending power,” he says.

Four cities in China are classified as first tier, according to McKinsey Global Institute, with 46 in tier two, 193 in tier three, and 696 in tier four. About 60% of the 833 million urban dwellers were living in third-tier cities and below in 2018. Household consumption reached $2.3 trillion in 2017, and Morgan Stanley projects it will hit $6.9 trillion by 2030. Of that, $8.4 trillion will come from urban centers and the rest from rural areas. 

Technology platforms that facilitate consumption in lower-tier cities are selling themselves only in so far as they are efficient and reliable intermediaries. But they must ensure their business models keep up with market trends. The rise of the lower-tier consumer has been linked to a shift from foreign to domestic brands. According to Jessie Yan, a director with consumer-focused mid-market buyout firm Lunar, local shoppers are more sophisticated, spend more time on research, and want value for money.

This raises two questions for Pinduoduo. First, are the barriers to entry sufficiently high that it can outmuscle rival platforms – with ample VC funding – looking to provide a similar service? Second, will selling low-margin goods to cost-sensitive consumers continue to make sense when those consumers start to place more emphasis on quality as opposed to just price? Even Yao Ming eventually grew up.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Consumer
• Technology
• China
• TMT
• Lunar Capital Management
• GGV Capital