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Five key challenges for China’s Pinduoduo to gain a firm foothold in e-commerce sector

The company now takes user engagement as the top priority over monetization, but difficulties remain ahead.

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Shanghai-based social e-commerce startup Pinduoduo closed down 23% on Nasdaq on Wednesday shortly after it disclosed worse-than-expected third-quarter earnings, an indicator that a number of investors might be bearish on its future and its value.

Pinduoduo booked RMB 7.5 billion (USD 1.05 billion) in net revenues in 2019 Q3, missing analyst expectations of USD 1.08 billion. The firm also widened its net loss to RMB 2.3 billion in the third quarter, from RMB 1.1 billion in the same period of 2018, missing analysts’ expectations.

Although Pinduoduo reported a 123% revenue growth in the quarter and a 75% year-over-year surge in annual spending per active buyer, difficulties are lingering for this four-year-old company. Below are some of the challenges ahead for Pinduoduo to overcome and to gain a strong foothold in China’s highly competitive e-commerce sector and to win back investors’ trust.

Is Pinduoduo’s current strategy solid enough?

Pinduoduo’s management remarked during the Q3 earnings call conference that the company now takes user engagement as the top priority over monetization.

Despite the fact that this strategy has helped the startup to achieve beating growth rates—active buyers were up 39% year-on-year to 536.3 million—this strategy can also be a double-edged sword as it strands Pinduoduo into mounting losses.

The so-called RMB 10 billion subsidy program, which has offered aggressive cuts on branded products, has been and will still be leveraged by Pinduoduo as the key measure in the foreseeable future to retain old users and attract new users, and encourage them to spend more money on the platform. All products under this program are labeled as authentic and promoted in an eye-catching area on the Pinduoduo app at a lower price compared to the same products on rival platforms.

This has allowed Pinduoduo to close its user base gap with the country’s largest e-commerce company Alibaba, whose active buyers on its China retail marketplaces reached 693 million over the same time frame.

Questions including whether Pindudouo can turn profitable while keeping expanding its user base will remain for now.

Cathy Roberson, president of Logistics TI, a research and consulting company, doubted that Pinduoduo could turn a profit in 2020, tech media Wired reported.

Will Pinduoduo find its own identity?

Four years ago, Huang Zheng set up a company called Pinhaohuo to tap China’s scattered agriculture sector, a niche market back then. Huang thought it was a better business strategy to deal with local producers instead than with big companies, which had already been working and selling its products on major established players such as Alibaba and JD.com.

Pinhaohuo started to get recognition from others by sourcing fruits directly from farms and selling them to price-sensitive buyers in smaller Chinese cities, but also big metropolis such as Beijing and Shangai. In a strategic change in 2016, Huang set up another company named Pinduoduo, as more and more merchants wanted to also sell their own agricultural products to consumers.

Pinduoduo merged with Pinhaohuo in the same year and the new company was rebranded as Pinduoduo only. The new company quickly scrapped the online direct sales model in the first quarter of 2017 to focus on expanding its e-commerce platform. The site began to offer various products’ bargains on a group-buying system, not limited to fruits anymore, and promptly attracted users mainly living in lower-tier cities and rural areas, who were not targeted by Alibaba and JD.com.

Pinduoduo’s low price strategy lowered the barrier for price-sensitive and less brand-conscious customers when it came to online shopping.  Discounts were given to groups of at least two buyers, a requirement that incentivized shoppers to share links with their social connections, fueling Pinduoduo’s viral growth.

Pinduoduo’s meteoric rise was phenomenal, leading many to scratch their heads trying to understand how it could crack China’s seemingly mature e-commerce sector in such a short time.

Little later, Pinduoduo got listed on Nasdaq in July 2018, but such a vertiginous rise in the Chinese e-commerce sector would not come unnoticed by both Alibaba and JD.com, which quickly fought back.

Alibaba’s B2C marketplace Taobao quickly launched a designated special “value for money” promotion area on its app, while JD.com rolled out a standalone app called Jingxi to target a part of users first lured by Pinduoduo.

Alibaba said that the increase of 19 million annual active consumers reported between June and September reflected its continuing penetration into both developed and less developed areas in China.

On the other hand, JD.com said that its annual active customers increased to 334.4 million in the twelve months ended September 30, from 321.3 million in the twelve months ended June 30, adding over 70% of new customers in the third quarter were from lower-tier cities.

Pinduoduo quickly counterattacked, tempting Alibaba and JD.com’s users with more upscale products on its platform, while competing for a space in China’s first and second-tier cities where Alibaba and JD.com are still the undisputed leaders.

“We don’t just sell apples, but we also sell authentic Apple iPhones,” said Huang during the Q3 earnings call.

However, people’s perception changes slowly, while Pinduoduo itself could come across an internal identity crisis. What’s more, Pinduoduo’s operating costs more than duplicated in the third quarter ended September 30, as the firm was luring users in big cities while maintaining its dominance in third and fourth-tier cities.

How to break the barriers set by competitors?

The so-called forced exclusiveness in China’s e-commerce sector, which means brand owners are demanded to choose only one platform to host their flagship stores, is always cited by Pinduoduo’s management as a negative factor affecting its growth.

With 536.3 million buyers, Pinduoduo should be an attractive platform for a lot of brand owners, but the reality is that most labels are still hooked by Alibaba’s Tmall. For the last 12 months, more than 10,000 brand owners were forced to take sides, said Huang in the Q3 earnings call.

In an attempt to break this system, JD.com has sued Alibaba and Tmall for “abusing its dominant market position”, but the lawsuit has taken years to progress. Finally, the Supreme People’s Court of China announced in October that it has ruled that the JD versus Alibaba and Tmall lawsuit will be heard in the high court of Beijing, where JD.com is headquartered, rather than the high court of Zhejiang, where Alibaba is headquartered.

Pinduoduo also applied to the Beijing high court to participate in the lawsuit as a “third person”, while JD.com welcomed Pinduoduo’s participation, as both companies feel they been harmed by Tmall.

However, it is hard to know when a final ruling could come out.

At the same time, Pinduoduo’s own plan to nurture more recognized brands advances slowly. David Liu, vice president of strategy confirmed on the Q3 earnings call that the scale of Pinduoduo’s C2M initiative, which is designed to help develop brands for domestic manufacturers, is still small and it’s going to take a long time before those brands can become a meaningful contributor to the platform’s gross merchandise volume.

How can Pinduoduo maintain its advantage as a budget-friendly marketplace?

Low price is a key factor attracting consumers to Pinduoduo’s platform for the first time, no matter whether they come to buy apples or Apple’s iPhones.

Pinduoduo charges lower commission fees and offers better marketing resources so that merchants, who also value the company’s huge user base, can keep with the platform and consumers could buy items at lower prices. However, this, in turn, has hurt Pinduoduo’s profitability.

Once the company will take a more aggressive approach toward monetization, such as charging higher commission fees, the firm might lose part of its competitive advantage.

Pinduoduo’s monetization rate, which refers to revenues expressed as a percentage of total GMV for a given time frame of last twelve months, has been increasing.

In the year ended December 31 2017, Pinduoduo’s monetization rate stood at 1.4% but advanced to 2.8% one year later and further to 3% in the twelve months ended on September 30, according to data disclosed by the company.

How to win patience from investors?

Huang Zheng, Pinduoduo’s chairman and CEO, still holds a 45% stake of the company, according to 36Kr, citing data of market intelligence provider Wind. Entities affiliated with Tencent retain a 17% stake while BanyanPartners Funds controls an 8% stake, and Sequoia Funds grabs a 7% stake.

Huang’s status as the largest shareholder could spare him some pressure from investors, allowing him to carry on the so-called longterm strategy of focusing more on user engagement than on monetization.

After the 23% one-day sell-off, Pinduoduo’s ADS closed at USD 31.58 on Thursday, up 0.57% from one day earlier and still way above its initial public offering price of USD 19.

Pinduoduo might still enjoy a high level of trust among some investors, but its future business strategies and its prolonged war with behemoths Alibaba and JD.com could raise another test for investors’ patience.