Chinese E-Commerce Business May Be Confined to Bargain Basket Items, Limiting Growth
There’s a new kid on the block getting a lot of attention in China’s white-hot e-commerce industry. The question is whether the popularity will endure.
Meet Pinduoduo, a social e-commerce platform that’s essentially a cross between eBay and Groupon. The platform allows Chinese shoppers in rural areas to get deals on merchandise such as apparel and cosmetics when they aggregate purchases with friends.
The company, which plans to list on Nasdaq next week under ticker “PDD”, has drawn big bucks from early-stage investors. A fundraising round earlier this year valued the company at $15 billion and the IPO price range indicates a higher valuation of up to $24 billion. That’s a stunning 87 times 2017 sales for the profitless company.
The main reason for such a steep valuation is a hope that PDD, which was founded only a few years ago, can continue its blistering pace of growth. In the first quarter of 2018, PDD’s revenue was 37 times the amount in the same period a year ago. And while the company hasn’t yet broken even, the third-party model like PDD’s allows it to have very high margins on the revenue it collects because it holds no physical inventory.
It is tempting to think that PDD could become a serious competitor to the likes of JD or even Alibaba. At the end of June, PDD had 344 million active buyers – not too far behind Alibaba’s 552 million as of its latest report.
But a closer look at PDD tells a different story. PDD deals almost exclusively in very cheap items sold at deep discounts and customers simply don’t spend much in total. The average customer’s annual spend is around $100, with each order roughly $5. That is just 1/5 of the average order size for JD and 1/13 of the average order size for Alibaba, according to 86Research.
And the quality of PDD merchandise is questionable at best. According to a study published on China Finance News Net, nearly half of the goods purchased in a sample order were deemed to be fake or counterfeit. It would be tough for PDD to monitor all merchandise shipped between third parties, particularly when the average shipment is just a few dollars.
A reputation for low-quality merchandise makes it difficult for PDD to contemplate moving into higher-value categories. While shoppers may be willing to purchase cheap apparel for a few dollars, they have different standards for more expensive items.
Another issue investors should consider carefully is PDD’s source of customer traffic. PDD has attracted sales from social-media platform WeChat, a unit of Tencent, where users can invite friends to join group purchases. Tencent, which owns an 18.5% stake in PDD, collects fees in return for the traffic.
But WeChat is a crowded place. The highly-popular social media platform also feeds traffic to competing platforms like JD and Vipshop. In fact, JD has launched its own “Pin Guo” platform that functions similarly to PDD. Tencent has stakes in both JD and Vipshop.
There’s also a lesson in Vipshop itself. A few years ago, the discount retail site was seen as a major player with potential to compete against Alibaba. The stock soared after its IPO only to fall to its current level at one-third of its peak.
One clear way to drive traffic is investment in marketing. Indeed, PDD’s sales and marketing rose to almost $200 million in the first quarter of 2018 from about $11 million a year earlier.
But even such aggressive investment doesn’t guarantee success. PDD’s growth in annual active buyers peaked at 58% in the third quarter of 2017 and fell in each of the following periods, down to 17% in the quarter through June. Growth in annual spending per buyer and gross merchandise volume slowed in a similar fashion.
PDD surely has a place in the Chinese retail landscape, offering bargain hunters a few purchases a year. But with competition so fierce and the hurdles to expansion so great, investors should beware chasing the IPO shares.