What happens when you combine social media, ecommerce and online gaming on one platform?
You get Pinduoduo, a company that reached a $150Billion market cap in just 5 years of its inception.
Here is a story of an entrepreneur and a company that entered into the territory of the mighty incumbents in Chinese e-commerce, Alibaba and JD and achieved to take market share away from them to build a company which is now worth $150B in only 5 years.
It took only 4 years for them to hit the $100B market cap. For perspective, there are only 3 companies from India who have a market cap of more than $100B, TCS, Reliance and HDFC Bank. Looks like an overnight success is it?
But things are rarely overnight successes, there are years of hard work behind it. Founder of Pinduoduo, Colin Huang’s parents were factory workers in a China, in a time where the country was just going to see the industrial boom and economic growth. They had not even cleared their junior high school.
But Colin Huang did very well academically. He landed an internship at Microsoft and then went to work for Google, where with his hard work rose up to the ranks pretty fast, made a good lot of money in Google’s IPO and headed the team that was building Google for China.
But the project was scrapped. From there the entrepreneurial journey of Colin Huang began in 2006. Colin was able to get mentorship from one of the best in tech and business, starting from Duan Yongpin who owns OnePlus & Oppo, Pony Ma, Founder of Tencent and William Ding (Founder of Net Ease).
Duan Yongpin wins the dinner with Warren Buffet in 2006 where he takes Colin with him. Says a lot about their mentor-mentee relationship.
In 2007, Colin saw this trend of rising incomes & consumption and the bulging middle class in China. He wishes to capitalize this opportunity. He starts a company which sells electronic and other goods called Ouku(dot)com which does pretty well and sells it in 2010.
When you have such heavy weight mentors, who have been serial entrepreneurs, you too are likely to pick up that bug. Colin starts another company ‘LEQI’, which helped non-chinese brands to sell and market their goods on Chinese e-commerce platforms, Alibaba and JD.
Next he picks up on another trend: Online Gaming. He starts a gaming studio where they put out games built on WeChat platform combining social and mobile gaming.
So here is Colin Huang, who caught on to some big trends early and now has experience in the field of e-commerce and mobile gaming, combined with his experience at Google. Super Combo to say the least.
He combines these trends with the social media app WeChat to form his next company Pinhuahuo. They sold agri goods to customers via WeChat. They took on the inventory. Low cost agri goods means that repeat orders would be high.
Also having low cost goods ensured that customers weren’t as hesitant to order from a new online retailer. They realise that farmers now have mobile phones, customers are on WeChat, they can accept payments through WeChat…why not bring all together?
From a retailer model they turn towards the marketplace model, where they charge a 0.6% commission on goods sold, instead of taking on inventory and taking care of spoilage like before. This marketplace became Pinduoduo (PDD).
They combined the Fruits which were Low cost and had high Repeat purchases + Marketplace + Social with WeChat + Gaming to form Pinduoduo. And only in its first year of operations it hit $70Million of revenue, not the GMV ( which is the Value of Goods sold), but their commissions and ad revenue.
It was Group Buying that helped it achieve this crazy growth and virality.
How does group buying work? When you want to place an order for any product, you see 2 prices for it, one price in very faded colours is the price you pay if you want to place the order alone. The bright red button is the cheaper option if you want to buy it in a group. Nice use of UI/UX.
If you want to buy toilet paper, you could either buy it standalone or in a group of say 10. Group size is decided by the seller. So if you want to buy the toilet paper at a discount of 30%, you either share the link in your WeChat groups or join an existing team.
It was the users itself which enabled virality by sharing links to form groups on social media platforms. Once you hit the Team purchase button, you have to be in a group or form a group in 24hours to get the discount. It was in your best interest to share as much as you can.
Team buying also aided in social proof that if your friend is buying it would be a good product. And if you could bring in enough customers, you also stood a chance to get the product for free. They call it the “Price Chop”
Say if you bring in 1 customer you get a 30% discount, if you bring in 3, you get a 50% discount and if you bring in 10, you get the product for free. The catch here is that you get the product either for free or get nothing. Great marketing trick to say nonetheless.
The trick played, by the end of December 2017, they had acquired 244.8million active buyers which now stand at 788.4million buyers. That is more than twice the whole population of the United States and 60% of India’s population.
Another ploy to bring customers on its platform daily: Users are given a small amount of bonus, each time they log-in. Over time this bonus gets accumulated and on crossing a certain threshold, say RMB50, they can spend it to buy goods on the platform.
Use of games to increase repeat purchases: In one of the games you get a seed and as you make purchases that seed gets the water and nourishment. After certain no. of purchases the tree bears fruit and an actual box of fruit is delivered to you.
Pinduoduo has successfully brought in a lot of customers on its platform. The demography primarily consisting of women, aged between 25-35 in Tier 3 & 4 cities, who wanted to save on their household purchases. For many, PDD was their first online shopping experience.
Pinduoduo was able to cut costs for the customers by eliminating the middlemen as well as helping the manufacturers gain economies of scale with bulk buying.
PDD also reached out to suppliers with unused capacity to produce the goods and helped them with the analytics and huge buyer base. Customers got the goods at cheaper rates and PDD got its commissions. Win-Win situation for all the parties involved.
When such contract manufacturers, say that of Nike, who produce T-shirts for them, get help from PDD in the form of analytics, what type of quantities to produce and what SKU’s to maintain, deters them from switching off from PDD. PDD calls this C2M (Customer to Manufacturer).
There was a lot of issues related to counterfeit products as well. To counter that PDD has taken significant measures, it takes a deposit from the supplier while onboarding, and incase of customer complaints, it cuts 10x the value of product from this deposit.
Another thing to know about PDD is that it is ‘Browse-centric’ and not ‘Search-centric’. What this means is that it works more like your Twitter feed page which runs on an algorithm compared to when you go to Amazon to search for something.
And because the user is not going to look specifically for something, many times PDD can get away with longer delivery time. Extensive use of AI is made to make recommendations to customers and ensure better conversions.
Now down to the financials. PDD spends large amounts of money on coupons, deals and marketing. The spending has been so large that they exceeded even the revenue earned in many quarters.
To dig its feet in Tier 1 & 2 cities and acquire customers there, PDD has been further burning cash with its subsidy scheme. PDD in effort to increase transaction value and upend the customer segment, offer goods like Apple iPhone at a discounted rate out of its own pocket.
While this increases the GMV, as well as the Average transaction size, such high customer acquisition costs looks a little on the upper end, especially when you are trying to keep the products on the PDD platform artificially cheap by subsidising them.
PDD earns by taking a 0.6% commission and a marketing fee from suppliers who want to put up an ad on the platform or get a preferential allotment. The marketing fee part forms around 80% of PDD’s revenue.
Gross Merchandise Value (that is, the Value of goods ordered through PDD), stood at $260B while PDD’s revenue stood at $9.25B. This means that PDD is able to capture only 3% of the value of goods which flows through its platform [ 9.25/260]. This metric has hovered around in this region., around 3%.
Compare that to Alibaba, who reported GMV of $1.2Trillion and was able to capture 8% of it as its revenue, reporting around $90B from the commerce segment.
With 38.3 billions orders on PDD and GMV of $260B, average transaction size comes to around $6.5. Primarily due to the low cost goods sold + higher customers from Tier 3 & 4 cities.
To increase this PDD spent large on marketing and in subsidy scheme (discussed above) to move towards high-value goods and in Tier 1 & 2 cities. Needless to say with such high marketing spends, PDD is loss making. It reported an operating loss of $1.4B for the year ending December 2020
From where does the funds come from?
- It generated $4B worth of free cash flow, aided by the security deposit and advance for ads taken from suppliers as talked above.
- The float it gets to keep between the time order is placed and the time that amount is transferred to the supplier.
While cash coming in the form of supplier deposit, sits as restricted cash(i.e, it cannot spend this money for marketing), PDD uses treasury operations to earn from these assets. On PDD’s balance sheet, this operation is worth $9.8B in short term securities.
Restricted Cash on the balance sheet is worth $8B. Between Merchant deposits and amount payable to merchants, the amount stands at almost $10B.
Clearly, while they improve operating cash flows, it does not help much with respect to burning cash to grow. So where does the money for spending come from? Raising Equity! PDD raised $5.7B from equity offerings and private placement.
In the past 3 years it has raised $8.5B in equity (including IPO). Additional ~$4B from the issuance of convertible debentures. With user growth likely at the upper band, increasing GMV and transaction value without lesser marketing spends is a challenge.
In July 2020, Colin Huang stepped down from the position of CEO and from the position of Chairman in March 2021. Both the posts were filled by Chen Lei, who had been the CTO.
While on the cash flow basis, the stock looks to be slightly overpriced at 35 times of operating cash flow, on a Prices to Sales basis of more than 15 it looks absolutely expensive compared to its peers Alibaba or Amazon.
While growth would be used to justify the valuation, the probability of copying such high growth seems low. In the past PDD has grown taking away market share from its peers in the e-commerce space.
PDD increased its share from 4 to 14% and Alibaba lost share from 72 to 63%. The point to note is that the pie itself is growing, so both the players are growing, just that PDD is growing much faster than others. E-commerce as a % of total spends in China has grown from 6% in 2012 to 24% now.
The thread cannot end without acknowledging the role of WeChat in PDD’s success. Tencent (owner of WeChat) is a major shareholder in PDD. PDD sees more activity on the WeChat’s Mini Program compared to its own native app.
Paytm had also launched a program similar to Mini Programs, the ‘Paytm Mini App Store’ from where you could order from Dominos or book a cab from Ola. (Was in the news when Play Store temporarily delisted Paytm App)
WeChat’s social platform + Mini Program + WeChat Pay formed major pillars in Pinduoduo’s growth and success. Further, for delivery the chinese logistics has a deep and mature network such that they can bid for the service and the supplier can choose the cheapest one.
So, PDD didn’t have to set up its own logistics channel. The merchants and farmers did it by themselves.
The Social E-Commerce was also tried in India by Grofers sometime back and by Paytm last year with ‘Bang’. The products on Bang didn’t seem worth buying.
To boil it down, PDD won with:
- Good Payments mechanism (WeChat)
- Good Logistics
- Good Marketing tricks
- Platform for social ecommerce (Mini Programs + Games)
If you are still here, Thank you for Listening!