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5 July 2024

Contents

Business Overview

Pinduoduo was founded in 2015 by Colin Huang (see here for more on Huang and the history). Today, it is one of the largest eCommerce platforms in China with US$35b in revenue, US$553B in gross merchandise value “GMV” (circa 20% domestic online market share), and 700m+ monthly active users (”MAUs”).

The business was first introduced to us in 2018 by a large Chinese asset management firm, who was an influential shareholder while the business was still private. We have been following the company since then, not least because of our position in Alibaba.

Like most eCommerce platforms, it is a two-sided network of consumers and merchants. The core value proposition for consumers is “value for money”, which usually means lower price but also lower quality. The business has been ruthless, both culturally and operationally, in its focus on meeting consumer needs. Increasingly, the “merchants” have included manufacturers as the company seeks to backward-integrate supply and lower prices for consumers.

“People living in the five rings of Beijing wouldn’t understand our purpose. The new consumer economy isn’t about giving Shanghainese the life of Parisians. It’s about providing paper towels and good fruit to people in Anhui province.” — Colin Huang

Pinduoduo has maintained a very capital light model (e.g. only US$0.5b in invested capital for 2024 and limited capex). This is because the primary business outsources the more capital-intensive areas. The newer business lines are slightly more capital intensive given Pinduoduo manages parts of the delivery and warehousing. Huang in his 2021 resignation letter said, “Pinduoduo has transformed from a pure asset-light third-party model to becoming more asset-heavy, with new investments in warehouses, agriculture-focused logistics, and upstream sources of agriculture products.” However, this has had a limited impact overall for the business to date.

Historically, we were sceptical of Pinduoduo’s market entry with a negative view on the sustainability of its lower prices and aggressive marketing spend to buy growth. We were wrong. As it turns out, the company had exceptional execution and it is now a fully scaled business with similar incumbent advantages to Taobao. It is a remarkable feat as prior to its rise, the strength of the incumbent platforms should have enabled them to rebuff Pinduoduo’s entry. Huang and the management team saw an under-served segment of the Chinese population and a value proposition that wasn’t being offered adequately by the incumbents. Pinduoduo also pioneered the team-purchase model, which enabled greater discounts for group orders and incentivised word-of-mouth customer acquisition, enhanced by smart use of social acquisition channels such as WeChat (at the time unavailable to Alibaba given competitive exclusion from Tencent). Meanwhile, Alibaba had poor execution but was also less able to compete directly without destroying its own margins and cash flow (discussed more below). China’s economic hardship over the last 3 years also had a role to play, as it meant a shift towards lower-priced items just as Pinduoduo came to scale.

Pinduoduo has expanded its grocery business with Duo Duo Maicai (Duo Duo Grocery in English) and globally with it’s cross-border Temu business. Duo Duo Grocery and Temu have entrusted models where merchants are charged a higher fee with varying elements of logistics and warehousing being handled by Pinduoduo. Duo Duo Grocery is often talked about by the investment community as a distinct business. However, despite the obvious supply chain differences and perishable nature of the product, management considers it very much part of the core platform, just an extension in product categories. While the team-purchase model has a role to play for Duo Duo Grocery, according to the company, local distribution points are already economically feasible without team-purchases, given the scale of the platform. A key advantage of grocery is the purchase frequency of the category; it brings consumers back to the platform more often.

<aside> <img src="https://img.icons8.com/ios/250/000000/light-on.png" alt="https://img.icons8.com/ios/250/000000/light-on.png" width="40px" /> 4Q 2020 Earnings Call:*“[Duo Duo Grocery] is not a typical community group purchase because unlike group purchases, where neighbors or group leaders or store owners actually aggregate a group and earn a commission for organizing that purchase, with an active buyer base of 788 million users, Duo Duo Grocery does not actually rely on community leaders to attract users, and users can just place order independently by themselves through our app. So this is the reason why we are approaching Duo Duo Grocery as an integrated extension of our e-commerce platform. So the economics accordingly and the type of roles that these group leaders play are quite different.

Second thing I would say is we introduced Duo Duo Grocery to cater to that rising demand that consumers have for convenient, affordable grocery, and it is now available in 300 cities across China.

A key part of this offering is really the agriculture-focused logistics infrastructure that we are working to build. And the idea here is to really reduce waste to lower costs and to speed up delivery of agricultural products. To that end, we are leaning on technology to achieve better quality control, better sourcing, better forecasting the demand, which can all reduce wastage and improve supply chain efficiency. We are working with third-party providers now to make strategic investment where needed to accelerate the build-out of the necessary infrastructure so we can achieve less than 24-hour turnaround time for the orders. We believe that has proven out in the last 5.5 years as long as we remain laser-focused on anticipating and meeting the users' needs, users, they will continue to vote for us with their wallets.”*

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Temu is different to the core business in that the consumers are international. In fact, given the geopolitical perceptions of a large Chinese company operating within the US, Temu tries to distance its association with its parent company, and even advertises itself as a Boston-based company. The international element creates complexity because the company needs to achieve positive contribution margins despite the higher logistics costs on low average order values (”AOVs”). To help merchants, Pinduoduo manages logistics from its Chinese warehouses to the end consumer. Despite these differences, the playbook is the same. They are spending aggressively to acquire customers (both brand and direct response advertising…to our recent benefit in our Meta position) and are subsidising certain products to maintain a significant price gap to Amazon and other competitors. Deliveries take longer than Amazon but, if the customer is willing to wait, the value is significant. Many items fit into the lower price but lower quality bucket but this is also the case for many of the items on Amazon. In a similar vein to our scepticism of Pinduoduo back in 2018, Temu faces criticism over the sustainability of this strategy. However, if the acquired customers become repeat customers, then the high customer acquisition spending is reasonable. We discuss Temu more below.

Pinduoduo’s main revenue stream is from auction-based performance advertising that merchants purchase to compete for traffic on the platform. Increasingly, the automation of managing this process means that merchants can reduce operational costs elsewhere, which enhances overall merchant ROI. A smaller piece of revenue is transaction services. These comprise merchant commission revenue (effectively a pass through of payment network costs with a mark-up) as well as other fulfilment services that Pinduoduo provides (e.g. delivery and warehousing), particularly for Duo Duo Grocery and Temu.

Source: Company, QuestMobile, Apptopia, Kalakau Avenue estimates

Business Quality & Cost of Capital

Pinduoduo offers a strong “low price, value-for-money” customer value proposition, reinforced with typical eCommerce platform competitive advantages as well as a counter-positioning advantage versus other incumbents. There is an attractive growth runway ahead in the domestic business with optionality in international markets. The quality of the business is let down by the lack of transparency in various areas (discussed below) and the risks associated with Temu.

Why do we like the business?

Our strategy isn’t to predict the future with great accuracy…an impossible task. Rather, we focus on identifying characteristics of companies that give them a better chance of success no matter what the future holds. This doesn’t mean we don’t consider how the future may unfold, only that we believe it is hard for us (or anyone for that matter) to predict the future with great precision. In the context of Chinese eCommerce, this is certainly the case. There are several dominant platforms including those coming from the social media and short-form entertainment space like Douyin (domestic TikTok) and Kuaishou. The macro-economy is hurting from a cyclical perspective and the population is expected to marginally decline over the next decade. There are several paths that could unfold. So what do we see in Pinduoduo that gives it an advantage in this uncertain future?