For some reason, no-one seems excited about this strange Chinese company that's somehow taken 10% of Chinese e-commerce in about two years.

Ex-google CEO Colin Huang has somehow created a firm that's competing head-to-head with Alibaba in its home territory. 

This is no accident. We've tried to pin down some of the reasons for one of the most impressive business achievements in recent years. 

All buying is viral and social

At first glance Pinduoduo looks like a glorified Groupon, which may be why so many investors pass on the company.

Every item on the site has a list price, and a lower price, which you can access by buying in a group, sometimes with only with one other person. Amongst mothers, elderly, and other cost-conscious demographics, this has been a massive hit. 

Customer acquisition viral and exponential by design. It’s no accident that Pinduoduo accumulated 500 million customers in four years. For example, when you first go on the site, you might be offered steeply discounted toilet paper – but only if you share the link and a friend commits to buying.

The model is consumer-to-manufacturer, and they mean it. Pinduoduo only takes a 0.25% transaction fee – astonishing strategic discipline. This means almost all the savings are shared between the customer and the manufacturer, and gives them a sustainable competitive advantage over any competing platform that takes a cut.

PDD optimizes for user time spent on their platform, rather than sales. Long before PDD overtook JD.com, customers were spending far more time on Pinduoduo’s apps. This offers several advantages:

  1. Advertising is cheap, because they have so much screen real estate to sell, and
  2. They have better data, and more opportunities to A/B test different prices, deals, rewards and lotteries.

A user who buys a lot of cheap items might be offered $50 off their next purchase over $100, for example, and then tracked afterwards to see if that changes their buying patterns.

Users are encouraged to browse, not search. Pinduoduo’s search bar is almost hidden. When you go on the app you see one-off deals, games, rewards, lotteries and new offers. This is a materially different user experience to search-based platforms like Alibaba (or Google and Amazon, for that matter), while offering new opportunities for the merchants that use the platform.

This all benefits small and mid-tier manufacturers. Search-driven e-commerce drives almost all traffic to the largest and most efficient manufacturers who can afford to win ad auctions. This sucks oxygen from anyone who's not on the front page of search results, which is most manufacturers and basically all farmers. 

Ten years ago things may have been different, but in 2019 the market for adwords is highly efficient. In the West, Amazon is not only search-driven, but also comes with a division that screens for fast-selling items and creates internal competitors. With Pinduoduo, a factory can retool for a single product and sell the lot in advance on a Pinduoduo flash sales.

Pinduoduo earns money through high margin advertising. It costs little to offer ads on a website, and the sales process can all be automated. This is how they make their revenue, which amounts to about 3% of GMV.

Pinduoduo aggregates demand. Ben Thompson at Stratechery developed a robust framework for evaluating different tech ‘platforms’, arguing that those that aggregate demand have all the power and accrue all the value. This is a helpful lens, demanding an answer to the question: who is directing customer flow?

It’s one of the reasons we think Afterpay might go all the way, as unlike Paypal or Visa, Afterpay is building a direct relationship with customers and driving incremental traffic.

‘Aggregation theory’ highlights strategic errors too: Uber aggregates passenger demand, so could position themselves as a capital-lite open layer on top of any competing self-driving platforms. Instead, they’ve burned capital trying to develop commodity self-driving hardware in a highly crowded field against multiple well-resourced and technologically sophisticated competitors.

For another example, Facebook and Google have been chillingly ruthless in using the demand aggregated on their sites to constrict independent journalism. The sweetest advertising model of all is when customers come to you to be directed to their next purchase. Pinduoduo has this in spades.

The fact that user experience is unique also means that Pinduoduo should be able to carve out a sustainable corner of the market. Alibaba can't exactly retool it's main website. 

This was not an easy investment. We first bought around $24 in March, then dramatically increased our position from May to July when the stock fell below $20. 

At this point, the chart looked horrific, and all kinds of bearish reports were coming out from leading investment banks and bomb-throwing short sellers. We wore the 20% hit, and the stock advanced over 120% in the months following. No doubt there will be further twists and turns.

So how do we get to $200 billion? 

Pinduoduo is currently taking about 31% of the $ growth of e-commerce, and this rate is increasing. Needless to say, with a high margin advertising business, if PDD maintains this momentum their market value will be an order of magnitude higher than the ~$20b EV we were buying at. 

In fact, if you assume growth fades from 169% currently, to 20% (system growth), between now and 2025. And taking broker assumptions on profitability, and apply a 25x PE, Pinduoduo would generate about US$100 billion of value. 

Ofcourse, my two cents is that Pinduoduo will keep investing, so profits will be lower, growth higher, and equity value far larger. Time will tell.  





Andrew O

Great article Michael and an innovative business that needs to be valued differently to standard valuation techniques.