Everything you need to know about Pinduoduo, the fast-growing rival to Alibaba and JD in China

• U.S.-listed Pinduoduo (PDD) is now the third-largest e-commerce player behind Alibaba and JD.com in China.
• A large part of PDD's appeal is the group buying function where the more people who buy a product leads to a lower price. 
• The company recently issued new shares and also made its first major investment as it looks to expand. 
• But JD and Alibaba have both launched rival products to PDD which could bring stiff competition to the smaller rival. 

In this article

• PDD
• BABA
• 9618-HK

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Colin Huang, chief executive officer and founder of Pinduoduo, speaks during the company's listing ceremony at Shanghai Tower on July 26, 2018 in Shanghai, China.

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U.S.-listed Pinduoduo (PDD) may not be a big name outside of China. But within the world's second-largest economy, the e-commerce firm is growing faster than major rivals Alibaba and JD.com and gaining share quickly.

Behind that success has been its "social shopping" model that encourages users to share links to items they purchase with friends and participate in group buying. 

Here's a look at how the platform works, its financial performance and how it competes with Alibaba and JD.

How does PDD work?

A large part of PDD's appeal is the group buying function. When a user selects an item on Pinduoduo, they can choose to participate in group buying. The more people that join in, the lower the price of the item goes.

This encourages buyers to share links to the item they are buying with friends and family or over social media. 

Each item has a minimum number of buyers required to complete the purchase. If that number is not met within 24 hours, then the group buy is cancelled and those who have already committed money will be refunded.

There is an option to just buy the item directly but the price of that product is higher than that of buying it in a group. 

PDD has also focused on making personal recommendations within its app. 

Business model

Currently, 100% of PDD's revenue comes from what it calls "online marketplace services." This is broadly made up of commission PDD takes from sales on its platform as well as advertising it runs. 

While Alibaba and JD.com make most of their money from e-commerce, they both have other emerging businesses such as cloud computing. So PDD's income stream is narrower.

But its revenue is growing faster in percentage terms. In the December quarter, PDD's revenue hit 10.79 billion yuan ($1.55 billion), an increase of 91%. In the same quarter, Alibaba's revenue was up 38% from last year but it raked in 161.45 billion yuan or $23.19 billion, nearly 15 times as much as PDD.

Both Alibaba and JD.com made a net income in the fourth quarter of 2019 while PDD recorded a loss.

User numbers

In 2019, PDD said it had 585.2 million active buyers — those that made at least one purchase on the platform during the year. JD.com had 362 million in the same period. Alibaba said it had 711 million annual active consumers on its Chinese e-commerce marketplaces in the 12-month period ended September 30, 2019, the latest available figure.

A large part of PDD's growth has been driven by the fact that it can be accessed on Tencent-owned messaging service WeChat, which has over a billion monthly users. WeChat is a key part of daily life in China and allows people to make payments within the app. So a buyer can access PDD via WeChat and make payments there. 

This has led to lower customer acquisition costs, according to analysts.

"Direct buyer traffic to PDD is primarily generated from word of mouth referrals by its existing buyers as well as the effect of its marketing campaigns," Shanghai-based Guotai Junan Securities, said in a report from March. "A portion of the Company's buyer traffic comes from its user recommendation or product introduction feature which buyers can share with friends or contacts through social networks such as WeChat and QQ." 

In terms of market share, PDD is the third-largest e-commerce player in China behind Alibaba and JD.com, according to a report released in July 2019 by eMarketer. 

A large part of PDD's user base is from smaller Chinese cities where there are perhaps more price-conscious consumers. JD.com and Alibaba appear to dominate in the so-called tier 1 cities in China. 

"They (PDD) have made no in roads into existing market share of tier 1 cities," Jacob Cooke, CEO of WPIC, an e-commerce tech and marketing firm that helps foreign brands sell in China, told CNBC.

Last year, PDD disclosed that 45% of its gross merchandising value (GMV) came from first and second-tier cities. That means that 55% still comes from tier three cities or below. GMV refers to the total value of all orders for products and services placed on the Pinduoduo mobile platform, regardless of whether the products and services are actually sold, delivered or returned, according to a financial filing from the company.

"We're here to serve everyone, and wanting value for your money isn't dictated by where you live," a PDD spokesperson told CNBC.

IPO and funding 

Pinduoduo went public in July 2018 on the Nasdaq, pricing its American depositary shares (ADS) at $19 apiece.

On Monday, shares closed at $50.11 each. That put PDD's market valuation at around $58.2 billion. 

The company also recently announced a new investment and funding.

In March, PDD carried out a private placement of $1.1 billion worth of newly issued Class A ordinary shares. At the time, the company said the funding will help its "strategic flexibility for expansion to bring more interactive experiences and value-for-money products to our users."

And on Sunday, PDD announced it would invest in convertible bonds issued by Hong Kong-listed GOME Retail. The investment will see GOME's product range, logistics and after-sales customer support integrated with PDD.

Competition and risk

Alibaba and JD have found success in larger so-called tier 1 and tier 2 cities in China which include the likes of Beijing and Shanghai. PDD's growth has come from smaller Chinese cities. 

But now Alibaba and JD have put a larger focus on gaining ground in these lower tier cities and have released products to compete with PDD.

In March, Alibaba launched a special version of its Taobao app that focuses on the so-called customer-to-manufacturer (C2M) model, which has been behind the rise of PDD. That's where consumers can interact and buy direct from the manufacturer rather than going through a third-party seller.

And last year, JD rolled out a group buying app called Jingxi, which is also accessible through WeChat. 

"From the prospective of end customers, the value proposition of PDD is not as prominent as before, because BABA and JD both rolled out their special edition (products)," Choi Chun, research director at Shanghai-based firm iResearch, told CNBC. 

Chun also noted that Alibaba and JD are building up relationships with factories for the C2M model of business. And with the Alibaba's strong cloud computing business, it "may have more to offer to the factories" in terms of digital capabilities, Chun said. 

Meanwhile, JD and Alibaba both have strong logistics capabilities. JD is known for being able to deliver items on the same day or day after. 

"Logistical capability is also lacking in PDD's ecosystem," Chun said.