Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) control nearly 75% of China's e-commerce market according to global marketing research company eMarketer. That near-duopoly makes it tough for smaller challengers to gain ground, but a new player called Pinduoduo (NASDAQ:PDD) might have a shot at cracking the market.

Pinduoduo ranks a distant third in China's e-commerce market with a 5% share, but it uses a disruptive strategy that targets Alibaba and JD's soft spots. Instead of focusing on single customer purchases, Pinduoduo lets its users team up with other members to split bulk purchases on its "social shopping" platform.

A shopping cart icon displayed on a smartphone.

Image source: Getty Images.

Why "bulk social shopping" works

Bulk purchases can result in discounts of up to 90% per item. On Pinduoduo, bed sheets and umbrellas cost around 10 RMB ($1.50), ten boxes of tissues cost about 13 RMB ($1.90), and low-end PCs cost just 1,000 RMB ($150), according to tech industry news publisher TechCrunch.

Pinduoduo keeps its prices low by focusing on generic brands and lower-income, third-tier and lower cities (based on the Chinese classification of cities into four tiers), which account for nearly two-thirds of its user base, compared to about half of the shoppers on JD.com and Alibaba's Taobao site.

Pinduoduo promotes its most popular items via a news feed. Members can share the products on popular social networks, like Tencent's (NASDAQOTH:TCEHY) WeChat and QQ, to attract more shoppers to their "shopping teams." Tencent, which is JD.com's top investor and Alibaba's ecosystem rival, is also one of Pinduoduo's biggest investors.

Pinduoduo runs on a B2C (business-to-consumer) model like Alibaba's Tmall and JD.com. It lets manufacturers ship products directly to consumers, which reduces overhead costs from layers of distributors and retailers. Since many Pinduoduo users add their friends, family members, and co-workers first, they're also sending products to shoppers with similar income levels and preferences.

How fast is Pinduoduo growing?

Pinduoduo's unique business model attracted plenty of investors when the company had its IPO in late July 2018. It went public at $19 per share, and surged about 40% to $26.70 on the first trading day as the company raised $1.6 billion. The stock subsequently retreated to the low $20s, but remains comfortably above its IPO price.

Pinduoduo's GMV (gross merchandise volume) hit 141.2 billion RMB ($20.7 billion) in 2017, with 4.3 billion mobile orders placed -- just two years after the company was founded. It took Alibaba's Taobao and JD.com five years and ten years, respectively, to exceed 100 billion RMB in annual GMV.

Pinduoduo generated 66.2 billion RMB ($9.7 billion) in GMV during the first quarter of 2018, with 1.7 billion mobile orders placed. Over the past 12 months, Pinduoduo's mobile app boasted an average of 103 million monthly active users (MAUs), its platform had 294.9 million active buyers, and it hosted over a million active merchants.

A tiny shopping cart of parcels on a computer keyboard.

Image source: Getty Images.

Pinduoduo previously ran a direct sales business that generated most of its revenues between 2015 and 2016. But in the first quarter of 2017, it abandoned that model and pivoted toward its current business model of online marketplace services for bulk orders. Its total revenues rose 245% to 1.74 billion RMB ($255 million) last year, and grew from just 37 million RMB to 1.38 billion RMB ($202 million) between the first quarters of 2017 and 2018. However, that annual growth rate was greatly distorted by its transition from its direct sales business last year.

But here's the bad news...

Pinduoduo's top line growth looks impressive, but it remains deeply unprofitable. It reported a net loss of 525.1 million RMB ($76.9 million) last year, compared to a loss of 292 million RMB ($42.8 million) in 2016. It also reported a net loss of 201 million RMB ($29.4 million) during the first quarter of 2018, compared to a net loss of 207.7 million ($30.4 million) a year earlier.

Pinduoduo spent over 88% of its first quarter revenues on marketing, indicating that it's struggling to acquire new users. According to TechCrunch, the company's average customer order is also tiny at about $6, compared to $60 on JD.com and $30 on Alibaba's Tmall and Taobao. Therefore, Pinduoduo can't easily offset the cost of acquiring new customers with fresh revenue from their purchases, which it generates via tiny transaction fees.

Pinduoduo's popularity has also attracted fresh competitors like Alibaba's Taobao Tejia, a dedicated e-commerce app for budget shoppers in lower-tier cities. Pinduoduo will likely need to ramp up its marketing spend to tackle these new rivals, so its losses could widen.

The key takeaway

Pinduoduo's business model combines elements of Groupon with social networks. But like Groupon, Pinduoduo could suffer from low margins and high customer acquisition costs as shoppers demand lower prices.

As a result, Pinduoduo's business could implode before it grows big enough to challenge Alibaba or JD. Unless it can get its costs under control, I'd rather stick with Alibaba or JD as my long-term plays on China's e-commerce market.

Leo Sun owns shares of JD.com and Tencent Holdings. The Motley Fool owns shares of and recommends JD.com and Tencent Holdings. The Motley Fool has a disclosure policy.