Investors who follow Chinese stocks likely recognize Alibaba (BABA -1.03%) and JD.com (JD -1.16%) as the country's two largest e-commerce players. Alibaba's Tmall and Taobao marketplaces give it the largest share of online sales, while JD Mall gives JD.com the No. 2 slot.
JD Mall is also China's largest direct retailer since it takes possession of the products it sells and uses its own logistics network. Tmall and Taobao, which use third-party courier services, mainly facilitate transactions among businesses, individual merchants, and consumers.
However, several recent reports claimed that Pinduoduo (PDD -2.73%), which went public last July, had overtaken JD to become China's second largest e-commerce player. That announcement likely stunned JD investors -- but it's not quite true.
What actually happened?
According to research firm QuestMobile (via TechCrunch), Pinduoduo's daily active users (DAUs) have outnumbered JD's over the past 12 months, including during the recent multiday June shopping festival.
Pinduoduo also has more active buyers, those who made at least one purchase over the past 12 months, than JD. Pinduoduo's number of active buyers grew 50% annually to 443.3 million during the first quarter, while JD's rose just 4% to 310.5 million. Pinduoduo certainly has more active shoppers than JD. However, Pinduoduo's marketplace isn't really comparable to JD Mall, Taobao, or Tmall.
Tmall and JD Mall mainly sell brand-name products while Pinduoduo mainly sells cheaper generic products to lower-income shoppers in lower-tier cities. Pinduoduo uses a "group purchase" model, which offers shoppers bigger discounts if they convince their friends, family members, or co-workers to team up for bulk orders. It nurtures that model by encouraging shoppers to share product links via Tencent's WeChat and other social platforms.
More users, less money
Therein lies the problem. Pinduoduo has more shoppers than JD, but its shoppers buy much cheaper products than the average JD shopper. If we compare the two companies' gross merchandise volume (GMV), or the value of all products sold, the situation reverses.
JD generated 1.68 trillion RMB ($243.9 billion) in GMV last year -- nearly quadruple Pinduoduo's GMV of 471.6 billion RMB ($68.6 billion). JD's total revenue rose 28% to 462 billion RMB ($67.2 billion) last year. Pinduoduo generated just 13.1 billion RMB ($1.9 billion) in revenue last year, although that marked a near eight-fold increase from the previous year.
Analysts currently expect JD's revenue to rise 18% to $81.1 billion this year, and for Pinduoduo's revenue to more than double to $4.1 billion. JD generates much more revenue than Pinduoduo, or Alibaba, because it takes ownership of the products it sells instead of simply charging transaction fees.
JD's business model, which also includes a massive network of warehouses and delivery services, is much more capital-intensive than Alibaba's or Pinduoduo's. However, JD's massive scale enables it to squeeze out profits, while Pinduoduo remains deeply unprofitable.
Pinduoduo doesn't generate much revenue per shopper, and it's constantly spending more cash on the expansion of its platform and marketing efforts. As a result, its net loss widened from 281.5 million RMB to 1.88 billion RMB ($279.8 million) between the first quarters of 2018 and 2019.
To make matters worse, Pinduoduo is currently being targeted by both Chinese and U.S. regulators for sales of "unbranded" products, which are arguably counterfeit versions of brand-name products. Chinese regulators launched a probe into Pinduoduo's practices last summer, and U.S. regulators recently put Pinduoduo (along with Alibaba's Taobao) on the "Notorious Markets List" over alleged sales of counterfeit products. The list is meant to spark "appropriate action" by governments and the private sector. JD, which exercises tighter controls over its inventories, wasn't targeted by regulators in either country.
The star that burns twice as bright...
All of these facts are true: Alibaba is China's largest e-commerce player by active buyers, JD is its biggest direct retailer by revenue, and Pinduoduo is now the second largest e-commerce platform by active buyers.
Investors should understand these distinctions when they read headlines proclaiming that Pinduoduo "overtook" JD. Comparing these two companies doesn't make sense -- JD Mall is the equivalent of a well-run online department store, while Pinduoduo is an online flea market crowded with low-income hagglers.
Pinduoduo will likely keep growing, but its growth doesn't seem sustainable. It's heavily dependent on low-income shoppers making tiny slivers of group purchases; selling "unbranded" products leaves it vulnerable to regulatory probes; and its losses are widening. JD, on the other hand, runs a tight ship that won't sink.