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Monday, January 24, 2022

The Fight For China’s Third Quartile Of Consumers

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It used to be that China’s e-commerce was oriented to the top two quartiles of consumers, the affluent and the upper-middle class. It was a way for those who were already enjoying a good life to thereby enjoy a better life. But today perhaps the fastest-growing segment in China’s e-commerce is the third quartile, composed of middle and the lower-middle class consumers. Of course, in China even one quartile of the population is 350 million people, a goal well worth pursuing.

So in addition to helping consumers to purchase premium and luxury brands, it is also a way to sell products—not just brands—across the value spectrum. These new channels work best in the commodity and un-branded space, where the consumer needs a functional product and is not as concerned about the label.

The almost universal availability of the internet was part of this evolution. The drop in price of personal computers and smartphones was also part. And the demonstration effect of the major channels, such as Tmall and JD, helped establish awareness. But none of that was primarily oriented to the third quartile.

Pinduoduo ($PDD) found success by first moving to this quartile with an emphasis on household goods and offering group-buying features that encourage social sharing. Although Pinduoduo’s annual revenue of $9.1 billion is eclipsed many times over by Alibaba’s $72 billion from its last fiscal year, the e-commerce app has managed to make huge inroads since it was founded in 2015.

In fact, Pinduduo recently announced that it had reached 788 million active consumers at the end of 2020, surpassing the 779 million users at Alibaba’s online marketplaces. But today, China’s internet sector is faced with increased regulatory scrutiny at the same time that Pinduduo will have to contend with growing competition from rivals like Alibaba ($BABA) and its Taobao Deals.

Taobao Deals

Taobao Deals is a factory-direct channel that Alibaba calls C2M or consumer-to-manufacturer as it allows the original manufacturer of the product to sell directly to the consumer. This is an additional channel for consumers to purchase daily essentials and household necessities. You can find an electric toothbrush, for example, for 9.9 yuan (about $1.50).

You might think this is Manufacturer-to-Consumer, but C2M is probably more accurate because the process involves a consumer pull as much as a manufacturing push. E-commerce allows for a collaborative process and manufacturing adaptation more than any other sales channel.

A case in point is the Jinye Paper Company in Hebei. This toilet paper company had sold little outside its home province, but now sells 200,000 orders a month through Taobao Deals. It got there because it could see through e-commerce that the consumers liked its virgin paper rolls, preferring a natural look and feel. This e-commerce feedback mechanism and scale is a tremendous boon to the manufacturer who otherwise might take far longer to achieve national distribution

Having just celebrated its one-year anniversary, Taobao Deals claims to have already reached 100 million Monthly Active Users (MAUs) who are being served by some 1.2 million manufacturers. Alibaba first found success in traditional retail with Taobao and Tmall and now it is venturing into traditional wholesale with Taobao Deals. The analogy is not exact because Taobao Deals is a retail sales channel, but it takes the wholesaler out of the mix.

Consider agriculture and food products, one of the fastest growing segments on Taobao Deals. Historically, the enoki mushroom farmer was entirely dependent on the wholesaler to market the goods. Through Taobao deals, the farmer can achieve national distribution directly—like the toilet paper company—and bypass the wholesaler.

Pinduoduo certainly deserves credit for its rapid growth by pioneering the third quartile. It found an underserved segment in the market and then catered to its needs, but the company still has yet to turn a profit since its listing on the Nasdaq in 2018.

JD has been quiet about its approach to the third quartile, but I suspect we will see an initiative from them this year as well. They have the national retail and logistics footprint, but have historically focused more on the premium segment, with great deals on smartphones and HDTV.

All of this means the battle for Chinese consumers has shifted to the third quartile, with the major competitors jumping in aggressively—to the benefit of consumers and manufacturers alike—and with ongoing growth potential for China’s e-commerce.

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