Social E-Commerce and Market Place 2.0
Social E-Commerce is creating a niche for itself in developing economies
In the past decade, Uber, and Ola have created ways in which people can monetize their time and become self-employed. These platforms took care of business hurdles like demand sourcing, marketplace liquidity, and pricing - allowing a driver to focus on the service. Marketplace 1.0 focused on prioritizing consistency and efficiency by focusing on a homogeneous experience.
This was true for e-commerce 1.0 platforms as well. The idea was to make e-commerce more convenient than an offline purchase, so that users can get educated and accustomed to shopping online. Amazon and other e-commerce platforms focused on price discovery, product availability, speed of delivery, a friendly return policy, etc., with the aim that e-commerce purchase experience should be better than offline purchase experience for a wide category of products. While e-commerce 1.0 continues to work fantastically, early adopters (at least in developing countries) have been the urban middle class that shopped in malls, and purchased branded products. E-commerce 1.0 did not percolate to the same to the masses living in smaller towns and cities.
New marketplace business models are unleashing a slew of internet entrepreneurs, who are focusing on monetizing their individuality. This is not just an India specific phenomenon, rather a worldwide one. We have entered an era of “Passion Economy” where living off the creative/entrepreneurial skills has trickled down to individuals at scale. Whether it is “key opinion leaders”(KoLs) in China, who are able to sell millions of dollar worth of products in hours, or TikTokers and Youtubers who are building their own personal brand - passion economy is likely to be the future of work.
Social e-commerce in India and across the world is a manifestation of the concept of passion economy. It allows users to set-up their own microbusinesses or build their own brand on the platform, without making capital investments that were required to establish such a business in the offline world. Social e-commerce platforms are usually based on 3-P model and handle most of the logistical tasks associated with online commerce (shipping, returns, payment, complaints etc.), allowing resellers/influencers to focus on building their business.
There is no strict definition of social e-commerce, the most generic definition is that social commerce is e-commerce facilitated through the use of social media. This encapsulates a wide variety of platforms, an obvious example of this would be Instagram, which is now one of the world’s largest social shopping platforms. Instagram has fostered a browsing-based feed from friends and influencers of things that might interest consumers, often accompanied with links to purchase. On the other end of the spectrum is Pinduoduo (PDD), which has successfully created a community shopping experience by catering to consumers in lower tiered cities and by selling them daily use value for money items. For India, social e-commerce is taking shape in forms and ways similar to that of Chinese social commerce platforms.
Social E-Commerce in India
E-commerce 1.0 in India focused on the urban middle class (the mall going population, with affinity for branded products). Introduction of 4G data services beyond tier-I cities has brought internet access to 250-300 million Indians. Before smartphones, their only offline retail experiences are from their local marketplace with vendors they have known and trust personally. Such interactions mitigate the concerns that are highlighted when modern e-commerce is proposed to this next wave of users.
These users are not happy with the current online shopping experience. They research online, discover prices but ultimately make the purchase offline. This is due to a lack of trust in the selling platforms. Therefore, product discovery is broken for these users.
But as these users get equipped with internet, Youtube is becoming their television and Whatsapp and Facebook have become their social network. Product discovery and distribution will increasingly take place through these social channels. Digital commerce experiences targeting these users will have to apply analogues of offline retail which these users are more used to. Social commerce platforms, which are more interactive by nature, can enable the transition to online commerce for the new 200 million internet users in India.
Social e-commerce overcomes these hurdles by:
Category education - how to use a product, its utility etc.
Trust building - Place individuals that are known (initially at a 1st/2nd degree) to the audience in a position of being sellers. With their reputation as collateral, the social trust inherent in offline transactions is replicated online. Similarly, an influencer can have his/her personal reputation as a trust building mechanism.
Rich interactions either through live Q&A or reaching out to your reseller any time through Whatsapp - mimicking experience of your local vendor, perhaps in local language.
Enable touch and feel - micro-influencers can communicate about product features through live demonstrations.
Because of these reasons, user profile and core customer base for social commerce has gravitated towards tier II through tier IV cities. Social commerce offers users in lower tiered cities a new platform to reach consumers in their community. For instance, the user base for reselling based apps comprise of housewives, teachers, students (90% women, 70% housewives). That come from mid & low-income households (<$10K/annum), 80% from tier-2, tier-3 cities. Moreover, these resellers use social ecommerce platforms to set-up their own microbusinesses with little to no capital.
Apart from the trust aspect, social e-commerce has a value for money proposition as well - which makes the business model viable in the longer run. Social e-commerce platforms disintermediates the usual commerce supply chain and allows suppliers/manufacturers to sell directly to consumers. For a traditional retail model, before products reach the customer, the product goes from factory, to the brand, to the distributor, then finally to the retailer who sells it to the customer. Each step requires an intermediary, who must make a margin. In India this supply chain is further complicated by a blackbox delivery network, which social commerce players can help simplify.
1P and 3P e-commerce business models partially solve for this blackbox supply chain. In a 1P model, brands/e-commerce players procure from factories then sell to consumers. In a 3P model brands/wholesalers open a flagship store on the marketplace and then go directly to the consumer after procuring from a factory. But in a social commerce player like Pinduoduo, the supplier/factory sells directly to the consumer, with distributors in between, resulting in value creation for both the customers and the supplier. The same can be replicated by Indian social commerce platforms.
Market Sizing and TAM
Sizing TAM is always error prone and it is more art than science. When sizing TAM for high growth e-commerce companies, I want to determine whether the TAM is large enough to allow the companies to grow sustainably at 20%+ rate for next decade. To size the TAM for social e-commerce players it is important to size the TAM for e-commerce in India.
It is still day 1 when it comes to e-commerce growth in India. Indian e-commerce players did a GMV of $35bn in 2019. E-commerce GMV is expected to grow at 29% over the next 5 years (source: Goldman Sachs). Beyond 2025, I expect the growth rate to continue at high-teens to make e-commerce a ~$300bn GMV category (please note there are multiple studies out there, with a similar GMV number for Indian ecommerce).
Paypal conducted a consumer survey in India which shows that 80% of the small and medium businesses surveyed have sold directly through Whatsapp in India. It’s not surprising, Whatsapp at over 400 million users, has 4x-5x bigger daily active user base than any e-commerce platform in India. India has just hit $2000 of GDP per capita mark, which is where a lot of emerging markets start experiencing acceleration in consumer spending. But what’s really unique about India is that India is the first major economy where internet penetration has preceded household income growth. As consumers climb the income ladder, they will discover new products, that satisfy their aspirational needs, online. This should lead to a snowball effect and new digital native businesses can achieve non-linear growth and scale at a much faster rate than what has been witnessed in the western economies.
This is the reason that Indian e-commerce landscape is likely to evolve in a manner similar to China. To understand the opportunity for social e-commerce players in the $300bn TAM e-commerce market, one needs to look at the progression of social e-commerce in China. Social e-commerce in China has grown rapidly, PDD now accounts for 14% of total e-commerce GMV in China with annual active buyers reaching 97% of Alibaba’s (BABA) active buyers.
Social commerce in China is close to 15% of e-commerce GMV (i.e. PDD+Yunji+other platforms). If I apply a similar social e-commerce market share to India’s $300bn 2030 e-commerce GMV then social commerce can be a $45bn GMV category. I believe these numbers are not very aggressive, one can argue that Indian social e-commerce players have come to the market when the e-commerce scene is still shaping up, with the two biggest incumbents having <65% market share vs China’s incumbents having 87% market share when social commerce was launched. This means new e-commerce players have a bigger whitespace opportunity to capture.
There are other numbers that expect social e-commerce to be a $70bn opportunity. $45bn can be a good lower bound for social e-commerce opportunity. This is still 1.3x of total e-commerce GMV of India in 2019, which implies that opportunity in front of social e-commerce players is huge.
What Contributed to PDD’s success?
Founded in 2015 in an industry where the incumbents (i.e. Alibaba and JD) held strong positions, Pinduoduo (PDD) has managed to emerge as the #3 e-commerce player in China by GMV within three years. When PDD was launched, JD and BABA generated a combined GMV of $433 bn. And within five years, PDD has gone from a start-up to a $175bn market cap company.
Pinduoduo found room in e-commerce, not as a competitor to search-based websites like JD, but as a new e-commerce platform focused on interactive and social shopping experiences online. Pinduoduo pioneered the innovative “team purchase” model in China, where buyers use popular social networks to invite social contacts to form a shopping team and enjoy more attractive prices. PDD leveraged social networks such as WeChat and QQ, to allow a “team captain” to share the product with friends and relatives to form a team and get a discounted price. Nearly all Pinduoduo transactions are completed using team purchase. In the early days, the size of many groups was large (e.g., 10+), but as Pinduoduo has scaled the group size requirements have declined.
Team purchase is beneficial to both buyers and manufacturers; buyers benefit from better prices for goods and sellers benefit from increased demand and better visibility of future demand. In addition to driving down prices, team purchase helps solve the “trust deficit” of retail in China’s developing cities, where more than 80% of retail is unorganized and consumers rely heavily on social recommendations to initiate transactions.
Best selling products on Pinduoduo include household staples such as tissues, detergents, diapers and fruits (often shipped directly from the farm). Over the years, it has become more difficult/more expensive for value-for-money (i.e. lower ASP) products and merchants to acquire traffic and operate stores on major e-commerce platforms. In the search driven model, organic traffic is usually centered on top merchants based on ranking algorithm. Paid traffic gets more expensive for other merchants each year. Pinduoduo’s team purchasing model relies less on keyword search, and offers relatively cheaper traffic to value-for-money product merchants. These products could be mass-produced at attractive price with economies of scale.
This value-for-money product selection, together with Pinduoduo’s team purchasing model, have brought onboard customers who were not active in online shopping before. This is the reason that 65% of PDD's customers are based in tier-3 and below cities vs 52% for the overall mobile shopping population as of 2018.
PDD generates revenues from marketing services, as well as commissions (which are fully passed on to payment service providers). Pinduoduo has got a unique value proposition which is value for money and that value proposition is very unlikely to change, and it also means it's going to be difficult for Alibaba and JD to stop PDD from gaining further market share. PDD should be able to reach profitability, although the profit margin is going to be lower than BABA's. Monetization rate for PDD will go up and sales and marketing will be able to come down. But consumers don’t trust PDD with higher ticket items. A dollar of GMV sold on PDD will be less valuable than a dollar of GMV sold on BABA or JD. The steady state numbers for PDD’s gross margins can easily be half of BABA’s e-commerce margins, but this still will be much more profitable compared to where PDD stands today.
There are three main takeaways from PDD’s success which will be relevant for Indian social commerce players:
Team purchase drove organic sharing of the product and as a result Pinduoduo was able to grow its user base very quickly. In five years, Pinduoduo has grown to 680 million annual active buyers. To compare, Alibaba took 15+ years after launch of its consumer facing marketplace to reach such a number.
Team purchase element and group discounts have been unique to China and PDD, therefore, it is reasonable to expect that Indian social e-commerce players will take longer to scale than PDD. But Indian social e-commerce platforms do have value for money proposition, i.e. better prices than offline retail and better prices relative to incumbents. This will allow them to scale faster but not at the same rate as PDD.
Lower tier city focus and PDD’s success in that income bucket demonstrates that Indian social e-commerce players have a right to win in lower tiered cities. These platforms are serving an unmet need of customers and the success is not just driven by current cash burn.
Profitability and take rates for PDD are expected to be lower than that of established e-commerce players. There are certain natural limitations on product categories that can be sold on social e-commerce platforms. If a platform can build a reputation on product quality and match that with value for money aspect - then this could be a long-run moat for the system.
In the world of excess liquidity, a big TAM will attract many competitors. There are multiple competing concepts within social e-commerce, which can be broadly categorized in three buckets:
Reseller Model: This is the most common form of social e-commerce model. The two-sided marketplace will have wholesalers/suppliers on the supply side and resellers on the demand side. Suppliers will list products on the app along with product description and price. Platform usually charges a take rate on the product, which varies by category (10%-20%). The other side of the marketplace is a reseller, who shares the product catalogue with his/her social network through Whatsapp or other means. Reseller adds his/her margin on each product, and keeps this margin as an earning. If someone in the reseller’s network wants a product, then the reseller places the order. The buyer gets the product directly from the wholesaler/manufacturer and pays either cash on delivery or pays to the reseller (if paying digitally). In the entire process, platform allows resellers to build their own micro-business/brand. For instance, when the product details are shared by reseller on Whatsapp - there is no mention of the platform or the wholesaler. Even during the shipment, care is taken that there is no mention of the platform in the invoice. This ensures that the reseller is able to create his/her own brand and platform does not dilute resellers’ business.
To achieve platform liquidity, getting the demand side/resellers on the platform is essential. Most companies offer a commission and a bonus to resellers on achieving certain milestones. Right now, all players are in a cash burn mode and are spending aggressively to acquire resellers and retain them through generous incentive structure. Reseller based platforms include Meesho, Shop 101, GlowRoad, etc.
Graphic representation of the ordering process at Meesho
Influencer Model: This model is slightly different from reseller model. A micro-influencer/host promotes the product during a live steam video or through pre-recorded videos. It aims to make online shopping more engaging and social, while offering consumers the opportunity to discover new products. These apps provide a platform for hosts to demonstrate products live, and answer viewers’ questions on a real time basis. Some apps also plan to offer group buying and sharing features that allow viewers to involve their friends and family for a more social experience. A future state may involve offering live streams in local Indian languages, targeting a wider range of local-language speakers and consumers outside major urban centers who may not find existing English-language e-commerce platforms accessible or engaging. Influencers/hosts get a commission from submitting an approved video and through sales made on the platform. These platforms can do a good job at educating consumers on categories that need product demonstration and education. The success in this model will be determined by how much following an influencer can generate - which will lead to demand aggregation.
This is still a nascent but promising category with BulbulTv and SimSim being the two major players in the category. I appreciate the value add that micro-influencers can provide to the long tail of unbranded products that sellers find difficult to sell on Amazon and Flipkart. And given the amount of content creation that happens on TikTok, ShareChat, and Moj, it is natural to believe that live-streaming has huge potential in India. Moreover, with unbranded products comes higher commission structures, which is an advantage that live-stream based commerce firms enjoy over other e-commerce companies.
Other social e-commerce platforms: This category includes platforms like Mall91, which can be considered as a hybrid of reseller based and video driven e-commerce platforms. Mall91 has an approach to deeply engage its users through multiple additional high engagement, high frequency use-cases in the form of mini-apps around social gaming, social content, utilities and entertainment. And lastly, there are concepts that are trying to emulate Piduoduo’s success in Indian grocery market (Deal Share).
Determinants of Success
Though the barriers to entry in social commerce are lower than physical retailing but barriers to scale in an online marketplace are much higher. Like e-commerce, competitive advantage in social commerce usually comes in the form of strength of network effects, brand value, and scale, among other things. As an online marketplace scales, it generates more organic traffic, which lowers customer acquisition cost or rent that is payable to Google/FB. While big e-commerce players dominate the online space, carving a niche of loyal customers can be an important way to get the flywheel going for a nascent social commerce platform. In social commerce, success will be a function of a platform’s ability to aggregate demand. Therefore, organic traffic and loyal customer base will be sources of competitive advantage in social commerce.
As of now most companies are focusing on acquiring the demand side of the platform. Acquiring supply has been much easier and I am confident that many wholesalers exist on multiple platforms. For suppliers, social is a distribution channel for their products which helps widen the audience, improves customer experience, and builds loyalty. Getting demand side requires significant investments in acquiring users and influencers to the platforms. This is the reason that most platforms are providing commissions, bonus, and other generous payouts to attract users to the platform and drive GMV and attain platform liquidity in the process.
Apart from GMV growth, it is helpful to track reseller/influencer level metrics. The more demand side earns from the platform, the more engaged and dedicated they will be to drive the growth of the platform. Therefore, tracking the number of successful creators and their average payout is crucial for the viability of the ecosystem. Similarly, tracking time to first sale and actual number of earning resellers/content creators is important. The sooner first sale is made, the more likely demand side sticks with the platform.
Lastly, product quality, customer service and merchant management can become a differentiator and competitive advantage. There have been concerns around the quality of products (as these are unbranded products), which can jeopardize reseller/micro-influencer reputation, leading to customer attrition and opening a window for traditional e-commerce players to sell to this new breed of e-commerce savvy customers in tier II and tier III customers. I consider this as one of the biggest risks for social e-commerce platforms.
Pinduoduo faced product quality issues and its public perception was impacted. For any social e-commerce platform, faulty/counterfeit products selling on the platform could damage the brand reputation or at least limit its TAM to low ticket items. Standards set by Amazon are cost of doing business in e-commerce and any platform that wants to make it big has to meet or exceed those standards.
P.S. - I do not work in VC industry; the information I have gathered is through public sources without talking to the management teams of any of the companies mentioned above. I have tried applying analogues from e-commerce 1.0 during this analysis.
PDD 2Q20: GMV miss outweighs margin improvement (published by Alliance Bernstein on 20th Aug 2020).
Best Proxy to eCommerce Take-off in Lower-Tier Cities (Morgan Stanley, Jan 15, 2019).
PDD 2Q20: GMV miss outweighs margin improvement (published by Alliance Bernstein on 20th Aug 2020).
2020 China E-Commerce Summit: What can China and US ecommerce learn from each other? (Webinar Transcript; Alliance Bernstein, July 29, 2020).