China's e-commerce business remains a gold mine in the eyes of many investors despite its massive growth in recent years. But as new and innovative business models continue to emerge, investors may find themselves stepping onto land mines if they do not examine their investments carefully.
One example is Tencent's recent decision to quit the fundraising round of e-commerce site Beidian. The young Chinese startup has a unique business model which appears to have some characters that make it looks like a pyramid scheme.
"Social e-commerce" sites like Beidian ask every customer to pay a membership fee and promise a commission for every new member they recruit. The customer can also get a commission from every product sell via the site to other members.
These companies call themselves social e-commerce platforms because their growth is mainly driven by the increase in user numbers. That differentiates them from tradtional e-commerce sites which are mostly valued by their transaction volume.
Some investors have endorsed the new business model, as evidenced by two recent fundraising cases by two of these so-called social e-commerce sites, each valued at about Rmb800 million ($119 million).
Beidian, part of mother and baby products site Beibei, is seeking at least $50 million from Hillhouse Capital and other investors, although Tencent backed out from its current fundraising. It now ranks the second among all Chinese social e-commerce website by user number.
Global Scanner, another social e-commerce site, ranks third and is raising money from Shunwei Capital and other investors, according to a source familiar with the fundraising.
These social e-commerce sites only started operation about two years ago. But their valuations have skyrocketed together with their user base.
Global Scanner’s valuation increased to $800 million from the $296 million in February last year, according to the source. Monthly sales of Beidian and Global Scanner rose to around Rmb1 billion each due to their exlarged user base.
“Users were motivated by the commission fee of every new member they recruit, and it is how these platforms grew so big in a short time,” the source said. “These social e-commerce sites have already started to make a profit after two or three years of operation.”
These platforms act as the middleman between customers and the manufacturers. They gather a huge amount of purchase orders and get a cheaper price for the products it provides. And the main revenue growth of these platforms is generated by the paid membership.
From the users' perspective, these platforms offer them cheaper products while giving them the commission from promoting the products to other members - another way to earn extra money.
Such a business model stimulates users willingness to recruit new members. What most users do is to solicit more downline members after joining, instead of enjoying discount or selling product to the downline users.
Beidian and Global Scanner both have the same business model, as new users first need a reference code from existing users to become members and, in turn, can earn commission for every new user that registers using their own reference code.
It's an area that is generating some investor interest, which explains why China's biggest "social e-commerce" site Yunji received $120 million in funding last April from CDH Investments and China Renaissance.
There is no doubt that it is a clever business model, as many of these platforms maintain a rapid growth and a positive cash flow.
But it is definitely a grey area. In 2017, Yunji was fined by Hangzhou Binjiang District Market Supervision and Administration for Rmb9.5 million for its similarity to pyramid sales. Yunji later issued a release saying its business model is different and already rectify its disputing part.
Besides, the products sold on these platforms are all purchased from third-party franchises and some are the “special edition” for these e-commerce sites. Such an arrangement made users hard to trace the source of product selling on the platforms.
And the way these sites acquire customers is still debatable. Chinese regulators have not yet banned this “pyramid-sales-like” business model yet, but investors still feel it is a very sensitive area to comment about.
Tencent, as an investor who would like to attend the investment, quit the fundraising because it felt a bit risky to invest in this uncertain business model, according to the source.
The source said Beidian, Global Scanner and Yunji all plan to list in Nasdaq in about four years’ time, as investors would like to exit before Beijing starts to regulate this business. Perhaps it is better for investors to keep an eye on this rapidly growing business before putting the money in.