Deflation in China Is Fueled by eCommerce: Pinduoduo Expected to Play a Role in Price Reduction

Deflation in China: Key Insights

• Decreasing Prices Lower Profit Margins: The price battle to the bottom in China is taking its toll on the many merchants who sell their products on the major eCommerce marketplaces and are seeing their profit margins shrink to stay competitive.

• eCommerce Marketplaces Play a Significant Role in the Economy: Four of the top five eCommerce marketplaces in the world are based in China. The economy is shaped by the moves the largest players make to stay relevant to consumers. But the many small merchants who sell their products on these sites are struggling to remain viable.

China’s deflation is worrying economic analysts who see eCommerce sites as a contributing factor to the overall shrinking price level in the economy. The increasingly low prices are squeezing profit margins, which threatens the many sellers who depend on eCommerce marketplaces for their sales. Because of the widespread push to lower prices, merchants are incentivized to offer products at a threshold below the margin that ensures their business viability. 

Deflation means that prices in an economy are falling, in contrast to inflation, where the price level is rising. Both are undesirable because they reflect an immobile economy where consumer spending is low. In China, deflation now means that consumers are willing to spend less and save more instead. Since this means that the flow of money in the economy is reduced, it takes away from the growth that businesses can generate through increased sales.

Top eCommerce Marketplaces Contribute to Falling Price Levels

The influence of Chinese eCommerce marketplaces is enormous, with four of the top five marketplaces in the world originating in China. While Amazon is still number one, it is outnumbered by the largest eCommerce retailers like Pinduoduo, Alibaba’s Taobao and Tmall and JD.com.

Because of their size and recognition, economies of scale allow these leading eCommerce retailers to offer lower prices while still maintaining a profit margin. Consumers flock to these sites precisely because their prices are so competitive. The top site in China is Pinduoduo, operated by PDD Holdings, which also launched Temu, the eCommerce site that is currently disrupting European markets with the same low-price strategy. 

The New York Times has linked the success of these platforms, particularly Pinduoduo, to the decline in consumer spending in China. While this may seem beneficial on the surface, there is pressure among merchants on the site to compete with the next seller offering a similar product by lowering prices. The eCommerce platforms incentivize lower prices because they benefit from increased sales, price competition and traffic to the site.

But deflation is disruptive to the rest of the economy, where other retailers do not have the resources to compete at this lower end of the price battle. China’s expression of the issue is a clear case in point, but due to the international nature of eCommerce, the rest of the world is not exempt from this.

Sources: Financial Times – New York Times