PDD Holdings' Margin Sacrifice: A Calculated Gamble for Long-Term Dominance

PDD Holdings (NASDAQ: PDD) has long been a bellwether for China's e-commerce landscape, but its first-quarter 2025 results reveal a bold strategic pivot: prioritizing merchant ecosystem health over short-term profitability. This shift, marked by a 38% plunge in operating profit to RMB16.09 billion, underscores a calculated risk—one that investors must weigh against the promise of sustainable growth. Here's why this trade-off could be a winning bet for patient investors.

The Trade-Off: Growth vs. Profitability

PDD's revenue rose 10% year-over-year to RMB95.67 billion, driven by its core online marketing and transaction services. Yet profits cratered as the company poured resources into its “100 Billion Support Program,” which reduces fees for small businesses, funds marketing campaigns, and shores up operational resilience. The move reflects CEO Lei Chen's belief that “healthy ecosystems outlast quick profits.”

But how sustainable is this margin compression? Let's break it down.

Why the Strategy Makes Sense

1. Merchant Retention is Key to Long-Term Dominance
   PDD's platform thrives when SMEs thrive. By reducing fees and offering marketing support, PDD is ensuring its ecosystem remains vibrant. A healthier merchant base attracts more consumers, creating a flywheel effect: more sales → more data → better algorithms → better user experience. This is a classic “ecosystem flywheel” play, akin to Amazon's early investments in third-party sellers.

2. Navigating Regulatory and Economic Headwinds
   PDD's leadership acknowledges external pressures, including tariff hikes and shifting policies, which disproportionately affect SMEs. By absorbing some of these costs, PDD is positioning itself as an indispensable partner. As Co-CEO Colin Zhao stated, “A resilient merchant ecosystem delivers better shopping experiences for consumers.”

3. Cash Reserves Provide a War Chest
   With RMB364.5 billion ($50.2 billion) in cash and equivalents, PDD has the liquidity to sustain this strategy. Compare this to peers like Alibaba, whose cloud investments have also pressured margins. The difference? PDD's focus is purely on its core e-commerce ecosystem, avoiding costly diversification.

The Risks—and Why They're Manageable

Critics will point to the 43% surge in sales and marketing expenses (to RMB33.4 billion) and question whether the ROI justifies the hit to profitability. Yet consider this:
- Margin Recovery Potential: Once SMEs stabilize and scale, they'll likely spend more on PDD's marketing tools, reversing the current drag.
- Competitive Advantage: PDD's merchant-centric model differentiates it from rivals like JD.com, which leans on first-party logistics. This could pay dividends as consumers prioritize value and choice.

Is Now the Time to Buy?

PDD's stock has underperformed peers in 2025, down 15% YTD as investors focus on near-term profits. But this creates an entry point for those who see the bigger picture.

Backtest the performance of PDD (PDD) when 'buy condition' is triggered on quarterly earnings announcement dates and 'hold for 20 trading days', from 2020 to 2025.

Historical backtests from 2020 to 2025 reveal that such a strategy would have yielded an average return of -40.19% over the holding period, with a maximum drawdown of -55.56%. This underscores the importance of a long-term perspective, as short-term volatility has historically overshadowed PDD's strategic trajectory.

Final Analysis: A Buy for the Next 3–5 Years

PDD's margin compression isn't a failure—it's a strategic choice. With a fortress balance sheet, a proven track record of ecosystem-building, and a focus on SMEs (which account for 90% of China's businesses), this bet has legs. Investors willing to look past the next quarter could reap rewards as PDD's ecosystem grows deeper and more defensible.

The question isn't whether PDD can recover profitability—it's whether it can dominate an e-commerce landscape where merchant health is the new moat. For now, the answer looks promising.

Act now—before the ecosystem rebuilds itself.