Alibaba Did Well in China but Is Unlikely to Replicate This Success Elsewhere
Yes, Alibaba—like China—is big. It just had the biggest IPO in the history of the United States, raising $25 billion. The question is: how did it get so big and does its size help it compete in other countries like the United States?
“They had the first mover advantage. This is the kind of business that once you get the scale, it’s hard to be dislodged,” said Linda Lim, a professor for business strategy at the University of Michigan.
In this way, Jack Ma was a visionary when he started copying physical catalogs of Chinese merchandise and made them accessible online for Western buyers to browse. His company emerged just before China’s ascension to the World Trade Organization and just after the dot-com revolution in the West. The timing was perfect.
“They rode the wave of the penetration of the Internet in China. The time was right in some sense. Alibaba put Western companies with manufacturers at the time when China became the factory of the world,” said Puneet Manchanda, professor of marketing at the University of Michigan. “It’s a winner take all model.”
However, becoming big in China is not possible without the blessing of the Communist Party. And Alibaba did have the Party’s blessing.
“They have a very good working relationship with the people who have political power, although it’s hard to say how exactly they have benefited. They have been allowed to flourish in the Chinese and political environment,” said Puneet Manchanda.
Although it is unclear what direct benefits Alibaba received, it was definitely not held back and rewarded its benefactors handsomely with the IPO.
When Alibaba bought back half of Yahoo’s stake in the company for $7.6 billion in 2012, three private Chinese investment firms (Boyu Capital, Citic Capital Holdings, and CDB Capital) indirectly acquired part of Yahoo’s shares. Another investment firm, New Horizon Capital, invested later in 2012.
What do these companies have in common? They were or are run by people who are directly related to members of the current or former Politburo, the highest instrument of power in China. One such person is the grandson of former President Jiang Zemin, Alvin Jiang, who is a partner at Boyu Capital.
Transferring shares from one holder (Yahoo) to another (Chinese investors) doesn’t make sense, unless the transfer is to a strategic partner, which the investors clearly are not. What the transfer did was enable the Chinese investors, instead of Yahoo, to make a windfall.
At the time of the transaction the company was valued at $45 billion, and Alibaba was already planning an IPO. At the current share price of $86, the company is now worth $223 billion, or five times as much. Assuming the investors acquired the shares at Yahoo’s 2012 selling price, they quintupled their money. According to the New York Times, Boyu Capital’s Alvin Jiang invested $400 million (possibly worth $2 billion now), which he may or may not have sold already.
What kind of favors the company received from the regime is only speculation. What we know is that Alibaba enjoys a quasi-monopoly on e-commerce in China and relatives of Communist Party officials in power during Alibaba’s rise benefited handsomely and unduly from its IPO.
This, of course, doesn’t mean Alibaba was in the right place at the right time and managed to get the blessing of the ruling party.
Although it copied a lot of e-commerce elements from Western companies, it did a lot of things right to adapt them to the Chinese market.
Alibaba’s Chinese eBay, Taobao, was founded in 2003 to pre-empt eBay’s entry into China; eBay eventually failed and had to withdraw. For good measure, Alibaba also copied PayPal with Alipay but did it in a way, which would win Chinese consumers over to e-commerce.
“Alipay was essentially designed as an escrow system. In China the idea of paying for the goods without getting it immediately was unheard of,” said prof. Manchanda. “EBay did not understand the Chinese market.”
Because of distrust of merchants, Chinese consumers would not wire money before receiving the product. Alibaba circumvented this issue by setting up Alipay as an escrow account. Consumers would wire the money to Alipay and the seller would only be paid after the merchandise was received in good order.
The approach succeeded handsomely: Taobao handled $55 billion in transactions in the quarter ending June 30, 2014. As a comparison, eBay handled $81 billion in the whole year ending June 30.
However, despite its innovations in China, the company and its sales volume are simply so large because of an obvious but often forgotten reason: the size of China itself and the fact that the country has 1.3 billion people.
And just size is not enough to believe Alibaba is going to take Western markets by storm, as USA Today would have us believe in a recent article titled “Alibaba IPO is Wake-up Call for Silicon Valley.”
The article cites the huge market caps of companies like Alibaba, Tencent, and Weibo as well as recent investments they made in American startup companies.
While it is traditionally hard for Western e-commerce companies to operate in China (eBay and Google didn’t make it, Facebook is not allowed, and Amazon is languishing), Chinese companies in any industry haven’t been successful operating outside their home turf, with the exception of foreign acquisitions.
“I don’t see any advantage Alibaba would have. You would have to learn about the marketplace. [Western companies] are entrenched and a much more sophisticated competition. [Alibaba] is a latecomer. The normal theory is that, if you are a foreigner and you are late, you are at a disadvantage,” said professor Lim.
She said the only way to enter a saturated market is through acquisitions and by hiring talented local management.
Professor Manchanda agrees: “There is no unique knowledge or asset Alibaba can bring to the Western markets. They have to come up with something completely new to bypass the incumbents.” After having copied and modified the Western system of e-commerce in the first place, this scenario is hard to imagine.
And while Alibaba now has around $15 billion in cash to spend, that is a paltry sum compared to that of eBay ($70 billion) and Amazon ($150 billion), which are snapping up human capital and startups all the same.
Both academics agree that Alibaba would be better off investing the money in China, where it can still explore business areas such as infrastructure and logistics, as well as mobile.
“They have not figured out something unique to compete in mobile,” said professor Manchanda, where Tencent is its biggest competitor.
Even Wall Street is not pricing in an expansion to Western markets, according to Jason Ma, a China expert at NTD Television in New York.
“The reason that the investors valued Alibaba stock so high was not because they expect Alibaba would come to the U.S. or Europe, beat out Amazon and eBay, and dominate e-commerce in the Western world. Alibaba’s high stock price was solely because of its domination in China’s e-commerce, and Wall Street’s expectation of the Chinese middle class’s continuous rapid growth in online consumption.”
Married to China
However, while many see the potential for Alibaba to grow in China, author David Stockman believes that even this is unlikely.
“There is no known capitalist market in which a mass merchandiser with no inventories, no stores, no warehouses, no patents, no state monopoly, and virtually no fixed assets whatsoever is worth $230 billion,” he wrote in a recent blog post. “Even in China its 40 percent broker’s margins cannot possibly endure the tsunami of competition it is likely to face.”
He is also worried about the China consumption story, as the economy is slowing down and housing prices are falling from bubble levels.
“The mirage of China’s booming middle class will become painfully evident. Indeed, it is the very same frenetic buyers of stuff on [Alibaba] websites who have jobs, which will disappear when the building boom stops,” he writes.
So the company will be doing well as long as China does well. If China stops doing well, there is nowhere for Alibaba to go.