[sociate] K@W - Open Sesame? Or Could the Doors Slam Shut for Alibaba.com?

http://knowledge.wharton.upenn.edu/article/1221.cfm

Open Sesame? Or Could the Doors Slam Shut for Alibaba.com?

In the tale "Ali Baba and the Forty Thieves," Ali Baba, a poor woodcutter,
uses the magical phrase "Open, sesame" to gain access to the cave where the
thieves have hidden their treasure. In a modern-day version of the story,
Jack Ma, an entrepreneur who grew up in modest circumstances, also has a key
to unlock riches. The difference, though, is that Ma is a real person and
his portal to wealth isn't a cave but the Internet. Ma is founder, chairman
and CEO of Alibaba.com, a China-based e-commerce company that has
established a global reputation as a major player in bringing buyers and
sellers together in cyberspace.

Ma, a former schoolteacher, and 17 colleagues launched the company in 1999
from an apartment in Hangzhou, which is south of Shanghai in eastern China.
Since that time, Alibaba has grown into three online marketplaces serving
the business-to-business, business-to-consumer and consumer-to-consumer
segments. Alibaba has a solid reputation in China, where it is a household
name and Ma is something of a business hero.

Faculty members at Wharton and other researchers and analysts around the
world who follow Alibaba say the company has done an exemplary job at using
its knowledge of China to grow its businesses there. The question is whether
Ma, in the months and years to come, can expand his business in other
countries while at the same time increasing his share of the intra-China B2B
market being fueled by exploding domestic economic growth. Ma and his
management team also are engaged in a showdown with global online auction
leader eBay for preeminence in the large and growing C2C space in China,
where there are an estimated 100 million Internet users.

Right now, Alibaba's sites display information about businesses and products
that bring buyers and sellers together. In business jargon, Alibaba acts as
an "aggregator" that serves as a go-between, according to Alberto Luiz
Albertin, professor at the Getulio Vargas Foundation's Business school in
São Paulo, Brazil. But the sites are largely free of charge, and once users
of the sites find each other, Alibaba does not finish the transaction; the
users contact one another to do the deal. A central challenge for Ma is to
become an online transaction service that takes a fee for each transaction
it makes possible. Ma must adjust his business model to ensure that the
company provides more value to customers than it does now and develops new
sources of revenue, these experts say. This is especially critical if
Alibaba decides to do an initial public offering. Many expected the company
to offer shares to the public in 2004, but it did not do so.

"One of Alibaba's biggest strengths is that it's located in the middle of
one of the world's largest collections of factories, near hundreds of
thousands of suppliers," says Wharton operations professor Ravi Aron. "And
being able to speak the language and understand the culture is very, very
valuable. It's by no means an insignificant strategic asset. That said,
other companies can come in and beat Alibaba at its game."

"It's too early to claim success," says Francesco D. Sandulli, head of the
Internet business management department of the Complutense University of
Madrid. "On numerous occasions, Ma has had to defend himself against charges
that his business model is fragile."

According to Wharton management professor Marshall Meyer, "the question is
whether the business model is sustainable. No doubt Jack Ma has accomplished
a lot, but what Alibaba does going forward, who can tell?"

A Focus on Small Firms

Alibaba has three businesses, each of which has a distinct target market and
portal. Alibaba International (www.alibaba.com) is an English-language
website that facilitates business transactions between small- and
medium-size enterprises (SMEs) in China with businesses worldwide. It has
one million registered users in more than 200 countries. Alibaba China
(www.china.alibaba.com) is a Chinese-language site that focuses on buying
and selling among small- and mid-size businesses in China. It has more than
five million registered users. Alibaba China's subscription fee includes
authentication and verification, by a third-party credit agency, of the
member's identity. The third business, TaoBao (www.taobao.com), is China's
most popular C2C site and is the business that is in direct competition with
eBay within China. TaoBao means "treasure hunt."

Alibaba has been successful because it recognized it could fill a gaping
market need: China has virtually no printed directories or electronic
databases that allow companies to describe their products and help buyers
and sellers find one another while providing a certain level of comfort that
the firms are on the up and up. Moreover, Alibaba focuses on mom-and-pop
businesses in China, of which there are untold numbers, rather than trying
to facilitate transactions between multinationals, which often have their
own web-based systems for dealing with suppliers, and other big companies.

Alibaba "offered a platform where China manufacturers can reach world
exporters and vice versa," says Safa Rashtchy, an e-commerce analyst with
the investment firm Piper Jaffray. "It's a pretty inefficient system [in
China] right now. The company figured if it signed up all the manufacturers
in China and carefully listed their products and made them available to the
U.S., Europe or wherever, it could extract good revenue. That's what they're
doing." Rashtchy credits Ma with achieving success in an underdeveloped
economic environment. "He's a highly determined man."

Yuxin Chen, a marketing professor at New York University's Stern School of
Business, says Alibaba's major advantage is that it is located in a country
that has emerged as the "manufacturing base for the world. Most companies in
China doing exporting are not big companies. So for them, Alibaba provides a
good platform." In addition, Chen likes the synergy provided by Alibaba's
three portals. "Those [small-business] sellers who use Alibaba will also use
Taobao," in much the same way that small-business owners who use eBay to
sell goods may also buy and sell items as consumers on eBay.

Generally, access to Alibaba's portals comes free of charge. But users also
can sign up for "premium" content. For companies using Alibaba
International, there is an annual subscription charge of $5,000 to $8,000.
For companies using Alibaba China, the cost is $300 a year. Generally,
companies that sign up for "premium" content can provide more details about
the products they offer, obtain personalized web pages, authorize payments,
and get preferential positioning on the portal. Alibaba offers a
secure-payment service called AliPay, which is similar to eBay's PayPal and
Moddo's ModdoCash.

Buyers and sellers using Alibaba's websites engaged in about $5 billion in
trade in 2004, according to the company. Alibaba, which employs 2,000 people
in China, the United States and Europe, is the only import-export
marketplace named "Best of the Web" five years in a row by Forbes magazine.
The company had $68 million in cash revenues in 2004.  

In Search of Revenue

But the company knows it must continue to innovate. "Currently, Alibaba's
management is considering new sources of revenue," says Sandulli. "They may
begin to charge commissions for their AliPay service. They may also launch a
new service that allows Chinese customers to search for offers using
keywords. They are also starting to consider ways to increase their
advertising revenues."

Wharton's Aron says obtaining new sources of revenue will be pivotal for
Alibaba going forward because of some inherent shortcomings in its B2B
business model. Typically, firms like Alibaba have primary revenue streams
(derived from charging customers for value-added services); secondary
streams (subscription fees and listing fees); and tertiary revenue streams
(advertising and fees for providing links to other sites).

"Most of the B2B companies that went under in the U.S. [when the Internet
bubble burst in 2000] did so because the revenue stream was tertiary, which
is easily lost," Aron explains. "The problem with SMEs is that, by their
nature, you're restricted to making money off commissions and advertising."
Another shortcoming is that Alibaba at the moment offers none of the
value-added services that major corporate buyers and sellers look for, such
as the ability to track shipments from start to finish in real time -- known
as "pick, pack and track" -- or manage invoicing or escrow accounts.

Major corporations -- in industries like chemicals, plastics or steel --
already have their own sophisticated procurement systems in place, which
Alibaba cannot match. As things stand today, successful B2B models are not
third-party B2B companies but private B2B markets owned and operated by
companies like GE, IBM and Boeing, according to Aron.

"The Chinese B2B market is immature," notes Aron. "It is indeed the world's
low-cost manufacturing destination of choice, but that does not mean it is
very sophisticated in its ability to handle information. Chinese suppliers
of most goods have fairly primitive information systems. So I don't worry
about third-party B2B companies going to China and knocking Alibaba off the
table. A shallow portal [like Alibaba] does not support value-added
services. But if Alibaba can get significant traction in vertical companies,
then it may be able to stand up to the behemoths of the West."

Sandulli in Madrid echoes Aron's view. "One of the problems Alibaba faces is
its horizontal quality. It is involved in too many sectors, and it loses the
ability to adapt to them the way a vertical portal such as Moddo in Spain
adapts in the footwear sector. Moddo offers services that are very close to
the companies in its sector, and delivers much greater added value than
Alibaba does. As a result, it has a more complete revenue model. For that
reason, I think it will be easier for vertical global markets to achieve
success than for markets that are more horizontal."

According to Sandulli, Alibaba's chief B2B competitors at present are Global
Sources in China, IndiaMart in India, and ECeurope, which is focused on
Asian business, despite its name. In addition, there are portals that offer
classifications and directories, including Yahoo, as well as eBay's consumer
business.

Sandulli also points out that although Alibaba has worldwide customers, the
company cannot truly be considered a global portal. "Although suppliers from
other countries such as India and Russia have joined this portal, most of
the companies tend to be Chinese. For each European company in Alibaba,
there are about three U.S. companies and eight Chinese companies. In other
portals, such as ECeurope, the ratio of Chinese companies is not that high."

Jack Ma's View

In an interview with Knowledge@Wharton, Ma, a slightly built man who speaks
fluent English, alternates between self-confidence and self-effacement. He
is aware of both what Alibaba has accomplished so far and the potential
pitfalls and opportunities ahead.

"Our B2B commerce site reflects our understanding of e-commerce in both
China and the world," says Ma. "We created our own style. Just a couple of
years ago, few people even recognized us as e-commerce, and now there are so
many B2B sites in China that all identify with us. We seem to be viewed as
the B2B standard, which I don't think is necessary. B2B has various formats,
and there are many ways to establish a big marketplace to help mid- and
small-sized companies succeed and make money. So B2B would exist even
without us, but it would likely be a B2B different from Alibaba."

Ma adds that "it's impossible for Alibaba to be unchallengeable" and that "a
lot of people are imitating us." He goes on to say that Alibaba is still a
small company -- "a kindergarten kid at most." He says Alibaba's success "is
due to our determination, but it's also accidental to some extent. We
believe in ourselves and don't care how other people view us, but care how
we view the world."

Alibaba's main domestic competitor in consumer e-commerce is EachNet, a
Chinese-language site that predates Taobao and was acquired in 2003 by eBay,
which is based in San Jose, Calif. eBay has said it will spend $100 million
to strengthen its presence in China in 2005. According to Forbes, eBay CEO
Meg Whitman told analysts earlier this year that China is a "must win" and
"is likely to be the defining measure of business success" on the Internet.
Alibaba says that in the first quarter of 2005 it passed EachNet as China's
largest consumer e-commerce site with $120 million in gross merchandise
volume, compared with EachNet's $85 million to $90 million. This advantage
may not last long if eBay throws its considerable financial resources behind
EachNet to further strengthen its position vis-à-vis Alibaba. eBay reported
revenues of $3.27 billion and net income of $778.2 million for 2004. For the
first quarter ended March 31, 2005, revenues were $1.032 billion and net
income was $256.3 million.

EachNet may be an older company than Taobao but Ma says he does not believe
that "the first-mover advantage is insurmountable. The followers can succeed
if they are determined and have strong execution capabilities. In fact,
EachNet was established five years before Taobao. So EachNet was the first
mover. But in the end, it's the execution that counts the most."

Ma appears more concerned about competing against eBay globally than against
EachNet domestically. "In terms of competitors worldwide, I think that only
eBay has the understanding and the capability, while EachNet doesn't. By way
of illustration, some people say dogs and wolves look alike, but they are
different animals. A wolf would know a wolf. We know that eBay is a lot like
us.... eBay also has realized that Alibaba is the only animal in the world
that is just like itself. It's because we share the same understanding about
the Internet, about interaction, about community, and about the
establishment of an e-marketplace. But EachNet doesn't share such an
understanding; it established only a website. So our beating EachNet doesn't
mean we can beat eBay."

Going Public

Asked about an IPO, Ma responds: "We don't know when we will go public, but
of course we embrace change. If we really are to go public, it could happen
quickly, because we're ready for an IPO. But we don't have a detailed IPO
plan; we're still very focused on our business. Secondly, our financial
conditions are expanding very well, and very comfortably. We have a big cash
reserve, which probably is at least equal to that of any other Internet
company in China. And our cash profits are among the best, compared to any
other Internet companies in China -- even including those that are already
publicly traded. We have a lot of cash, and we have a lot of things to do.
So we don't think that an IPO is the most important thing for us. We can
still expand if we want to expand. But at present, there is not a single
company we want to buy."

Rashtchy of Piper Jaffray agrees that there is no immediate need for Alibaba
to go public and says he feels that Ma is being wise in biding his time. A
company and its investors should wait until they achieve "good critical
mass" before going public, Rashtchy says, adding that Google could have gone
public several years before it finally did so in 2004. Doing an IPO also
"creates expectations" that a company may or may not be ready to meet.

But Wharton's Meyer says Alibaba's decision not to do an IPO last year may
be a sign that the company has much more work to do in convincing investors
it can grow. The decision also is an indication that China, even with its
burgeoning economy, is still a place where transparency is rare and accurate
information about companies wishing to buy and sell on the Internet is hard
to come by.

"It was clear they wanted to do an IPO last year but didn't," Meyer
explains. "What does this tell you about Alibaba and China? This is a
business that thrives in the vacant spaces, the interstices. It reminds you
that China is still a developing economy, not a mature economy. Western
society is full of information and the job is sorting it out. In China, it's
exactly the opposite. Ma has come in and filled only part of the vacuum."

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