Demystifying the Alibaba Phenomenon

Mention “Alibaba” and people tend to associate it with two things. First, that it completed the largest Initial Public Offering (IPO) in history with $25 billion (compared to Facebook’s $16 billion). Second, that it is an e-commerce company that threatens domestic icons Amazon and eBay and wants to take over the United States. Alibaba certainly looks formidable by sheer volume of business- it had $80 billion in gross merchandise volume in the second quarter of 2014, compared to eBay’s $20 million.

But will Alibaba necessarily be a threat to the existence of Amazon and eBay? Its differences with the two domestic giants, as well as inherent challenges it faces, suggest not. For one, it is more similar to eBay than Amazon. Instead of selling goods directly to customers (which is what Amazon does), Alibaba provides an online bazaar that matches buyers and sellers. Unlike Amazon, Walmart or Staples it does not have a vast network of warehouses. Alibaba has multiple marketplaces: Taobao, China’s biggest consumer-to-consumer shopping site that is home to 7 million merchants and a billion products; Tmall.com, China’s largest third-party platform for brands and retailers; and Alibaba.com, the world’s largest online business-to-business trading platform.

It earns revenue primarily from charging merchants for advertising and transaction fees on its sites. Like Google, Taobao charges sellers for putting their names on top of search queries- in contrast to eBay and Amazon, who pay Google to have their products listed. Thus Taobao gets a hearty portion of the revenue that would otherwise go to search engines. While it offers all basic services free to both buyers and sellers, it charges for online advertisements, and extra services like website design- expenses that sellers clearly think worthwhile in differentiating themselves on the messy, chaotic Taobao cyberspace. Alibaba’s lower fixed costs in terms of infrastructure and fewer employees allows for its astounding profit margin of 80%, and a net income of $1.35 billion in the October-December quarter, trouncing Amazon’s mere $247 million of net annual income and eBay’s $2.86 billion.

 

Revenue, 2Q 2014 (Billions)                                                                            Net profit margins, 2Q 2014

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It is no secret that Alibaba aspires to expand its e-commerce business globally. This June it launched 11 Main, a US shopping website in high-end fashion, sporting goods, toys and jewelry, which aims to appeal to US customers. In Europe, Alibaba made deals with the Italian and French governments for easier sales on TMall. It is also partnering with Brazil’s state-owned postal services company, Correios, to allow small businesses to use its electronic payment system, Alipay, to sell products in China. Alipay is Alibaba’s very own payments system which buyers can use to purchase everything from movie tickets to taxi rides. Just this week, news about a possible “marriage” between Alipay and Applepay (Apple’s own version of a mobile wallet which lets iPhone 6 users make payments at retailers with their smartphones) has been causing excitement in the business community. Besides launching 11 Main, Alibaba is looking for other ways to increase the number of consumers it has. The company intends to get into video creation to propagate its sites, and Alibaba founder Jack Ma allegedly intends to travel to several Hollywood studios to strike content deals.

However, it is clear that Alibaba does not have a very strong presence amid retail consumers in the United States, and indeed elsewhere in many developed economies. One reason is that it is a relatively new player, but it is also because it suffers from a reputation of counterfeits. The reputation is both real and by association with China, which has been globally condemned many times for its thriving market of fake luxury items. Up until the end of last year, Taobao was on the American government’s list of “notorious markets”. Its removal reflects the effort the firm has put into cracking down on fakes by working with multinationals, but fakes are still too readily available throughout the site. Ma has an exceptional track record of building trust among buyers and sellers in China and has also been celebrated for his philosophy of putting customers before employees and shareholders. Yet, despite all this, the trust of consumers in developed economies continues to elude Alibaba.

Furthermore, the fact that Alibaba is a from a country that is perceived to be the economic and military rival of the United States, immediately inclines Americans to stick with home companies they perceive to be safer. This is perhaps why the primary focus of Alibaba in the near future remains to attract Chinese consumers, especially given the ferocious competition it faces with domestic competitors. In fact, its recent US acquisitions reflect the company’s awareness of the need to stay ahead. Alibaba has been buying American start-ups focused on mobile and e-commerce, such as messaging app Tango ($280 million) and peer-to-peer ridesharing app Lyft ($250 million). These apps might give Alibaba an edge over domestic competitors back in China such as Tencent, which is a behemoth collection of businesses that is also a leader in mobile apps. Tencent launched messaging app WeChat, which is hugely popular in China and has 438 million active users globally (compared to Whatsapp’s 465 million).

In fact, Alibaba’s greatest potential for overseas expansion lie in emerging economies with conditions similar to those in China that allowed Alibaba to rise to prominence in the first place. Countries in Africa, Latin America and Asia are likelier to have plenty of small to medium sized businesses that rely on low capital and infrastructure, which stand to benefit the most from the online market platforms offered by Alibaba. As some have already pointed out, it is unclear that Alibaba’s marketplace business approach, which allows it to do without warehouses and other tangible assets, will be successful in a country like the United States, where there are already dominant internet retailers.

Indeed, as Yahoo Finance reports, Brazil has a fragmented retail economy and millions of small merchants like those that Alibaba already targets in China. It also has a growing middle class eager for shopping bargains in Chinese-made goods, making it the fastest growing e-commerce market in the world after China. These factors have allowed Alibaba to be successful in its ventures in the region. Last year, Alibaba opened a Portuguese e-commerce site and integrated a locally dominant payment forum known as Boleto. In July, 12 million Brazilian visited AliExpress, almost ten times the traffic garnered one year ago.

Thus it remains very unlikely that Alibaba will immediately swallow up Amazon and eBay in the foreseeable future. Alibaba does not sell directly to American consumers, while Amazon retains the heavy capital for its retail services. A resurgent eBay holds the upper hand in reliability and consumer trust. The interest and buzz surrounding Alibaba’s IPO and stock prices are from companies and individuals seeking to profit from its status as a large, promising and stable company with strong ambitions to continue to grow. Yahoo, which owned about 24% stake in Alibaba just before the IPO, has seen its profits soar, earning no less than $6.3 billion from selling part of that stake. While these profits are impressive, Alibaba’s future will remain hinged on its ability to make smart investment decisions both at home and abroad.