Alibaba

by Duncan Clark

  With fresh capital, new recruits, and more than 150,000 members in 188 countries signed up on the website, things were looking up for Alibaba. But the bubble was about to pop.

  Chapter Eight

  Burst and Back to China

  Be the last man standing.

  —Jack Ma

  By the spring of 2000, Alibaba was signing up more than a thousand new members a day.

  Connecting suppliers in China with global buyers was clearly a good idea. But other companies with the same idea were proliferating, and some actively raising capital, too. MeetChina raised another $11 million, some of which came from a SoftBank fund, and announced a sales target of $10 million that year and planning for an IPO. Global Sources, the veteran publisher of trade magazines, announced it had hired Goldman Sachs to prepare for a Nasdaq IPO and stepped up its hiring in China.

  Other contenders entered the fray as well, including entrepreneurs1 who pivoted to business-to-business e-commerce after seeing Alibaba’s success in raising capital.

  Faced with increasing competition, and flush with cash, Alibaba accelerated its expansion. In the months following SoftBank’s investment, the company went on a hiring spree in mainland China, Hong Kong, and Fremont, California, where incoming CTO John Wu set up their U.S. outpost.

  Government on the Fence

  Speculation grew about an IPO. Yet the most likely companies to go public, the three Chinese portals, had hit a roadblock. Their success was helping popularize the consumer Internet faster than the government had expected. Four million Internet users was a drop in the ocean in a population of 1.3 billion. Yet the things that made the portals popular, especially email and news, made a government bent on control increasingly nervous.

  Within China’s ruling Communist Party a debate was raging over how to handle the Internet. Conservatives pointed out that the Internet had originated as the project of a U.S. defense agency. They argued that just because it was new, there was no reason to exclude Internet companies from the same restrictions that prevented or severely constrained foreign investment in the telecom sector or in print, radio, film, and TV. There was no “Ministry of Internet,” but the Internet touched so many areas that it set off bitter turf battles between existing regulators. To demonstrate their relevance, China’s regulators regulate regularly, manifested in the “Great Firewall of China,” under construction ever since the Internet came to China’s shore, an unceasing effort to filter content they deemed a threat to the country or to Communist Party rule.

  At the same time, with its huge investments in telecom infrastructure the government had been actually pushing xinxihua—informatization—as essential for developing China’s economy. There was consensus among the all-powerful politburo standing committee—nearly all trained as engineers—that China needed a “knowledge economy.”

  An inability to adapt to new technology could spell disaster. The fall of the Qing dynasty is popularly attributed in part to its failure to adapt to modern military and industrial technologies, leaving it vulnerable to domination by Western powers. Some in China also blamed the fall of the Soviet Union on a failure to keep up with waves of technological advances in Silicon Valley, such as the semiconductor, computer, and software industries.

  But the government rejected any notion that the Internet would usher in the Western concept of an “information society,” something they believed could pose an existential threat to the Communist Party.

  Yet without foreign investment, how could China’s Internet entrepreneurs finance their ventures? Restricting them to domestic financing channels was impractical. China’s own venture capital market was in its infancy, and its stock markets were dominated by SOEs. In any case, the Shanghai and Shenzhen exchanges required companies to have been in business for at least three years, and to be profitable. All of China’s Internet companies were new, and operating unashamedly at a loss.

  China wanted a Silicon Valley, but one that it could control, built on its terms. Yet the distributed, bottom-up nature of the Internet was inimical to China’s traditions, both imperial and Leninist, of top-down control of information. For those coming online, this was the Internet’s central appeal.

  Professor Xu Rongsheng, who had helped establish the first connection between the Institute of High Energy Physics in Beijing and Stanford University, describes the impact of the Internet as an “information bomb” exploding over China. Another popular description was that the Internet was “God’s gift to the Chinese,” something echoed by investors and dissidents2 alike.

  Unable to stop the Internet, but nervous about facilitating its rise, how was the government to proceed?

  How could Chinese Internet entrepreneurs raise money overseas without their companies being classified as foreign companies and walled off from businesses in China? To resolve the contradiction the three portals attempted all manner of contortions to secure government approval for their IPOs, arguing they weren’t even Internet companies.

  After months of debate, an accommodation was finally reached: the “VIE.” The VIE, or “variable interest entity,” is much loved by corporate lawyers in China for its rich, fee-producing complexity. Still in use today, it allows the Chinese government effectively to have its cake and eat it, too—in this case allowing a thriving entrepreneurial Internet, while maintaining control. The VIE is the subject of ongoing debate for investors in Alibaba—how much protection does it really give them? The structure allows foreign investors a degree of control over the revenues generated by a Chinese company (through a complicated arrangement of interlocking contracts) that, thanks to the personal engagement of Chinese entrepreneur founders, continues to treat that company as Chinese.

  The compromise was brokered by Sina (and its lawyers) with the Ministry of Information Industry (MII), amongst other agencies. MII minister Wu Jichuan had earlier stood in the way of any portal IPOs, but the VIE broke the logjam. His voice carried weight, as he was the architect of the drive for “informatization,” the investment in infrastructure without which the country’s Internet boom would not have been possible. The VIE has its origins in another complicated investment structure3 that a few years earlier Wu, ironically, had taken the lead in dismantling.

  On April 13, 2000, the first of the three Chinese portals finally got its IPO. Sina raised $68 million on the Nasdaq. NetEase and Sohu soon followed.

  But the portals were to have a very difficult birth as public companies. The reason? The bubble had burst.

  Bubble Ball and Burst

  From its peak in March 2000, the Nasdaq began a two-year losing streak, wiping out trillions of dollars of market capitalization and taking down many technology firms with it. NetEase’s shares dropped 20 percent on the first day of trading after its IPO in June. Sohu limped to an IPO in July but after that there would be no more issuances for Chinese Internet companies for more than three years. The IPO door was now firmly shut to the other Chinese Internet companies, including Alibaba, as investors once again cared about revenues and profits.

  Just as the markets started to tank, and on the fringes of the Internet World conference in Beijing, I hosted a party at a business club called the Capital Club. I titled the party, as a joke, “The Bubble Ball.” They say you never know you’re in a bubble until it pops. But in the spring of 2000 there was a growing sense that everything was about to come to a crashing halt.

  For me the trigger was an event a few weeks after Time magazine ran a cover story, on February 28, 2000, on the Chinese Internet market, entitled “struggle.com.” The opening paragraph was a story I had told to Time journalist Terry McCarthy about my first meeting with one of the portal pioneers:

  William Ding, founder of Netease, one of China’s top Internet portals, was uneasy. As he talked to a friend in a Beijing restaurant last summer, something was irritating him. The air-conditioning. It was too cold. Without interrupting the conversation, the self-taught techie took out his Palm Pilot electronic organizer, pointed the infrared port
at the aircon unit and adjusted the temperature from across the room. His friend’s jaw dropped.

  At an extravagant dinner party hosted in Shanghai on the grounds of a colonial-era mansion a few weeks after the Time article ran, an investor came up to introduce herself and told me excitedly about how our host, a senior investment banker, had confided that she, not I, was the “friend” featured in the article. Wounded ego aside, I started to realize that, as the bankers began to invent stories of their closeness to the entrepreneur, the days of the Internet boom were numbered.

  The Bubble Ball name proved more apt than I could have imagined. Jack came along and danced until the small hours, along with Charles Zhang from Sohu—in a unique style that reminded me of Elaine Benes in Seinfeld—William Ding from NetEase, and four hundred others, in what turned out to be the last party of a short-lived but Gatsbyesque era. CNN and the Australian broadcaster ABC were there to videotape the scene. Viewed today, the graininess of the videos conveys how long ago it was but also the unbridled exuberance of that time.

  For Jack, the bursting of the bubble represented a great opportunity for Alibaba. “I made a call to our Hangzhou team and said, ‘Have you heard the exciting news about the Nasdaq?’ . . . I’d like to have had a bottle of champagne on hand,” adding, “This is healthy for the market, and it’s very healthy for companies like us.”

  He felt confident that now the IPO gate had closed, venture capitalists would stop funding Alibaba’s competitors. “In the next three months more than sixty percent of the Internet companies in China will close their doors,” he said, adding that Alibaba had spent only $5 million of the $25 million it had raised. “We haven’t touched our second-round funding. We have lots of gasoline in our tank.”

  With the field opening up, Alibaba increased its hiring of foreign employees to market the company to buyers overseas. Jack started to travel intensively around the world to attend trade shows and meet chambers of commerce. Jack was by this time quite familiar with the United States. On his first trips to Europe, though, he experienced some culture shock. I advised Alibaba on its expansion strategy there, recommending a Swiss friend of mine, Abir Oreibi, who would oversee the company’s European operations for the next eight years. On his first visit to London, Jack was booked into the city’s prestigious Connaught Hotel but couldn’t understand why he had to stay in such an old building. In Zurich, Jack and Cathy were perplexed by the fact that all the shops were closed. Abir explained that it was a Sunday, prompting Cathy to exclaim, “Oh, I see, they’re all working second jobs today.” Coming from the nonstop business culture of China, the concept of shopkeepers taking a whole day off to rest was unimaginable.

  Alibaba stepped up its advertising, too. Suddenly the company’s signature orange blanketed print and online media in the mainland, including on the Chinese portals. Alibaba commissioned a glossy television ad that ran on CNBC and CNN, a first for a China-based tech start-up. Todd Daum, an American executive who had recently joined Alibaba in Hong Kong, oversaw the production of the video, which Jack described to him jokingly as “my second favorite video, after Forrest Gump.”

  TV ad campaigns aside, Jack continued to be Alibaba’s most effective marketing tool. Despite the dot-com downturn, people came in droves to hear his speeches. When he spoke in Hong Kong in May 2000 at an I&I (Internet & Information Asia) event in the Furama Hotel, more than five hundred people turned up. Jack was gaining profile overseas, too, invited as a global Internet luminary to an Internet event in Barcelona, Spain. As Alibaba surpassed the 300,000-member mark, Jack was featured on the cover of Forbes Global magazine, which named the company—along with Global Sources—as “Best of the Web” for B2B e-commerce. That was followed by a full-page profile in The Economist titled “The Jack Who Would Be King.”

  But as the stock market continued its downward slide, enthusiasm for Internet companies of any description began to dwindle. In August 2000, NetEase’s shares sank below a third of their IPO price, and Sohu’s under half. In late July, only five months after a blockbuster Hong Kong IPO, the local portal Tom.com, backed by billionaire Li Ka-shing, laid off eighty employees. China.com followed suit soon after.

  The Internet conferences started to thin out. I&I even dropped the word Internet and then faded into oblivion along with many of the companies that had once presented at its events. Dot-com had become dot-bomb.

  At a venture capital investor conference in Hong Kong that fall, Jack was one of the featured speakers. In a dramatic reversal from the crowds that Jack had drawn just a few months earlier, Goldman Sachs had to scramble to find people to fill an empty conference room to hear his pitch. Standing at the podium in front of a skeptical audience, an investor recounted to me, Jack cupped his hands in front of his face, squinted his eyes, and declared, “I can see the end of the tunnel.” But in the face of growing investor cynicism about the sector, Jack Magic was wearing off.

  Meanwhile, in California, Alibaba’s efforts to build an R&D center under John Wu’s leadership were running into problems. In an effort to overhaul the company’s disparate software platforms, Alibaba had hired more than thirty engineers in its new Fremont office, but coordinating with their colleagues in China across a fifteen-hour time difference was proving a headache. Forced to use English for the benefit of non-Chinese-speaking colleagues in California, Chinese engineers in both offices struggled to communicate among themselves. The team started to fracture and tempers frayed as Hangzhou pushed to develop one product and Fremont another. After an infrastructure upgrade, the whole Alibaba.com site went down. Jack was visiting Fremont at the time and had to step in personally to force better cooperation between the two teams so that the problem could be fixed. It was clear that splitting the technology team across the Pacific had failed. Alibaba started to move core functions back to Hangzhou. Alibaba was about to embark on a new, defensive strategy: “B2C,” or “Back to China.”

  Pressures were mounting on Jack, including from his first investor Goldman Sachs, to prove that Alibaba could actually make money. “Alibaba.com has a revenue plan for today, tomorrow, and the day after tomorrow,” Jack commented. “Today we are focused on revenues from online marketing services. Tomorrow, we will add revenue sharing with third-party service providers. And the day after tomorrow, we will add transaction-based revenues.”

  To reassure investors and his team, Alibaba agreed to look at offering third-party services such as credit, transport, and insurance services. Together these accounted for as much as $300 billion in annual revenues on total global trade of $7 trillion. Grabbing even a small slice of this pie could be extremely lucrative.

  This was the strategy already touted by MeetChina. The company claimed that more than 70,000 Chinese suppliers and 15,000 prospective purchasers had joined its site. Although few transactions had been facilitated online, it disclosed it planned to take 2 to 6 percent of all transactions on its site. Bucking the investment downturn, MeetChina surprised the market with a fresh venture capital infusion of $30 million, taking its total haul to over $40 million, some $15 million more than Alibaba. Cofounder Thomas Rosenthal told reporters, “The volatility of the Nasdaq actually made it relatively easier to get private financing. You have a large amount of money chasing fewer deals.” Recently appointed CEO Len Cordiner pursued a vision for the site as a place where “you cannot only find buyers but also negotiate online.” But MeetChina would never make much headway in China. Talking up partnerships with third parties was much easier than making them work, and many of the tie-ups ending up being nothing more than links to its partners’ websites. A former employee4 later summed up MeetChina’s experience as spending $30 million to “train Chinese enterprises to use the Internet.” Eventually the company switched focus to Southeast Asia, launching MeetPhilippines.com and MeetVietnam.com (in the presence of President Clinton) and inking partnerships in India, Indonesia, South Korea, and Thailand, before it folded.5

  Jack had long been dismissive of MeetChina, and as it fell t
o the wayside he turned his guns on Global Sources, now Alibaba’s main rival, and its founder, Merle Hinrichs. Jack dismissed Global Sources as an “old economy” company that had misunderstood the nature of online trade: “They are a company pushing a publication.” Merle Hinrichs in turn dismissed Alibaba as “a mile wide and half an inch deep.” Although Global Sources’ (recently listed) shares6 had tanked along with the Nasdaq, it was buoyed by substantial profits generated from its offline print business.

  Later in 2000, Jack and Hinrichs were both keynote speakers at an Internet conference in Hong Kong. Although he never referred to Hinrichs by name, Jack later told a story about a rival (who owned “a beautiful yacht”) who after paying a $50,000 fee to be a keynote speaker was incensed to find that Jack had been invited to give a keynote speech without having to pay a fee. The conference organizers explained to his rival, so Jack’s story goes, that “it is because you want to be a keynote speaker, but the audience wants Jack Ma to speak,” to which his rival vowed, “I will sail the yacht to Hong Kong and will invite all the keynote speakers and speakers of the conference to have a party on my yacht, but I have one condition: that Jack Ma is not allowed.” Merle Hinrichs’s office declined to comment on the spat, but the rivalry is something that Jack, the philosopher CEO, invested with a deeper meaning: “If you can’t tolerate your opponents, you will be definitely beaten by your opponent. . . . If you treat your opponents as enemies, you have already lost at the beginning of the game. If you hang your opponent as a target, and practice throwing darts at him every day, you are only able to fight this one enemy, not others. . . . Competition is the greatest joy. When you compete with others, and find that it brings you more and more agony, there must be something wrong with your competition strategy.”