Alibaba

by Duncan Clark

  Alibaba was furious, questioning the SAIC’s methodology and its motivations. Remarkably, both the SAIC’s report and Alibaba’s response to it were on full view to the public. In China, discussions between the government and companies are typically conducted in private, as the opacity of PBOC’s intentions and interactions during the Alipay crisis had already illustrated. But here was one of China’s largest companies directly criticizing the government. More spectacularly, a posting by a Taobao customer service representative on the company’s official social media14 account even named the individual SAIC official15 involved: “Director Liu Hongliang! You’re breaking the rules, stop being a crooked referee!” The post continued, “We are willing to accept your God-like existence, but cannot agree with the double standards used in various sampling procedures and your irrational logic.”

  Although the post was deleted by Alibaba a few hours later, it was replaced by an official communication that was still remarkable for its frankness: “We are open to fair supervision, and are opposed to no supervision, misconceived supervision, or supervision with malicious aims.” Alibaba also indicated that it had filed a complaint against the SAIC official for misusing procedures and using erroneous methods to get a “non-objective conclusion,” adding, “We believe Director Liu Hongliang’s procedural misconduct during the supervision process, irrational enforcement of the law and obtaining a biased conclusion using the wrong methodology has inflicted irreparable and serious damage to Taobao and Chinese online businesses.”

  For Alibaba the timing of the dispute was particularly inopportune, coming one day before16 the release of its quarterly earnings report. Alibaba reported sales of 40 percent,17 but investors were unimpressed by its numbers, sending its shares down a further 8.8 percent. Tens of billions of dollars had been wiped off its valuation in just two days. In the earnings call, Joe Tsai, now executive vice chairman, fought back: “At Alibaba we believe in fairness. We support rigorous supervision of our company, but we also feel compelled to speak out when there are inaccurate and unfair attacks being leveled against us.”

  And the tit-for-tat wasn’t over yet. SAIC then disclosed that it had kept private the details of the July 2014 meeting in order not “to impede Alibaba’s preparations for its initial public offering.” This was particularly unhelpful to the newly public Alibaba because it raised the ugly possibility that management had failed to disclose the dispute to investors ahead of its IPO, something that should have formed part of the (already voluminous) risk factors section of the prospectus. But Alibaba denied the accusation, saying it neither had prior knowledge of a white paper nor had requested SAIC to delay publication of any report, adding that meetings with regulators were a normal occurrence. Unsurprisingly all of this triggered a class-action lawsuit against Alibaba the following week.

  Finally, the mudslinging had become too much. SAIC deleted the report from its website. Jack flew to Beijing to meet with the regulator’s head, Zhang Mao.18 There the two men, in public at least, buried the hatchet. Jack promised to “actively cooperate with the government and devote more technology and capital” to rooting out the sale of fake goods. Zhang Mao praised Alibaba for its efforts to safeguard consumer interests and said SAIC would look to develop new tools to oversee the e-commerce sector.

  Looking back at the incident, one former senior Alibaba executive told me the company would have been better off not responding to the SAIC announcement in the first place: “Alibaba is still relatively young, but to some they’ve become such a big monster. Even the government doesn’t know how to manage them. In the future, there will be a lot of conflicts. That’s natural. Because this government has never had to deal with a company this influential.”

  For Alibaba, and any private company, the Chinese government itself is a multiheaded hydra of agencies, often competing with one another for influence, licensing fees, or other forms of rent to justify their existence, often lacking sufficient central government support to finance their operations. These agencies exist at both the national level and at multiple levels below. Some are replicated all the way down through the provinces to municipalities and finally to the level of rural counties.

  Jack often repeats a line about his relationship with the Chinese government: “Fall in love with the government, don’t marry them—respect them.” With so many departments, if he were truly to marry the government, he’d end up a polygamist. Jack revealed19 that Alibaba had hosted in 2014 alone over forty-four thousand visits from various government delegations in China.

  Yet, short of marrying, even respecting the government can be a challenge. Jack once explained to a friend that he was never really sure of his schedule from one day to the next. If the party secretary of Zhejiang, for example, requested he travel with him as part of a business delegation to Taiwan, then he would have little choice but to make the trip. Owning a Gulfstream G650 jet is quite a privilege, but unlike his tycoon peers in the West, for Jack there is always a lurking sense of not knowing where to tell the pilots to fly it.

  Jack receives Xi Jinping, the Communist Party Secretary of Shanghai, at Alibaba in Hangzhou, July 23, 2007. Alibaba

  Respecting the government also involves cultivating good relations with a wide range of officials, including future leaders of the country who might one day hold huge sway over the company. A typical feature in the lobby of any large company in China, whether state or privately owned, is a wall of photos memorializing meetings between the boss and various government dignitaries. Alibaba is no exception. At the entrance to its VIP visitor suite there is a photo20 from July 2007 of Jack welcoming Xi Jinping to Alibaba. Xi today of course is president of China but back then he was Communist Party secretary of Shanghai.21

  Entrepreneurs in China can never eliminate the risk for their business of arbitrary regulations or actions. Instead they can try to shield their companies by helping the government do its job.

  Part of the SAIC’s job is to stem the flood of pirated goods.22 Online or offline, fighting piracy is like a game of Whack-A-Mole: Whack one molehill, and the moles will pop up somewhere else. To turn the page on its dispute with SAIC, Alibaba increased the number of staff dedicated to combating counterfeiting, from 150 to 450 people, including a team of “secret shoppers” to root out fakes. Alibaba operates a “three strikes you’re out” system to sanction vendors. Selling the same fake good on three occasions23 gets a merchant kicked off the platform. To weed out merchants who later resurface with another name—the “whack a mole” problem—Alibaba has adopted some creative countermeasures. Similar to the “proof of life” tactics used by hostage negotiators, the company asks merchants to prove their identities by taking a photo of themselves with their ID card and today’s newspaper. They may even ask them to adopt a particular “pose of the day” in the photo as an extra security measure.

  At a closed-door dinner in London in October 2015, Jack summed up the problem as follows: “Maybe one percent of the merchants on our platform are bad guys.” Yet with nine million merchants on Taobao, that works out at ninety thousand “bad guys.” An investor present at the dinner, David Giampaolo, summarized Jack’s message that evening: “He is focused on solving the problem. However, few people, especially overseas, appreciate the enormity of the task.”

  In Beijing on Singles’ Day 2015, Jack went further: “Every consumer that buys one counterfeit on our site, we lose five customers. We are also victims of [counterfeits]. We hate this thing. . . . We have been fighting for years, but we are fighting human nature, human instinct.” Explaining that piracy had been rampant in China’s offline retail sector for the past thirty years, Jack added, “We are fighting online and helping fighting offline. We have two thousand people working on it, we have fifty-seven hundred volunteers working on it. With special task forces, with the technology we have, we are making progress. I think the opportunity is whether we should work together to fight against these thieves. We are running a platform for more than ten million businesses. They [the p
irates] are tiny; they are everywhere.” Some of Jack’s rivals are sympathetic to his predicament. One told me: “When you’re managing a platform with nine million merchants on it, you’re running a country.”

  A key part of Alibaba’s response is its Internet Security Team, headed by ex-cop Ni Liang. The team operates a “notification and take down” system that merchants can use to flag fake products24 being sold on Alibaba’s sites. Using techniques such as “price point analysis,” brand owners can identify large quantities of high-margin items such as luxury bags being sold at impossibly low prices. But this method doesn’t work well for high-volume, low-margin items such as soap or shampoo, where it can be hard to sort legitimate products from fakes. So Alibaba is looking to the power of Big Data: Company names, addresses, trading history, and bank accounts can all be useful to establish patterns of distribution and go after infringers. The power to deny them the use of Alipay as a payment tool on other platforms can also be an effective deterrent.

  The reality is that, for piracy, e-commerce is both part of the problem and part of the solution. The Internet is more effective at distributing fake goods than offline methods, but also more effective at identifying and combating infringers.

  Taobao, dominated by mostly mom-and-pop store owners, is less easy to police than Tmall. So with events like the November 11 Singles’ Day, Alibaba is spending more marketing dollars on Tmall than Taobao. Tmall sets a higher bar25 for merchants to trade. Also Alibaba generates commission fees on Tmall, meaning that shifting business away from Taobao makes more money for Alibaba as well.

  But not all brands are convinced. A few months after the SAIC controversy the American Apparel & Footwear Association (AAFA), which represents more than a thousand brands, was again pushing for Taobao to be added back to the USTR’s list of notorious markets; the association complained about the “rampant proliferation” of fake goods on Taobao and the “slow, sluggish, and confusing systems” that Alibaba has put in place to remove them. Yet despite AAFA’s action, a number of its members, including Macy’s and Nordstrom, continue to work closely with Alibaba on initiatives including Singles’ Day, revealing a lack of consensus about the way forward. In November 2015, Juanita Duggan, the person who as CEO and president had spearheaded the complaint, resigned from her post.

  Alibaba faces criticisms from some brand owners in Europe, too. In May 2015, Kering, the French luxury goods holding company of brands including Gucci and Yves Saint Laurent, filed a lawsuit against Alibaba alleging violations of its trademarks and racketeering laws. Part of the complaint included allegations that when customers enter the word Gucci in Alibaba’s search engine, it returns links to fake products branded “guchi” or “cucchi.” Alibaba is fighting the suit, countering that Kering has “chosen the path of wasteful litigation instead of the path of constructive cooperation.” In an interview on Singles’ Day 2015 with Bloomberg, Jack was even blunter, revealing his frustration with lawyers: “Don’t send lawyers. These lawyers don’t understand business; they don’t understand e-commerce.” The following month, Alibaba stepped up its IP enforcement efforts by appointing Matthew J. Bassiur as head of Global Intellectual Property Enforcement. Bassiur had previously overseen anticounterfeiting operations at the pharmaceutical company Pfizer after several years with Apple Computer. Prior to his corporate career, Bassiur served as a federal prosecutor in the U.S. Department of Justice.

  Fake goods weren’t the only issue weighing on Alibaba’s share price after its IPO. Some investors fretted about fake trades, too. Also known as “brushing,” fake trades involve merchants shipping empty boxes to ghost customers to boost their rankings.26 Local brands—particularly those in highly competitive sectors like apparel, cosmetics, and electronics goods—are the main culprits. Rather than carrying out the fake trades themselves, these merchants typically hire “click farming” companies to generate the fake purchases for them. They can also hire the same click farms to generate fake, positive product reviews to influence real purchasers. By one estimate, four click farms27 interviewed each claim to control at least five million Taobao buyer accounts. These firms no doubt exaggerate their influence—to boost their appeal to potential customers—but collectively the click farm companies claim that in 2015 they accounted for double digit percentages of the total merchandise volume of Singles’ Day purchases in 2015. Alibaba and other e-commerce players are on the lookout for these companies—monitoring traffic and transaction patterns to root out suspicious activity. (Although the click farms claim they can circumvent these attempts, they assent that these methods are not rigorously applied.) As with the battle against fake goods, Alibaba and other e-commerce players are engaged in a cat-and-mouse game. Like piracy, brushing cannot be eliminated entirely, unless the algorithms that rank merchants based on sales volume are abandoned. The e-commerce players can, and do, act to increase the costs of bad actors. Tmall’s “anti-brushing” systems monitor behavior to establish if a purchaser is a real person, for example, by ensuring that the session involves clicks on a range of products—suggesting actual browsing of goods on sale—and sufficient time spent on each web page, concluding with a purchase deemed to be a reasonable amount for one person to make. In response, the click farms have increased the sophistication of their service, charging as much as thirty yuan ($4.70) per faked order, compared to the typical range of ten to twenty yuan ($1.56–3.12) per order, depending on the costs involved, such as commissions, payment fees, and generating fake logistics information. Tmall is more prone to brushing than Taobao, as the competition to secure high-ranking sales—and the publicity these can generate—in promotions like Singles’ Day is so intense.

  Alibaba’s e-commerce platforms have become so large that policing the huge volume of goods and transactions is becoming ever more complex. Yet this size is also Alibaba’s great strength. Merchants on Alibaba’s sites are increasingly willing to spend money to upgrade their stores. Even merchants who prefer to sell goods on other sites still keep a presence on Taobao because it means consumers trust them more.

  Competitors in the Wings

  Nevertheless Alibaba is facing rising competition in a number of categories like clothing,28 cosmetics,29 books,30 and food.31 To buttress its position in electronics and electrical appliances, Alibaba has even started to make investments in traditional retailers as part of the new trend, mentioned earlier, called “omni-channel” or “online to offline,” abbreviated as “O2O.” In August 2015, Alibaba shelled out more than $4.5 billion to buy a stake32 in Suning, an electronics and white goods retailer. But some analysts questioned the logic of buying into a company with more than 1,600 stores across the country that, like Best Buy in the United States, were at risk of becoming merely expensive showrooms used by customers to try out products that they would later buy online. Alibaba made the investment in Suning in part to counter its biggest competitor in e-commerce, a well-funded company called JD.com,33 which went public in the United States four months before Alibaba. JD is a threat to Alibaba in part because it represents a competition of ideas. Unlike Alibaba, JD is more closely modeled on Amazon, purchasing and selling its own inventory. In addition, while Alibaba has kept one step removed, JD owns and operates its own logistics network. While Alibaba argues that JD will never rival it in scale due to the costs of owning inventory and shifting physical goods, JD counters that its model ensures a higher quality of product and speed of delivery to its customers.

  JD clearly riles Jack. In early 2015 he turned his guns on the founder of JD, Richard Liu. Although he spoke the words to a friend in what he thought was confidence, Jack’s criticism of the company was posted on social media: “JD.com will eventually be a tragedy and this is a tragedy I have warned everyone about from day one. . . . So I’ve told everyone in the company, don’t go near JD.com.” Soon after the incident, Jack apologized, joking, “The next time I have a conversation, it’ll be in a public bath.”

  The Big Two

  Another reason why Jack has
trained his guns on JD is that it enjoys the backing34 of Tencent, Alibaba’s main Internet rival. As Alibaba extends into new territory beyond e-commerce, it is increasingly bumping into Tencent, whose valuation in 2015 at times surpassed that of Alibaba. Tencent makes most of its money in online games but is a threat to Alibaba because of the phenomenal success of WeChat,35 the mobile application it launched in 2011 that has amassed more than 650 million regular users. WeChat is the primary mobile messaging platform in China, benefiting from—and even driving—China’s smartphone boom. WeChat has been described36 as “one app to rule them all.” Without WeChat a cell phone in China loses much of its utility. The WeChat app effectively has made the contact book redundant. Most users check the application at least ten times a day. But WeChat is about far more than chat. Chinese consumers use it37 for a much wider range of services than their peers in the West (who use Apple’s iMessage, Facebook’s Messenger, or WhatsApp). The power of Tencent’s ability to innovate was demonstrated most dramatically in 2014 with WeChat’s Lunar New Year “red packet” (hong bao) campaign. In just two days, WeChat users sent out more than 20 million virtual envelopes38 of cash. Jack even compared the psychological impact of WeChat’s campaign on Alibaba to Pearl Harbor. Alibaba fought back in 2015 but despite doling out $100 million in cash-and-coupon promotions, it was able to rack up only a quarter of the red packets sent by WeChat users.

  WeChat exposed a critical gap in Alibaba’s armory that it tried to close with its own mobile social app, Laiwang. Throwing everything it could at promoting Laiwang, Alibaba even required every employee to sign up one hundred users in order to qualify for their annual bonus. But Laiwang launched two years after WeChat. By then it had already lost the battle. Today even Alibaba’s senior executives use WeChat, resorting to Laiwang only for official communications with colleagues.