New Kid on the Block – How Alibaba's IPO Will Change the Competitive Landscape

September 17, 2014

“In China, Alibaba, TenCent and Baidu are the three internet companies you can call platforms, and they are exposed to many of the same growth drivers (especially, explosive growth in usage of mobile phones, messaging, e-commerce, etc.).”

– Di Zhou, analyst at Thornburg Investment Management

While no one can credibly claim that Alibaba’s IPO this week will “change everything”, you have to think that it will have a big impact on the tech industry globally. For one thing, although TenCent and Baidu already made their IPO debuts years ago and today have market caps of $150bn. and $75bn. respectively, neither one had the drawing power of Alibaba’s coming-out party, which is rivaling those of Microsoft (1986), Google (2004), and Facebook (2012). When Alibaba completes the trio of major public companies, China will basically have reset the balance of geopolitical power in tech. No longer will the U.S. be as dominant in the Top 10 or 20 most influential tech companies on anyone’s global list, as these three companies taken together will have over $375 bn. in market value. Overall, this has to be healthy for global competition, and for customers and consumers everywhere.

If you’ve been reading the news you are probably familiar with some or all of the numbers related to the Chinese marketplace as well as to Alibaba’s accomplishments thus far, but consider these facts:

  • 300m. out of the 600m. users in China’s population of 1.35bn. are Alibaba users. With more than 700m. people still to become smartphone and internet users, this provides plenty of opportunity for continued growth.

  • Today Alibaba has 80% of the e-commerce market and is responsible for 60% of all package deliveries in China.

  • Alibaba had 230m. active users in 2013, 136m. of whom were active mobile users.

  • Active user engagement equated to 49 purchases per user annually.

  • Mobile spending in 2013 was just under 20% of Alibaba’s gross merchandising value of $240bn, up by almost 200% from 2012.

  • Alibaba is already bigger than Amazon in gross sales turnover, and after the IPO will have a similar market cap with a lot of upside still to go based on the current P/E multiples of not only Amazon but other successful franchises such as Facebook, Google, etc.

  • In stark contrast to Amazon, Alibaba is profitable, generating over $3bn in 2013, and expected to deliver $5bn in 2014 and over $7bn in 2015.

  • Alibaba competes directly against eBay as well as Amazon and is already larger in sales volume than each of them. Furthermore, its business model is quite different from Amazon’s and in essence cleaner. (I’ll cover this in more detail below).

What has made Alibaba the company it is today is a shrewd marketing strategy to build trust with Chinese consumers, who traditionally were not accustomed to being able to trust their traditional brick and mortar stores the way U.S. shoppers trust The Gap or or Macy’s. Jack Ma, the company’s colorful and eccentric CEO, realized early on that if he offered consumers the ability to pay cash on delivery, he would earn their trust and capture their business. Leveraging its “local” familiarity with Chinese culture has been a definite advantage to the company ever since it was founded in 1999.

Added to this trust factor, Alibaba has aggressively exploited the Chinese tech boom and in particular the mobile phone boom of the past six or seven years. Taobao was the first commercial site, launched in 2003 as an eBay knockoff. The Taobao Mall (TMall for short) followed shortly afterwards, aiming to become the Amazon online shopping marketplace for China. What’s different about Alibaba’s business model, in stark contrast with Amazon, is that it does not handle product logistics or fulfillment, Instead it operates as an intermediary, limiting itself to providing the marketplace platform and the user experience. As Kelland Willis, an analyst with Forrester Research, says: “When you buy from you engage with Amazon, whereas when you buy from Alibaba’s TMall, you engage with each different brand.”

This difference in business models is what has enabled Alibaba to generate profits because it takes a cut of every sale, whereas Amazon is solely responsible for the prices it places on the goods it sells, and it pays for both the products and all the fulfillment costs. In contrast, as we have seen for the past twenty years, Amazon is virtually guaranteed to have a tough time making money because of its flat-out commitment to undercut every other retail outlet on earth, in effect being a hyper-aggressive online version of Walmart.

So what does all this tell us about the chances of major U.S. internet businesses to prosper in China, and about Alibaba’s chances of consolidating its success in China and establishing a powerful presence in other Asian countries as well as in the U.S., Europe, Latin America and beyond?

Google, which had an early skirmish with the Chinese government around its search results on political events such as Tiananmen Square, is now based in Hong Kong and has a market share that has dwindled to less than 2%, placing it way back in third place behind Baidu and eBay ceased operations in China in 2007 because it was losing so heavily to Taobao. In contrast, by some accounts Amazon has been quietly expanding its footprint and fulfillment capabilities in China despite currently lagging way behind Alibaba’s TMall. Some observers believe Bezos and co. will eventually be able to compete effectively against TMall because it actually underwrites every sale and every delivery with its brand (one throat to choke) whereas Alibaba is sometimes forced to blame its third-party vendors for not fulfilling their side of the bargain with timely or complete deliveries.

My belief is that virtually every U.S. based internet company needs to monitor Alibaba (and TenCent, and Baidu) carefully, from online retailers to auction sites to players in the emerging sharing economy. Like his counterpart at Tencent, Pony Ma, Jack Ma (no relative) has already demonstrated a liking for entering myriad businesses, in Alibaba’s case acquiring a department store operation, starting a messaging app (Tango, already becoming quite successful), founding Weibo (China’s Twitter), and of course AliPay (equivalent to PayPal). With a penchant for turning Alibaba into a holding company for every imaginable type of online business, what’s to stop Alibaba emulating TenCent by starting a ride-sharing or hospitality app (thus marginalizing Uber, Lyft, Airbnb, and others)?

There are, however, some caveats to this success story. Investors in Alibaba’s IPO will be buying into an opaque entity based in the Cayman Islands, so they will not literally “own” shares in Alibaba. Ma has in the past done the dirty on partners – famously so, when he separated out the ownership of AliPay without informing his board in order to avoid allowing Yahoo! to benefit more than it was already profiting from its shareholding in Alibaba. Ma, who owns 9% of Alibaba today, has concentrated his power somewhat along the lines of Google’s owners and Facebook’s Mark Zuckerberg, with privileged voting powers. Furthermore, he is owner, partner and/or investor in a host of Alibaba-related businesses that are not part of the IPO. He is also very tied in to prominent members of the governing Communist Party and their relatives, which may or may not be a positive. Some of Alibaba’s accounting practices have drawn criticism from close observers, though you have to believe that once they are a public company they’ll need to hew closely to accepted accounting standards. It’s important to remember that China has only had any kind of market economy for a couple of decades, so perhaps it’s a stretch to expect full U.S.-style transparency. Let’s face it, we don’t always have sufficient transparency in the lobbying-intensive and cartel-laden U.S. economy, so investors need to be realistic and not expect that a fifteen-year-old Chinese internet company will come wrinkle-free.

At the end of the day, my belief is that we should welcome this relatively new raft of significant internet companies from outside the U.S. It’s healthy for global competition because it’ll keep existing U.S. power players honest and on their toes, just as Samsung and others have done against Apple in smart-phones and tablets, and just as they are doing in wearable computers.

Back to the Chinese market: Despite their different origins in types of business, TenCent and Alibaba are becoming fierce competitors against each other. As stated in an article published today in the International Business Times, “If Alibaba is China’s Amazon and eBay wrapped into one, Tencent’s enormous user base has drawn comparisons to another company: Facebook. And with personal computing moving more to mobile phones, Tencent is primed to convert China’s cell-phone wielding masses into big-time consumers. ‘For Alibaba the danger from Tencent, and WeChat’s 430 million users, is immense,’ said Steven Millward, a China analyst at Tech in Asia.” This competitive tension explains recent moves by both companies to acquire companies that get them aggressively into each other’s domain, making for a fascinating duel to come – not only in the Chinese market but in the rest of Asia, as well as in other regions of the world including the Americas and Europe.

Beyond these competition-related factors, the success of China’s top three internet conglomerates demonstrates the potential for other emerging-market countries such as India, Russia, Brazil, and others to source their own successful online businesses – if only their bloated (India) or kleptocratic (Russia, Brazil) governments can get out of the way, and instead of protecting corrupt and outmoded business cartels, establish legal frameworks and an entrepreneurial environment that foster the birth of innovative and trustworthy businesses.

In summary, we now have more notable competition, from a new part of the global economy. True, Alibaba and its two closest Chinese competitors have been around for a decade or more. But now the rest of the world is officially on notice that China is a player in tech. As a close friend of mine likes to say, “We cannot any longer pretend that we don’t know.”