Jack Ma Says Alibaba At ‘Most Critical Moment’ As China Starts New Investigation

http://www.forbes.com/sites/gordonchang/2015/02/15/jack-ma-says-alibaba-at-most-critical-moment-as-china-starts-new-investigation/print/

Gordon G. ChangContributor

WORLD AFFAIRS 2/15/2015 @ 12:20PM 20,219 views

Jack Ma Says Alibaba At ‘Most Critical Moment’ As China Starts New Investigation

After authorities accused Alibaba of allowing illegal actions on its shopping platform, Jack Ma said he does not want the site to be seen as a hub for fake products. (AFP PHOTO)

On Friday, China’s powerful National Development and Reform Commissionannounced it was probing e-commerce businesses to ensure a “fair” market. The NDRC said it would “organize and develop special inspections into the online retail sector’s pricing behavior,” especially the practice of inflating prices before reducing them in special offers. The agency also stated it will investigate holiday pricing. Although the state regulator did not name targets, news organizations fingered Alibaba Group Holding, the giant founded by Jack Ma, and JD.com. Of the two, Alibaba, due to its business model, appears to be the focus of the probe. The references to fake special offers and pricing around holidays put Singles’ Day, Alibaba’s November 11 extravaganza, into the crosshairs. Merchants selling on Alibaba’s platforms are widely known to engage in deceptive pricing practices, particularly around that day.Alibaba’s rules essentially pave the way for merchants to engage in practices the NDRC is targeting. For instance, to participate on Alibaba’s Tmall on Singles’ Day—technically the “11.11 Shopping Festival”—online shops, according to those in the industry, must offer discounts of at least 50%. To have any chance of making money, shops up their prices so they can then offer discounts qualifying for the big event.

Moreover, Alibaba determines rankings on its site by sales volume. Online merchants fake sales by paying people to buy and then return their goods, thereby facilitating genuine sales because shoppers tend to purchase from the highest-grossing merchants. In fact, an industry has developed in China mainly to “print”—fake—sales on Alibaba sites.

Alibaba on its online platforms doesn’t carry inventory of its own and so does not engage in these deceptive practices, but it knows about them and, despite protestations to the contrary, has taken only insufficient remedial steps.

Ma’s behemoth has incentives to look the other way. Alibaba earns revenue from the online shops engaging in the questionable pricing and other practices, and surging revenue contributed to the high valuation in its initial public offering in New York in September, the world’s largest.
Alibaba is a growth play. Its stock fell 8.8% on January 29 when it announced results for the quarter ended December 31, largely because revenue disappointed, increasing only 39.7% from the same period in 2013.

Imagine what happens to Alibaba’s stock when revenue begins to fall. To many, especially those believing the company will eventually trade above $300 per share (it closed at $89.05 on Friday), a decline in the near future is virtually inconceivable. There are, however, many reasons for a revenue drop.

For example, by next November’s Singles’ Day the NDRC will have had time to crack down on deceptive pricing and other practices pervading Alibaba’s online platforms. Moreover, SAIC, the State Administration for Industry & Commerce, by then will have had the opportunity to root out sales of counterfeit and substandard items, another revenue-destroying campaign targeting the company.

Beijing has reason to make an example of Alibaba. The NDRC, for instance, is under attack for what appears to be its highly discriminatory enforcement actions against foreign companies, and state media has been defending the agency. The targeting of Alibaba, a domestic business, would bolster Beijing’s case of impartiality. Moreover, tough enforcement will be popular among online shoppers, and Alibaba’s competitors will surely be pushing regulators to clean up Jack Ma’s almost-anything-goes approach to growth.

In his annual Lunar New Year letter to Alibaba’s employees, Ma said the company is at its “most critical moment.” And in a sense he is correct. Chinese regulators are not the only ones bearing down. The Securities and Exchange Commission has just sent a letter to Alibaba seeking information about the SAIC matter, and at least six groups of shareholders have sued Alibaba over the failure to disclose SAIC’s contacts with the company in July.

Regardless of the disposition of these government actions and private lawsuits, Alibaba will have to take steps that will substantially reduce revenue. That means Ma will have to find new sources to feed growth. In its core business, that will be hard as others are determined to compete with Ma’s company not by emulating Alibaba but building alternative routes to customers.

For example, Baoshan Iron & Steel, a unit of China’s Baosteel Group, will soon be selling its products in a new online platform. Bricks-and-mortar stores are building sites, and some, like Walmart, are finding success. The Bentonville, Arkansas-based retailer is closing physical stores in China but prospering there online. Alibaba is essentially a toll booth, and large businesses may soon figure out how to bypass it.

Ma’s answer is to diversify in many directions, to extend what his executives call the “ecosystem.” After the IPO, he traveled to Hollywood in October on a deal-scouting trip. And since the offering his company has bought a part of Huayi Brothers, a Beijing-based TV and movie studio; made an investment in Singapore-based V-Key, a tech security concern; scooped up a variety of apps and mobile games; and announced an investment of $590 million in Meizu Technology, an also-ran Chinese smartphone maker, in a bid to extend Alibaba’s YunOS mobile-operating system.

Ma has yet to prove he can make his diverse acquisitions work. In the meantime, sentiment is clearly changing. David Tepper’s Appaloosa Management, in its Q4 13F filing, revealed it had dumped all its position in Alibaba.

So as investors change their minds, Chinese and American regulators are scrutinizing the company, shareholders are filing lawsuits, and competitors are on the attack. Yes, Ma is right, this is Alibaba’s “most critical moment.”

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