Unraveling the Success of e-commerce in China: an Empirical Study of Alibaba

By HAO-JUN YU

Introduction

With prevalence of Internet access, on-line shopping and e-commerce in China has witnessed a boom in the last decade. Among all others, Alibaba, a leading e-commerce known as China’s eBay, experienced a fast growth since its founding in 1999. Alibaba Group mainly operates trading platforms for small manufacturers to sell their wares. It introduced its first platform Alibaba.com in 1999 and its B/C-C platform, Taobao.com, 4 years later. In 2008, an on-line-mall platform, Shangcheng or http://www.tmall.com/ is introduced and embedded in taobao.com. The different platforms focus on different groups of consumers so as to segment the market. Briefly, Alibaba focuses on B-B large scale trade business and Taobao and tmall focuses on B-C/C-C small scale trade business. The role of different platforms evolves in time, and different development strategies are implemented at different stages for each platform. As Yun Ma, the founder of Alibaba Group stated, the role of Taobao is to attract buyers/sellers to enlarge its market share at present and profitability is a secondary consideration, while Alibaba is still the main driving force for Groups’ profitability.

Alibaba group also introduced programs including small business loan-assistance program in collaboration with banks (Ali-Loan), pay-for-performance keyword bidding system (Ali-Advance), wholesale platform on the international marketplace (Ali-Express), and the first Small Business Credit Rating System in China to facilitate trade from buyers and sellers and to support its main business. In return, its profit has increased to 1.36 billion RMB in second quarter 2010, after its break even in December 2010. Unraveling Alibaba’s success as trading platforms is important to understand the future of e-commerce in China.

On the theory side, Alibaba provides a perfect example of two-sided market. As a trading platform, it attracts both sellers and buyers. Each end benefits from having a large group on the other end: a larger group of buyers provides a larger market, and a larger group of sellers provides more purchase choice. The platform charge two ends for operating on the platform differently. The cross group externality is considered in pricing: usually one end is subsidized (in this case, the buyers) to attract users on the other end (in this case, the sellers).

Another characteristic to notice is that Alibaba runs several platforms simultaneously. Alibaba.com and Taobao.com are two distinguished ones, and tmall.com may also be treated separatedly though it is now embedded in Taobao by using the same search engine. Though paying the cost of running two or three platforms has the benefit of segmenting the market further, it could be that the new platform mostly attracts users from the old ones. From the nature of two-sided market, where attracting users is more important than in other traditional industries, running multiple platforms has other benefits such as separating sellers/ buyers and deterring entry of potential competitors.

Although Alibaba provides platforms for trade, the on-line transaction is not automatic. Different from face-to-face trade, when buyers make their purchase decisions, they usually do not observe the items they are going to get. There is probability that they receive low-quality items, or even do not receive anything at all. The possibility of fraud or just buyer’s suspect of fraud can frustrate the spread of on-line transaction, especially in its early stages. Most of Alibaba’s support programs are designed to prevent fraud and build participants’ trust, so as to facilitate on-line transaction. For example, Aliwangwang, an instant message tool, helps contacting buyers more quickly; its credit rating system and innovative payment method Alipay2 guarantee safe transaction. I will also focus on the role of these support programs in facilitating transaction in this project.
The discussion below is divided into 4 sections: section 1 discusses the convention platform pricing and the incentive for buyer/seller to join platforms; section 2 discusses the role of multiple platforms to segment market and to separate users; section 3 discusses the role of these support programs in facilitating transaction in general; section 4 briefly documents my activity in the summer. Section 1-3 should be supported by a theoretic model in mathematic language, but I only decide to present the basic tradeoffs laterally here in this report.

Pricing on one platform

In this section, I discuss the pricing strategy for the platform, following the seminal work of Rochet and Tirole (2003) and Armstrong (2006). Also this section benefits from discussion in Hagiu (2010). Platform works as a “focal point” for buyers and sellers. Buyers join the platform for purchasing in order to save searching cost of buying from other places. They benefit from a larger group of sellers, for both an enlarged set to choose from and from price advantage due to sellers’ competition. Sellers join the platform for a potential larger market than say, its own on-line or off-line selling site, especially when its name is not publicly known. For business beginners, joining a platform also has the benefit of establishing its operation routines easier and faster. The sellers benefit from large group of buyers for a potential large demand but suffer from large group of other sellers of identical or similar items for a more fierce competition.

Due to the cross-group benefit, the platform does not charge both group users in the same way: their ability to attract users on the other side is rewarded. The more one group is “attractive” to the other group, the less it is charged. In this example, the users are free to purchase from the platform, just to encourage their participant. The sellers are charged, but in different ways according to both their own characteristics and the current development goal of the platform. For example, in Taobao.com, sellers are free to list their items on the platform. They are only charged a transaction fee proportional to realized price for using its payment method Alipay whenever transaction takes place. On the other hand, sellers have to pay a membership fee to join the e-mall (tmall.com) besides reaching some entry standards. Also, advertisement is another main source of profits. On all platforms, sellers have to pay proportional to traffic (number of clicks) if they decide to be listed on the right ad column ruled by a bidding rule.

In sum, we notice two points: first, the pricing strategy balances both profitability consideration and the ability to attract buyers / sellers. The entrance threshold for sellers is essentially low, and charge only happens when sellers’ sale accumulates high (though fees proportional to transaction volume) and when sellers want to signal themselves (though advertisements or joining t-mall). Second, the pricing strategy is not static: for the importance of attracting users on both ends, market share is more emphasized than other industries. At early developing stages, when its main target is to enlarge the market share, the charge is generally low. Charges increase in all variant forms when platform becomes mature with a considerable large group of end-users willing to pay to distinguish themselves.

Multiple platforms: to segment market

Alibaba runs several platforms simultaneously. Alibaba.com and Taobao.com are two distinguished ones, and tmall.com may also be treated separated though it is now embedded in Taobao by using the same search engine. In literature, different platforms are often assumed to be operated by different owners and the multiple platform issue is new to the best of my knowledge.

The Alibaba and Taobao difference is easy to understand as B-B and B/C-C market are mostly separated. By having two platforms, the market is segmented with little overlapping. In contrast, the emerging of tmall.com in 2004 is more subtle to understand, as it mostly overlaps with users on Taobao.com, the groups’ own platform. If it happens that buyers/sellers move from one platform to another, it does not seem like a profitable developing strategy. I argue operating on multiple platforms has at least two other benefits: to further separate sellers/buyers; and to deter entry of potential competitors (or at least increase competition capacity against other competitors).

Taobao set a very low entry threshold for its sellers: virtually everyone can be listed on Taobao when (s)he wants to sell something. That leaves a mixed group of sellers differing in business size, prices and reputation. Meanwhile, tmall.com has a higher entry threshold: the sellers have to meet a certain criteria regulating the size, brand owning, etc and are required to submitting legal documents like licenses. Also, there is a 6000 Yuan annual membership fee and a required minimal deposit for warranty of 10,000 Yuan. By join tmall.com, sellers send a costly signal to separate themselves so as to attract buyers. On the other hand, buyers also have different concerns on the quality or security of on-line trade. Those who concern more on quality or security are more likely to purchase on tmall.com than on other sellers on Taobao.com, though the price is generally higher. Running two platforms allows sellers/ buyers to self-sort into different groups and the platforms can charge them differently due to their revealed preference. The idea is similar to Ambrus and Argenziano (2009), though in their paper the two platforms are owned by different owners.

Another advantage is to deter entry, or at least increase competition capacity. Though Taobao is the most frequently visited on-line selling website, it still faces fierce competition from say, Amazon and 360buy, in some items (like books and digital goods) and by challenged by new websites like emerging group purchase websites. Internet business is in essentially a business of eye-balls and the current market share matters more than other conventional industries. By investing in a new differentiate platform, it helps to enforce Alibaba’s leading status in on-line shopping. Actually Alibaba group is ambitious enough to invest in every corner of Internet business. It has cooperated with Yahoo to invest in search engine and just launched its cloud computation and smart phone program recently. With the emerging of Groupon style group purchasing, Alibaba also initials its group selling program embedded on its platform Taobao and tmall.com. Though the focus of this project focuses on its platform operations, I believe all of these measures help to raise its image as an integrated Internet giant.

Supporting programs: to facilitate trade

The on-line transaction is not automatic with the establishment of a platform. Different from Amazon who sells items by the website itself, Alibaba Group only provide an intermediate service and the transaction is still between sellers and buyers. Like all online transactions, the negotiation, payment and delivery does not necessarily happen at the same time. The transaction could abort if the seller and buyer lack the basic trust to each other. For example, the buyer suspects the seller may send her a low-quality item or nothing at all after she pays first, or the seller worries the buyer may refuse to pay after the item is delivered. Such extreme case may be rare, let us consider a subtle case. When an item’s price is low enough under a sale– not unusual case for sellers to attract buyers – potential buyers may instead suspect the low price signals a low quality of the item: a typical example of adverse selection in asymmetric information literature. Such concerns may greatly frustrate the spread of on-line transaction and thus the development of platforms.

Accordingly Alibaba Group proposed a series of supporting programs to build the basic trust and to facilitate transaction, some of which is listed in the introduction section. Here I discuss the role of these supporting programs in general. First, the programs are supportive both ex ante and ex post. Buyers need to screen from a list sellers to decide from whom to buy before purchasing occurs. To help the screening process, the platforms provide a small business credit rating system to document sales information, number of fraud occurrence, rating score summing feedbacks from previous buyers, etc. Also, buyer can view all worded feedbacks from previous buyers and the sellers’ reply, as to judge the item’s quality or the seller’s service altitude. The rating and feedbacks are from previous buyers, which increase its credibility. To prevent sellers from manipulating its rating score by hiring shell buyers or trading small digital item, the system also provides scores for only main business where manipulating is more difficult or too costly. As claimed by Alibaba, the small business credit rating system is very the first one in mainland China. Ex post, after the purchasing occurs, the buyers are reassured a way to return or change items should a low quality/damage debate occurs. On Taobao.com, a consumer warranty is provided and sellers have the option to join or not; also, sellers can choose to deposit a certain amount of funds which is used exclusively for warranty. By joining the warranty and depositing, the sellers both signal themselves out from other sellers and also reassure the potential buyers for responsive return/change if needed. Both ex ante screening and ex post warranty increase buyers’ confidence and thus facilitate transaction. From a recent empirical study by Roberts (2011), the two effects do not substitute each other.

Second, the programs differ for different platforms due to the different nature of potential fraud. An intuitive example is from the difference of Alibaba.com and Taobao.com. On the former platform, where trades are of large volume per transaction and repeated trades more likely to occur, knowing the identity of trade partner is more important. Accordingly, Alibaba.com provides much more detailed information on sellers’ identity, including the location, business, name and contact of legal representatives, as well as legal documents like production license, etc. Buyers on Alibaba.com, usually also small business, have a higher ability to track sellers if a fraud occurs than buyers on Taobao.com, so warranty is more emphasized on Taobao.com than on Alibaba.com. Also, Alibaba.com does not adopt the same credit scoring system as on Taobao.com which requires a large number of purchasing occurrences. Instead, it provides a x-year membership icon to indicate the supplier has been listed on the platform for x years. In sum, the effort of these supporting programs should be understood from the practical operation on different platforms.

Summer activities

Alibaba Group usually is supportive for academic and commercial researches for China’s e-commerce analysis, especially those relating to its own business. Though there is not much academic research on Alibaba yet as compared to, say, eBay, it is growing in recent years. The Group founded a research center branch in 2007, headquartered in Beijing. The research center does analysis and publishes reports in e-commerce topics, such as rules and regulations, market evolution patterns, annual on-line seller development pattern analysis, etc. The center is also the main channel to deal with cooperation issues with scholars. I also benefit from the center during the preparation period of this project and in this summer.

Usually data are available conditional on a confidential agreement and willingness to share the research results with the center, as I was told by one of the staff in the research center. However, eventually I did not get the data as described in the proposal, even though I negotiated repeated though all means I had with the research center in the summer. For unknown reasons, the Groups become more cautious for releasing their data, especially the micro level transaction data that I requested. Though not fully convincing, from anecdotal evidence I guess it is also related to the Alipay dispute with Yahoo and Softbank Corp that daunting the Groups during that time.3 Nevertheless, the research center still provided me some background information that helped me to better understand the basic operation, their current focus-on and future concerns.

Besides continuing communication with the center in the hope of getting the data, I also try to fix the data problem by other ways. One way is to develop a web spider algorithm to collect the data myself and the other is to find a partner specialized in computer science and do the data collection. The shortcoming of the two alternative methods is that only the current cross sectional data are available at best and it takes time to build a panel. Collecting data by myself has the advantage of knowing exactly what information is needed but the disadvantage is low efficiency from lack of coding experience. Hiring a CS expert has the opposite advantage and disadvantage and communication is a big issue. I am doing in both ways: together with a few PhD students, we contacted a PhD student from Chinese Academy of Sciences specialized in web crawling to help me do data collection. The work is still carrying out. Also I spent some time to learn Python, a language for web crawling, and did the data collection myself. Due to network connection constraint and maybe the efficiency of my code, the data collection is still small scale.

During my time in Beijing, I also talked to professors in Peking University (where I got my master degree from) and Phil Haile (a Yale professor who happened to hold a short course in Beijing) on my project. They suggested ways to refine the topic, provided helpful on-the-frontier empirical tools, and also introduced other people’s work on related research to me. Their suggestions helped me to better clarify my thought on the topic as well as inspired me to realize how important and promising this project can be.

Click here to view projects of other 2011-2012 USCI Graduate Summer Fieldwork Grant receipients.