12 May 2014

The Alibaba Effect


The Internet giant is the quintessential success story in the new consumer-oriented Chinese economy. Although it plans to make its mark in the US financial market with a potentially record-breaking initial public offering, its stomping ground will continue to be its huge homeland.

Bill Kirby & Warren McFarlan

Alibaba is about to make history with the first genuine mega-IPO of a Chinese entrepreneur-founded company in the United States. The numbers are historic as well --an anticipated market capitalization of some $200 billion.

It comes to the U.S. rather than Hong Kong for the most old-fashioned of American reasons: to "raise capital and maintain management control," which they couldn’t do in Hong Kong. Hong Kong believes in the principle that each share of stock is entitled to one vote. The U.S. markets, on the other hand, proclaim that some classes of shares can have more clout than others. Thus, founder Jack Ma and his management team, who own a little over 9% of the company, can still retain control of its destiny. (Meanwhile, although Hong Kong stock market authorities are officially pleased to stay true to their rules and principles, we anticipate intense internal second guessing among them and probably an eventual change in policies and views. Losing Alibaba really stung.)

Alibaba was founded in 1999 in the city of Hangzhou in Zhejiang province in eastern China. In those early days, it was a small, struggling startup with an opaque mission and a remarkable ability to both raise and burn cash. Its only asset was Mr. Ma, its charismatic and dynamic founder. After we wrote our first case study about the company in 2000, we were afraid it would go bankrupt before we could teach the case for the first time. Instead, we were present at the birth of one of today's great online giants.

Still largely unknown in the West, Alibaba dominates China’s Internet and logistics space with over 600 million subscribers and nearly a quarter trillion dollars of annual transactions. A combination of Amazon and eBay, it holds an 80% share of the e-commerce market in the world’s second largest economy. Its net income for 2013 was four times more than in 2012. Its products and services lie at the core of an extraordinary transformation of China today from a low-cost, export-driven economy to one that is driven by consumers.

Like no other company, Alibaba has succeeded in making China—a country with countless internal barriers to trade—seem like one market, where goods can be purchased, delivered, and paid for with a confidence unimaginable little more than a decade ago. It has done more for China’s small- and medium-sized enterprises than any government policy, ministry, or bank.

Alibaba’s only limits are those imposed by the speed at which these enterprises continue to grow. Health and welfare systems—especially for China’s rural poor—also need to function if today’s 40% personal savings rate is to be reduced, thereby unleashing cash to fuel new growth in consumer spending. Creating this domestic safety net will be crucial to enabling Alibaba to grow even faster.

But don’t look for the company to make aggressive inroads into international markets. The commercial opportunities supported by the extraordinary Internet and emerging logistics structure in China means that Alibaba’s future lies at home. It has huge market growth potential, real heft against local opponents, and little fear of foreign entrants, since language, government policy, scale, and entrenched competition have erected formidable barriers to entry. The major global giants like Amazon and eBay have either exited the market or not even tried to enter it. Thus, think of Alibaba as a pure China play where you are betting on the future of the Chinese economy.

This is a story not just of China but also of one region. For centuries Zhejiang has been a hotbed of entrepreneurship and private enterprise. The Communists built few state-owned enterprises there. Hangzhou today is China’s leading business city. As another remarkable Hangzhou entrepreneur, Lu Guanqiu of the automotive components maker Wanxiang, once told us: “As long as there is a human race, there will be Chinese. And as long as there is a market, there will be people from Zhejiang.”

This is also a story of Chinese innovation. Alibaba’s roots are those of a Chinese startup, not those of a state-owned enterprise. Its unique combination of timing, wits, external capital, and alliances make it the kind of home-grown success story Apple and Amazon have been in the U.S.

Operating away from the politically sensitive domains of blogs, personal information, and news, Alibaba has had an open playing field that it continues to exploit. Free from the domain of state-owned enterprise, it is an example of what entrepreneurship can do in China. As Ma puts it, “State-owned enterprises are big because they are state-owned. We’re big because we’re good.”

All this having been said, when it comes to innovation and entrepreneurship, Alibaba is far from alone in China. It is merely at the head of a parade. Stay tuned.

Warren McFarlan and Bill Kirby are professors at Harvard Business School and coauthors of the new book Can China Lead? Reaching the Limits of Power and Growth (Harvard Business Review Press). In addition, Kirby is a member of the Faculty of Arts and Sciences at Harvard University, where he chairs the Harvard China Fund.

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