The Ali Baba Business Model: Selling Clicks, Keywords - and Customers

Stuff? There are no margins in stuff. Even - or especially - in China. No, dude, Ali Baba, China's - and soon, potentially - the world's dominant ecommerce company is a post industrial enterprise.

Selling stuff is for the little guy. Alibaba sells something far more valuable: access. To the world's biggest and fastest growing consumer market and to the myriad services that can be wrapped around all those products that others wish to sell.

It owns 80 percent of that market and with fewer employees than eBay, whose business is similar but whose hold on the US market is far more tenuous.

The biggest problems that Ali Baba is likely to face in foreseeable future have to do with expectations: that it will defy the law of big numbers and continue to grow, that it can expand successfully outside its home market and that its sellers can make a profit. All of those are challenging, the last being arguably the most crucial and the hardest. But then given how far the enterprise has come, who's going to bet they can't? JL

Charles Clover reports in the Financial Times:

Alibaba, China’s hottest internet company, has built a massive ecommerce business without selling a single pair of jeans, washing machine, or book. What it sells instead are consumers, and it sells them in droves to retailers who pay for clicks, keywords, ad views, and sales.
But while Alibaba makes handsome profits from its Taobao and Tmall shopping platforms – the company earned net income of $3.7bn in its 2014 financial year – many of the small businesses that make up Alibaba’s main customer base do not. As Alibaba looks toward an initial public offering later this year that could raise $20bn-$25bn, some of its customers are beginning to rethink their business models amid a shakeout that has slashed the number of small and medium-sized sellers on China’s internet.

Chen Xiaogang, chief executive officer of Lisa Womens’ shoe store based in the southern city of Shenzhen, which employs about 50 people, has been selling on Ebay-like Taobao since its founding six years ago, but recently opened up stores on websites belonging to competitors. “[Sellers] invest too much in advertising [on Taobao] but revenue doesn’t catch up. So generally speaking, we don’t make money on Taobao,” he said.

He said intense competition on Taobao and the price of advertising – 40 per cent of his revenues – has driven him to look for alternatives. “Everyone is competing desperately. It’s cut-throat competition. It’s difficult.”

Wang Chun, ecommerce manager for Kudi pet, a pet supply store that sells on both Taobao and Tmall – Alibaba’s equivalent to Amazon, where bigger branded businesses sell to consumers – is more blunt than most: “In any industry, including this one, the top-ranked seller is losing 10 per cent [of costs] per month, the second-ranked seller is losing 8 per cent, the third-ranked seller is losing 5 per cent, and so on”, he says.
“Everyone is losing money, but it’s investors’ money. When it runs out, they just get more investors.”
Alibaba does not publish information on how many of the stores operating on the site are profitable, but one merchant who advises Alibaba sellers on how to optimise their e-stores says that depending on the industry, only between 3 and 10 per cent of stores on Taobao are making money. The data were better on Tmall, the business-to-consumer site analogous to Amazon that sells branded items.

Taobao does not charge store fees and Tmall’s fees are minimal, but sellers cite the rising cost of advertising as the main reason they are finding it hard to make money despite huge increases in ecommerce sales volumes. Advertising rates for commonly used keywords and banner ads are set by competitive auction.

Li Siyuan, who sells freshly cut flowers in Beijing from using Taobao, says the average advertising rate for keywords like “flowers” has increased three times in three years, from Rmb5 per click in 2011 to Rmb15, and says it takes approximately 50 clicks to get a sale. The reason he tolerates losing around Rmb200 on new orders is because “that is what it costs for a new customer, but returning customers are free”.
“I guess it must be worth that, otherwise no one would pay the money,” he said. “You need high volumes because the margins are thinner than in offline sales”.
Staying in business makes sense for those with deep pockets or other sources of income, but for many others who opened a few years ago amid a burst of optimism about the transformative power of the internet, the dream of small entrepreneurship is fading.

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While Alibaba says active buyers increased 10 per cent last year to 255m, active sellers are falling, according to independent research. Alibaba does not publish historical data, saying only that 8m sellers made at least one sale on Taobao or Tmall in its 2014 fiscal year.
But the China e-Business Research Centre, a consultancy based in Alibaba’s home town of Hangzhou, estimates the total number of private consumer-to-consumer sellers in China was down 17.8 per cent year-on-year to 11.22m at the end of 2013 and predicted a further fall to 9.18m by the end of 2014. Taobao is estimated to comprise four-fifths of this market.
“Most sellers on Taobao are now in a stage of losing money,” said Mo Daiqing, lead analyst the centre. “Leaving Taobao is also a trend now, because there are more ecommerce platforms, thus sellers have more options.”
Alibaba has been keen to underline the fact that some sellers leaving Taobao are in fact switching to Tmall, a more exclusive club with only about 100,000 of Alibaba’s 8m total active sellers. “It’s important to keep in mind the pie is growing,” says one person familiar with Alibaba.

Taobao contributed 69 per cent of Alibaba’s total sales volumes in the first quarter, compared to Tmall’s 31 per cent, according to an amended IPO prospectus released June 16. By 2017, business-to-consumer sales will have caught up to consumer-to-consumer sales volumes, according to iResearch, a Beijing based internet consultancy.

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Michael Clendenin, author of a highly regarded profile of Alibaba for Redtech Advisers, a Shanghai-based consultancy, says China’s retail sellers are notoriously competitive, and Alibaba’s business model was designed with that in mind: “To many of China’s second-generation ecommerce entrepreneurs, making a sale and gaining a potential long-term customer is far more important than profit. That’s why the best way to benefit from this blood sport is to be a promoter, not a participant.”

Still, one venture capitalist compared having a store on Taobao or Tmall to Chanel opening a boutique in Sanlitun, the upscale shopping district of Beijing: “You’re not going to make money but you need to have the public presence.”