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China has been the ‘workshop of
the world’ since the late 20th century, providing cheap products to global
markets, especially to the richer countries. Alibaba is now becoming recognised
as an important addition to China’s economic prowess, although in the sphere of
commerce rather than in production.
Alibaba’s business has been
focused domestically upon the huge and growing Chinese market. It has been able
to fend off Google and eBay, important US competitors. It has also benefited
from funding by Goldman Sachs and Yahoo – who both provided much-needed cash in
its early days – while managing to avoid their control of its operations. Now
Alibaba is in a strong position to expand into other countries. So, rather than
being prominent only as a big player in one big (Chinese) market, Alibaba could
become a major global player too. When commerce is the core of a company’s
business, then huge volumes are critical for generating revenues. Alibaba has
been able to get these, helped by being based in China, a country with a strong
government and also with the largest national population.
Here I do not plan to discuss
all of Alibaba’s operations or its historical development.[1]
Instead, I want to use the example of Alibaba to weigh up China’s economic
challenge to the established order, when imperial economic power today takes on
a much more commercial and financial form.
Millions and billions
Alibaba’s operations can most
easily be summarised as a combination of Amazon, eBay and Paypal. But that
understates the scope of its business as it expands into other areas.
Nevertheless, the limit on seeing it as a global giant is that more than
three-quarters of its commerce-based revenues derive from China, as does
basically all of its profit. Its newer segments of business – including cloud
computing, digital media and entertainment – are running at a loss, subsidised
by the China commerce revenues.
In terms of stock market
capitalisation, the main company, Alibaba Group Holding, was worth $365bn on 26
June. This was not so far behind Amazon’s $475bn value, especially if one also
includes the separately managed Ant Financial arm (formerly known as Alipay)
estimated at around $60bn. Alibaba’s profitability was also much higher than
Amazon’s in the latest financial year, at $6.0bn versus Amazon’s $2.4bn for net
income after tax and net interest payments.[2]
Alibaba started out as a
business-to-business middleman, facilitating buying and selling, but this
failed to generate much revenue. Now retail business (business-to-consumer)
dominates its commercial operations. Hundreds of millions of Chinese use its
systems to shop online, sell goods and make online payments. Alibaba has two
retail sites: Taobao, selling products sold by smaller scale Chinese-based
companies; and Tmall, which has attracted three-quarters of the world’s top 100
brand-names to sell into the huge Chinese domestic market. Although China is a
poor country, 1.4 billion people and a growing middle class consumer base make
it an attractive market for all global corporations.
Merchants on Alibaba’s Taobao
site get a free listing; on Tmall, these bigger sellers pay an annual service
fee, plus commissions on their sales ranging from 0.4% to 5.0%, depending on
the product. However, revenues from these sites derive mainly from companies
buying extra marketing services that Alibaba’s system provides, including its
analysis of consumer activity to target advertisements. In this respect, it
follows what other established companies do, like Amazon, Google and Facebook.
In the year to 31 March 2017,
Alibaba had a huge volume of business: 454 million active buyers on its retail
platforms and, in March 2017, 507 million active users of its mobile services.
This potential for economies of scale is fundamental for a commercial operation,
and one that helps Alibaba’s expansion into other countries.
The relatively low retail
revenue per buyer deflates the importance of these numbers, and reflects low
average Chinese incomes: just $36 per active buyer in retail revenue per year
and $26 per person from mobile-based services. Nevertheless, a growing revenue
per person multiplied by a very large and increasing number of buyers and users
in China leads to big and rapidly rising total revenues. Alibaba’s China-based
commercial revenues rose by 40% in the year to March 2017, reaching some $18
billion.
Helped by this position in a
market US business would like to penetrate, Jack Ma, the principal founder and
the controller of Alibaba, was the first foreign businessman to meet US
President Trump in January this year. Playing up to Trump’s ‘America First’
policy, Ma promised that he could add one million jobs in the US if its small
companies joined its commercial platform, Tmall, to sell their products into
the Chinese market. This no doubt appealed to Trump, but it would also help
Alibaba boost its revenues outside China, when its foreign revenues have so far
been largely dependent upon regional Asian countries.
Ownership and financing
The ownership and control
structure of Alibaba is murky or, more charitably put, difficult to pin down.
The Alibaba Group Holding company was registered in the Cayman Islands in June
1999, and there is, in addition, a system of contractual links between its many
subsidiaries. Good luck in working your way through its 303-page 2016 annual
report, with 74 of them giving ‘Notes to consolidated financial statements’.
Jack Ma started out by being
moderately generous with his offering of a (very) small stake in the fledgling
company to the initial group of employees, but had later to divest a much
larger share of it to important early backers and suppliers of funds. More or
less the first was Goldman Sachs, which lent Alibaba $3.3m and later sold its
stake very profitably for around $22m, although much too early to realise
dramatically higher returns. Sometimes you just cannot be greedy enough.
Another important supplier of
early funds was Yahoo, which still maintains a stake after later reducing its
holding. The biggest backer of Alibaba, however, was Japan’s Softbank, which
has built an important share. According to the 2016 annual report, Jack Ma
owned 7.8% of Alibaba Group, other directors owned 4.7%, Softbank had 32% and
Yahoo had 15.4%. However, this understates Ma’s position.
At first sight, the ownership
numbers would imply that Jack Ma has little control over the company. However,
this conclusion is questioned by an important deal, one ostensibly made to get
around Chinese government restrictions on foreign ownership of non-financial
companies. This was when Ma took control of Alipay.
In the early 2010s, almost all
of the payments made through the Alibaba commercial system were transacted
through its subsidiary Alipay, which handled $700m per day in transactions.
Alipay had an ‘escrow system’ for security of payment, whereby funds were
transferred to the seller only after satisfactory delivery of goods to the
buyer. This payment system proved very attractive to users, especially given
inefficient Chinese bank payments and the low use of credit cards in China,
since it improved the chance of getting your money back after being delivered
poor quality goods. Although Alipay itself did not necessarily make any charges
directly, and so was not an important source of funds to the main company, it
was nevertheless a key part of the Alibaba operation, important for keeping the
buying/selling/services business model ticking over.
In 2011, news emerged – buried
in a quarterly Yahoo earnings report – that Jack Ma had taken control of Alipay
in the previous year or two and had transferred it out of the Alibaba group.
The price paid by the company owned by Jack Ma was roughly $51m for a business
that was seen as then being worth around $1 billion. This was done through a
so-called Variable Interest Entity (VIE) structure, something that other companies
have also used to get around China’s regulation of foreign ownership of
companies licensed to operate payment systems in the country. However, whatever
the motivation behind the deal, it meant that a VIE company largely owned by
Jack Ma would now control a key Alibaba-related business.[3]
After its expansion into other areas, Alipay is now Ant Financial. Today it is
estimated to be worth very much more.
Such deals may have been a
reason for Hong Kong’s stock exchange to reject the initial public offering
(IPO) of Alibaba shares on the public capitalist market, although it appears
that the most important issue was the favoured voting positions of Alibaba’s
founding shareholders that were seen as being detrimental to new shareholders
in an IPO. The New York Stock Exchange nevertheless accepted the deal, no doubt
encouraged by the potentially lucrative transaction fees. In September 2014,
the IPO sale of some shares in Alibaba Group Holding (ie minus Alipay) raised a
record $25bn, with reported fees amounting to some $300m.
Alibaba and Ant Financial
Alipay was renamed Ant Financial
in 2014. Based on its 2016 round of fundraising, which brought in China’s
sovereign wealth fund and other state institutions, it has been valued at
$60bn, but there is no detail of costs and revenue flows in Ant Financial’s
2016 report. Nevertheless, it is certainly big. Ant Financial performs more
than 150 million payments per day, 10 times the volume for Paypal; it is the
world’s third largest cash management service, lends money to small businesses
and offers insurance services.
Alibaba’s own annual report
shows the following key fact: 37.5% of Ant Financial’s pre-tax income is due to
Alibaba (although I have not been able to find what that income might be!).
There are also many other flows of income between the two groups, with Alibaba
paying Ant Financial for bank processing costs and operating costs – roughly
$760m in the 2016 financial year – and the latter paying Alibaba royalties,
fees for software technology and for other services. The impression given in
one table of transactions is that Alibaba pays Ant Financial more than it
receives, roughly a net $350m in the 2016 financial year, but that will
probably exclude the share of pre-tax income Alibaba gets from Ant Financial.
More information on the latter’s business will be published when it eventually
lists its shares on a stock exchange, an event expected to happen by 2019. In
the meantime, both companies are continuing to expand into other markets and
other countries with acquisitions and cooperation deals, including in the US
and Europe.
Alibaba and global corporate trends
The company’s name comes from
the story of Ali Baba and the Forty Thieves, one of the ‘Arabian Nights’ tales.
The hero, Ali Baba, finds out the command ‘Open Sesame’ for the cave in which
the thieves have hidden their stolen treasure. Jack Ma chose the name as
something that would both be recognisable in global markets and encourage
consumers to think that they too could find treasure. In the same way, the name
of one of the company’s original sites, Taobao, means ‘searching for treasure’
in Chinese. But the company name is more revealing than might have been
intended about Alibaba’s business.
In economic terms, Alibaba is
not itself stealing or receiving stolen goods, although through its powerful
mechanism it is taking a cut from the commercial transactions taking place,
including through selling its advertising services. In this, it is at one with
key developments in the world economy over the past few decades: don’t produce
anything; instead take a share of the value that others have produced by
managing the markets in which they operate!
Monopolisation of commercial
relationships has been a fundamental feature of global
corporations, so much so that most of the leading companies by stock market
capitalisation these days are ones that have a strong commercial power, rather
than being powerful producers. For example, Amazon is now worth more on the
stock market than ExxonMobil, and so is Alibaba. Apple Inc, the world’s largest
company in these terms, has the largest capitalisation of a private company,
but does very little production itself and relies on its domination of supply
chains for assembly and its consumer market power – one should also note its
use of the financial system.[4]
Alibaba’s business model fits with these important trends and it could well
develop into another of these powerful global companies, supported
from its strong domestic base in China.
Tony Norfield, 28 June 2017
[1] For more
detail on these I would recommend Duncan Clark’s book, Alibaba: The House
That Jack Ma Built, Ecco, 2016, and this article by Louise Lucas, ‘Alibaba
bets on do-it-yourself globalisation’, Financial Times, 23 May 2017.
[2] Alibaba does
not have Amazon’s system of warehouses for delivering many of its online
ordered goods, which saves it some costs. Instead, it delivers most goods
within China through the ‘warehouse and delivery network partners’ of its
47%-owned affiliate, Cainiao, which employs 1.7 million delivery personnel and
operates in more than 600 cities in China.
[3] See Duncan
Clark’s book, pp219-224.
