Everybody loves superlatives, and it is definitely Superlatives Week for the tech press. Alibaba’s IPO will represent “surely one of tech’s largest ever” Kara Swisher of Re/code intoned. Heather Somerville and Brandon Bailey of the San Jose Mercury News said that the company would have “an immediate market value greater than Facebook and Amazon” when it debuts. And the Wall Street Journal argued that it “is China’s — and by some measures, the world’s — biggest online commerce company.”
The Journal continued, describing the company as “a marketplace, a search engine, and a bank, all in one.” Quartz went all the way to the asymptotic extreme, arguing that the company “isn’t just the ’Amazon of China’—it’s also the Dropbox, PayPal, Uber, Hulu, ING Direct, and more […] Alibaba’s distinct businesses resemble more than a dozen major Western companies, by our count.”
Alibaba is just the kind of multi-headed dragon that acts as an ink-blot test for American journalists. As one common narrative would have it, Western Internet companies should be trembling at Alibaba’s impending IPO because it indicates that the company intends to expand beyond its current Chinese confines. As the Mercury News quoted one financial analyst from PrivCo, “I think Alibaba is definitely going to be a major player. There’s no reason for them not to go after the U.S. market. It’s not a matter of if, but when.”
Except for its decidedly digital focus, Alibaba’s corporate structure has more in common with Warren Buffet’s Berkshire Hathaway than it does with America’s elite tech companies.
Yet, it is precisely a matter of “if,” not “when.” For lost in all the superlatives of the last 48 hours is a more fundamental recognition of what Alibaba truly is – a holding company with businesses that dominate large markets in the second-largest economy in the world. Except for its decidedly digital focus, Alibaba’s corporate structure has more in common with Warren Buffet’s Berkshire Hathaway than it does with America’s elite tech companies. Its strength in its home market is impregnable, but its desire for international expansion remains low.
To truly understand Alibaba and to place it in context, we have to expand our lens to conglomerates in general, the advantages they can hold in their local markets, and the challenges they face in expanding overseas. Alibaba is hardly the only prominent technology conglomerate coming out of Asia, where companies like Tencent, Samsung, Hyundai and Rakuten have their hands in dozens of business lines. There are intrinsic advantages to this organizational structure around financing, recruitment, and government relations, but these conglomerates are also creatures of the habitat they live in. We shouldn’t expect them to easily expand outside their borders, even if they wanted to.
The Power of Conglomerates over Startups in Under-Developed Markets
Finance may be the fuel of startups, but in many global markets, financing options for new businesses are limited or even non-existent. This is particularly true of asset classes like venture capital, where advanced levels of economic development are needed just to get started. For VCs to invest, there has to be well-developed property rights to protect investments with a potential time horizon of a decade, strong public equity markets to provide for exits, as well as trust between management, investors, and government to ensure stability of business operations.
In the absence of such sources of capital, startups have two options: they can bootstrap or they can receive public funding. In Korea, large conglomerates like Samsung and Hyundai were offered guaranteed monopolies over sectors of the economy along with the necessary investment capital in exchange for following the orders of the country’s political leadership. Samsung went from being a food trading company in one of the smaller metropolitan regions of Korea to one of the largest market cap companies in the world. Alibaba is relatively unique in that its founder, Jack Ma, built the company with his own raised capital, in spite of the dominance of China’s state-owned enterprises.
Through a quickly expanding web of financing and cross-subsidization, the one-product company can suddenly become an economic juggernaut, owning more and more industries as the underlying national economy grows.
Regardless of government involvement, these startups follow a well-torn path to growth. First, build up the business with a focus on generating large positive cash flow, and then aggressively invest those profits into the original business as well as into strategic side products with decent technical overlap. Through a quickly expanding web of financing and cross-subsidization, the one-product company can suddenly become an economic juggernaut, owning more and more industries as the underlying national economy grows. This corporate model is at the heart of Japan’s zaibatsu, Korea’s chaebol and China’s major Internet holding companies.
For the individual or family who owns the conglomerate, there are few avenues to turn their corporate equity into liquid assets, an issue particularly acute in China due to its on-and-off bans on IPOs. Without robust stock markets, private equity, or major acquirers due to the early stage of the economy, owners have little choice but to expand their own holdings through broadening the scope of a holding company. Thus, these conglomerates can act in some ways as a family office, which simultaneously offers the company a reasonable level of stability.
In addition to financing, another advantage that these large conglomerates share is that they have an easier time locating talent in their core business areas. Since each new business expansion is near a current market, the company has the ability to reuse its cultivated know-how to lower the barriers in a new market and get a head start against competitors. This is especially important in developing markets like China where competitors may not even exist and a first-mover advantage can prove crucial. This is the story of Alibaba, which has expanded into new products as it explored the desires of its customers.
Perhaps the most important reason why conglomerates are important, though, is the need to engage with government bureaucrats, an issue that is particularly acute in China. China, like Korea, Japan and many other Asian nations, places a much greater role on state-driven economic development than, say, the United States. Even today, many of China’s largest companies are state-owned enterprises, and the Chinese Communist Party has extensive control over the success and failure of business in the country. With larger size comes a greater ability to develop the critical relationships to allow a company to succeed.
The Challenge of Expanding Globally
Conglomerates like Alibaba have financing, talent and government relations advantages in China that are unrivaled by others. Yet, none of these advantages demonstrate the company’s ability to engage in markets far outside of its immediate home market. Alibaba’s DNA was crafted for the Chinese consumer, and it will face the same problems any company experiences when it leaves its local cocoon.
Among the major conglomerates in Asia, one of the few to successfully expand globally is Samsung. Up to 1993, it was among the least-reputable electronics and appliance manufacturers in the world. In a famous speech given in Frankfurt that year, the company’s chairman exhorted his colleagues to start over from scratch, and demanded that the company become one of the top electronics companies in the ensuing years.
The e-commerce companies that target a specific population are going to have intrinsic advantages locally, but this simultaneously means decreasing the ability of the company to win internationally.
It would take more than a decade for Samsung to develop the global product, sales, and marketing know-how it needed to become the company it is today. Those expecting Alibaba to magically abbreviate that process are going to be disappointed.
One strategy that we have witnessed the past few years is for Chinese companies to invest in overseas startups to start the global osmosis process. Most prominently, Tencent has invested in a multitude of companies such as Snapchat, KakaoTalk, Weebly, Kamcord, and Plain Vanilla Games (the makers of trivia app QuizUp). But investments, no matter the size, are no substitute for learning the actual inner workings of a market and a culture. To me, these investments feel reminiscent of Japanese investors buying American properties like the Rockefeller Plaza in the 1980s, only updated for the 21st century.
The Real Story
The right story is that Alibaba represents a trend we have known about for some time, namely, that e-commerce is fundamentally local. Amazon and eBay dominate in their home market of America, Rakuten in Japan, Flipkart in India, Gmarket in Korea, and of course, Alibaba in China, along with e-commerce startups like Vente Privee in France and Coupang in Korea. There are, of course, some exceptions like eBay, which receives half of its overseas revenue from Germany and the United Kingdom. Although Amazon receives about 40 percent of its revenue from international sales, this figure is down from 43 percent a year ago as it faces local competitors.
It should be obvious, but consumers in different countries, even neighboring ones, have quite different tastes. The e-commerce companies that target a specific population are going to have intrinsic advantages locally, but this simultaneously means decreasing the ability of the company to win internationally.
Alibaba seems to understand the need for market focus. Its S–1 makes little mention of global expansion and focuses exclusively on local competitors and market dynamics. Thus, let’s analyze Alibaba the way it should be seen – as a tremendous example of the success of a Chinese entrepreneur to build a massive business in an era of dizzying growth in the Middle Kingdom – rather than a competitive threat that causes us to tremble with fear instead of crying felicitations.
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