Alibaba is confusing.
The company just keeps getting bigger and more complicated. There is really nothing like it in other countries. For example, most e-commerce sites don’t own movie studios and soccer clubs.
And now we are seeing the emergence of new retail, which is a dramatic change in Alibaba (and other Chinese e-commerce platforms). I will give my explanation of new retail in Part 2. But first, I thought I would try to lay out a simple framework to explain Alibaba and China’s other super-platforms. Which is basically an evolution with 4 stages.
Stage 1: Build Basic Demand-Side Scale Around 1-2 Core Interactions.
Alibaba started as a simple B2B platform. And then Taobao, launched in 2003, connected consumers with small merchants and entrepreneurs. It was closer to C2C than B2C, a sort of virtual bazaar or village marketplace. Next came Tmall (originally Taobao Mall), launched in 2008, as a more controlled site. It had established brands / merchants and licensed distributors, making it more like a shopping mall than a bazaar.
This basic theory behind is you create a platform (digital better than physical) that enables two different users groups (in this case consumers and merchants) to connect and do transactions. The purpose of the platform is to drop the transaction costs (search, coordination, negotiation, information asymmetry) such that these groups can do transactions. People can find products to buy, people to date, information they want, and so on.
And you want to get as many users as possible on both sides of the platform. And get as much activity as possible by users. And ideally, you start to build network effects (also called demand economies of scale) such that your service improves with use.
But the goal of stage 1 is to get the platform functioning around 1-2 core interactions. This is actually pretty hard.
Stage 2: Add Demand-Side Scale. By Adding Other Advantages.
Once you’ve got a basic platform running, you want to start creating additional demand-side scale. That means growing users, participation and data (the core assets that create the platform). And, if its e-commerce, you go for a data network effect (on the consumer-side).
In a data network effect, the more a consumer uses the site, the more data the platform gets about them, and the more their experience can be personalized. They get shown products they are more likely to want. Which makes the service better for them. Then consumers use the site more (because it’s better) and the cycle repeats. This type of data network effect works at the individual and the aggregate level.
Alibaba has been doing this for a long-time. It’s why you always hear the management talking about personalization and curation. The site has been optimizing itself overall and to each individual consumer. This increases the demand-side scale.
The site can also start trying to build other competitive advantages. For consumers, that usually means creating habits. Getting people used to buying on impulse (‘one-click buying’). You make it fun. And shopping becomes about purchasing and entertainment. You speak to needs and aspirations. But it’s not just about finding a product you want and buying.
For merchants, the site can start building in switching costs. Merchants build up customer bases on the site. They build up revenue coming from the site. They start getting the data. They start developing new products based on the data. That’s all great for them, especially small merchants. But it also makes it harder to switch back and forth to other e-commerce sites quickly. They become invested in the success of the platform.
Stage 2b: Add Demand-Side Scale. By Adding New Users and Use Cases.
The above two stages are pretty standard in e-commerce. Not much new there in terms of China. Just bigger numbers. But Stage 3 is where China starts to diverge.
Platforms tend to beat product companies (also called pipelines and vertically-integrated companies). They can subsidize pricing between users groups (it’s why Google, Facebook and Wechat are free to consumers). Similarly, three-sided platforms tend to beat two-sided platforms (more ability to subsidize prices and do creative stuff that your competitors can’t). And so on. Having more sides to a platform is usually an advantage.
So these platforms start adding new user groups. They can add advertisers (usually advertising agencies are platforms themselves that connect ad supply and demand). They can add content creators (in this case Youku-Tudou). And they can start to add application developers (really important). These are the companies that build new software that runs on top of the platform (think of all the apps that run on Google Maps and Earth. Just count the number of APIs available).
And this is when things get really cool. Because with multiple users groups and lots of data, you can start to go identify and exploit new use cases. You can start to offer entirely new services. And this is also where digital China really gets pretty crazy. China’s platforms jump into everything: payments, credit, money market funds, bicycles, on-demand delivery, local food services, healthcare, etc. They just keep adding user groups and taking on new use cases. It’s crazy how fast they move.
For example, Alibaba frequently talks about how it is merging e-commerce and entertainment. They have “see now, buy now” idea and their big gala. And as mentioned, they even have their own movie studio.
In China, the net result of Stage 1 and 2 is tremendous scale on the demand-side. Hundreds of millions of users doing all sorts of services. That is where the power is in the consumer-facing markets of digital China.
Stage 3: Build Supply-Side Scale
Along the way, these platforms have been increasing their spending on some mostly fixed costs, such as IT / web services. Probably logistics. And likely R&D. And as they get larger than rivals, they start to get scale effects on the supply-side. If you are spending 20% of revenue on IT services and you are 3x larger than a rival, then you are outspending them on this.
These supply-side economies of scale are common in software companies in both China and the rest of the world, especially in IT/Web services.
What is different in China is that internet companies are not afraid to get their hands dirty – and go into managing physical assets and activities on the supply-side. They hire tens of thousands of delivery riders. They built huge numbers of warehouses. They build and buy supermarkets. They build their own delivery drones and autonomous vehicles. They open physical banks. They are currently building clinics.
Western digital giants tend to stay purely digital creatures, doing software in nice business parks. But Chinese companies are comfortable doing hardware and manufacturing (it’s all done in China anyways). And they will go into services, customer service and other labor-intensive activities (which are cheaper in China as well).
And while this is operationally complicated – and decreases the attractiveness of their economics – it also gets them a degree of competitive protection from China’s ferociously competitive online world (yes, much more than in the West). When Chinese digital companies get market leadership, they will often diversify into more services (Stage 3) and go for supply-side scale, including with physical assets and activities. This gets them some degree of competitive protection. You can really see this in companies like Meituan and JD.
Stage 3b: Add Supply-Side Scale. By Digitizing Capabilities and Inverting.
This process continues on the supply-side. And there are additional advantages you can build like government advantages (yes, it’s important). You can also get cost advantages through purchasing costs, location / transportation cost advantages and other.
However, the most interesting move is when companies digitize and invert their core capabilities.
- Amazon was an early pioneer in this, turning its IT/web services capabilities into Amazon Web Services.
- Alibaba did the same with AliCloud.
- Alibaba and JD both did the same in payments by creating Alipay / Ant Financial and JD Finance.
- JD is now doing this with JD Logistics (called “retail as a service”).
- Didi is even doing this right now with its new driver solutions business (called Xiaoju).
By turning an internal capability into a market-facing business, the company gets even greater scale on the supply-side. It also gets you a second business (note: AWS throws off like $8B in operating cash flow per year, which subsidizes delivery). And sometimes it even gets you another platform business (Ant Financial was recently “valued’ at $150B).
Stage 4: Exploit and Innovate Really Fast (The Elon Musk Strategy).
There is an ongoing discussion about going for competitive advantage vs. being a really fast innovator. Elon Musk (and others) argue that speed of innovation is the only advantage you can have now. Warren Buffett has argued his candy and soda companies are well-protected, even against Elon Musk. Elon Musk has announced he is launching a candy company.
My take is that ability and speed of innovation is critical – but these can be greatly amplified by your structure and competitive advantages. Competing in a race with a car is better than with a bicycle.
So the next stage is to take the existing structure (robust platform plus supply side scale) and use that to exploit and innovate really fast.
Alibaba has a sea of data now. It has many user groups that are very active. The company can study all of this and identify new needs and opportunities. They can come up with new services, products and business models. And they can then implement them very rapidly, by rolling them out to their existing users.
And they are really good at this. Because their management is as good as you will find anywhere. They made big moves in groceries and fashion last year. They are entering hotels and maybe restaurants (including a new partnership with Starbucks). They, like most of the super-platforms of China, are also targeting finance and healthcare. They are moving really fast in multiple areas. This is how you get from a basic e-commerce site to +20 businesses, most of which are named after animals. The joke is that Alibaba is building the world’s biggest petting zoo. Note: their new hotel is called Flyzoo.
Stage 4 is about becoming a fast and relentless innovator. And using the existing business as an almost unique advantage in doing this.
Stage 4b: Add Complementary Platforms and Linked Businesses
And with a little luck, some of these new services, products, use cases and business models will turn into platforms themselves. And they can complement the current platform. Likely on the consumer side but it’s also possible on the enterprise-side. Or with advertisers. Maybe app developers.
For Alibaba, the situation is pretty amazing now. They have multiple complementary platforms: Taobao, Tmall, Youku-Tudou, Alipay, and others. They reinforce each other. And create service offerings that are impossible for competitors to match.
And even if their new services don’t create complementary platforms, they can still be linked businesses. They can share customers (lowering acquisition costs), technology and capital. A good example of this is Baidu’s relationship with investee iQiyi. They have a master agreement that covers AI, web services, online advertising, internet traffic, data / content and smart devices. You can see the details in the iQiyi F-1.
And that is my basic explanation for what has been going on with Alibaba. I think you can see this same pattern in e-commerce and other Chinese digital giants pretty regularly.
Which brings us to New Retail, which is a big change to the entire evolution I just outlined. That’s what I will cover in Part 2 (coming next week).
Cheers from Shanghai, jeff
Also, if you want to know what someone looks like 15 minutes after selling $30b of goods in a day. See the two guys below.
I write and speak about digital China.