This is an excellent book to understand Jack Ma, Alibaba and the Chinese tech ecosystem.
Start with a Team: Alibaba’s 18 founders. At a young age, Jack Ma taught himself English by offering tours of his hometown Hangzhou to locals coming from English speaking countries. Jack went on to study English at Hangzhou Teachers Institute where he graduated in 1988. Following graduation, he taught English for a few years and because of his English skills, he was selected to go on a trip to America, on behalf of the Hangzhou government. While there, he tried using the internet to look up “beer” and noticed there were very few Chinese web pages. When he got back to China, he started China Pages, a custom website development shop for Chinese businesses. The business received funding from the Ministry of Foreign Trade and Economic Cooperation but was losing out to rival telecom company Hangzhou Communications that had recently started a competitor. China Pages was struggling to help customers realize return on their investments because there was so little business happening online at that time in China. Frustrated by competition and worried about the long-term effects of being funded by the government, Jack rounded up a group of 17 people - some were former students, some colleagues in the government, some employees at China Pages - and started Alibaba. Jack also met and recruited Joe Tsai, the first Taiwanese graduate of Yale Law School, who was then working at Investor AB on private equity investments, to join as CFO and founding board member. The team focused on the business to business market which they felt should gain more traction before business to consumer focused companies like Amazon.
Open Door Policies: How China became an economic powerhouse. In 2009, China became the World’s biggest exporter, a trend that until recently, seemed all the more likely to continue. But how did we get to this point in China? In 1979, Deng Xiaoping began a series of economic reforms in China that set the stage for enormous growth. The first major act was allowing Chinese individuals to start businesses, a practice that had been strictly forbidden during the previous political era. Next, Deng announced an Open Door Policy, to allow foreign business and investment to flow into specific, Special Economic Zones. This investment spawned incredible growth in now-famous Chinese regions including Shenzhen, which grew GDP on average of 40% per year from 1981 to 1993 and by 2005 became the world’s 3rd busiest port. This incredible growth has created massive companies and seen incredible innovation but has also created global pollution. How sustainable is this great economic expansion?
Right Place at the Right Time: The Importance of Timing in Innovation at Alibaba. When trying to build a business, timing can often be more important than the product itself. This can work in a number of ways - during the internet bubble, several entrepreneurs became millionaires on the backs of grandiose ideas without business models. Alibaba is the perfect example of excellent timing. Alibaba was founded in 1999, right as the internet bubble started to heat up. As valuations rose, institutional investors saw returns skyrocketing; this led Goldman Sachs to open up a dedicated Asia Tech fund, focused on investing small amounts into growing Chinese tech companies. Goldman led Alibaba’s first round in 1999 (a $3.3M fundraise), which allowed Alibaba to grow to significant scale with their tight founding team. The internet bubble also attracted a now re-famous Masayoshi Son, and his software distributor turned VC firm, Softbank, to start investing heavily in the internet. Aliababa was by no means the only fast growing Asian Tech company: Sohu (Founded in 1996 by Charles Zhang), Sina (founded in 1998 by Charles Chao who pioneered the Variable Interest Entity designation in China), and NetEase (Founded in 1997 by Ding Lei) were the famed Asian tech darlings of the day. In March 2001, right before the bubble burst, Softbank led a $20M round into Alibaba (which we discuss more below) that allowed Jack the flexibility to weather the internet bubble storm and keep Alibaba private despite growing losses. Sohu, Sina, and NetEase all needed to IPO and limped out into the public markets at poor valuations (Sohu dropped below $1 per share at one point), which caused a long-term drag on their stock prices and business performance. While Alibaba clearly had reached product-market fit by that time, their fortuitous timing (much like that of Amazon’s bond offering) allowed the Company to stay in business during a tough financial time.
Different Approaches to Similar Problems: Amazon vs. Alibaba. Alibaba is often hailed as the Amazon of China, but it’s actually, quite different in many major aspects. As discussed recently in this Stratechery article, Amazon’s core e-commerce business is about controlling inventory and logistics. Amazon buys at whole sale prices from brands, keeps the inventory in their 400+ warehouses and ships them out to customers. Retailers pay Amazon a fee on the sale as commission. While this revenue model is similar to Alibaba’s Tmall, a major brand e-commerce site that charges commissions on sale, Alibaba does not retain any inventory in the process. Furthermore, on Alibaba’s Taobao, independent small merchants can list any item for sale and pay no commissions, instead they pay for higher ranking on the site’s internal search engine, similar to Google’s revenue model. While Amazon boxes are delivered nationwide, primarily by Amazon, in China, Alibaba leverages a slew of 3rd party logistics providers to deliver packages any way possible: via bike, motorcycle, car, or on foot. This impacts profit margins as Amazon has to employ its entire logistics operation (350,000+ people) whereas Alibaba is comparatively smaller at 50,000 employees. Beyond their core e-commerce businesses, both Alibaba and Amazon have cloud computing offerings – as discussed before, AWS is the biggest platform in North America, and Alibaba is the biggest in China. While cloud in China is now growing more quickly than North America, it remains a much smaller piece of the overall global cloud landscape.
A Lesson in Investing: Analyzing Goldman, Softbank, and Yahoo’s Returns. Alibaba’s funding history is long and complex but illustrates a common dilemma faced by investors and shareholders in startups. Alibaba’s first funding round was led by Goldman Sachs at a $5M pre-money valuation. The next round was a $20M investment in Alibaba, led by Softbank to acquire 1/3 of the Company. At the next funding round in 2004, Softbank invested in an $82M round and Goldman sold its shares, thereby inking a 6.7x return in about 5 years, which by all means is a great investment. However, if Goldman had held on to that share, as Softbank did with its share, at IPO it would have been worth $12.5B, a 3,600x+ return. This is the dilemma faced by several VCs – do I sell now, ink a great return, and make my limited partners happy? Or do I risk it, let my winners ride and realize a potentially career changing win? Yahoo is another example of this complex dilemma. Yahoo invested $1B in Alibaba in 2005 for a 40% stake in the Company (a funding round that was allegedly hashed out over golf at Pebble Beach). After rebuffing Microsoft’s $44.6B offer to buy the Company, Yahoo’s stock price plummeted. A difficult fight with activist investors ensued, and Jerry Yang was eventually fired. This all set up nicely for new CFO, Scott Thompson to come in and promptly offload half of its Alibaba stake for $7.1B, two years later that would be worth $51B. Yahoo, now owned by Verizon, sold its remaining stake earlier this year, and its expected to net shareholders roughly $40B in value.
The Everything Companies: The Holdings of Chinese Internet Giants. The number and variety of companies owned by the major tech giants in China is simply staggering. Alibaba has bet big on a wide variety of companies including delivery giant Meituan-Dianping, Lyft, Snap, bike sharing startup Ofo, Chinese ride-hailing company Didi (which recently merged with Uber’s China business), fintech spinoff Ali-Pay and several others. Tencent, creator of the famous all-in-one application, WeChat, has invested in JD.com, League of Legends creator Riot Games, Fortnite creator Epic Games, and many more. Alibaba and Tencent are so competitive with one another that in recent years, the Companies have made thousands of investments trying to fund the next phase of growth in Chinese Tech. As the economist writes, “Tencent has a portfolio of 600 stakeholdings acquired over the past six years (see chart), many unannounced. There is barely a trace of bombast when Jack Ma, Alibaba’s founder, says that he eventually hopes to see former Alibaba employees running 200 of the top 500 Chinese firms.” It will be interesting to see how these investments mature – in 2018 rival delivery firms Meituan and Dianping had to merge to avoid going bankrupt despite billions in funding from Alibaba and Tencent.