Analyzing Alibaba’s Magic

Can any innovations come from China? Many influential people don’t think so.

As Forbes contributor Edward Tse noted last year, when Joe Biden was vice-president of the United States, he was comfortable challenging American military cadets to “name me one innovative project, one innovative change, one innovative product that has come out of China,” during a 2014 commencement ceremony at the U.S. Air Force Academy in Colorado Springs.

And then there is Carly Fiorina. In her book Rising to the Challenge: My Leadership Journey, the former Hewlett-Packard CEO insisted the Chinese people are gifted in many ways, but not when it comes to innovation and entrepreneurship. She made similar comments while arguing against U.S. calls for more centralized and standardized education as an American presidential hopeful.  “I’ve been doing business in China for decades,” Fiorina said on the GOP campaign trail in 2015, “and I will tell you that yeah, the Chinese can take a test, but what they can’t do is innovate. They’re not terribly imaginative. They’re not entrepreneurial. They don’t innovate. That’s why they’re stealing our intellectual property.”

Just using patents as an indicator, however, you can argue that corporate China has been doing comparatively very well on the innovation front in recent years. After all, according to World Intellectual Property Organization, China’s Huawei filed the largest number of international patent applications in the world (surpassing Qualcomm, Samsung, and Hewlett-Packard) in 2015—when Biden still had an office on White House grounds.

Today, of course, Alibaba is the Chinese firm that clearly stands out. The online juggernaut was founded in 1999, when less than 1 per cent of China’s population even bothered using the Internet. Since then, Alibaba has become one of the top e-commerce companies in the world with a market capitalization and revenue roughly comparable to Amazon’s. The company’s rise, however, is not fully explained by traditional Western theory, which argues that companies spearhead innovation to meet the needs of their sophisticated consumers.

The rapid growth of firms in Japan and Korea forced researchers to revisit that logic somewhat, but these markets were not considered home to true innovators (with a few exceptions); local success was mostly attributed to mimicking Western innovations and selling copycat products at reduced rates.

China has also been called a copycat market. But Alibaba is a different story. The company has become a leading innovator on the world stage despite its country’s so-called institutional voids.[i]

This paper argues that Alibaba’s impressive success has actually been driven in no small way by the institutional voids that challenge other firms in the same business environment.

Let’s start with some brief history. Chairman Mao Zedong heralded a new era of communism when he founded the People’s Republic of China in 1949. Chairman Mao believed in a closed economy, and promoted self-sufficiency in China. However, Deng Xiaoping eventually rose to power—despite Chairman Mao’s efforts to silence his differing views on economic policy—and opened the door to a market-based economy in China in the late 1970s. Deng Xiaoping is credited with sowing the seeds of the rapid development of the Chinese economy over the last few decades.

Residual effects of the closed economic system that Chairman Mao proclaimed plagued Alibaba throughout its economic rise. A shortage of institutional support for basic business operations—an institutional void—made for unreliable sources of market information, an uncertain regulatory environment, and an inefficient judicial system.[ii]

“The lacking Chinese landscape and unsupportive social systems made it easier to leave existing business models behind and leap into innovative online enterprises.”

Alibaba was founded in the late 1990s, a time when Chinese consumers generally bought their food and household needs from street markets; logistics systems lagged far behind those of developed countries; roads were largely unpaved or congested with a mix of cars, bicycles, motorcycles, carts, and pedestrians; most transactions were cash-based; the use of credit cards online was feared; Chinese markets (especially online) were highly regulated by strict government rules and policies; and government officials were generally seen as corrupt. In fact, Alibaba not only thrived in an institutional void, it was a filler of institutional voids.

Alibaba offered alternative marketplaces where buyers and sellers could interact and undertake transactions. It overcame an inefficient logistics system by developing a sophisticated information platform to reach both urban and rural customers.

The company also managed to convince consumers that its payment systems were safe and secure. Alibaba then developed a tracking system that collected and efficiently employed customer data. It now plans to develop demand-driven entertainment by using the data it collected, as well as expanding into brick-and-mortar stores through its alliance with Suning, one of the largest consumer electronics retail chains in China.[iii]

Alibaba’s success has been attributed to factors including the massive size and rapid growth of the Chinese market, an influx of capital by Goldman Sachs and SoftBank, and an ingenious mix of Chinese and Western business systems. However, there are four key reasons why China’s institutional void effect cannot be ignored.

Selective Government Support: China has the largest population of any country in the world (1.4 billion in 2016). Its economy was ranked second in the world by gross national income in 2016 and is expected to surpass the U.S. economy by around 2030. The potential of the Chinese economy attracts a relentless stream of foreign companies to the Chinese market. But despite these opportunities, doing business in China can be mired in vague rules and regulations that change frequently and unpredictably.

However, what is niggling and puzzling to Westerners is easily understandable to many Chinese. The goal of the Chinese government is clear: promote the interests of the Chinese economy and its people. Government officials in developing countries are often motivated to reduce imports from other countries and protect local businesses to make them more competitive. Alibaba was an obvious choice for its government to support as a first-mover in the e-commerce industry.

China provides selective and large-scale support to only a few leading companies. This is unlike well-established institutional environments, where business transactions and operations are based on the efficient flow of information and resources in the market, and where participants easily access information and capital markets. In an environment with institutional voids, the government is highly motivated to lend selective support to only dominant (or promising) domestic firms. These kinds of government interventions are aimed at stifling foreign firms and developing world-class domestic companies.

Strong CEO Effect: Alibaba chief executive officer Jack Ma is a visionary who is fluent in English but understands the direction of China’s government policies. He has a long-term vision (a 30-year plan), can quickly adapt to new directions, and efficiently communicates his vision and encouragement to employees and investors. For example, he persuaded 17 entrepreneurs to help start Alibaba in a small apartment in Hangzhou. He also successfully enticed senior managers at Goldman Sachs, SoftBank, and Yahoo, and other venture capitalists.

Ma also brought to Alibaba experience as a government official, where he learned essential skills in navigating China’s bureaucracy, corporate policies, and compliance. Arguably, Jack Ma’s environment—an institutional void—made him a more influential leader. As some experts contend, uncertainty in his business environment enhanced the CEO effect by disrupting established patterns of corporate behaviour, and by allowing greater managerial discretion and less oversight.[iv]

Better Fit to a Paradigm Shift: Jack Ma once stated that while e-commerce may be only a dessert for the United States, it is the main course in China. Retail chains and shopping malls were not quite developed when Alibaba was founded—they still fall short today by Western standards. Until foreign retailers such as Walmart and Carrefour arrived in the country, the fragmented Chinese retail industry was dominated by state-owned localized enterprises backed by plenty of capital from the government or state-owned banks, with little incentive to perform.[v]

With a lack of institutional support, private companies readily welcomed a transition to e-commerce. And consumers eagerly made the switch to online retailers from the largely uninspired traditional stores. This was unlike in Western countries, where traditional retailers generally provided a welcoming experience for consumers. The favourable consumer behaviour was especially seen in e-commerce by mobile phone. Alibaba’s online shopping revenue in this segment grew dramatically from 1 per cent in 2012 to 75 per cent in 2016. Comparatively, the mobile phone share of online shopping in the United States reached only 48 percent in 2016.[vi]

Interestingly, the lacking Chinese landscape and unsupportive social systems made it easier to leave existing business models behind and leap into innovative online enterprises. And consumers, who were largely ignored by traditional retailers, willingly made the transition to online shopping.

Theorists explain this concept as institutionalization, a process through which organizations try to conform to the formal rules and informal norms prevailing in the business environment.[vii] As a result of their attempts, organizations gain legitimacy by being considered acceptable members of society. However, once they are closely tied to the system into which they have tried to fit, organizations often become less agile and less able to adapt to massive changes in the business environment.

Firms in advanced economies found the burden of institutionalization especially difficult to overcome. However, firms in dysfunctional institutional environments, such as Alibaba in China, faced much weaker opposing forces from their institutional environment and were thus more able to introduce and develop new businesses.

Greater Benefits through Ecosystem Development: Following its initial success in online shopping businesses, Alibaba expanded its innovation network through acquisitions. The company first focused on online shopping, logistics, and online payment. Later, Alibaba broadened its portfolio to include businesses that seemed unrelated to its core businesses, but that helped it generate new innovations.

Arguably, developing a broad business ecosystem offers more benefits in an environment with institutional voids. One of the key tenets of an institutional void is the lack of market information—both for consumers and for businesses—which inhibits effective business operations.[viii] However, Alibaba became an infomediary for consumers by collecting information to help them make informed shopping decisions. Alibaba then collected consumer behaviour data from its online ecosystem, which is expected to have a significant impact on various dimensions of China’s business world and society.

Simply put, Alibaba has evolved into a leading innovator on the world stage. And institutional voids in the Chinese business environment were instrumental in its journey to success.

References

[i] Khanna, T., and Palepu, K. 1997. “Why focused strategies may be wrong for emerging markets.” Harvard Business Review, 75(4): 41-51.

[ii] Hoskisson, R. E., Eden, L., Lau, C. M., and Wright, M. 2000. “Strategy in emerging economies,” Academy of Management Journal, 43(3): 249–267; Khanna, T., and Palepu, K. 2010. “Winning in emerging markets: A road map for strategy and execution,” Harvard Business Press.

[iii] Shih, G. 2015. “Alibaba to invest $4.6 billion in China electronics retailer Suning,” Reuters, accessed July 23, www.reuters.com/article/us-alibaba-suning-appliance-idUSKCN0QF0VP20150810.

[iv]   Rajagopalan, N., and Finkelstein, S. “Effects of strategic orientation and environmental change on senior management reward systems,” Strategic Management Journal, 13 no. S1 (1992.): 127–141; Finkelstein, S., and Hambrick, D. C. “Top-management-team tenure and organizational outcomes: The moderating role of managerial discretion,” Administrative Science Quarterly (1990): 484-503.

[v] Clark, D. Alibaba: The House That Jack Ma Built (New York: Ecco Press, 2016).

[vi] Statista, Alibaba Group, Statista Dossier, 2016.

[vii] Paul J. DiMaggio and Walter W. Powell, “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields,” American Sociological Review 48, no. 2 (1983): 147–160; John W. Meyer and Brian Rowan, “Institutionalized Organizations: Formal Structures as Myth and Ceremony,” American Journal of Sociology 83, no. 2 (1977): 340–363.

[viii] Tarun Khanna and Krishna Palepu, Winning in Emerging Markets: A Road Map for Strategy and Execution (Boston: Harvard Business Press, 2010).

One response on “Analyzing Alibaba’s Magic

  1. Chris Albinson

    Nice piece and largely agree. You missed a couple critical points in my view (i) a dynamic founder that is driven by creating a globally dominant company that Alibaba and Amazon share is a critical to the speed of innovation (ii) Suspect, by western standards, accounting that allowed for the company to grow and raise capital efficiently causing very little to dilution of the founders ownership allowing for control and government-sanctioned predatory, but not disclosed, pricing. This included overt deception of shareholders (iii) Overt Chinese government policies to bait and switch US internet companies to come to China train significant numbers of Chinese engineers and then either from overt theft of source code (Huawei, owned the Chinese Peoples Liberation Army of Cisco’s source code) and or abusive pricing and competitive practices that destroyed US competitors ability to sustain in China leaving their employees no choice but to join the Chinese competitor Baidu who was getting 2:1 advantage of search results sent to Bidu over Google.cn by the network layer and embedded clients which are largely Chinese forcing Google to abandon the 2nd largest market $300M of revenue, $1B of investment, and 700 highlly trained, there are many other examples of Chinesse government bait and switch tactics that allow Chineese companies to steal IP and employees after having encouraging this capacty and investment (Yahoo, ebay, and more recently Uber and Amazon itself who had to sell its assets in China to comply to operate their service). No a single Chinese company facing similar anticompetitive structures to operate in Western countries with the exception of Huawei which has largely been prevented from entering core network markets in the US because it remains 100% owned by the People’s Liberation Army of China, the theft of Intellectual IP of source code, and repeated use of predatory pricing which has effectively put both Alcatel and Ericcson out of business. (iv) with similar structural cost advantage that Amazon and Alibaba have over incumbents retailers they can selectively target retailers most profitable repeat customers (typically retailers will get 40% of their revenue from 10% of customers) using sophisticated internet cookie technology they can offer these clients far superior value and service by services like Amazon prime. This systemic targeting of physical retail’s most makes the embedded cost structures non-viable. Jeff Bezos, CEO of Amazon, launched this attack using a data-based structural attack to give lower costs, easier access, and better products to Borders best customers and the 20,000 employees of Borders were out of work in 2011 when the company filed for bankruptcy. Ironically, slightly aided in the early years by the US government’s postal service and the “book rate” for shipping books was below the actual cost to ship books within the United States. Amazon is now, post its acquisition of Whole Foods, attempting to bankrupt Wallmart in the US using similar tactics within 5 years. They are taking on Wallmart mostly because of the bigger threat to Amazon, Alibaba, they have no ability to compete with given the Chinese government’s protection.

Leave a Reply

Your email address will not be published. Required fields are marked *