Alibaba wields its pricing power
By Sherman So

HONG KONG - A recent boast by Alibaba, China's biggest e-commerce company, that it will invest US$4.5 billion to transform the country's logistics business within 10 years, may turn out to be little more than an eye-catching publicity gimmick.

Its less prominent decision to raise the fee for membership of its business-to-business (B2B) market last September could prove the real driver to boost profit.

Hangzhou-based Alibaba Group on January 19 said it was planning to build a network of warehouses across China. The goal is to create a logistics platform that will help merchants to meet rapidly growing domestic consumption needs and to improve service quality to Chinese consumers.

"Hopefully within 10 years' time, anyone placing an order online

 

from anywhere in China will receive their goods within eight hours, allowing for the virtual urbanization of every village across China," said chairman and chief executive Jack Ma. "In order to achieve this, we will need to establish a modern, 21st century logistics network."

The company announcement said Alibaba Group and its financing partners would commit between 20 billion and 30 billion yuan (US$3 billion to $4.5 billion), in the project.

However, according to a source close to Alibaba, there is no concrete plan for building warehouses. "At the moment, it only means Alibaba will set up a platform for small traders to choose between different logistics service providers [for example UPS and Fedex]. And Alibaba can take some commissions from facilitating such service," said the source.

Sellers on Alibaba's online auction subsidiary, Taobao, have been doing that already. It is merely going to further enhance the existing services.

Similarly with its B2B market, Hong Kong-listed Alibaba.com recently launched a new service to enhance AliExpress, its service to help small traders to ship their products worldwide. The new fulfillment service allows traders to combine multiple orders into one shipment and track the orders using a single online interface. It seems that Alibaba's partner, GELS Enterprise Shanghai Co Ltd, is going to do all the work.

"Alibaba.com's shipping and logistics partner, GELS Enterprise Shanghai Co Ltd, will handle all warehousing, shipping and logistics for AliExpress orders that choose to use the fulfillment service, offering a choice of discounted rates from international carriers such as UPS and EMS, with other shipping carriers to be added in the future," it said in an announcement on January 18.

Dick Wei, China Internet analyst at JPMorgan said Alibaba Group's management "said they want to be Amazon. That means it will build warehouses and a logistics platform. Maybe they are building warehouses somewhere. Just that, I am not aware of them yet." 

If there are to be no warehouses, no actual involvement in shipping or logistics, why does Alibaba need to invest US$4.5 billion?

"Well, it is just the first step of an overall plan. If everything goes well, of course, more can be done in the future and the investment can gradually increase," the source said.

However, history shows that a lot of Alibaba's previous plans have not been realized. For example, Alisoft, its project to provide inexpensive business software to small companies in China, is basically a failure. Alisoft is a small division with at present less than 50 staff at the listed B2B subsidiary, Alibaba.com.

Then there is Ali-loans, its plan to provide bank loans to small companies.

"Another failure," said the source.

There are two parts of Ali-loans business. One part is to act as a middleman between banks and small companies. "After four years, the banks found out they can deal with the small companies directly, and there is no need for Alibaba's involvement," said the source.

Another part of the business is lending Alibaba's own money to small companies, but "Alibaba does not have a lot of capital. How many small companies can it lend to?" said the source.

In short, Alibaba's US$4.5 billion investment into the logistics industry could prove to be for publicity only. It is just enhancing its current services, and no new major investment is yet confirmed.

While the new logistics platform is just an idealistic long-term plan, and it is questionable whether it will be executed, Alibaba's decision to raise the membership fee of its B2B market could prove a real profit driver.

"Many Chinese businessmen think that the lower the price, the more you can sell. But that is not always the best strategy for profit," said an industry insider.

During the financial crisis in 2008, Alibaba lowered its cheapest membership package to about US$2,900 (20,000 yuan) from $5,000 when its key competitor, Global Source, cut its price by half. Last September, Alibaba raised its price by 50%. The cheapest membership is now about $4,500.

"Alibaba lowered its price in response to Global Source's price cut. But in fact, Alibaba does not need to do this. It is much bigger than Global Source," said the insider.

Alibaba.com made $140 million profit in 2009 on sales of $550 million, while Global Sources earned only $16 million on revenue of US$174 million.

The higher membership fee of 30,000 yuan is also thought unlikely to deter many small traders who rely on Alibaba to win overseas buyers. "Profit from one or two customers can cover that already," said the insider.

And if the small traders find Alibaba's B2B market ineffective, that is, they are not successful in getting more business after they sign up for Alibaba's paid membership, they will not continue their subscription, even if the price drops. There are many such cases.

"It could be Alibaba's fault - not enough active buyers. Or it could be the traders', if they don't know how to use the Internet platform effectively. Many small traders are not used to computers and e-mails," the insider said.

The 50% price difference will not cause a 50% increase or decrease in the number of subscribers, and if that is the case, Alibaba should raise the price. "It was rather stupid for it to lower its price in late 2008. The effect was that revenue only increased 30% and profit dropped by 10% last year," said the insider.

Even so, Alibaba was not alone in seeing profit decline amid the financial crisis, which hit consumer spending in the West and cut China's exports. Many small traders in China closed their business in early 2009, including Alibaba's paying members.

With the price hike and the global economic recovery, Alibaba.com's profit should increase again this year. “Alibaba expected growth of paid members to be flattish this year,” said JPMorgan's Wei. "If that is the case, revenue could be up 50%, as price increased by 50%.  Profit could grow even more, as margin is improved."

The company's fourth-quarter profit, to be announced next month, may surge as much as 30%, to 368.5 million yuan, according to Credit Suisse analyst Wallace Cheung. This could be a conservative estimate if the price hike is more acceptable than investors expect. 

For companies with pricing power, the sure way of better profit is just to raise prices. As with big talk of investment in logistics, it just makes for good publicity.

Sherman So is a Hong Kong-based correspondent and co-author of Red Wired: China's Internet Revolution.

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