July 31, 2014 12:00 am JST

An ever-growing fish in a massive pond

TORU SUGAWARA, Nikkei staff writer

SHANGHAI -- It is no secret which way the wind is blowing in China's retail business. Consumers are increasingly going online to do their shopping. Merchants are taking to the Internet to peddle their wares. Massive amounts of virtual money are passing to and fro.

     The digital marketplace has drawn in people like Qin Xian, a Shanghai office worker who loves to browse stores on her iPhone and has recently taken to buying fresh fruit directly from farmers. Or Wu Xiaoai, who works for a foreign company in the city but doubles as an Internet vendor, selling clothing, shoes and accessories.

     "I cover my living expenses with my company salary," Wu said, "and use the profits from the online business to travel abroad."

     The rise of e-commerce has changed life in China. It has dramatically altered consumption patterns and created jobs. And Alibaba Group, to a large extent, set the stage for the phenomenon.

     Founded by Jack Ma Yun in 1999, the company has built a sprawling digital empire, making it easier than ever for individuals to buy goods and entrepreneurs to sell them. Its online shopping services boast 255 million users, while vendors number 8 million. Gross merchandise volume totaled about $270 billion in fiscal 2013 through this past March, surpassing the combined tally of major U.S. shopping sites Amazon.com and eBay.

     The group's online settlement service, Alipay, has also proved wildly successful. The company has been on an acquisition binge. And soon it will go public in the U.S.

     It all seems to be going swimmingly. Yet some at Alibaba question whether the company is really on the right track.

Fabric of society

It is hard to argue with the results. The China E-Commerce Research Center says the nation's online shopping sector was valued at 1.88 trillion yuan ($303 billion) in 2013. So Alibaba's online shopping service alone accounts for roughly 80% of the market.

     Overall, online transactions made up 8% of total retail sales in China last year. Real-world retailers, meanwhile, face head winds: In the first half of this year, 100 major players suffered a 0.2% drop in aggregate sales, according to data from the China Nation Commercial Information Center.

     As far as Qin, the Shanghai office worker, is concerned, the shift is natural. "At real stores, product lineups are limited and service tends to be poor," she said. "You can save time and money by comparing products online."

     Alibaba offers users plenty of shopping options. Following the launch of the Taobao auction site in 2003, it set up a virtual mall in 2008 that is now called Tmall. The mall mostly handles brand-name products. 

     The company also runs a site called Juhuasuan, which offers deals to groups of buyers, similar to the U.S. site Groupon.

     From entrepreneurs' perspective, Taobao can seem like a virtual paradise. Alibaba does not charge new merchants a commission to set up shop, so the site is an easy way for individuals with little seed money to suddenly reach a huge number of eyeballs. Sellers can opt for an auction format or fixed prices.

     Cao Qing runs a company that designs clothes and sells them under a label called 7 GeGe. She started selling on Taobao in 2006, and now her virtual store gets 200,000 visitors a day. The business employs 300 people and rings up 300 million yuan in annual sales.

     Cao is bullish about her company's prospects: "Sales will continue to expand at an annual pace of 30-50%," she predicted.

     Not everyone is making money on Alibaba's marketplaces, though. Competition among vendors is stiff. A source close to the company estimated that "only 10% of the vendors generate profits."

     Alibaba, at least, has created some juicy profit sources for itself. The main ones are fees for advertising on Taobao and technical service charges paid by Tmall tenants. The company logged sales of $8.44 billion in fiscal 2013 with a 40%-plus operating profit margin.

     The group has another advantage besides its websites. Kosuke Okame, an expert on Chinese retailers at Cast Consulting (Shanghai), said the buildup of Alibaba's online settlement system is a key source of the company's strength.

     Alibaba started Alipay in 2004, offering a safe way to shop online in a country where credit cards are not yet widespread, save for debit-type ones. In fiscal 2013, Alipay settled $623 billion worth of transactions. Alibaba's own sites accounted for only 33.9% -- the rest were payments to utilities, restaurants and other businesses. Put another way, Alipay has become embedded in the fabric of everyday life.

     Still, at its core, Alibaba is a Web shopping company. The explosion of the market has attracted competitors, and while they have a long way to go, they have gained ground. Alibaba has felt pressure to diversify, and this is where those doubts start to creep in.

"Small is beautiful"

Some rival shopping sites are carving niches by focusing on specific types of products. JD.com mainly sells consumer electronics. Yihaodian is an online grocery store.

     Companies are also joining forces, creating more potent competition for Alibaba. JD.com has allied with Tencent, whose WeChat messaging application has a user base of 400 million.

     Cao sees no reason to limit her clothing brand to Taobao. "We go where there are customers," she said. Indeed, her company has set up online stores on other sites and has seen the ratio of sales on Taobao gradually decline to 50-60%. The company considers WeChat part of its customer-enticing tool kit.

     As more vendors appear on other sites, Taobao's and Tmall's traffic could decline. Recognizing there are limits to growth fueled by online shopping, Alibaba has gone on a shopping spree of its own.

     Alibaba's prospectus for its listing on the New York Stock Exchange says the company spent roughly $8 billion on acquisitions and investments in other businesses. The list includes Youku Tudou, which runs China's biggest video site; AutoNavi, a provider of online maps; Intime Retail Group, a major department store company; and Guangzhou Evergrande Football Club, a professional soccer team. With Alibaba expected to raise some $200 billion through the initial public offering, market watchers reckon the company may chase still more deals.

     But how many businesses is too many? "Small is beautiful" is a mantra of Ma's, yet corporate data as of July shows Alibaba has 202 group units. Some company insiders worry about the hasty expansion. "Lately, we've been wondering where Alibaba is headed," one said.

     Alibaba's next task is to clarify the direction it wants to take after its big splash on the stock market.