'Free Is Not a Business Model'

In my previous post on copycatting and software entrepreneurs, I noted that when Chinese copycats went head to head with their Silicon Valley forefathers, they took that American unwillingness to adapt and weaponized it. As a result, every divergence between Chinese user preferences and a global product became an opening that local competitors could attack.

Jack Ma made an art of these kinds of attacks in the early days of the Chinese e-commerce company Alibaba. Ma founded his company in 1999, and for the first couple of years of operation his main competitors were other local Chinese companies. But in 2002, eBay entered the Chinese market. At that time, eBay was the biggest e-commerce company in the world and a darling of both Silicon Valley and Wall Street. Alibaba’s online marketplace was derided as another Chinese copycat with no right to be in the same room as the big dogs of Silicon Valley. And so, Ma launched a five-year guerrilla war against eBay, turning the foreign company’s size against it and relentlessly punishing the invader for failing to adapt to local conditions.

When eBay entered the Chinese market in 2002, it did so by buying the leading Chinese online auction site—not Alibaba but an eBay impersonator called EachNet. The marriage created the ultimate power couple: the top global e-commerce site and China’s number one knockoff.

Then eBay proceeded to strip away the Chinese company’s user interface, rebuilding the site in eBay’s global product image. Company leadership brought in international managers for the new China operations, who directed all traffic through eBay’s servers back in the United States. But the new user interface didn’t match Chinese web-surfing habits, the new leadership didn’t understand Chinese domestic markets, and the transpacific routing of traffic slowed page-loading times. At one point an earthquake under the Pacific Ocean severed key cables and knocked the site offline for a few days.

Meanwhile, Alibaba founder Jack Ma was busy copying eBay’s core functions and adapting the business model to Chinese realities.

He began by creating an auction-style platform, Taobao, to directly compete with eBay’s core business. From there, Ma’s team continually tweaked Taobao’s functions and tacked on features to meet unique Chinese needs. His strongest localization plays were in payment and revenue models. To overcome a deficit of user trust in online purchases, Ma created Alipay, a payment tool that would hold money from purchases in escrow until the buyer confirmed the receipt of goods. Taobao also added instant messaging functions to allow buyers and sellers to communicate on the platform in real time. These business innovations helped Taobao claw away market share from eBay, whose global product mentality and deep centralization of decision-making power in Silicon Valley made it slow to react and add features.

But Ma’s greatest weapon was his deployment of a “freemium” revenue model, the practice of keeping basic functions free while charging for premium services. At the time, eBay charged sellers a fee just to list their products, another fee when the products were sold, and a final fee if eBay-owned PayPal was used for payment. Conventional wisdom held that auction sites or e- commerce marketplace sites needed to do this in order to guarantee steady revenue streams.

But as competition with eBay heated up, Ma developed a new approach: he pledged to make all listings and transactions on Taobao free for the next three years, a promise he soon extended indefinitely.

It was an ingenious PR move and a savvy business play. In the short term, it won goodwill from Chinese sellers still leery of internet transactions. Allowing them to list for free helped Ma build a thriving marketplace in a low-trust society. It took years to get there, but in the long term, that marketplace grew so large that in order to get their products noticed, power sellers had to pay Ma for advertisements and higher search rankings. Brands would end up claiming “free is not a business model.”

As a Nasdaq-listed public company, eBay was under pressure to show ever-rising revenues and profits. American public companies tend to treat international markets as cash cows, sources of bonus revenue to which they are entitled by virtue of winning at home. Silicon Valley’s richest e-commerce company wasn’t about to make an exception to its global model to match the wild pronouncements of a pesky Chinese copycat.

That kind of shortsighted stubbornness sealed eBay’s fate in China. Taobao rapidly peeled away users and sellers from the American juggernaut. With eBay’s market share in freefall, eBay CEO Meg Whitman briefly relocated to China to try and salvage the operations there. When that didn’t work, she invited Ma to Silicon Valley to try and broker a deal. But Ma smelled blood in the water, and he wanted total victory. Within a year, eBay fully retreated from the Chinese market.

In my next post, I explore the global versus local approach from my perspective leading Google China. In the meantime, I would love to hear from you. Have you ever encountered online services that don't seem to understand the local culture? Or have you favored sites that speak to your needs over some that don't seem to care about how the customers behave? Thank you for sharing.

Posted by Dr. Kai-Fu Lee on Sep 13, 2018 in All Posts China Innovations AI & China

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