Methods for Underdogs: How Alibaba's Taobao Dominated eBay in China | Cold Call

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1:30trillion dollar global industry. According to Retailer.com, 50 % of e-commerce sales were made through online marketplaces in 2019, a number that is expected to grow rapidly in the coming decade. Digital natives could be forgiven for assuming that it's always been this way. But of course, like every other disruption in business, the evolution of e-commerce has involved fierce competition and strategic gamesmanship between global players on a rapidly changing landscape. and to the victor go the spoils. Today on Cold Call, we welcome Professor Felix Oberholzer-G to discuss his case entitled Alibaba's Taobao.

2:07I'm your host, Brian Kenney, and you're listening to Cold Call on the HBR Presents Network. Felix Oberholzer-G is an expert on competitive strategy and international competition. He is the author of the newly published book, Better Simpler Strategy, a value-based guide to exceptional performance. And he's also a podcaster. He's the co-host of a fabulous podcast called After Hours, along with other HBS faculty, Youngmi Moon, Mihir Desai, and various guests that are popping in and out. It's one of my favorite shows. Felix, I'm thrilled to have you on Cold Call today. Thanks for joining me.

2:41Felix Oberholzer-Gee:It's great to be here. Thank you, Brian. What I really want to do is use this case that we're going to talk about today as a way to hear about some of the ideas in your new book. I know that the case is a good stepping off point for that. The book is about strategy, and that's something that you think deeply about and that you teach about here at the school. So I think people will really enjoy listening to the story about Taobao, which is part of Alibaba. Let's just dig in. Tell me, what would your cold call be to start this case in the classroom? Like many faculty members, I have a few go-to cases that I just love teaching.

3:14Felix Oberholzer-Gee:I must have taught the Taobao case dozens of times, and if I could teach it tomorrow, I definitely would. It's a case about an underdog in an industry landscape that is typically dominated by big platforms. Now, of course, we're thinking of Taobao as China's equivalent of perhaps Amazon today. But at the time of the case in the early 2000s, eBay, interestingly, was dominant in China. And it was just like it's almost unthinkable how you might compete against Amazon in the United States. It was almost unthinkable how you might compete against eBay in China at that particular time. And then, of course, Alibaba did it.

3:58Felix Oberholzer-Gee:And Taobao is now the top dog, faces new competition, interestingly, also in China today. But it's the story of being the small player, the small company in a market that is dominated by a big platform. The case develops an idea that is featured prominently in the book also, what I often refer to as strategies for underdogs. What can you do that the big player cannot easily imitate? This case takes place in the mid-2000s into the early 2010 timeframe. How does it relate to the questions that you try to answer as a scholar? And importantly, how does it surface in the book that you've just published?

4:39Felix Oberholzer-Gee:So the big question is really how you compete as a smaller player against a big platform. This is a theme that I explore at length in the book. The big platforms, they all benefit from what we call network effects. Network effects are a mechanism that renders a platform or a business or a product more valuable if more people use it. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes.

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6:00Felix Oberholzer-Gee:So imagine you're the only person on Facebook. Well, it's not such a great experience. The more people join, the more valuable it becomes. The question then is, if the big platform is so far ahead, what can you do to catch up? And the Taobao versus eBay story set in China explores the possibilities. Taobao uses really two things, I think, that I see in lots of other markets and that I describe in the book also about how smaller platforms can compete. The first idea is really the big network benefits from an increased willingness to pay. Willingness to pay, one of the key strategic variables in thinking about competitive strategy, is the most a customer would ever pay for a product or a service.

6:51Felix Oberholzer-Gee:If my company benefits from network effects, that's elevated irrespective of the quality of the service or the attractiveness of the platform to begin with. And so the smaller player needs to think about how can I increase my customers, my clients' willingness to pay without having the benefit of scale. So for instance, if you have an idea that involves significant fixed cost, that's probably not a leading candidate to compete against the big platform, because the big platform can spread fixed costs much more easily than you can. And so not surprisingly, what we see Alibaba do is implement a whole range of ideas that are essentially low cost or variable cost, so that the big platform, if it decides to imitate, doesn't have a natural advantage in this imitation process.

7:44So for people who aren't familiar with Alibaba, maybe you can describe them before we dive into those details. What is Alibaba? And a little bit about Jack Ma, too, the founder. He's a colorful character. Yes, certainly.

7:55Felix Oberholzer-Gee:He's a teacher originally. And then the first really big business that he built is Alibaba, the name of the group today. And Alibaba is really a B2B business. So it allowed many smaller and medium-sized Chinese companies to start selling online, Start selling online domestically, that was important. But I think even more important is selling internationally, because it wasn't easy for Chinese businesses at that point in time to reach their overseas customers. When you think about just how dramatically important exports are for the Chinese economy, in part, this was facilitated in a really big way by Alibaba.

8:38Felix Oberholzer-Gee:But eBay and Alibaba didn't really touch one another for quite some time because eBay, just like in the US, was mostly a consumer-oriented site. And Alibaba competed in this B2B space. And then in the Chinese context, eBay had a really quick increase in what they call power sellers. So power sellers are people who are essentially middlemen. They look a little bit like individual customers and they look a little bit like an actual B2B business with B2B transactions. And so naturally, Jack Ma was very concerned about eBay encroaching on Alibaba's turf. So that triggered the response that during the SARS epidemic, he decided, and we're going to build a business called Taobao, which means hunting for treasures, that is squarely in the C2C space.

9:32Felix Oberholzer-Gee:The team that developed the business was locked up in Jack Ma's apartment in Shanghai. They couldn't go outside, just like during COVID. We can't go outside because SARS was potentially even more fatal than COVID-19 today. And so they used that period of time when they had engineering resources that couldn't really go anywhere. They used that period of time to build a competitor. eBay had 85 % market share at the time. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications and more.

10:12Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean.

10:51And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com.

10:59Felix Oberholzer-Gee:How on earth would you ever compete? The case essentially allows students to see what kinds of variable cost ideas that a company might have in order to increase its customers' willingness to pay. And the discovery is that it's sort of a different design. It's a whole suite of features that are interestingly not really directed at eBay's customers in the first place. This is early days of the internet. It seemed mildly crazy to buy something online. And many people waited on the sidelines. In the book, these groups of people I call near customers. They're almost in the market, but not quite. their willingness to pay.

11:46Felix Oberholzer-Gee:It's just slightly shy of the price that you would have to pay. It has to do with lots of concerns. You know, I'm giving someone my financial information. Maybe you're going to send me the packet that I ordered. Maybe you're not going to send me the product. Maybe the product will be broken. And so you see Taobao develop a whole range of features that essentially build trust among near customers. And that has two effects. One is you're not really fighting for the same group of customers that eBay already owns. That's much easier to do than luring customers from a big platform that benefits from network effects.

12:22Felix Oberholzer-Gee:And it solves a major issue in the development of e-commerce. In fact, that market, the market that Taobao targeted, ended up being so much more important than eBay's market. And eBay eventually, you might remember, they left China. So let's talk a little bit about Meg Whitman and the way that she was sizing this whole thing up. You know, eBay at this time already had expanded into the European market. They were obviously the founder in the US, so they had sort of cornered that space. How were they thinking about the China market? What did they think the opportunity was there? So they were extremely optimistic about the prospects of eBay in the China market.

13:01Felix Oberholzer-Gee:They made a minority investment first in a business that was built by two HBS graduates who started the Taobao, and then eventually they took over the company. And if you look at the China market, everything looks perfect, right? It looks like we have deep local knowledge because we have these two local founders who really understand the local market. We have 85 % market share, which is decisive if you think about competition between different platforms. In public statements, Meg Whitman is just very optimistic. China is eBay's Toulouse, and there isn't really competition inside. Now, one of the really interesting dynamics that we end up talking in the class is if the entrant goes after near customers, that's not something you easily see in your own data.

13:51Felix Oberholzer-Gee:And you don't realize that someone else is catching up on you because the someone else is actually not exactly catering to the people you serve to begin with. By the time you notice that someone else, Taobao, is actually so big that now the network effects tip, what used to be this wonderful protection that eBay had in that they had the biggest network effects, now turns against them because they're relatively small and Taobao has a greater customer size, has greater network effects. So there's really two ideas that are at the center of the case. First is the idea that if I compete against someone with network effects, I need to find alternative ways to build willingness to pay over time.

14:38Felix Oberholzer-Gee:And I need to do it in a cheap variable cost manner. And the second idea is if I go after near customers, that's actually much more promising, much easier to do. And in particular, you know, it's not so concerning for my rival because you don't actually see in your data what is happening, possibly until it's too late. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes.

15:17Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsored jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners. Sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together.

15:57Shop now at palmolive.com. The important is local knowledge to this case. So in other words, Taobao, obviously, they're from China. They understand the Chinese culture. They understand the buying habits of Chinese people. The case alludes to eBay going into Japan and having a rough go of it. And I'm wondering, what do they take away from that? Did they do anything differently when they went into China, or should they have?

16:20Felix Oberholzer-Gee:It's a beautiful example of strategic learning. I usually start the class by asking everyone, what happened in Japan? You know, eBay globally, so many markets, so successful. And then all of a sudden, you strike out in Japan. And that discussion sort of builds two insights. The first one is this network effects story so that everybody knows about the importance of network effects for these platforms. And the second insight is really the insight around just how important local knowledge is. So, for instance, eBay was completely used to using credit cards. Japanese customers cash on demand. The eBay model is essentially, you know, sort of used products kind of model in the United States.

17:04Felix Oberholzer-Gee:It's everything that's been sitting in your garage for a long time and you haven't had a chance to think about it. That's a prospect for a sale on eBay. And in Japan, people were interested in new products. No one was interested in sort of the secondhand or rarity products. There is a particular amount of local knowledge that you need in order to be successful. And what's really beautiful about eBay's strategy is so they lose Japan. And then when you see what they do in China, they buy a local business started by our alums that has 85 % market share. And that, of course, gives you this amazing confidence that there's really nothing that can go wrong because now you have both of these things.

17:46Felix Oberholzer-Gee:You have network effects, and then you have local knowledge, and you should be just okay until you're not because you have a rival that competes in very smart ways. So there were some pivotal decisions that the Taobao team made early on as they were moving down this path and they sort of set their sights on eBay. Can you describe what some of those important strategic calls that they made early on were and how they impacted the trajectory of Taobao? One major decision was to organize the Taobao website in the exact same manner that Chinese department stores are organized. And the reason why this is important is, remember, we're trying to cater to these near customers that are nervous about buying online.

18:29Felix Oberholzer-Gee:So if I go online and I look at the website, they know, oh my God, I sort of know how things are arranged here. This is exactly what a Chinese department store looks like. That's, of course, a big advantage. And then really one of the most important things that they did was the creation of Alipay. Alipay is essentially an escrow service. The seller of a product is not being paid until the recipient acknowledges that he or she has received a product. In a low-trust environment where the internet was relatively novel, that played an enormous role. In the book, I call this a compliment. So a compliment is a product or a service that increases willingness to pay for something else.

19:11Felix Oberholzer-Gee:But that was really a key decision that every company that has compliments needs to very carefully think about. Do you provide these complements just for your own product? And then that means you have a leg up in the market relative to the competition. Or do you provide it for the entire market? In which case, you help the market as a whole grow. So let me give you an example. Tesla superchargers. You have a choice. You could make these chargers so that they only charge Tesla cars. In which case, Tesla has an advantage against all the other producers of electric vehicles. Or you could decide, no, actually, the big problem with electric vehicles is that we don't have enough charging stations, period.

19:55Felix Oberholzer-Gee:And so you make it available to everyone. And that really fuels the market. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsored jobs.

20:31This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners. Sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com.

21:00Felix Oberholzer-Gee:It does away with that relative advantage, but it fuels the market as a whole. And in the case of Alipay, very smartly and after a hot internal debate, Alibaba decided to make Alipay available to everyone. And then from there, it grew its financial services business, which is probably now as valuable as the remaining e-commerce businesses that they've built over time. That's amazing. Well, it also makes me think of PayPal, which I think started as an eBay service and is now being used across all these other platforms. Is that a fair comparison? That's right. So when eBay purchases PayPal, the idea is exactly this idea of a complement.

21:41Felix Oberholzer-Gee:That's something that is an interesting decision to make. Do you want the complement to be in-house or do you want the complement to be provided by someone who's a different entity, possibly by lots of different entities? Think of Apple. Used to be all the profits came from the hardware side. Now, all of a sudden, we see such dramatic increase in the profits that come from the software side. That's the power of complement. You get to shift profit pools back and forth, essentially responding to competitive pressures. As long as you're way ahead in hardware, you make all your money on hardware. When that's a little less obvious, you start making money on services.

22:28Felix Oberholzer-Gee:And you see the same within Amazon, you see the same within Alibaba Group. This is now literally dozens of companies with dozens of opportunities to shift profit pools among these companies in really interesting ways. So that's maybe the third big lesson other than network effects near customers is just the importance of these complements to make your company grow and to put your company in a favorable competitive position in the market. Those are great examples. And I'm wondering, in the book, you must provide some other examples of companies that have faced sort of similar scenarios as Tao Bao was facing, these sort of underdog firms.

23:06Are there any that you can share with us? We still want people to buy the book, by the way.

23:11Felix Oberholzer-Gee:So there's a really interesting example that involves Facebook. Facebook, obviously, you know, building a small business first, right, which is a little counterintuitive. Oh, social networks have these network effects. Why on earth would you restrict who can be on Facebook to begin with? In the beginning, it's literally only Harvard. Then it's the Ivy League universities. And then they grow very slowly. The intuition here is that if you target a particular subset of the market where people highly, highly value being connected to one another, that can be as powerful can be as successful as sort of being you know an average platform where you meet lots and lots of other average people you value connections but there's nothing particularly special and you see this in social networks you see this in dating platforms we have interesting differentiation strategies depending on to what extent you cater to a niche and to what extent you build sort of one platform serves all kinds of businesses that then benefit from network effects.

24:21Felix Oberholzer-Gee:But the network effects are not super, super strong, because I don't highly value being connected to people in Norway, because I don't know anyone in Norway, as opposed to all the platform is relatively small, but I value everyone else who happens to be on this platform. And so it's a counterintuitive way of building platforms where the fact that you're small, the fact that you're niche, actually ends up being an advantage, at least in the early days of building the business. Yeah. We've had several episodes of Cold Call where we've talked about platform companies. It's an increasingly important aspect of the landscape these days.

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