Talking Point

Jumping Jack bashed

Alibaba has a bad month over fake goods, fake trades and flawed accounts

Chinese CEO Jack Ma of Alibaba listens to Chinese President Xi Jinping at a U.S.-China business roundtable comprised of U.S. and Chinese CEOs in Seattle Washington

Down in the dumps: counterfeiting controversy for Ma as well as criticism over Alibaba’s accounting practices

What we are proud of most today is not how many goods we sell, but the exploration and innovation we’ve made in terms of intellectual property protection,” Alibaba’s Jack Ma explained to the Chinese media last year.

China’s e-commerce giant was pioneering new ways to protect intellectual property, he told Xinhua, and companies like Amazon were asking its advice on fighting fakes.

How then to reconcile this with events last month when Ma cancelled his keynote speech to an anti-counterfeiting association after opposition grew to Alibaba becoming a member?

Luxury label Michael Kors was the first to quit in protest, furious that the anti-counterfeiting association had “chosen to provide cover to our most dangerous and damaging adversary”. (Gucci also quit.)

And the rest of May wasn’t going to get much better for Ma, with a flurry of media coverage taking Alibaba to task for fake goods, fake trades and flawed numbers.

A miserable May

The first batch of bad news came earlier in the month after the rebellion in the ranks at the International Anti-Counterfeiting Coalition. Alibaba joined the IACC in April the announcement quickly triggered high profile resignations from some brand owners. An anonymous email was also sent to the IACC’s board, threatening a mass walkout unless Alibaba was shown the door.

Then there were further uproars on May 13 as the Associated Press reported that IACC’s president Robert Barchiesi has actually owned Alibaba’s shares since its New York IPO in 2014. On the same day, the IACC announced that it was suspending Alibaba’s membership, pending “further discussion”.

Much of the disgruntlement is that Alibaba hasn’t done enough to reduce the sale of counterfeit goods on its e-commerce platforms, especially Taobao.com, its hugely popular consumer-to-consumer (C2C) marketplace.

Similar shortcomings were identified in 2008 by the Office of the US Trade Representative (USTR) which put Alibaba.com, a B2B marketplace, and Taobao.com on its list of “notorious markets” for counterfeits. After lobbying, Alibaba.com came off the list in 2011 and Taobao was removed the following year. Alibaba then signed hundreds of agreements with some of the world’s biggest brands in the lead-up to its IPO two years ago, promising swifter action against sellers of counterfeit products.

However, there were signs that the US authorities were losing patience again last year when the USTR warned Alibaba that it had to do more to counter piracy if it was to stay off the blacklist.

Alibaba is also a defendant in a lawsuit filed by Kering, the owner of luxury labels like Alexander McQueen, Gucci and Yves Saint Laurent, that alleges that its marketplaces have knowingly sold counterfeit or trademark infringing merchandise.

The brouhaha surrounding its IACC membership is another setback – and an embarrassing one for Ma, who was scheduled to give the keynote address at the coalition’s annual meeting in Orlando.

Instead Michael Evans, Alibaba’s president, did the honours, highlighting how the Chinese internet firm has been working to stamp out the trade in fake goods. At least 300 people were arrested last year for involvement in illegal activity, he said, and $125 million of fake products had been confiscated. More than 120 million listings of suspicious products were taken down from Taobao while Alibaba, he added, is beefing up its technology in fighting fraud. “We have the scale, we have the data and we have the commitment to be a global leader in anti-counterfeiting,” Evans told the IACC group.

Alibaba under attack

Alibaba runs a ‘notification and take down’ system for brand owners to flag fake products sold on its sites. Additionally technology is helping to identify when luxury goods are sold for impossibly low prices or advertised with suspicious photos and faulty descriptions.

But brand owners complain that the e-commerce giant is too slow to penalise transgressing merchants. Meanwhile Richard Liu, the founder of Alibaba’s main rival JD.com, sought to exploit the row with the IACC in a scathing opinion piece for World Trademark Review, a bi-monthly magazine and daily email news service.

Although Liu avoided mention of Alibaba by name, the meaning was crystal clear when he scoffed at how “a Chinese e-commerce marketplace has apparently discovered a newfound belief in protecting IP, after years of enabling sellers to abuse rights holders”.

“The Chinese e-commerce industry is at a crossroads. False profits have ruled for too long,” Liu proclaimed. “Online shoppers are turning against the consumer-to-consumer market – a cesspool for cheap counterfeits that we have shunned.”

How many of the goods sold on Alibaba’s platforms could be fake is a much- debated topic. Last January China’s State Administration for Industry and Commerce estimated that no more than 37% of the items purchased on Taobao were genuine, for instance, although Alibaba castigated the findings and the report was later withdrawn.

Much of the daigou sales – or unauthorised reselling – of international brands on Alibaba may not be counterfeit, however.

Daigou sellers (literally, ‘buying on behalf of’) purchase luxury labels in overseas markets, where prices are generally cheaper and the goods are regarded as more likely to be authentic. Then they sell the items to customers in China, typically avoiding import duties. Even with the additional fees charged by the agents, the cost is usually less than buying the item at home.

The practice isn’t restricted to sales on Alibaba, with the daigou working through channels like Sina Weibo and Tencent’s messaging app WeChat as well. Last year the reselling of international brands was estimated to be worth Rmb43 billion ($6.5 billion), or about 38% of all luxury sales in China, according to the consultancy Bain.

Because these goods are being bought somewhere outside China, there is a short-term boost for the brands in their sales figures. In some cases the daigou are finding new customers for the luxury labels by supporting purchases from people who live in lower-tier cities in China lacking luxury outlets, or who don’t have the means to travel overseas.

But most brand owners don’t like the unauthorised selling because it confuses their pricing strategies and leaves them with little sense of where their goods are ending up. In addition, many of the daigou mix their range with counterfeits as well – which means a missed revenue opportunity for the brands, plus cases in which consumers blame the labels for poor product quality, not realising that they have purchased fakes.

How real are the numbers?

The month didn’t get any better for Ma following Alibaba’s announcement on May 25 that the US Securities and Exchange Commission had started an investigation into its accounting practices. The company’s shares traded down almost 7% the same day.

Specifically, the SEC says it is looking at the financials for Cainiao Network, a three-year old logistics joint venture, and at the reporting data from Singles’ Day, the world’s biggest online shopping festival, held every year on November 11 (and making $14.3 billion in gross merchandise value last year). A third area of the inquiry is focusing on related-party transactions.

Alibaba owns 47% of Cainiao so it doesn’t incorporate its revenues or expenses into the group-level financial results. Its opponents counter that this is odd because Alibaba has effective control of the delivery network and used it to coordinate the shipment of more than 12 billion packages last year.

Alibaba also uses a metric called gross merchandise value (GMV) to report the dollar value of all the products sold across its platforms. Other e-commerce firms use the same measure, although unlike revenues and profits, GMV isn’t an audited number regulated by GAAP accounting rules. Another problem is that no two companies seem to define GMV in the same way, Paul Gillis, a professor at Peking University, told the Wall Street Journal.

Another more contentious angle on Alibaba’s GMV is the allegation that as much as a third of it could have been overstated because of “sales brushing”, a dark art to circumvent e-commerce platforms’ rating system (one which is based on buyers giving credit points and review comments on retailers).

The brushers follow instructions to complete orders and make payment, then they write glowing reviews for the online stores to encourage other customers to purchase goods. Some merchants even send fake deliveries of hollow boxes or fill them full of worthless items such as toilet paper rolls.

Buying advertising is the other way of attracting attention on Taobao, but many vendors regard brushing as more cost-effective because shipping more goods would give them better placement on the site and a better chance to garner more real sales.

Jack Ma has admitted to doing something similar in Alibaba’s early days: “Back then, no one wanted to buy or sell things on Taobao. So a dozen of us listed the items from our homes and sold them on the platform. But no one was interested in buying, so we just ended up buying and selling the items amongst each other.”

He isn’t the only one to confess. When Aishang, an online flower retailer, filed for its initial public offering earlier this year it acknowledged fictitious sales of its own, culminating in more than 163,000 fake orders, or almost half of its total business, by the middle of last year.

“Under pressure from competitors, Aishang resorted to creating fake orders,” its IPO documents admitted. “We didn’t count the sales from those fake orders and have stopped doing it since August 2015”.

Beijing News reported last month on the work of one of the “brushing factories” and their growing army of professional fraudsters, explaining how more than 40,000 retailers use its services on a daily basis.

“A professional brusher can brush four deals in an hour,” a team leader told the newspaper. “At Rmb6 per deal, eight working hours a day, and 22 working days a month, that means monthly income of more than Rmb4,000.”

Indeed, Alibaba has warned in its own listing document in 2014 that Taobao shops may “engage in fictitious or phantom transactions” to inflate their reputation and search results ranking. But the malpractice has worsened to such a degree that the China Securities Journal casts these brushers as like “maggots on the bone, never perishing despite repeated crackdowns”. The Xinhua-run paper added: “At root, this is forged trading and it is ruining the entire rating system, turning it into the Achilles heel of the sector,” it warned. “If left uncontrolled, it could very likely destroy the entire e-commerce industry.”

Too much of a success story?

Alibaba has denied allegations questioning the accuracy of its GMV data, saying that it scrubs its final calculation of fictitious transactions.

Chi Tsang, HSBC’s head of internet research, was sanguine about the SEC investigation into the company’s accounting practices too. “In our view, none of these actions would have a material impact on Alibaba’s financials,” he concluded last week, adding that the SEC is “reviewing Alibaba’s procedures and policies in general and not investigating any particular deal”.

The counter-argument is that the investigation is scrutinising two of the pillars of Alibaba’s profits and that there could be more pressure on the share price if investigators decide that they need to dig a little deeper. Singles’ Day is the showpiece event in the sales calendar, while Alibaba’s relationship with Cainaio is typical of a business model in which it serves as a middleman, but doesn’t stock or ship any goods itself.

These asset-light arrangements have made Alibaba much more profitable than its rivals, but detractors like Richard Liu claim that they make it a haven for fakes as well. Because the goods are never in Alibaba’s possession, it’s harder to verify that they are legitimate.

News of the SEC investigation buoyed other critics, including those who query whether Alibaba’s numbers are too good to be true.

The Hangzhou-headquartered firm reported a 193% jump in net profit in the year to March, with total revenue surging by a third on the back of record gross merchandise volume of Rmb3.09 trillion. This prompted questions about how Alibaba can be growing so much faster than the rest of the economy, especially when it already has such a dominant position in the domestic market.

Others are taking aim at its financial information, including Jim Chanos, one of Alibaba’s most vocal critics, whose firm is betting against its shares. He referred to Alibaba’s accounting last month as “among the most questionable I have ever seen for a major multi-billion market cap company that went public [in the US]”, adding that, “What the company is really earning we don’t know”.

Alibaba says its latest annual report disclosed Cainiao’s revenues and losses for the first time and that the figures are “exactly the kind of robust and transparent information that will address the underlying issues in the SEC’s inquiry”.

Short sellers like Chanos have every incentive to talk down Alibaba’s prospects, of course. Some also add that things were not all bad for Jack Ma last month. In fact, he met US President Barack Obama just a few days before the IACC annual meeting. The White House confirmed that Obama had lunch with the Alibaba chairman but refused to disclose details of their meeting. “The timing is good and such high-level lobbying is very valuable,” a financial columnist wrote on Baidu.

Others have been more complimentary about its performance – in fact, nearly three-quarters of the analysts that cover its stock were showing buy or overweight ratings last week, according to FactSet.

Experts like HSBC’s Tsang have been citing a step-change in Alibaba’s revenue generation as one of the reasons to be more positive. More sophisticated technology is allowing merchants to personalise their online stores for consumers, he says, generating more relevant offers and better sales conversions.

Another common rebuttal of the naysayers is that they are missing the point on the magnitude of the changes in China’s consumer landscape. Duncan Clark, a Beijing-based consultant who has just written a book about Alibaba, says that the surging growth rates are plausible because e-commerce is biting into the traditional retail sector in a way that hasn’t been seen in other markets.

“In China there are often very poor or inefficient offline services, so the online alternatives have had a disproportionate impact on commerce,” Clark told the Financial Times earlier this year. “That fuels a leapfrogging effect and big growth.”

Joseph Tsai, Alibaba’s executive vice-chairman, also fired back at the short sellers this week, accusing them of failing to see the bigger picture. “We believe it is still difficult for US generalist investors to grasp the massive numbers on Singles’ Day because they under-appreciate the potential purchasing power of Chinese consumers and the prevalence of mobile commerce in China,” he told the (Alibaba-owned) South China Morning Post.


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