Within minutes of trading Friday morning, shares of Alibaba Inc. (NYSE, ticker:BABA) were trading at valuations above $200 billion. Among US-traded tech companies, only Apple, Microsoft, and Google are larger.

A year ago, few people had heard of the Hangzhou-based e-commerce giant. Today, the name comes up more in business circles than literature courses. Yet, most people know very little about Alibaba’s many businesses and their individual stories.

Taobao is Alibaba’s most dominant brand and its best story. A consumer-to-consumer (C2C) auction platform with over 231 million active buyers and more than 750 million product listings, Taobao is the most convenient, cheap, and secure way to shop for many goods in China. It is currently the largest online marketplace and tenth most-visted site in the world. For perspective, 9.2 billion packages are shipped in China each year. Half are estimated to originate from Taobao.

Interestingly, Taobao wasn’t always Alibaba’s primary business. In fact, had market conditions not forced CEO Jack Ma’s hand, Taobao may never have existed. But they did, and the company’s rise to the top of the e-commerce world has been incredible.

Taobao’s story reads like a familiar movie script: a scrappy, undersized fighter that punches way above its weight class for the title. It’s a story full of business lessons for both aspiring and established entrepreneurs. It’s a story about ants and elephants.

This article will cover Taobao’s rise, its fight with eBay for control of the Chinese C2C auction space, and three of the broader learnings that can be taken away from its victory. Finally, we’ll briefly look over Alibaba/Taobao’s current position in Chinese e-commerce and speculate on potential markets for expansion.

Searching for Treasure

“eBay may be a shark in the ocean but I am a crocodile in the Yangtze River. If we fight in the ocean, we lose — but if we fight in the river, we win.”

– Jack Ma, Alibaba CEO, 2003

In January 2003, Alibaba is just under four years old, a young company focused on its B2B outsourcing platform, Alibaba.com. Business is good and Alibaba is growing, but so is the market. eBay, the world’s leading e-commerce site, is in the process of acquiring EachNet, the dominant Chinese C2C auction website. Having seen eBay start in C2C and quickly move into B2B in the U.S., Alibaba’s core business may soon come under threat.

Reading the tea leaves, Ma assembles a team of engineers and sends them to his apartment with orders to build a consumer-side firewall for Alibaba. A few months later, in May 2003, Alibaba launches Taobao (淘宝), a small C2C auction platform with a clever name, “searching for treasure.”

Starting with zero customers and a team of “ants” doing handstands to stay awake, Taobao immediately goes after eBay’s 85% marketshare. On a relatively tight budget ($12 million to eBay’s $100 million), by October 2004, Taobao’s marketshare is level with eBay at 45%. A year later, by December 2006, Taobao has completely overtaken eBay and owns nearly 80% of the market. Two weeks before ringing in the New Year, eBay CEO Meg Whitman announces eBay’s exit from China’s C2C auction sector.

At the time, Taobao had less than $173 million in annual revenue and no real experience in C2C auctions, yet it had won: Alibaba’s ants had defeated a $3.3 billion/year elephant.

Lessons From The Fight

The broader narrative is pretty amazing. But just as no war is won with a single battle, Taobao didn’t beat eBay in one fell swoop. Taobao won by sticking to and executing on three simple business principals:

1. Know your customers

Taobao understood its customers better than eBay, reflected in its product and marketing decisions from day one.

90 > 7: At first, Taobao only had 1 million RMB (approximately $120,500 in 2004) and it spent most of it TV ads. eBay had $100 million and signed exclusive deals with major internet portals like Sohu and Sina. The catch is that in 2004, only 7% of the Chinese population had access to the internet while more than 90% owned televisions. eBay’s ads reached 70 million people. Taobao’s reached 1.17 billion and cost less.

Identify Pain Points, Fix Them: Because buyers and sellers new to the web struggled with trust and logistical issues, Taobao provided contact information and free instant messaging and voicemail to help customers communicate. In contrast, “eBay didn’t allow you to put your phone number on the site,” one merchant complained. “It was like in ancient times when we had to rely on a horse to deliver our messages [between us].” Eventually, Taobao also rolled out Aliwangwang, an instant messenger tool that helped resolve on-the-spot questions for customers new to the online retail experience.

Leverage Existing Mental Models: Taobao created an online experience that felt more like shopping at a department store than transacting business online. Rather than dividing the site by buyers and sellers, it sorted products by categories (Men’s, Women’s, Electronics, etc) that new users were already familiar with. The effect was that customers felt like Taobao was more approachable than eBay.

2. Provide immediate, obvious value

Because Taobao understood its customers, it knew how to give them what they cared about most in an experience.

Free: In a price war, nothing beats free. Where eBay charged transactional fees for using its platform, Taobao gave the platform away for free and monetized accounts that wanted to be promoted. From Ma’s 2005 announcement to keep Taobao free for another three years: “With Alibaba and Taobao our theory has always been, only after our members make money using our marketplaces should we make money.” Contrast that rhetoric to eBay’s rebuttal of “free isn’t a business model.”

Easy: Within three months of launching Taobao, Alibaba launched a quick setup payment platform, Alipay, which put the buyer’s cash into an escrow account until the goods were delivered and judged to be satisfactory. Alipay was straightforward and easy to use compared to eBay, which offered two services, PayPal and AnFuTong. Having two payment products led to confusion among consumers, who would mistakenly think that the transaction had run into an error when it was actually just moving between separate systems. The resulting frustration incentivized sellers to adopt Alipay — in 2005, 79% of listings on Taobao accepted online payments compared to just 21% for eBay China — which in turn led them to Taobao.

3. Know your limits

Know when you’re reaching too far and refocus.

Don’t Beat Yourself: For all Taobao did right, eBay also beat itself. Coming in with $3.3 billion in annual revenue, 85% of the market, and a growing presence worldwide, eBay wanted to add China to its global platform. The move required migrating all the different countries’ technology platforms to California, a decision that proved disastrous for eBay China.

The migration occurred in October 2004. To prepare, a year beforehand, development of new features for eBay China basically stopped. “It took nine months to implement any major changes and nine weeks to even change a word on the website as everything had to go through the headquarters technology development team [beforehand],” Bo Shao, founder of EachNet, explained. “This is unthinkable. Fast reaction to user demands is crucial in this market.” Once China’s platform was housed in the U.S., page load times in China skyrocketed and sometimes even failed. Traffic dropped 50% on the day of the migration, primarily because some of eBay’s listings were triggering the “Great Firewall,” which blocks suspicious content and the foreign servers that process it. Exacerbating the problem, no one within eBay reported the problem to HQ until it was too late. In the middle of the fight of its life, eBay China’s slow, unstable service compelled users to not choose its service.

Don’t Be A Tourist: Last, eBay was too comfortable being an outsider in China. Where Taobao marketed itself as a local company, with moderator screen names based on characters in kung fu novels to even “declaring war” on eBay and getting some press from nationalistic Chinese media outlets, eBay didn’t do anything to reflect genuine interest in the country. “EBay was too Westernized,” Tao Shulin told the LA Times in 2006. Be a tourist on vacation. Be a local in business.

Alibaba & Taobao Today

Today, Alibaba and Taobao dominate China’s e-commerce market:

• In 2013, Alibaba processed $248 billion in purchases. (For context, Amazon and Ebay processed $176 billion combined.)
• Just less than 650 million people use the internet in China, a penetration rate of less than 50%. That number is expected to grow to 850 million by 2015.
• E-commerce retail transactions accounted for more than 10% of all retail transactions in China in 2013, growing 60% year-over-year. E-commerce transactions are expected to grow 50% in 2014.
• Alibaba’s platforms support 80% of Chinese e-commerce transactions.

Future growth opportunities for Alibaba/Taobao are overseas markets with low-trust, underbanked emerging economies — Africa, Latin America, Asia — with similar problems as China had at the turn of the century. Mobile commerce in China is another opportunity as well and Alibaba is well positioned in the market, with 76.2% of total mobile gross merchandise volume transacting within its apps. Taobao is the top mobile commerce app.

Regardless of what the future holds, e-commerce in China is sure to remain a massive business, and Alibaba the dominant player. It’s important to remember that this wasn’t always the case. Business, like history, repeats itself and studying past winners helps us understand the present and occasionally foresee the future. Alibaba and Taobao, one of the most valuable companies in the world and its primary brand, are a case study full of valuable lessons: Know your customers, offer them immediate, obvious value, and know your limits, and even a startup of ants can outmatch a corporate elephant.

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