Jack Ma and the Hundred Alibaba Thieves

At the mentoring session he starred in during the World Economic Forum’s Annual Meeting of the New Champions in Tianjin last year, Alibaba founder Jack Ma Yun (pictured) emphasized again and again the importance of honesty in business.

 
Speaking in Mandarin, he said: “Business leaders must always tell the truth and avoid blaming subordinates for their mistakes.” Managers should utilize those errors as opportunities to learn, for themselves and their people. “There are secrets to success but, equally, there are also valuable lessons from failure,” he added.
 
Ma’s conviction was on full display this week. On February 21, Hong Kong-listed Alibaba.com Limited sent a surprise announcement to the Stock Exchange of Hong Kong that David Wei Zhe had resigned as CEO and Elvis Lee Shi-Huei had also stepped down as COO. Jonathan Lu Zhaoxi, the 41-year-old chief executive officer of Alibaba.com sister company Tao Bao Holdings and an executive vice president at Alibaba Group, took over as CEO.
 
Culture and Values
The reason for the resignations, according to the disclosure, was that the two men wished to “take responsibility for the systemic breakdown in our Company’s culture of integrity.” An internal investigation had found that some 100 Alibaba sales representatives (out of 5,000) and a few supervisors and managers had allowed fraudulent storefronts on Alibaba’s online marketplace, or were negligent in the task of screening them out. 
 
Alibaba absolved Wei, Lee and other senior executives of involvement. “It saddens me to see talented people leave the Company, but David and Elvis are doing the honorable thing to accept full responsibility,” Ma, now Alibaba’s non-executive Chairman, was quoted in the statement.
 
“One of our most important values is Integrity,” he stressed. “That means integrity of our employees and integrity of our online marketplaces as trusted and safe places for our small business customers . . . We must send a strong message that it is unacceptable to compromise our culture and values.”
 
Anatomy of a Fraud
As Alibaba tells it, senior managers detected last year a noticeable increase in fraud claims by global buyers against sellers that the company had certified as China Gold Suppliers. The company’s Gold Supplier program is a paid-for premium membership service that confers privileges to pre-qualified sellers, such as unlimited product display with first-level priority listing.
 
Alibaba’s probe found that 1,219 China Gold Suppliers, which it says represent 1.1% of the total, were bogus sellers in 2009. Last year, 1,107 such suppliers, 0.8% of the total Gold Suppliers, were discovered to be fake as well. Their storefronts typically offered low-priced popular consumer electronics items and accepted low minimum order volumes and less reliable payment transfer methods.
 
The ordered goods were never delivered and so the duped buyers sought redress from a fund that Alibaba had set up in 2009 to compensate defrauded customers. The average value of each claim was less than US$1,200, said Alibaba.
 
It did not give a figure of how much it has given out in compensation, but said the refunds “have not had a material financial impact on our Company during the period involved as the activities and our reaction to them have been appropriately provided for in previously reported financial periods.”
 
Alibaba.com Limited reported revenues of RMB4 billion (US$615 million at the current exchange rate) in the first nine months of 2010, up 46% from the same period in 2009. Net profit for the January-to-September period last year was RMB1 billion (US$152 million), up 45% from the same period in 2009. Presumably, these figures already took the refunds into account.
 
Overkill?
Given the relatively small number of bogus China Gold Suppliers, some may regard the resignation of the CEO and COO as an overreaction, especially since they had been cleared of involvement. But Alibaba is evidently trying to send a very strong message to its own people and everyone else that it would not tolerate fraud of any magnitude.
 
In particular, any doubts about the integrity and effectiveness of its vetting procedures with regard to Gold Supplier certification strike at the very heart of its business model. Paid-for value-added services offered to the company’s 56.7 million registered users account for a large part of revenues. That earnings stream will be at risk if buyers stay away from Alibaba because they had lost confidence in its online marketplace.
 
As it is, the number of Global Gold Suppliers as of September 30 last year had fallen 41% to 11,017 members from a year ago. Alibaba attributes the fall to higher pricing for premium membership, which was implemented in July 2009. The China Gold Supplier numbers grew larger in the same period, to 108,572, albeit at a slower pace because of the clean up of the fraudulent storefronts.
 
The growth in China premium memberships may slow even further as Alibaba rolls out a more expensive China Gold Supplier membership package – it is priced at RMB29,800 per annum – to replace the current offering. The company expects the higher rates, which come with additional and enhanced service features, to cushion drop-outs, if any. The higher fees may also discourage fraudsters, who will need to invest more in upfront costs.
 
Shallow Bench
For now, Alibaba is in full damage control mode. “Our Company will take action against any other suppliers who exhibit a high risk of fraud based on our Company’s fraud detection model,” it promised in the February 21 statement. The company also pledged to “identify deficiencies in policies, structures, procedures and systems to prevent a recurrence.”
 
The board has instructed new CEO Jonathan Lu “to take effective measures to further strengthen trust and safety on the Alibaba.com marketplace.” He has his work cut out. Lu will remain CEO of Tao Bao and EVP of the group in a concurrent capacity.
 
In turning to Lu, Ma is tapping a homegrown talent. The new CEO had joined the group in 2000, managing the South China sales region among other leadership role. In contrast, Wei, the former CEO, came on board in 2006, a year before Alibaba.com listed in Hong Kong, after stints as CFO and president of B&Q China and as an investment banker with Chinese firm Orient Securities.
 
The intent appears to be to make Lu Alibaba.com’s permanent CEO. Some analysts see the prospect as a positive, as this may foster more and closer synergies with Tao Bao, which is an auction site similar to eBay. But others question whether Lu will have the time and energy to fulfill his multiple responsibilities. There is no word on who the next COO will be.
 
Ma’s personnel choices do raise questions about the shallowness of Alibaba’s internal management bench, and possible disruption in the acquisition of new China and Global Gold Members and development of additional value-added services.
 
The concerns contributed to the near 10% fall in the company’s stock price on February 22. Worried about the impact of the fraud on revenues, some analysts have lowered their call on the stock from overweight to equal weight, in the case of Morgan Stanley, and to hold from buy, in the case of Mizuho Financial Group.
 
“We are concerned that the clean-up of fraudulent accounts puts near-term revenue growth under pressure,” Mizuho’s Muzhi Li wrote in a note to clients. But the Hong Kong-based analyst is more optimistic going forward. “We believe the company could benefit from this shake-up in the longer term,” Li concludes, echoing the opinion of other analysts from Goldman Sachs and Royal Bank of Scotland.
 
Ma is counting on it. The top-level clean-up at Alibaba.com appears to be dictated as much by his personal convictions as the business’s recognition that integrity and trust are the lifeblood of an online marketplace – particularly when the company is raising the price for the right to sell there.
 
The challenge is to strike a balance between following one’s personal beliefs and the reality that top management talent -- including finance executives -- is a scarce commodity that should be nurtured and not thrown away.
 
About the Author
Cesar Bacani is the Editor-in-Chief of CFO Innovation.
 
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