Not so long ago, China's e-commerce businesses looked unstoppable. Investors around the world flocked to their online offerings, as did Internet shoppers from across the country. Shanghai-based apparel retailer Mecox Lane was a testimony to that popularity. Founded in 1996 as a catalog business, it began selling its own brands like Euromods and Rampage first in offline stores, and then online.

With its online business taking off, Mecox Lane joined a wave of Chinese companies listing on Nasdaq in the U.S. in October 2010. According to Bloomberg reporting at the time, it raised US$129 million, "pricing its initial public offering above the forecast range in the latest sign of surging demand for U.S. IPOs of Chinese Internet companies." But not long after, Mecox Lane began sliding into the red. Between January and November 2011, its shares slumped 77.7%.

But its latest unaudited quarterly results in early December offer insight into how its online business is in the fore in getting the company back on track. Reducing the number of directly operated offline stores to 115 from 143 in the same period the year earlier, overall revenues were down 4% year on year, to US$53.1 million, though revenue from its Internet platform increased 7.7% to US$30 million and average monthly unique visitors to its site increased 23%, "validating our strategic approach,"stated Alfred Gu, Mecox Lane's CEO for the past 10 years, in a press release at the time.

In an interview with China Knowledge at Wharton, Gu, 41 and a Shanghai native, gives his take on the "fierce pressure" that hit China's e-commerce companies in 2011, and also offers his predictions for what they can expect — and what they need for success — in 2012 and beyond.

Edited extracts of the conversation follows.

China Knowledge at Wharton: Competition in China’s e-commerce sector is extraordinarily fierce at the moment. Whether they're traditional resellers or dedicated "e-tailing" platforms, everyone in the sector seems to be chasing market share aggressively. Although Mecox Lane has traditionally been a vertical apparel platform selling your own brands, and started carrying third-party brands this past year. What does that say about how the firm is now positioning itself?

Alfred Gu: Some firms have begun selling a wide range of products and brands. But after assessing our own strengths, branding, scale and the competitive landscape, Mecox Lane has been focusing on our own brands. We differentiate ourselves by going deep into the apparel sector to provide better fashion for a particular demographic.

China Knowledge at Wharton: What was the thinking behind that decision?

Gu: Both models have pros and cons. Pure-play platforms can scale up rapidly in a short period of time. However, in the current landscape in China, Taobao holds more than 80% of the market share. You would have to invest heavily and be prepared to make a loss for five to 10 years. Also, there is a winner-takes-all phenomenon. In particular categories like shoes, clothing and electronics, there might be only three or four platforms that will survive, which increases the risk significantly if you choose to compete in one of those categories. Pure-play platforms also require a high level of capabilities in areas like IT and logistics, while the operational capabilities and human capital are different for each model.

As a vertical e-tailer, you have more advantages. The Internet can be just one of several channels used to expand your brand. You can take part in online events launched by platform companies like the Shopping Festival on November 11 that Taobao runs [which generated RMB 5.2 billion, or around US$821 million, of sales this year, three times more than the previous year]. At the same time, we save time and resources by focusing on our own products and branding.

China Knowledge at Wharton: On, you're now selling other brands alongside your proprietary brands like Euromoda and Rampage. What criteria do you use when deciding which brands to include on your site?

Gu: At the moment, the proprietary brands account for 70% of our online products. They also are among the top-selling brands. Folk brand Rib, leisure brand MinMan and others complement our products. Unlike the Taobao model [which allows brands to open individual stores on its site], we require brands to undergo quality control and other checks before they can be sold on our platform and become part of our dedicated logistics service. That selection process will continue, as will our primary focus on our own brands.

China Knowledge at Wharton: There has been a huge amount of venture capital coming into e-commerce over the past year. But most of the firms are still operating at a loss. How do you see the future?

Gu: E-commerce has received too much attention from venture capitalists over the past two years. A few years ago, it was just a trickle, which watered just a few trees. But the light rain turned into a downpour, and then a flood. Millions of dollars of capital flooded "irrationally" into China’s e-commerce in the first half of 2011, both via IPOs and private financing. 360buy alone raised US$1.5 billion in 2011 [the biggest ever private financing in China] and the top three retailers on Taobao have been swept up by private equity.

The whole sector is awash with capital. Many companies that used to be profitable investments are now making losses after raising financing. Why? Because investors are saying that top-line growth is more important than bottom-line growth. How can you grow market share? Spending! So ad rates in all kinds of media, from online to outdoor, and human capital costs are rising rapidly while profitability is declining dramatically. Everyone is under enormous pressure and the industry as a whole is not profitable. Mecox Lane was profitable over the past several years but we started losing money this year.

The current situation is abnormal and not sustainable. Capital will not keep flooding in. The outlook started to change in the second half of this year because of the European debt crisis, the [struggles of U.S.-listed] Chinese stocks [under investigation by the Securities and Exchange Commission] and so on. The wind in the capital markets is starting to change direction and the rain has stopped. The land that was damaged by the storm is showing signs of recovery and the seeds can be prepared to sow.

Next year will be more normal. E-tailers that squandered the most capital and were the slowest to finance themselves will be weeded out, and the less competitive ones in terms of products and services will gradually be swept away.

China Knowledge at Wharton: Do you mean that China’s e-commerce companies will start making a profit in 2012?

Gu: Not everyone. There will be a time lag. For platform companies, the investments and competitive jostling will continue. For verticals, profitability will improve next year when the capital markets have calmed down. But a lot depends on the competitive landscape and the respective business models of each vertical. I expect a certain number of e-tailers to continue losing money and even go bankrupt, and there will be a few mergers and acquisitions. After 2012, there will be many factors to consider, including China’s economy, the global markets and the operating models of individual companies.

China Knowledge at Wharton: Besides money, what do e-commerce companies need the most?

Gu: In the apparel industry, it's design capabilities, brand equity, popularity with customers, an artistic sense and so on, and a pricing or quality advantage. Service is also important, which covers the whole chain of a consumer's experience, from a web site's accessibility, pre- and after-sales service, delivery, and convenient return policies.

China Knowledge at Wharton: What's the thinking behind Mecox Lane's logistics and after-sales services?

Gu: We have regional warehouses in Beijing, Shanghai, Guangzhou and Chengdu. The companies we outsource our delivery service are benchmarked against various metrics to gauge the quality of their service. We've been providing a [Cash on Delivery] service for a long time now, so you can pay cash if you are satisfied with the goods upon delivery. We also have an unconditional refund and return policy within 10 to 30 days of a customer receiving a product. We even have people pick up the goods and refund money in person to improve efficiency.

We are not planning to develop our own logistics services for the time being, since we are a brand that needs to focus our energy and know-how on improving our product design and quality.

China Knowledge at Wharton: How do Mecox Lane’s online and offline businesses complement each other?

Gu: We have nearly 460 offline stores, two-thirds of which are franchises. We haven't invested much in offline channels in the past year, and we basically position offline stores as just one of several sales channels. The overall brand strategy, operating model and products are online oriented.

China Knowledge at Wharton: Many e-commerce companies have been spending heavily to acquire new customers. 360Buy spent RMB 230 millionin November during the bidding for 2012 ad slots on CCTV (the country's largest TV station, and most expensive one for advertisers). How do you view the relationship between ad spend and customer acquisition?

Gu: In the early days, the efficiency of display ads was quite high. However, with the proliferation of online ads and rising rates, online ads are no longer a very effective channel to acquire customers. Companies have to be innovative with not only the advertising channels they choose, but also the promotions they offer and the actual content their ads provide.

At the same time, ads are just one part of what's needed to attract new customers. The most important thing is to improve the user experience and have access to good word-of-mouth mechanisms. Online customers will make repeat purchases if they enjoyed the buying experience. I think the user experience is the most important way to measure the performance of e-commerce companies. The Internet itself is a very strong communications tool, which feeds off word-of-mouth. If your customer is happy with his experience, his positive comments will spread that message online.

China Knowledge at Wharton: The open platform is very popular among China’s Internet companies. M18 is co-operating with Sina Weibo and TMall, the business-to-consumer unit of Taobao, which used to see verticals as competitors, but just recently has begun wooing them. How do you position yourself in this regard?

Gu: It depends on how companies position themselves. Taobao's current strategy is to develop an open platform that accommodates all kinds of brands and verticals. Taobao has traffic and it also charges for ads and commissions for transactions. This kind of co-operation is a good fit for both of us. Also, as a company offering quality and after-sales service that's entirely controlled by us, that helps us stay as close as possible to customer "touch points."

China Knowledge at Wharton: You've been at the helm of Mecox Lane for 10 years. What challenges have you had to confront?

Gu: The change in China’s e-commerce market in the past few years might be 10 times that of what is happening in foreign markets. We had been a substantial player in the  catalog business, but rapidly rising Internet sales made  catalogs as a percentage of sales shrink dramatically. When your customers are changing at full speed, your operating models have to be transformed at the same speed. In the process, management has to act quickly; otherwise, a new team might be needed to run the business. At the same time, the company has to know how to juggle the new and old [parts of its business], amid stiff competition from other companies for your staff.

China Knowledge at Wharton: Human capital costs have been rising fast at Internet companies this year and there is a lot of poaching going on. How do you keep your team stable?

Gu: We have a healthy corporate culture; we strive to build a fair environment, instead of letting office politics get in the way. For example, not one of our staff of 4,000 is a relative of mine. Many relatives and friends have asked whether I could get them a job. Of course, the answer is no. Even just one small job [given to friends or family] would destroy the fair culture we have had for 10 years. Our employees know Mecox Lane is a pretty straightforward place to work. As long as you perform well, you are hero. We reward people who create value for the company. Our culture makes people who are considering leaving for another company offering a higher salary think twice.

I am open to delegating to line managers. My philosophy is that if every decision has to be made by me, I will eventually become the bottleneck for the company's development. I may control the overall strategy, but I prefer to delegate specific business decisions that require in-depth market knowledge to channel or brand managers. Even if there are mistakes, I trust that they learn from them. This kind of corporate culture attracts and retains a certain kind of talent.

China Knowledge at Wharton: The latest Internet catchphrase is SOLOMO — social, local and mobile. What are your thoughts about it?

Gu: SOLOMO is a reflection of the Internet's vast range of opportunities. For e-commerce, the key is commerce. The "e" is the method to display your products and a channel to communicate with customers. In mobile platforms, we send coupons to users by SMS, and many of them visit our site after receiving one of them. In a post-PC era, we will monitor the changes in consumer behavior closely, and keep on innovating to interact with our customers.

Every type of media has its own needs, and both mobile and social networking on the Internet are the key areas we are exploring. People behave differently using mobile and PC technology, which we need to explore further. Mobile marketing is a new field so there is still a lot of experimenting going on. We found that the peak time to use mobile technology is when people are leaving the office. So we are designing special promotions targeting them then. Another thing we have had to think about is that a mobile device's screen is much smaller, which affects the marketing features we use.

Social networking is another major trend we are paying close attention to. This is, how can we transform social network traffic into e-commerce traffic? That is still at a pretty early stage of development.