With 80 million registered users, Taobao.com, a subsidiary of online global trade giant Alibaba Group, is China’s largest consumer-to-consumer e-commerce company. Since its launch in 2003, it has captured close to 80% of China’s online-shopping market share, in part because it doesn’t charge transaction fees and also through such innovations as AliPay, an escrow system that enables online payments in the absence of high credit card penetration among Chinese consumers. For the first half of 2008, the company recorded a trade volume of RMB 41 billion — almost the total volume for all of 2007. What are the key challenges to managing such a high-growth business in a rapidly developing market? And what potential obstacles lie ahead? China Knowledge at Wharton spoke with Zhang Yong, COO of Taobao.com, about these and other issues at the company’s headquarters in Hangzhou.


An edited transcript of the conversation follows:


China Knowledge at Wharton: Mr. Zhang, it’s nice to be visiting Taobao. To begin with, could you brief us on the e-commerce market in China and Taobao’s position?


Zhang Yong: Taobao is by far the biggest e-commerce platform in China. We position ourselves as an online retail platform. We are not sellers or buyers; instead, we provide an open platform to all users, offering them opportunities to do business online. Taobao, started in 2003, is a full subsidiary of Alibaba Group. After five years of development, our trading volume had reached RMB 43.3 billion (US$5.6 billion) in 2007. For the first half of this year, the number is RMB 41 billion, which is close to the annual volume last year. Basically, if you look at the growth rate over the last several years, it almost doubled every year: RMB 8 billion for 2005, RMB 18 billion for 2006, RMB 43 billion for 2007, and it is expected to exceed RMB 100 billion (US$16 billion) this year.


China Knowledge at Wharton: What are the key operational challenges for a company that is growing so quickly?


Zhang Yong: The e-commerce market has been growing rapidly in China in recent years. Taobao has taken this opportunity to grow its business and to build up its platform. Actually, the online population in China is huge; however, the penetration rate, which refers to the number of online shoppers divided by all the internet users, is only 26% in China, versus 80% in the U.S.


Nowadays in China, many people can’t live without a computer and the Internet; they will often read news online, communicate with colleagues or friends using Instant Message tools, or write blogs, but there is still a significant portion who have never tried online shopping. This is the biggest challenge we have been facing in the past and now. We are trying, through different approaches, to get these people to try once, twice, to buy goods online.


We are very confident and find with interest that, based on the past five years’ experience, as long as someone has tried online shopping more than five times, he will be able to enjoy the online shopping process and he will visit Taobao regularly from that time onwards. 


China knowledge@Wharton: Do you find the financial crisis has impacted the pace of online shopping growth?


Zhang Yong: The current financial crisis has not much impacted Taobao overall, and in some senses, it may even have a positive impact on our business. Why is that? You know that the downturn in the world economy will have a big impact on China’s export companies, because those export businesses which used to do well are now forced to turn their models the other way around. So nowadays, the phrase “driving domestic demand” is very hot. But how do you drive domestic demand?


The answer may lie here. We have a huge bulk of domestic consumers. Now is the moment that those manufacturers are forced to explore ways to reach more domestic consumers. For example, originally your [company’s] toys were for export to the U.S. market, but now the export orders are declining, and you therefore have to think of other ways to survive. What are the other ways? We are providing a shortcut to domestic consumers. Taobao is by far the biggest retail channel in China and we are the biggest consumer market in China.


The above discussion is for sellers. For buyers, it’s more interesting. Just as American consumers are now more prudent in their spending, Chinese people are usually more price sensitive. Compared with off-line retail channels, Taobao has a big advantage on price. It’s usual that you will find a 10%-12% price difference on our platform. So, with the same amount of money, you can buy more on Taobao. Therefore, the more price sensitive the consumers are, the bigger the advantage Taobao will have.


China Knowledge at Wharton: What are the primary hurdles to encouraging consumers to become regular online shoppers?


Zhang Yong: The biggest hurdle is that they are not familiar with the online purchasing process. They will have concerns about payment safety issues and product quality. As in any place in the world, if you buy online, you can’t see your counterpart, and you can’t touch the goods; but then you also have to pay online, so you will have some concerns about the reliability of online payment. Furthermore, you might also have some concerns about delivery, the logistics service. Will the goods be delivered to you on time, undamaged and with good service? If you buy something in a store, you won’t have those questions.


China Knowledge at Wharton: How do you tackle these challenges?


Zhang Yong: Over the past five years, Taobao has not only set up a marketplace, but has also established a whole set of market trading rules and processes, including critical systems like a complicated credit rating system for both buyers and sellers. The logic is this: Since you don’t see the counter parties online, people who make their living on e-commerce or frequent online buyers can rely on a credit rating system much more than off-line traders.


Our credit system is open to everybody, so everyone can see your track record. All people are making their purchasing decisions based on your credit rating and your track record. If you did not do well in the past, you will have trouble getting deals done in the future.


This rating system is particularly important for online shop owners. If your store has a lot of bad feedback or poor ratings, you won’t have a business in future. And we think this system is also helpful to educate Chinese people as a whole to be reliable and build up trust among them.


Meanwhile, in order to address the issue of quality concerns, we have been trying for the past several years to promote an initiative called our “Customer Protection Program.” Every shop that joins this program will have to pay a deposit for us to compensate buyers if any of them claim a loss. For example, for a shop who joins this program, we will place a notice on his store saying, “[If a] product [is] false, refund [will be] tripled,” so visitors will be more willing to buy stuff in those shops. These initiatives are all associated with economic benefits.


The other critical system is our online payment system. Just as eBay has Paypal, we have a unique payment solution named “AliPay”, something like an escrow account which perfectly eliminates buyers’ concerns about e-commerce. Imagine you are a buyer: After you make your purchasing decision, your money will be transferred to your AliPay account, and the seller will then deliver the goods to you. Only after you have received the goods and are happy about the quality, and only after you have agreed to confirm the payment online, the money will then be transferred from your AliPay account to the seller’s account.


Nowadays, many small e-commerce companies have directly adopted our AliPay system and pay a commission to us for every transaction done. Some big e-commerce companies will build up their own payment systems, with a same model and design. So far, we still have to use an escrow service in stead of direct credit card payments, which is a big difference from what eBay is doing in the U.S.


China Knowledge at Wharton: Who are your competitors?


Zhang Yong: Taobao has more than 80% of the market share of the e-commerce market in China. So in a certain sense, we represent the whole online retail market in China. Five years ago, eBay acquired the then-big player Eachnet in China, but it sold the business to a third party three years ago and now we have learned that the third party has terminated the business. At this moment, the second and third largest players in this market have no more than single-digit market share in China. This is the status quo. However, we know that this market has huge potential, so we have to keep going — to encourage more internet users to try online shopping.


China Knowledge at Wharton: How do you hope to reach those people? What are your strategies?


Zhang Yong: Fundamentally, it’s a matter of branding, building up customers’ awareness and the concept of online education. The most often referred-to examples are U.S. food companies, like KFC or McDonalds. When they entered the China market, they all had a place in their restaurants for kids to play. This was not just to build up a market share; this is more about mindshare. We think that market share is only “for now” and it’s transitory, but mindshare will be difficult to change once it is shaped. We are more focused on educating the younger generation to enjoy the online shopping experience.


China Knowledge at Wharton: You have very young employees (the average age is 25); is that a deliberate strategy in terms of human resources or is it simply because a younger demographic fits your corporate culture?


Zhang Yong: I think it’s both. The business we are doing now is unprecedented in China, and past experience has proven that if you simply copy other companies’ practices, it’s not going to work in China. Even if you take the experience from abroad, you still have to implement something new and local. In other words, you have to be innovative. Innovation is critical to our business. Young people are like blank paper: They don’t have many blinders, and as a result they contribute a lot of fresh ideas to the company, which are very precious assets to us.


On the other hand, the corporate motto of Taobao is to “Work with Fun.” We hope our employees enjoy their work, which is very attractive to young people. Their job is to manage the site and to think from the perspectives of consumers and to generate more ideas; these are the things young people are longing to do.


We have a very unique Chinese Wu-Xia culture in our company. Everyone has a nick name. You see, my name is “Xiao Yao Zi” (which is a character in a famous Chinese Wu-Xia novel). We embrace the value of integrity, to do the right thing and to benefit others, rather than just making money for ourselves.


China Knowledge at Wharton: Does that mean your corporation has a very flat organizational structure? Are there any problems with this kind of structure?


Zhang Yong: In my view, no organizational structure will be perfect. It all depends on what is needed for the company at a certain stage in time, and whether there are particular people to do it. Taobao is still changing continuously itself — it’s in fact a very young company and China’s economy is growing fast at the moment, therefore, a flat organization will help the company deal with any challenges or changes very quickly.


China Knowledge at Wharton: Who are your target customers?


Zhang Yong: Our customers are a broad spectrum. Everyday, there are more than one million people buying goods on Taobao. For different sexes, there are different categories. In general, the breakdown is almost equal, with slightly more women than men. For example, in cosmetics, women are the dominant buyers, but for outdoor equipment or electronic products, men are the majority buyers.


Age wise, the 18-30 age group is by far the largest, but we have found the edge is expanding. Middle school students are now buying online, as well as middle-aged men. From a geographic perspective, for the last several years, the transactions were always focused on the eastern regions of the country. However, this is changing now. With the development of the 2nd and 3rd tier cities inside China and the popularization of broadband, more and more people from those places are joining us.


China Knowledge at Wharton: It looks like your business model involves expanding your customer base continuously. Does that mean that you will also have to keep growing your operational team and capacity to match the former? Otherwise, you may not be able to deal with such a growth?


Zhang Yong: That is a good question. There is a difference between online shopping and off-line shopping. What we are going to build up is a scalable and sustainable model. Scalable means that you don’t have to multiply your investments in headcount or resources when the transaction volume or user base multiplies continuously. Certainly, there are somethings that need to be increased linearly — e.g., your servers, your rented bandwidth — but if you are talking about direct cost, staff cost, this doesn’t need to be added linearly. Only by growing this way, your business can be sustainable. This is also the biggest advantage to doing business online, which makes it possible.


China Knowledge at Wharton: In the U.S., some big retailers are now going online, like Wal-Mart. How is the situation in China?


Zhang Yong: In fact, every retailer in China thinks that online trading is the future and they are all willing to do some experiments. But so far, no one is really doing it. At the most, some are creating websites, and that’s all. In terms of the off-line retail business model, that has also been evolving in recent years — from single stores to supermarkets, and now the shopping mall is dominant. The mall is not only a place for shopping, it’s also a place for entertainment in a broad sense. For Taobao itself, we are not only building up a marketplace, but also trying to make an ideal shopping environment for our consumers.