Alibaba's Strategy Reset

Between Market Challenges and Leadership Changes

Yesterday, I was reading about JingDong (JD.com) [$JD]'s recent earnings. While I was not particularly impressed by those earnings, which showed a mere 3.6% revenue growth, the market reacted very positively, and the stock went up 15%. Earlier, Alibaba [$BABA] reported a 5% revenue growth, and its stock tanked by 8%. However, I feel that the market's reaction was fully rational and justified. In this article, I want to explain why I think this is the case.

I'm by no means a big fan of JingDong; quite the contrary, I find their customer service inferior to all the others, particularly to Pinduoduo's [$PDD]. Personally, if I can avoid it, I never buy from JingDong, preferring instead to order from Pinduoduo, Alibaba, or Meituan [$3690.HK].

There are other reasons why I avoid JingDong. It has happened to me several times that after ordering something from JingDong, when I wanted to return the item, I was told that I had to contact Pinduoduo because I bought it from their website. Initially, I thought this was a mistake, but then it was explained to me that buying cheaply on Pinduoduo and then reselling for a much higher price on JingDong and Alibaba is a very profitable business model. I experienced the same with hotel bookings: bought cheaply on Meituan and then resold on Trip.com. Of course, these observations, based on a rather small sample size and what friends have told me, are not a systematic investigation. However, they seem reasonable as being or cutting out the middleman is a significant aspect of business in China across various sectors. But I am digressing from what I initially wanted to say about Alibaba.

Alibaba is Falling Behind

There is a striking contrast between JD.com and Alibaba, especially in their strategic approaches to business adjustments and market challenges. Both made the huge mistake of allowing Pinduoduo to become a significant force in Chinese e-commerce, despite their dominant positions a few years ago. However, JD.com recognized this much earlier. When founder Richard Qiangdong Liu returned last year, JD.com made the necessary adjustments. In 2023, JD.com embarked on a series of strategic adjustments, leading to a significant increase in user engagement, merchant participation on its platform, and repurchase rates. With the Chinese economy still struggling, they increasingly focused on the price sensitivity of their customers and tried to counter the competitive prices one can find on Pinduoduo. In their recent earnings call, they seemed very confident, calling 2023 a year in which they laid the important foundation, and now in 2024, they are able to execute their new strategy. Essentially, JD.com has already laid the groundwork for continued success, focusing on sustainable growth and market dominance.

In stark contrast, Alibaba is currently in the early stages of making similar strategic adjustments. This delay places Alibaba behind the curve. What JD did last year, and what Pinduoduo has been doing for a long time, is now being announced by Alibaba’s China e-commerce units, Taobao and Tmall. Alibaba is only beginning to address their problems. Quote from the call: “We concluded that to maintain our competitive edge, we must increase our investment in core capabilities and adopt a more aggressive approach towards competition in order to win growth.”

Challenges Beyond E-commerce

However, this problem is not isolated to Chinese e-commerce. Their second important business unit, the cloud intelligence group, is not performing better either. The cloud computing sector further illustrates this trend of delayed responses by Alibaba. Growth is essentially stagnant. While they attributed this for a long time to an important client (ByteDance) terminating their usage of Ali Cloud for non-product-specific reasons, it's clear that there are deeper structural problems.

More than one year ago, Tencent [$TCEHY] already announced a strategic shift in their cloud business, phasing out low-margin and highly individualized projects in favor of sustainable growth. This move was aimed at optimizing its cloud business for profitability and long-term success. Before, the strategy of many Chinese tech companies in the cloud space was growth at all costs. However, this has recently reversed, and Tencent's adjustment was the trailblazer, with many companies having followed the phasing out of unprofitable projects since.

Alibaba, on the other hand, has only recently begun to talk about making similar adjustments to its cloud business. This one-year lag not only highlights Alibaba's reactive stance but also raises concerns about its ability to anticipate and adapt to market changes. Quote from the call: “We have proactively optimized our business structure, reduced revenue from project-based contracts, and increased investment in public cloud products.”

In Chinese, there is a saying: 起个大早，赶个晚集, which roughly translates to: "Got up early but was late to the market." This phrase is usually used when talking about Baidu [$BIDU], but increasingly it should be used for Alibaba.

Leadership Missteps: The Daniel Zhang Era

Under the leadership of Daniel Zhang, Alibaba experienced several strategic missteps that have contributed to its current challenges. Once the dominant force in e-commerce and cloud computing, things changed. Zhang’s tenure saw Alibaba losing its dominance in e-commerce to rising competitors like Pinduoduo, ceding ground in the cloud computing sector, and falling behind in the food delivery (Ele.me vs. Meituan) and international e-commerce (Lazada vs. Sea Group [$SE]) markets.

Zhang's push for an integrated online and offline retail strategy led to significant investments in physical retailers, a move Alibaba is now reversing in light of its current strategic reevaluation. Hema (Freshippo) is still loss-making, Sun Art is closing down parts of its operation although only acquired in late 2020. Intime, their department stores, is also failing, and new management wants to divest it together with Hema and Sun Art. There also have been huge impairments from Sun Art and Youku. It's remarkable when they announce in the call, “Excluding Sun Art, Freshippo, and Intime businesses that have physical retail operations, group revenue would have grown at approximately 8% in our group consolidated adjusted EBITA margin would have been 4 percentage points higher at approximately 24% this quarter.” In other words, without Daniel Zhang’s missteps, we would have seen 8% growth.

The critique of Daniel Zhang's leadership extends beyond strategic missteps in core areas to his penchant for accumulating a wide array of businesses, leading to a sprawling "other" segment within Alibaba's portfolio. This segment, as vast as the cloud computing and international e-commerce units combined, consists of all the non-core units Alibaba accumulated. Remarkably, this segment has not only shown negligible growth but, in some instances, is shrinking but is never really talked about despite its huge size.

The Reversal of Zhang's Strategies

Alibaba's latest earnings call reads like a plain critique of Zhang's decisions, with the company now undoing many of his initiatives. This strategic reversal is not only a clear acknowledgment of the missteps made under Zhang's leadership but also highlights the challenges Alibaba faces in realigning its business. The reversal of strategies indicates a painful adjustment period ahead for Alibaba, as it seeks to correct its course and rejuvenate its operations.

The new management team at Alibaba, recognizing the drag the “others” conglomerate of non-core assets imposes on the company's overall performance and strategic focus, has now signaled a decisive pivot. They have expressed a clear intention to divest many of these businesses, which notably include Sun Art, Freshippo, AliHealth, Intime, and Fliggy, among others. This move is part of a broader effort to streamline Alibaba's operations, focusing more intently on areas with the potential for growth and profitability. By shedding these non-core assets, Alibaba aims to rid itself of underperforming segments and reallocate resources towards its core e-commerce and cloud computing divisions, thereby facilitating a more agile and focused approach to regaining market leadership. This strategic shift underscores the new leadership's commitment to correcting past missteps and steering Alibaba towards a more sustainable and profitable future.

The Road Ahead for Alibaba

Alibaba is at a crossroads, facing the daunting task of reversing previous strategies and implementing necessary adjustments. This period of transition will undoubtedly be challenging; however, I believe they are still in a very strong position and have the ability to reverse their previous mistakes. If they now make the necessary painful adjustments, then in a few quarters, things might look much better.

Let me end with a comment on the new leadership team. I think Joseph Tsai is great, and it's a huge positive that he is back. However, it will take time for Alibaba to turn things around. I believe they got caught unprepared and are to some extent still struggling to find their way.

Yongming Wu’s answer on the call, when he was asked about the advantages of the Taobao and Tmall Group compared to their competitors, was telling:

“In terms of how Taobao and Tmall Group is different from its competitors, I think from the merchant perspective, certainly, TTG is the strongest platform with the most robust overall capabilities that it can offer merchants. We have live streaming and other marketing modalities on Taobao that can help to quickly drive purchase volumes for new product launches. Very important for merchants also are the day-to-day marketing operating tools that we offer. And in fact, a lot of purchases, of course, are made via the search function on Taobao.”

What a non-answer about their biggest business unit. Nowadays, everybody has live streaming, marketing tools, and all the other things he mentions. What I hear from merchants is that Pinduoduo is a much better place to be and it is profitable to buy on Pinduoduo and resell on Alibaba.

Conclusion:

Alibaba's strategic realignment marks a pivotal moment in the company's history, as it seeks to navigate through the challenges posed by delayed adjustments and leadership missteps. The good news is that current management has recognized the problems, albeit late. It's time to execute the changes now that their competitors made some time ago. However, the good news is that at current levels, most of the bad things are priced in, and any progress should push the stock upwards. I'm not aiming for a detailed valuation at this point as this article is already too long, but it seems clear to me that the cash position and Chinese e-commerce alone should be equal to the current market capitalization.