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Years ago, we here at China Law Blog made clear our views on VIEs and nothing about those views has changed.  For that reason, and becuase VIEs have little to nothing to do with most companies doing business in China, we stopped writing about them years ago.  In a nutshell, we don’t like them, don’t trust them, and don’t do them.  Quite frankly, our malpractice insurance just isn’t high enough for the massive risks we see in these investment vehicles.  We simply believe that when push comes to shove, China’s courts simply won’t enforce the contractual agreements that are necessary to support such a structure.

Seems we are not alone in this assessment and we now have company from a Chinese court.  Sue-Lin Wong just did a story on VIEs for the International Herald Tribune/New York Times and because both Steve Dickinson and I were quoted in it, I cannot resist retreading old ground here and again writing about VIEs.

The NYTimes story is entitled China Court Ruling Could Threaten Some Foreign-Invested Companies and it comes on the heels of a recent ruling by China’s Supreme People’s Court holding that “contracts used by non-Chinese citizens to gain access to sectors of the Chinese economy that are protected from foreign investment were invalid.”  Ms. Wong nicely explains why V.I.E.’s exist at all:

Sectors the Chinese government considers sensitive, including finance, media, technology, the Internet and education, have long been largely off-limits to foreign investment. To get around that, some of the biggest companies in the country founded by Chinese people, including the Internet giants Baidu, Alibaba, Tencent and Sina, create variable interest entities, or V.I.E.’s, that give overseas investors de facto control over companies technically owned by their Chinese partners, as Neil reported. V.I.E.’s account for differing proportions of these companies’ income and assets, ranging from several percent to as much as 100 percent.

V.I.E.’s have for the most part worked just fine and this likely will not change, until there is a problem.  And that itself is the problem.  To make up a Yogi Berra quote, there is no problem with V.I.E.’s until there is a problem.  Problems arise if the Chinese partners decide they don’t want to follow the contracts any longer because, for example, they already have the money and know-how they were seeking, as has happened in several instances. When that happens, the foreign party most likely has no legal recourse.  China Law Blog’s own Steve Dickinson is quoted on the biggest problem with V.I.E.’s:

“Chinese law has a very clear provision. A contract written to avoid the requirements of Chinese law is void and the court will not enforce it,” said Steve Dickinson, a partner at Harris Bricken and a co-author of the China Law Blog.

In other words, they almost certainly are not legal.  Though some are seeking to distinguish this recent Supreme Court case because it involved a type of company structure that predated V.I.E’s, Steve isn’t buying that:

“This group of people will distinguish the recent Supreme People’s Court ruling because it was an earlier set of documents, not entirely the same as the V.I.E. structure,” Mr. Dickinson predicted. “But what the court said is that any contract that is designed to avoid the clear requirements of Chinese law is void from the very first step. That is what the V.I.E. is.”

I then chime in to explain why despite the risks V.I.E formations just keep on coming:

“Accountants, lawyers and stock brokers make a ton of money off IPOs so they have no incentive to slow them down,” said Dan Harris, a China lawyer with Harris Bricken and a co-author of the China Law Blog. “They have every incentive to keep the V.I.E. structure going.”

Of course it is not just Steve and me who view V.I.E’s with such trepidation.  Andrew Gilhom, head of Asia analysis at Control Risks describes them as a way for foreigners “to make some money for a few years but ultimately it’s kind of open season.”

Does this mean that all V.I.E’s are going to disappear or be sued out of existence?  Absolutely not, because as the article rightly notes, it is “unlikely that the Chinese government wants to turn the V.I.E. structure into a huge issue”:

“They don’t want all the U.S.-listed stocks suddenly tumbling and companies failing and panic,” Mr. Gilholm said. “I don’t really see any signs that they are going to proactively go out and across the board say that all these structures have to be unwound.”

Even if no full on shut down of VIEs should be expected, is there anything that will stop a VIE or two or three from encountering major problems?  What do you think?

If you want to learn more about VIEs, I suggest you read the following China Law Blog posts:

And the following China Hearsay posts:

And the following China Accounting posts:

And the following China Finance posts:

If you read all of the above, you will probably know more about VIEs than anyone else alive. If you are going to read just one post, make it “Explaining VIE structures.” Oh, and just to give you more to read, I also recommend you read the Silicon Hutong post, “VIEs, The Long Resolution.” In that post, David Wolf talks of how the Chinese government likes to “boil its frogs slowly, not all at once,” and he then talks of how VIEs are on the wrong side of where China wants to be going. I could not agree more. I do not see VIEs disappearing overnight; instead, I see foreign companies involved with VIEs suffering a very long and very gradual squeeze out.

What do you think?

 

 

A number of our clients manufacture products that sell for relatively high prices due in large part to distinguishing characteristics of our client’s company or product.  In other words, the exact kind of product counterfeiters love to copy.

Not sure why, but we have been spending more time lately in helping our clients prevent counterfeiting and in deal with it once it has been discovered.  Hence, this post on how to stop China counterfeiting, or at least reduce it.

Here are the four keys to stopping China counterfeiting:

1.  Much counterfeiting comes from people and entities that know your product well. This could be your manufacturers, your distributers, or your retailers, or your own employee or an employee of a company with whom you are doing business.  It therefore behooves you to do your utmost to conduct business with well-run and reputable companies and to keep your eye on them nonetheless.  If possible, it also behooves you to do your best to prevent these companies from having full and unfettered access to what they need to copy your products.

2. Register your trademarks in China and in your home country, and wherever else you sell or plan to sell your product.  I know regular readers must be getting tired of us always saying this, but hey, it’s the truth. Why is registering trademarks so critical to protecting trademark rights in China?  Because without registering them, you pretty much do not have any such rights. Also, if you register your trademarks in China, you can then also register them with China Customs, which greatly increases the likelihood of China Customs stopping counterfeits of your products from leaving China.  For more on this, check out Register Your China Trademark Now. Then Register It Again With Customs.

If you register your trademarks in the United States and then complete an Intellectual Property Rights e-Recordation (IPRR) application online, US customs will then be on guard for counterfeits of your products coming into the US.

It also helps to go visit with China Customs and with US Customs (particularly at the ports where your products are most likely to transit) to show them examples of your legitimate products and to do what you can to train them to spot counterfeits of your products.

3.  Monitor, monitor, and monitor some more.  Check the internet constantly to see if anyone is selling counterfeit versions of your product.  At minimum, check both the Chinese language and the English language internet.  When we do this sort of monitoring for our clients, we invariably find the really big volume sellers on the Chinese internet.  Search the internet for counterfeits of your product both by name and by image.

4.  Do something to stop counterfeiters once found.  When we find someone on the internet selling counterfeit versions of our clients’ products, we typically send the seller a cease and desist letter.  If, as is usually the case, the seller is based in China, we send that letter in both Chinese and in English. We make clear that if the seller of the counterfeit goods does not immediately cease, we will retain a local Chinese law firm (which we usually name in the letter) to pursue litigation.  These letters usually work. In fact, many times, the seller will profess not to have known that they were selling counterfeit goods (and in some cases I have believed them) and they will often ask whether they can buy the real thing at wholesale for retail resale.

In most instances, the counterfeit goods are being sold on some sort of marketplace site such as eBay or Amazon or Alibaba or Taobao, or — in many cases — some lesser known Chinese online marketplace. The bigger name marketplaces (American and Chinese) have procedures for securing the removal of counterfeit goods from their sites.  The Chinese sites remove the counterfeits only if you can prove you have a Chinese trademark and the American sites generally require proof of an American trademark.

If the above actions do not achieve your desired results, you need to consider suing somebody somewhere to stop the counterfeiting.

What do you think?

For years I have been fighting against those who claim Chinese laws are gray. China’s business laws are generally as well written or as clear as any other country’s. My contention has always been that those who claim China’s laws are grey are usually just saying that to excuse their own failure to abide by them.

I wrote on this way back in 2007, in the post, “China Company Formation Law Is Clear — WFOEs Are Easy,” where I talked of how the so-called lack of clarity in China’s laws on forming companies arises from those who have not actually read them or from those who benefit from propagating this idea:

We recently took on three new WFOE formation matters for U.S. lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given. They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China’s WFOE laws were “vague” and/or “ever changing.”

What these company formation firms are saying is just not true.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese lawyer in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China’s laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for “ever changing,” on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these lawyers seeking information on forming a China WFOE is the minimum registered capital requirement.

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

I wrote on this again in 2009, in a post entitled, “China’s Business Laws. Ignore Them At Your Peril.” In that post, I reiterated that China’s business laws are just fine:

But what about the grey areas in China’s laws? China’s laws are simply not that grey. They were grey five years ago, but their business laws are now, for the most part, pretty clear, particularly as they apply to issues important to foreigners.

I really do not see much more gray in China’s business laws than in those in the US.

In the post, “Rationalizing Risk: Phantom Gray Areas in Chinese Law,” China lawyer Stan Abrams seems to concur. Stan’s post is on VIEs and he gets all nicely worked up by those who attribute the problems that arise from them to gray areas in China’s laws. Stan starts out by talking of how the media (and others) have been chalking up Yahoo’s problems with Alibaba to “gray areas in Chinese law” and Stan ain’t buying it:

It sounds comforting, but I think it’s a rationalization employed by those responsible for making risky moves in the first place. When the Board of Directors is staring you down and asking “How the f#@% did this happen?” you tend to shift the blame elsewhere.

Bloomberg ran an article on the Yahoo/Alibaba case, written by Debra Mao in Hong Kong, in which the dispute was explained away, for the most part, as the result of uncertainty due to legal gray areas. (The title of the piece was “Yahoo’s Alibaba Spinoff Losses Show Dangers of China’s Legal Gray Areas.”)

For my take on Yahoo/Alibaba/Alipay, check out “Yahoo/Alibaba/Alipay/Jack Ma/Carol Bratz: What Really Happened And What It All Means.

Stan goes on to extoll a quote from Pillsbury Winthrop’s Tom Shoesmith:

Western businesses come into China and they want to know what the rules are, Shoesmith said. There’s the technically correct answer, there’s the practical answer, and then the third one is, “Who cares anyway?” Sometimes the answer is “Who cares anyway?” until you get busted.

Stan sees Shoesmith as saying “that his clients sometimes flaunt risk entirely, hoping that they won’t get caught. This isn’t about whether the system here is transparent, or unclear, or if gray areas exist. This is about understanding risk and plowing ahead anyway.”

I 100% agree. Just as my firm always makes very clear in writing the fact that VIE structures are inherently risky and are of questionable legality in China, I am quite certain that every other legitimate law firm does the exact same thing. That being the case, no company can claim that it had no idea of the potential problems with VIEs and no company that does a VIE structure in China can claim a “gray area” excuse. Or as Stan puts it, gray areas in Chinese law “does not explain Yahoo/Alibaba, and it doesn’t mesh with what Shoesmith was saying.”

And lest anyone out there think that the VIE structures are gray, Stan emphatically tells us that they are not; at minimum, they clearly go against the spirit of Chinese law:

Remember the fundamental problem with the so-called “Sina Structure” or “VIE” that I’ve talked so much about recently? If you recall, the government restricts foreign companies from investing in certain industries, yet some of those sectors are so attractive that foreign investors will pretty much do anything to get in anyway.

So what happens? An elaborate structure is cobbled together that includes offshore holding companies, onshore subsidiaries, and a series of exclusive commercial agreements. This is done to approximate, as much as possible, a direct investment.

Here’s the crux of the matter. Is this kind of structure an example of a legal gray area under Chinese law? News Flash: this isn’t a gray area at all; it’s obviously improper, designed to circumvent Chinese foreign investment law.

Yeah, I really said that. It’s rather obvious. All those folks out there, including many of the top Internet firms in China that received foreign money, who set things up to skirt legal restrictions, are violating the spirit of the law.

Stan then points out that the real issue with VIEs is not their legality, it is simply whether the Chinese government will continue to look the other way and allow them to continue:

To be clear, I’m not suggesting that legal uncertainty doesn’t exist. Indeed, when I counsel these guys, the discussion is not “Hey, you know you’re violating the spirit of the law?” They already know that. What they really want to know is the likelihood that: a) their structures will be enforceable, and b) will the government swoop down on them at some point and force them to restructure (e.g. Yahoo/Alibaba).

So yes, there is uncertainty here with respect to enforcement of these structures and their related commercial agreements. Moreover, the authorities here are aware of these “spirit of the law” violations and generally allow them to exist (at least until they decide otherwise).

That’s a far cry, however, from suggesting that the structures themselves occupy a gray area under Chinese law. They don’t. That’s wishful thinking and a rationalization.

But I understand what’s going on here, at least psychologically. If there is a gray area, then the investor and his lawyer are off the hook, at least to a certain extent. Instead of telling the Board of Directors “I knew it was illegal, but since everyone is doing it, we decided to go for it and hope for the best,” a more respectable “The legality of the structure is unclear, so we moved forward as carefully as possible” can be used instead.

So true.

In fact, I am going to go a step further and say that the Chinese government generally does not crack down on foreign companies unless their violations of Chinese law are clear. So the next time a foreign company claims its Chinese legal problems were due to “gray areas” at least make them explain the law being discussed.

I also like Law Professor Donald Clarke’s post, “Phantom gray areas in Chinese law.” Professor Clarke also notes how “gray areas” are used as an excuse for contravening what was actually quite clear:

I want to recommend this post from China Hearsay on what the author (Stan Abrams) calls “phantom gray areas” in Chinese law. These are areas where the law really isn’t uncertain at all, but people for various reasons like to pretend it is. Sometimes it’s just because they don’t like the rule; sometimes it’s so that they can blame unpredictable government policy instead of themselves when things go wrong. Stan’s example is that of the use of contractually-based Variable Interest Entities to attempt to get around Chinese restrictions on foreign ownership in various industries.

One favorite area of mine is the uncertainty I often heard alleged about what would happen to long-term land-use rights under the Urban Real Estate Administration Law when their term expired. (This is before the Property Law injected real uncertainty into the process.) Well, the answer was always quite clear: everything goes back to the state, including all buildings on the land, without any further compensation. But holders of LURs didn’t like this result – they would conjure up pictures of granny being thrown out onto the street as year 70 expired. (As if the LUR holder hadn’t had a full 70 years’ advance notice that this was going to happen!)

Where’s the gray?

What do you think?

I have been doing a lot of consulting lately for investment professionals concerned about the issues recently raised by Muddy Waters LLC about Sino-Forest and other Chinese companies listed on North American stock exchanges through reverse mergers. I have found that most of these investment professionals are confused about what is going on with Chinese companies listed on foreign stock exchanges and their confusion is causing them to improperly evaluate the true risks of investing in Chinese companies.

The fact is that there are risks concerning every Chinese company that lists outside of China. China is a developing country based on socialist market principles that are unclear even to the Chinese. It is a certainty that even the best managed and most profitable Chinese company will not be managed and operated in a manner that would be typical of a well-managed U.S., Canadian or Western European company. This is going to be true of pretty much any company from the developing world. However, it is also important to account for major distinctions concerning Chinese companies that have listed outside China.

There are basically three kinds of companies that list their shares outside China:

The first group is made up of well established Chinese companies that form the heart of the Chinese industrial and service economy. These companies are typically state owned enterprises already listed within China on the Shanghai and Shenzhen stock exchanges. Examples of such companies that have listed on the New York Stock Exchange are:

  • Aluminum Corporation of China Ltd
  • China Eastern Airlines Corporation Limited
  • China Life Insurance Company Limited
  • China Mobile (Hong Kong) Limited
  • China Netcom Group Corporation (Hong Kong) Limited
  • China Petroleum and Chemical Corporation
  • China Southern Airlines Company Limited
  • China Telecom Corporation Limited
  • China Unicom
  • Guangshen Railway Company Limited
  • Huaneng Power International Incorporated
  • Jilin Chemical Industrial Company Limited
  • Petro China Company Limited
  • Semiconductor Manufacturing International Corporation
  • Sinopec Shanghai Petrochemical Company Limited
  • Suntech Power Holdings Company Limited
  • Yanzhou Coal Mining Company Limited (ACH)

It makes sense to ask whether or not these companies are actually profitable. It may also make sense to ask whether these companies are working on behalf of their investors, both Chinese and foreign. However, it is absurd to even consider whether these are “real” companies, with real assets, real operations and real cash flow.

The same is true of many other lesser known privately held Chinese companies that have listed in the United States. Whatever an investor may think about how they run their business, there is no question that they are in business and are working actively to make money for someone.

The next group are typified by companies that operate in China under unique structures such as the VIE (variable interest entity) structure that is common in the Internet sector. Many people are surprised to learn that Alibaba, Baidu, Sina, Tudou and other foreign listed Internet companies do not actually have any direct Internet operations in China. This is because, as foreign companies, they are not permitted to operate directly in China’s Internet sector. They therefore operate through Chinese companies that they create and then “control” through elaborate contractual arrangements. Though one can certainly raise many questions about the security of these contractual relationships in terms of calculating the real worth of these companies, there is no question about whether or not these are “real” companies. Alibaba and Baidu and their related companies dominate the Internet sector in China and operate vast numbers of businesses. Since they operate on the Internet, these businesses are relatively easy to monitor to determine whether or not they really exist. In addition, in their public filings in the U.S. and Hong Kong, these companies clearly describe every detail about the structure of their business and clearly state the possible risks arising from their unusual business structures. This means that while the VIE approach to doing business in China raises unusual risks, it would be difficult to claim that their structures are not well described and that their risks have not been exposed. More importantly, one cannot say that their business structures are designed to conceal a business that does not really exist or that operates on a scale far small than reported.

Muddy Waters and its followers are not claiming that their target companies fall into either of the above two categories. Muddy Waters states quite clearly that it believes that Sino-Forest and others are absolute frauds. The claim is that these companies have used complex structures and claims about the unique nature of doing business in China to hide the fact that they are complete frauds. The claim is that they are not doing any real business in China at all. The claim is that they have no income, no employees, no factories, no nothing. They are empty shells, created to take money from naive foreign investors.

I do not know whether these claims are true and I am not personally aware of any proof that any of the Chinese companies listed in the U.S. and Canada are complete frauds. I have found, however, that many investment professionals are confused about the accusations against Sino-Forest and others. In an attempt to make a case that they have not been completely duped by the fraudsters, the investment community seems to want to argue that Sino-Forest and others should be treated as though they were members of the two groups of companies I describe above. In this way, they can excuse their analysis by claiming that the company practices of Sino-Forest and its ilk can be “excused” by the unique characteristics of the Chinese business environment and regulatory system.

This position is a mistake. The claim against Sino-Forest is not that it has a complex business structure required for doing business in the Chinese market in wood products. The claim is that Sino-Forest has used this argument as a smoke screen for creating a company that is a complete fraud. The claim is that Sino-Forest owns little or nothing in China. The claim is that Sino-Forest has earned little or nothing in China and has no prospects for any real earnings in the future. This has nothing to do with the nature of the Chinese system. The claim is a simple assertion that Sino-Forest is a hollow shell and a fraud.

I do not know whether this claim against Sino-Forest and other Chinese companies that have listed as reverse mergers is true or false. However, this claim is quite different from the concerns that can be raised against Chinese companies that come within the two categories I enumerate above and two mistakes arise from this confusion.

First, legitimate companies under the first two categories are unfairly questioned and their stock is unfairly attacked. I am not contending that their stock is properly valued. However, the accusations against Sino- Forest and others should have no bearing on evaluating the business of these companies.

Second, Sino-Forest and others are given too much credit because investors assume they must be using legitimate business practices that are employed by the legitimate companies that fall into the first two categories.  Many people who have discussed the Sino Forest matter with me assert that Sino-Forest must be using a VIE structure. They argue that since Alibaba and others use a VIE structure, the Sino-Forest system must be acceptable. Though I do not understand Sino-Forest’s so-called “authorized intermediary” structure, I can say for sure that it is not a VIE structure. Therefore, Sino-Forest should not be assumed to be engaging in an unusual and risk but otherwise well known business practice. This is just an example of wishful thinking common in the investment community.

What do you think?

The media has been doing a thorough job of covering the Yahoo/Alibaba/Alipay so I am only going to summarize the situation in the briefest terms. Yahoo (along with Softbank) owns a large portion of Alibaba, which in turn, owned Alipay. Alipay is in the online payment business, which, according to Chinese law, means it cannot be foreign owned. A few weeks ago, Yahoo alleges it just recently learned that Alibaba had transferred ownership of Alipay to a fully domestic Chinese entity. Alibaba is saying it did that so as to bring Alipay in line with the laws prohibiting foreign ownership of an online payment company.

Financial advisory services and investment banks frequently call me when something like the above story breaks. Typically, they are calling because they want to know what to advice their own clients (usually either investors or investment firms). In most cases, I spend 1-2 hours reading the news regarding the latest story on which I am to opine and then I draft up a quick analysis and then we talk.

This Yahoo/Alibaba/Alipay story was different. I spent nearly a full day reading just about every story on it (this was a few weeks ago so it is possible something has changed since then, but my quick perusal of the news today did not turn up anything) and even then I still felt that I was lacking sufficient facts. Nonetheless, I went ahead and answered a bunch of questions from various Wall Street firms, consisting mostly of the following:

  1. Was what Alibaba/Alipay did ilegal?
  2. What can Yahoo do about it?
  3. Why did Alibaba/Alipay do what it did?
  4. Is it possible Yahoo really did not know about it until just recently?
  5. What is the Chinese government going to do?
  6. Is this sort of thing unprecedented?
  7. Will this lead to a decline in foreign investment into China?
  8. Are we going to hear more stories like this in the future?

Here again are the questions, this time with answers to the best of my ability:

Was what Alibaba/Alipay did legal?  I do not know and I cannot answer that without having access to Alibaba’s and/or Alipay’s corporate documents. China does not protect minority shareholders nearly to the same extent as the United States. Alibaba’s or Alipay’s corporate documents may very well have given a small group within the company authority to do exactly what was done here. I have not seen anyone from Yahoo claim what happened was illegal, which makes me think that it may have been perfectly legal. In other words, it is quite possible that Alibaba/Alipay had every legal right to do what they did.

At which point, the advisers asked me if it was possible that Yahoo would have agreed to such a  corporate structure and I responded by saying that was possible and I had in fact been involved in many cases where foreign companies had, usually without knowing, put themselves in similar situations.

What can Yahoo do about it? I do not know as it so much depends on whether Alibaba/Alipay acted legally or not. Yahoo has essentially three options: legal, economic, and political. I do not know what sort of strength they have in any of these three arenas vis a vis Alibaba/Alipay. I do not even know in what forum it would be best to fight on any of these fronts (United States, Mainland China, Hong Kong, British Virgin Islands?).

Why did Alibaba/Alipay do what it did? Do what? Make the ownership transfer or do it allegedly without telling Yahoo?  I think what Alibaba/Alipay is saying about the need to make the transfer makes sense, legally. I do not know why it appears not to have kept Yahoo more in the loop.

At which point, many of the advisers told me that they had heard that when Yahoo’s new CEO, Carol Bratz, came on board, she tried to rein Jack Ma in and did so in a way that caused him to lose face. The word on the street is that this is payback for that.

What will the Chinese government do? This whole thing is pretty public and if in the end it makes it seem as though Chinese companies can just go off and seize assets that belong to foreign companies (whether this is what happened or not), it will not be good for China business. Therefore, I am guessing that the Chinese government wants this matter resolved and resolved “somewhat fairly” and is probably operating behind (or in front of) the scenes to try to accomplish that.

Is this sort of thing unprecedented? Not at all. My tiny law firm has been involved in probably a dozen similar matters. The only difference here is that we are dealing with extremely well-known companies. This sort of thing goes on all the time with small and mid-sized companies and nearly every time it is due to a fault in the initial structure of the business. The Chinese company took advantage of the legal ignorance of the foreign company and set things up so that it would eventually be able to shut the foreign company out, purely legally. Is this what happened to Yahoo? I do not know.

Will this lead to a decline in foreign investment into China? To a large extent it will depend on how it is finally resolved. But probably not.

Are we going to hear more stories like this in the future? Yes.

What do you think?

 

Clients sometimes ask me whether they should be using Global Sources or Alibaba as a first cut for finding China suppliers. My response is always that I do not know, but that “I hear better things about Global Sources.” Asia Business Media just did a post, entitled, “Alibaba and Global Sources: Competing less and less,” explaining differences between Alibaba and Global Sources.

The post does this explaining by analyzing who the two companies seem to be targeting for their online supplier directories:

If we make some rough, back of the envelope calculations: Global Sources posted US$94 million in online revenues. If we estimate that the average supplier paid RMB 40,000 (US$6,000) in 2010 to post its products online. That results in approximately 15,700 paid suppliers on the Global Sources.com platform.

Alibaba.com had nearly 810,000 paid suppliers in 2010 – but that figure includes suppliers on both the International and the China platform. If we just look at the International platform, Alibaba.com, there were almost 132,000 paid suppliers.

Even if there were perfect overlap, which there is not, that would mean that just 12% of Alibaba.com’s suppliers were also on Global Sources.

Alibaba.com reports that there were 132,000 paid suppliers on its International website which generated revenues of US$494 million. That results in an average of US$3,740 (RMB 24,500) per supplier.

So Alibaba.com has 132,000 suppliers paying RMB 24,500. Global Sources.com has 16,000 paying RMB 40,000. In all likelihood, these two companies are not going after the same suppliers.

Alibaba is trying to build an SME ecosystem through its subsidiaries Alibaba.com, Alipay.com, Taobao.com, AliExpress and AliLoan. Global Sources is targeting larger, more established exporters who are interested in its multi-media platform (exhibitions, online, print, private buyer events).

With each passing quarter, it is clear that these two companies are not exactly knocking on the same doors across China.

What do you think? Alibaba v. Global Sources. Who do you use? When and why?

More than three years ago, I did a post, entitled, “I Hate Alibaba (The Website, Not The Company),” voicing my concerns with foreign companies thinking that they were safe sourcing through Alibaba. My concern at that time stemmed from the fact that many of the calls my office was getting regarding really bad or never delivered product were coming from people who had sourced through Alibaba.

Just back from China (Hong Kong, actually), where I saw a television interview with Jack Ma of Alibaba. He never fails to impress the hell out of me and every time I see him my first thought is BUY.

But then I think about all the harm Alibaba has caused to so many Western SMEs and I change my mind about calling my broker/brother. Alibaba makes the naive think China sourcing is easy. I realize blaming Alibaba for the mistakes companies make in using its site is really not fair to Alibaba, but at the same time, I do not see much use for the site beyond its serving as a really good directory of potential manufacturers of particular products.

Sourcing from China is not easy and my concern with Alibaba is how so many who use it start to think it is easy and then they fail to take precautions and then they call my firm because they are out hundreds of thousands (more or less) of dollars. Seems it is even worse than I thought.

Now we learn from Time Magazine that not just some of the companies that list on Alibaba are fraudulent, but that Alibaba engaged in fraud as well:

An internal investigation by independent board member Savio Kwan revealed that beginning in late 2009, Alibaba had noticed an increase in fraud claims against sellers designated as “gold suppliers,” which means they had been vetted by an independent party as legitimate merchants. The investigation revealed that about 100 Alibaba sales people, out of a staff of 5,000, were responsible for letting fraudulent entities evade regular verification measures and establish online storefronts.

The company said it uncovered fraudulent transactions by 1,219 of the “gold suppliers” registered in 2009 and 1,107 of those in 2010, accounting for about 1% of the total number of gold suppliers during those years. It further said that “the vast majority of these storefronts were set up to intentionally defraud global buyers” by advertising consumer electronics at cheap prices with low minimum-order requirements.

Whether you use Alibaba or not, there are certain “rules” you should follow when sourcing from China and those rules include conducting due diligence on your potential supplier, notwithstanding the color of star by their name.

Alibaba. A force for good or for evil? What do you think?

UPDATE: Michael Zakkour of the China Business Blog did a post, entitled, “Alibaba Fraud Case Not Surpising,” [link no longer exists] in which he talks of visisting two grossly inferior factories that looked just great on Alibaba. Makes for some good (and funny) reading.

Just back from China (Hong Kong, actually), where I saw a television interview with Jack Ma of Alibaba. He never fails to impress the hell out of me and every time I see him my first thought is BUY.

But then I think about all the harm Alibaba has caused to so many Western SMEs and I change my mind about calling my broker/brother. Alibaba makes the naive think China sourcing is easy. I realize blaming Alibaba for the mistakes companies make in using its site is really not fair to Alibaba, but at the same time, I do not see much use for the site beyond its serving as a really good directory of potential manufacturers of particular products.

Turns out I have company.

Paul Midler (who is believed to have coined the term “quality fade” to describe how Chinese manufacturers eventually reduce their product quality), over at his new blog, The China Game [no longer exists], just came out with a post where he questions Alibaba’s value and posits that its usefulness has declined and will continue to do so. The post is entitled, “Irrationally Exuberant: Is Alibaba.com Really Worth US$7.8bn?” and Midler has this to say about Alibaba’s value to product buyers:

Alibaba.com is a website that provides information on China manufacturers (Yahoo! owns a 39% stake). The website serves as a kind of directory. Consider it a Yellow Page for prospective importers. Those who say that website is a great business model emphasize the company’s first-mover advantage. Many also get excited about this being a “B2B play” — the phrase is so “2000,” but never mind that part. My lack of enthusiasm for the IPO has more to do with many uninspired experiences with the company’s website. To be frank, I just don’t get it. Aren’t the best China supplier relationships those where the supplier and buyer are known to each other, where the two have an on-going work relationship? Established players have little use for the website after the relationship is in play, and it’s hard to imagine that, for example, Mattel, ever used Alibaba.com (its supplier relationships predate the Internet).

Midler goes on to say that though Alibaba has some value to fledgling Chinese factories looking for buyers, this is a consolidating market:

If the website has any value at all, it’s in enabling fledgling factories to find would-be buyers. If you believe there is value in such a proposition, let’s reference all of those financial analysts reports that suggest the industry is rapidly consolidating. It would be one thing if factories were like single people — dating websites enjoy a steady stream of new single customers — but manufacturing is not the same. In the long run (or sooner?), all capable manufacturers are known to the market. The website works best in a world with murky market data. We are heading away from that world, not towards it. There are already websites that allow companies to list information for free and Chinese are using these sites with greater frequency.

Despite all this, Midler has “no doubt” Alibaba’s upcoming “IPO will come out strong” because it involves both China and the internet. Throw in a few more Jack Ma TV interviews and it seems Alibaba’s stock will be unstoppable. In the short term anyway.