All one problem really

Four problems that irritate Amazon, but threaten Alibaba’s existence

May 7, 2014
May 7, 2014

Included in Alibaba’s highly anticipated IPO filing was a reminder that despite the benefits and wealth it has reaped from China’s massive population, being a Chinese corporate giant—particularly one based on the internet—isn’t a walk in the park.

In its filing, Alibaba reminded investors of some of the unique issues it faces. These are challenges that any company operating in China has to deal with, but since Alibaba gets nearly all of its revenue from China, and likely will for some time to come, they present several major threats.

The government owns all the pipes

Alibaba is obviously very dependent on the internet infrastructure in China. That means relying on the government.

From the filing:

Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology of China. In addition, the national networks in China are connected to the Internet through state-owned international gateways, which are the only channels through which a domestic user can connect to the Internet outside of China. We may not have access to alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure.

Beyond that lack of alternatives, accessing enough reliable bandwidth could be a problem, and it’s hard to tell how much the company might have to pay for that access in the future.

Censorship is a minefield for a huge online marketplace

As Western companies have found out, there are substantial restrictions on content in China, which can sometimes lead to overzealous self-censorship. And the sheer size of Alibaba’s market and user base means that it has a big job when it comes to implementing these restrictions.

The company has to monitor its website for items or content that is deemed to be “socially destabilizing, obscene, superstitious or defamatory, as well as items, content or services that are illegal to sell online or otherwise,” and promptly take appropriate action.

The company may be liable for the unlawful actions of customers or users, and it’s not always easy to tell what might bring down the hammer.

Getting around restrictions on foreign investment can lead to other problems

China has a variety of restrictions on foreign ownership of businesses: for example, foreign investors can’t generally own more half of the equity in a value-added domestic telecom. Because Alibaba gets most of its revenue from wholly foreign-owned businesses, and is going public in the US, it faces the tricky task of keeping certain sectors of its business under Chinese control.

To do this, it has a variety of complicated investment vehicles called “variable interest entities.” These allow it to to get around that law and accept money from foreign investors for businesses while Chinese citizens (often Chairman Jack Ma) hold nominal ownership. Alibaba maintains effective control through contractual arrangements.

The practice is common in China, but could lead to several problems: China could change the law governing these investments; there could be conflicts of interest with the Chinese individuals who directly control the entities; the companies involved could breach contracts and shared control arrangements; or there could be tax consequences.

The law can be… flexible

The Chinese legal system still remains very much a work in progress. There’s a lot more wiggle room and unpredictability than in much of the rest of the world, as the IPO filing describes:

Recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be subject to significant degrees of interpretation by PRC regulatory agencies. In particular, because these laws, rules and regulations are relatively new, and because of the limited number of published decisions and the nonbinding nature of such decisions, and because the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and enforcement of these laws, rules and regulations involve uncertainties and can be inconsistent and unpredictable.

And, the filing notes, the government is maddeningly opaque, leaving companies in the dark about what laws they must follow.

In addition, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and which may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation.

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