Amazon Vs. Alibaba: Game On

| About:, Inc. (AMZN)

Hello dear cherubs, I'm getting worked up again, this time over the prospects for an Amazon (NASDAQ:AMZN) and Alibaba competitive clash. The first shot across the bow: Alibaba's $206 million investment in ShopRunner, an American-based online retailer. On its own, ShopRunner was irrelevant. But in the arms of Alibaba, it's suddenly interesting. Later in this column, I'll tell you the Amazon weakness that Jack Ma has targeted for attack (he's attacked competitors with similar weakness in China and elsewhere).

First, a bit more on Alibaba, which I'm sure you've heard of by now - it's about 3x as big as Amazon, sort of a blend of Amazon and eBay (NASDAQ:EBAY) in China, with a pinch of Google (NASDAQ:GOOG), and it's growing leaps and bounds. Maybe 60% top line growth? (We'll find out when they IPO in 2014.)

Alibaba dominates China. Amazon dominates North America. Obviously they're going to meet head on in territories outside their respective bases. Alibaba has certain competitive advantages, no doubt about it, beginning with scale. When you're three times bigger, you've got cost efficiencies. And it's growing faster: in China, physical stores are not as abundant. It's why McKinsey says online retail is growing faster in China, its "leapfrogging" traditional retail development.

Alibaba also has the government behind them. China wants to shift its economy toward consumerism (less reliance on manufacturing), and Alibaba is the chosen vehicle, accounting for about 70% of all e-commerce in China. It's one of the crown jewels of China, and now that's the #1 online retailer in the world, the attitude is sort of like, is there anything we can do to help? (Alibaba squabbles with the Hong Kong exchange are likely to be set aside; it's hard to imagine the top company in China listed in the USA, but we'll see.)

Online retail in North America and China may be locked down, but the rest of the world is up for grabs. Don't make the mistake of underestimating Jack Ma (age 49), even if he's officially retired from the CEO position of Alibaba. He's still the driving force; unless a third player emerges, it may come down to a Jack Ma v. Jeff Bezos contest for world supremacy in online retail.

Jack Ma v. Jeff Bezos?

Even though Amazon is the number two player globally in online retail - and the gap (yikes) is widening - the company is not lacking in assets. After all, it has Jeff Bezos. He's the central figure of the book I reviewed, The Everything Store. I'll share the review with you, then I'll tell you why Amazon may have to disrupt itself in response to the Alibaba threat:

Well, then. This was not the book I expected. (Disclosure: I'm a professional money manager and I own shares of Amazon.)

I'd put off reading this book because Jeff Bezos said it was too early to write Amazon's history and I agreed. There was MacKenzie Bezos one-star review, as well as Andy Jassy's; both insiders with a front-row seat, their opinions had to be respected.

But now that I've read it: This might be the best business book of the year; certainly a must-read for anyone wanting to learn about business. Jeff Stone provides source material for professors, enough to fill a semester-long course. Interesting characters fill the book, such as the Riggio Brothers (Barnes & Noble founders), who, all by themselves, cover just about every conceivable way of "How NOT to Respond to a Competitive Threat."

The setting: it's 1995 in a Seattle restaurant (p. 56), still early days for the Internet, and the Riggio brothers sit down for dinner with Bezos and an associate. CEO Len Riggio is described in the book as a "tough-as-nails Bronx-born businessman." The problem: He didn't take Amazon seriously, even though the threat should've been obvious to CEO Riggio, given the cost advantage of an Internet model (no need to build, staff and inventory hundreds of stores).

Riggio's game plan going into the meeting - threaten like a bully, then offer to collaborate - is standard stuff. He told Bezos he would "crush Amazon" once Barnes & Noble launched its website. Then he offered to work together. Later in the book, Len Riggio completes his clown imitation by dismissing e-books (such as the Kindle), saying the market was "small," and this classic: "when the market is there, we'll be there." (p. 254) Denial, anchoring, confirmation bias, it's all here.

Book lovers, you'll enjoy the behind-the-scenes look at the birth of AWS (Amazon Web Services). I'll tell you how Bezos did it, but for context, let me tell you what the market looks like today: AWS completely dominates computing infrastructure, an end market that will eventually be measured in the trillions. AWS is 5 times bigger than the next 14 competitors combined.

Stone's book reveals this: AWS was created from scratch ten years ago based on ideas Bezos obtained from a couple of books! Google, Microsoft, and IBM were much better positioned to capture the infrastructure-as-a-service vertical, it was there for the taking. But here's Bezos, driven by principles articulated in Clayton Christensen's superb series of books on disruption, tying it to a book by video game developer Steve Grand (p. 211). As Stone reported: "Grand wrote that his approach to creating intelligent life was to focus on designing simple computational building blocks, called primitives."

Bezos took the building block idea and extended it, insisting to his engineers: "This has to scale to infinity with no planned downtime. Infinity!"

In the much ballyhooed confrontation between IBM and AWS for the CIA contract, now part of the public record because IBM sued to block it (and lost), the Judge made it clear - even though IBM had the lower priced-bid - AWS was vastly superior in auto-scaling. Their scaling technology (which is key to their dominance), now we know, is traceable to a book by a video game developer.

Mrs. Bezos one-star rating makes sense in context. Bezos could've come off as more personable in this book (and I'm sure he is), but I'm not sure the world needs a Jeff Bezos Admiration Society just yet. The game isn't over yet, for one thing. On a global basis, Amazon is a distant number two to Alibaba, and a competitive clash is certain to occur.

I don't know, I sort of like Bezos in the feisty, underdog role. Game on.

Handicapping the Amazon versus Alibaba battle:

There are competitive battles between these two titans looming in two different verticals. I have one side favored in each:

Amazon Web Services and Alibaba's copycat equivalent (they were smart to copy it) are in the top of the first inning in a multi-trillion dollar game (computing infrastructure). Most of computing will be centralized eventually, it's inefficient to pack desktops and tablets with all that excess, unused computing power when it can be centralized (like electricity).

By the way, the cloud simply means centralized (versus discrete); the way this vertical works, it's pretty much a winner-take-all. The early lead is huge for AWS (nobody else is close); why bet any other way?

On the other hand, I have to confess, I like the cleverly-designed Alibaba retail model better than Amazon's. We'll learn more when they IPO, but from what I can see, they extract about 4.5% of each dollar transacted and they do it on the back end, via fees, including Google-like revenue generated from ads. The reason Taobao and Tmall have swept to prominence in China is because Jack Ma made the upfront cost of commerce in China effectively zero. Zero is tough to beat.

To understand Amazon's vulnerability, refer to Jeff Stone's book. Bezos copied much of the Costco (NASDAQ:COST) markup model and applied it to Amazon, including auto-rebate of scale economies (which I discuss in more detail here). Costco's 12-15% markups are the lowest in physical retail (Wal-Mart markups are 34%). Surprise, surprise, what amounts to an impenetrable moat in physical retail (Costco is untouchable) is subject to disruption online.

Amazon Marketplace is a rich revenue stream (about $10 billion in commissions this year, net of shipping), but I suspect those 12% commissions will be disrupted soon. Bezos is known for taking the lead on things like this, so don't be surprised if Amazon Marketplace unilaterally lowers fees, and soon. It has to, in my view, to protect the moat. If not, here comes Alibaba…

(Amazon was one of my picks for 2013, check the record here.)

Disclosure: I am long AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.