Business Lessons from Jack Ma- Alibaba and the 40 SaaS

Jack Ma is the founder and executive chairman of Alibaba. The Wall Street Journal describes Alibaba as: “a marketplace, a search engine and a bank, all in one.” Wikipedia’s description is longer: “Alibaba is a Chinese multinational e-commerce, retail, Internet, AI and technology conglomerate founded in 1999 that provides consumer-to-consumer, business-to-consumer and business-to-business sales services via web portals, as well as electronic payment services.”

As is customary on this blog, the quotes from Ma are in bold text:

“Every empire will be toppled someday, but an ecosystem is sustainable.”

The network effects generated by an ecosystem (e.g., a platform) can be very strong, which makes creation of such systems an attractive goal for entrepreneurs and investors. Unfortunately, an economy can enable only so many platforms as big as Alibaba, Amazon or Facebook at any given time since there are limits on how much revenue can collectively flow through these ecosystems. In other words, a business which generates as much revenue and profit as a company like Google appears only a few times in a decade due to fundamental top-down constraints that exist in an economy.

A platform business like Facebook scores highly when certain key attributes are evaluated, including key elements of the unit economics equation. For example, Facebook has:

low recurring COGS;
low CAC due to high virality and cross selling to the existing customer base;
a sticky product due to network effects;
attractive revenue from clear product/market fit; and
a huge addressable market.

Few platform businesses are as attractive as Facebook and every business ecosystem is unique. This means that some platforms are very profitable and some are not. In order to help people understand how to better compare the strengths and weaknesses of various platforms I have created this matrix below.

Understanding these attributes is important because as Warren Buffet says: When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Facebook arguably sets the standard for sustainable profitability since it is attractive in terms of so many important business attributes.

How would you complete the boxes in my matrix the case of Alibaba?

2. “I am just lucky to do the right things at the right time. We are just the lucky ones in this time. Like all successful people, we are not more capable or energetic.”

The story of how Ma was introduced to the internet represents an interesting example of the role that luck plays in determining outcomes in life. Part of Ma’s success can be traced to a series of events that happened in 1995. Geekwire tells the story in this way:

“Ma tried the Internet in Seattle in a building called U.S. Bank. His friend encouraged him to try searching the Internet for the first time. Initially, he hesitated since he knew that computers were expensive, and if he broke it, he wouldn’t be able to afford to replace it. ‘He said ‘just search it,’ so I searched the first word ‘beer,’ Ma said. ‘I don’t know why, but maybe because it was easy to spell? I see beers from Germany, U.S.A. and Japan, but I don’t see any from China, so I searched for the second word ‘China,’ and there was nothing.’ So, he recalls that they made a small, ‘ugly-looking” page, and three hours after launching it, I got a phone call from my friend who said, ‘Jack, you have five emails, and I said ‘What is email?’” Based on the number of responses, he said, ‘This is something interesting, so we should do it.’”

An article in Science describes the relationship between luck and skill:

“Although success is likely determined to some extent by intrinsic factors such as quality or skill, it also likely depends to some (potentially large) extent on extrinsic factors such as luck and cumulative advantage. Depending on the balance between these two sets of factors, any explanation for why a particular person, product, or idea succeeded when other similar entities did not will be limited, not because we lack the appropriate model of success, but rather because success itself is in part random.”

Skill clearly played a role in what Ma accomplished in addition to luck. What sort of skills were important? Discussion that question fully would require a couple of blog posts. But it can be said one skill in this case was Ma’s ability to spot and act on the new business opportunity he saw emerging. He recognized the optionality associated with the new business and aggressively acted to capitalize on that opportunity. Most people would not have seen the potential of the new business or acted to profit from it even if they did. Ma also has a range of skill that enabled him to build the business. For example, Ma has said about himself:

“At first, I knew nothing about technology. I knew nothing about management. But the thing is, you don’t have to know a lot of things. You have to find the people who are smarter than you are. For so many years, I always tried to find the people smarter than I and when you find so many smart people, my job is to make sure the smart people can work together.” “There’s an examination for young people to go to university. I failed it three times. I failed a lot. So I applied to 30 different jobs and got rejected. I went for a job with the police; they said, ‘You’re no good.’ I even went to KFC when it came to my city. Twenty-four people went for the job. Twenty-three were accepted.”

My go to resource on all questions related to skill and luck is Michael Mauboussin:

“One of the ways I like to think about this is as a continuum of activities from pure luck and no skill on one end to pure skill and no luck on the other end. Obviously, most things reside somewhere between the extremes, and where an activity sits can be very important…. Not surprisingly, when you look out into the world, whether it’s business, investing or your favorite sports team, both skill and luck are contributing. The real question is, in what proportion?”

What Ma created at Alibaba is clearly a positive outlier which is part of a power law distribution of success. In a February 2018 paper Michael Golosovsky writes: “Power-law distributions were brought to attention of scientific community about a century ago and they made sharp contrast with previously known Gaussians. The intriguing question arose- what is the generative mechanism of these weird distributions…theoretical studies indicate that the preferential attachment mechanism is plausibly robust. Namely, it generates complex networks with the power law degree distribution.” Understanding a power law phenomenon would be simple if power laws had a single simple explanation. Unfortunately, there are many models that generate power laws that may or may not be accurate reflections of any real process in the world. Proving that any given factor or a combination of factors generated the power law distribution of outcomes is often impossible to specify with certainty.

When Golosovsky substantial research using a model based on “fitness” he found:

“Surprisingly, the two opposing assumptions underlying network growth- all nodes are born equal or different result in the same growth equation.” With respect to the power-law degree distribution in complex networks: the preferential attachment relates it to the strategy by which the new node attaches to old nodes, while the fitness model implies that this distribution is inherited from the fitness distribution. The fitness model successfully explains the first-mover advantage, degree distribution for the nodes of the same age, different trajectories of the nodes of the same age, etc. However, this model does not account for the nonlinear dynamic growth rule that is observed in some networks”.

Another February 2018 paper entitled “Talent vs Luck: the role of randomness in success and failure” reaches conclusions about the impact of how success compounds on itself:

“…although talent has a Gaussian distribution among agents, the resulting distribution of success/capital after a working life of 40 years, follows a power law which respects the “80-20” Pareto law for the distribution of wealth found in the real world. An important result of the simulations is that the most successful agents are almost never the most talented ones, but those around the average of the Gaussian talent distribution – another stylized fact often reported in the literature. The model shows the importance, very frequently underestimated, of lucky events in determining the final level of individual success. …rewards and resources are usually given to those that have already reached a high level of success, mistakenly considered as a measure of competence/talent.”

My own view on this set of issues is that people who are lucky and more talented acquire more skill as a result of being successful. In other words, it is not just success that compounds, but skill. For example, an actor not only gets more acting roles the more acting roles they get, they get more talented as a result of doing the work. If both luck and fitness “result in the same growth equation” as the Golosovsky argues, then it should be hard to tease the important of two casual factors apart. In fact, it is hard to do so. The other “Talent vs Luck” paper nicely summarizes the views of many people who have written on this topic:

“In recent years many authors, among whom the statistician and risk analyst Nassim Taleb the investment strategist Michael Mauboussin and the economist Robert Frank, have explored in several successful books the relationship between luck and skill in financial trading, business, sports, art, music, literature, science and in many other fields. They reach the conclusion that chance events play a much larger role in life than many people once imagined…. they conclude that talent and efforts are not enough: luck also matters, even if its role is almost always underestimated by successful people. This happens because randomness often plays out in subtle ways, therefore it is easy to construct narratives that portray success as having been inevitable. Taleb calls this tendency “narrative fallacy,” while the sociologist Paul Lazarsfeld adopts the terminology “hindsight bias.” In his recent book “Everything Is Obvious: Once You Know the Answer”, the sociologist and network science pioneer Duncan J. Watts, suggests that both narrative fallacy and hindsight bias operate with particular force when people observe unusually successful outcomes and consider them as the necessary product of hard work and talent, while they mainly emerge from a complex and interwoven sequence of steps, each depending on precedent ones: if any of them had been different, an entire career or life trajectory would almost surely differ too.”

3. “I call Alibaba ‘1,001 mistakes.’ We expanded too fast, and then in the dot-com bubble, we had to have layoffs. By 2002, we had only enough cash to survive for 18 months. We had a lot of free members using our site, and we didn’t know how we’d make money. So we developed a product for China exporters to meet U.S. buyers online. This model saved us.”

Ma is describing the inevitable process that leads to innovation. Every new business tries different approaches many of which fail. The new business is also subjected to the business cycle which can have both negative and positive effects on business outcomes. After some period of time the experimentation process hopefully discovers a business offering that has product/market fit. Most new business never find real product/market fit, which is the biggest single reason why they fail.

Ma is also saying that he did not plan well for the cash needs of the business, which is another aspect of business that he learned the hard way. Ma says about his experience with Alibaba: “My first round [of] money, I gathered from 18 founders — US$50,000. We thought this US$50,000 could last for 10 months. We even counted every cent we spent, but it lasted less than four months and we were almost bankrupt.” The first rule of business is never run out of cash The second rule is: don’t forget the first rule.

4. “Everybody couldn’t find four things at home we could sell because we were too poor. So we gathered 21 products, we listed on the website, we waited for three days, nobody came to buy. For almost 30 days, everything people sold, we bought them. So we have a whole house of rubbish we bought online, trying to make sure that those guys who are able to sell say, ‘Oh wow, this thing really can sell things’.”

Ma is talking about an approach to bootstrapping a startup recommended by people like Paul Graham of YCombinator. Sometimes critical mass must be achieved in non-scalable ways before a business becomes scalable. Graham points out that sometimes doing what does not scale is essential to enabling critical mass: “One of the most common types of advice we give at YCombinator is to do things that don’t scale. In Airbnb’s case, these consisted of going door to door in New York, recruiting new users and helping existing ones improve their listings.”

5. “A new business is like a newborn baby. Other than you, no one else thinks she is beautiful. But she’ll become more beautiful as she grows, and with time and effort, it’ll become great.” “People who do believe in you won’t say anything to support you, but those who don’t will always jump out to say so.”

Ma is saying that anyone starting a business will generate some viewpoints, either silent or overt, that what you are doing is, well, nuts. This is why missionaries start so many more businesses than mercenaries: they don’t care as much what people think. A reality distortion zone can make taking the leap to start the business easier. Many missionaries of course fail after taking an arrow in the back and the magnitude of the unfavorable success rate is hidden by survivor bias. But there is no question that people like Ma do tend to create the really big successes that change the world in a nonlinear way.

6. “When everybody says yes, there’s no chance for you – so be unique. Use your mind, think why you can do better, why you can do different.” “You should learn from your competitor, but never copy. Copy and you die.”

In talking about the importance of being unique Ma in part is talking about a simple idea that people like Andy Rachleff have identified. Rachleff puts it this way: “Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.” Rachleff’s matrix is as follows:

aandy

The other critical factor that uniqueness can potentially deliver is a sustainable competitive advantage (AKA a moat). If a business is not doing something that is more valuable than its competitors that comes from being unique in some way, the probably that it will deliver significant financial returns higher than its opportunity cost of capital drops to zero,

7. “E-commerce was so cold. Nobody believed in it, but we believed in it. We didn’t care what other people said. We thought it had a future, we thought it would help people, so we started.”

To create something valuable you must first start. Taking that first step is hard for many people to actually do. People who are accustomed to big salaries in what seem like a safe business have a hard time actually making the leap or if they do they spend so much money replicating the cushy environment that they left behind, that they fail. Talking about starting a company is easy; actually doing it is hard. If it was easy, then the creation of highly successful businesses would be much more common.

8. “Today is hard. Tomorrow will be worse. But the day after that will be beautiful. Most of your talent won’t make it past tomorrow.”

This comment from Ma reminds me of what Scott Belsky describes as “the messy middle.” Belsky writes:

“In reality, the middle is extraordinarily volatile—a continuous sequence of ups and downs, expansions and contractions. Once the honeymoon period of starting a new journey dissipates, reality hits you. Hard. You’ll feel lost and then you’ll find a new direction; you’ll make progress and then you’ll stumble. Every advance will reveal a new shortcoming. Major upsets will give rise to new realizations that lead to breakthroughs in progress. At best, you’ll move two steps forward, one step back—at worst, you’ll realize you’ve been walking the wrong path entirely for months. This is what that journey actually looks like.”

Belsky has a new book on this topic that will appear soon and I am looking forward to reading it.

9. “A great entrepreneur is optimistic for the future. And you have to ask what problem you can solve, and how you solve it is different from the others.”

The greatest entrepreneurs are optimistic that they can solve a real problem. Daniel Kahneman believes that humans tend to be too optimistic: “Most of us view the world as more benign than it really is, our own attributes as more favorable than they truly are, and the goals we adopt as more achievable than they are likely to be.” Many entrepreneurs are aware of the failure rate in business, but believe that those odds only apply to other people. This attitude is a great thing for society since we all benefit from it, but for the entrepreneurs it can be a hard knock life.

10. “We know well we haven’t survived because our strategies are farsighted and brilliant, or because our execution is perfect, but because for 15 years we have persevered in our mission of ‘making it easier to do business across the world,’ because we have insisted on a ‘customer first’ value system, because we have persisted in believing in the future, and because we have insisted that normal people can do extraordinary things.”

Missionaries tend to persevere. Mercenaries often bail too easily. Do mercenaries sometimes succeed financially? Sure, but they do not do so as often or with the same impact on society as missionaries. Ma also seem to be taking about the importance of grit to being successful. The great entrepreneurs tend to be relentless about the mission of their business. For them, their business is more of calling than a job.

11. “Don’t say I want to win next month, I want to succeed next year. Impossible. Forget about it. If you think I will win this in three years, prepare for five years. “Will I win in three years or 10 years? If you have a great idea, prepare for 10 years. You’re lucky if you win in one year – but most people will not have this opportunity.”

Creating a successful business takes time. Despite what many people think, even a technology business is rarely about a get rich quick result and even if it is, it is usually because a big company buys the opportunity relatively early in the cycle. Both Instagram and WhatsApp fall in this latter category. Yes, there are overnight successes in businesses but they tend to be the exception and not the rule. Many entrepreneurs spend a decade of more becoming an overnight success.

12. “Yesterday’s successes often hinder progress. “Successful people are the most difficult people to change.”

Progress often advances one business funeral at a time. Sometimes it takes a great fall from grace by a business for old dogma to become discredited. And sometimes what made you a success later proves to be your downfall.

End Notes:

Science: http://science.sciencemag.org/content/355/6324/486.full

What is Alibaba: http://projects.wsj.com/alibaba/

Ma in Seattle: https://www.nytimes.com/2014/09/07/business/international/at-alibaba-the-founder-is-squarely-in-charge.html

Golosovsky https://arxiv.org/pdf/1802.09786.pdf

Talent vs Luck: the role of randomness in success and failure, A. Pluchino, A. E. Biondo, A. Rapisarda https://arxiv.org/abs/1802.07068

Belsky on the Messy Middle: http://digest.scottbelsky.com/issues/positive-slope-s-belsky-the-messy-middle-killing-elephants-the-state-of-creative-process-57110

Mauboussin: https://www.forbes.com/sites/investor/2013/11/05/the-role-of-luck-and-skill-in-investing/#6a35624cb737

http://www.scmp.com/tech/leaders-founders/article/2102718/seven-more-lessons-successful-career-and-life-jack-ma

https://www.scmp.com/video/2102683/how-new-business-newborn-baby-jack-ma-answers

https://www.nytimes.com/2014/05/08/technology/the-unlikely-ascent-of-jack-ma-alibabas-founder.html

http://fortune.com/2017/03/24/jack-ma-alibaba-china-ecommerce-world-greatest-leaders/