Alibaba and the 40,000 thieves

Be warned: Jack Ma, the man who oversees the world’s largest online retailer and whom Forbes ranks as the 22nd most powerful person in the world, doesn’t like lawyers. Especially those attacking the very underpinnings of the $200 billion empire he’s built. As rail-thin as ever, Ma almost leaps off the sofa in his Hangzhou office in China when talking about the fancy New York attorneys who have sued him for trademark infringement and trafficking in counterfeits on behalf of their client, Kering, the French luxury goods conglomerate that owns Gucci and Yves Saint Laurent. There’s no chance, he insists, of settling.

“I would [rather] lose the case, lose the money,” says Ma. “But we would gain our dignity and respect.”

That is true if he means respect in the eyes of the hundreds of thousands of small Chinese entrepreneurs who’ve made a living on Alibaba’s online bazaar, called Taobao. To Ma, whose Chinese retail sites handle five times the volume of eBay—last year $394 billion of, well, everything—these sellers are his lifeblood. To the sellers, Ma is a hero of capitalism, offering them a path to the middle class. In the centre of this social compact, however, is an unacknowledged truth: The Alibaba juggernaut has been constructed to a significant degree on illegal, counterfeit products.

The scale of the fakery is enormous—at any given time, Taobao offers millions of suspect goods for sale, from handbags to auto parts, sportswear to jewellery. When Forbes searched for listings on Taobao with the word ‘Gucci’ and set the preferred price range under 300 yuan, or less than $50, well below the price of real Gucci products, 30,000 results popped up. The sellers of four of the items on the first page confirmed in online chatting that they hire factories to produce these wares using the original design. A large number of the rest are of designs similar to those of Gucci products, with slight alterations, such as the replacement of the letter ‘G’ in a handbag’s pattern with ‘D’.

NetNames, a firm that helps brands fight online counterfeits, says that its clients believe as much as 80 percent of the merchandise sold as theirs on Taobao is fake. That’s backed up by Dan McKinnon, head of global brand protection at sneakermaker New Balance. Since the Boston company has no authorised dealers on Taobao, McKinnon figures that at least 80 percent of the supposed New Balance products sold over the site are counterfeit or suspicious. Alibaba, for its part, won’t hazard an estimate.

In some ways, it can’t afford to. Ma pulled off the world’s biggest IPO last year on the New York Stock Exchange, raising $25 billion. Alibaba’s revenue more than doubled over its last two fiscal years to $12.3 billion, while net income nearly tripled, to $3.9 billion. Ma is personally worth $21.8 billion. What would happen if Alibaba eradicated fake goods from its shopping sites—if that were even possible? Harley Lewin, a veteran intellectual property lawyer at McCarter & English, has an opinion: “They’d go broke.”

Ma has no interest in that outcome. But he also has incentive to get ahead of the narrative prior to executing Alibaba’s audacious next phase: Moving from a giant in China to retail dominance worldwide. That requires building trust with consumers everywhere—trust that could be undermined by a buyer-beware reputation. “Jack Ma has made a lot of money,” says William Forsythe, brand-protection manager at the North American unit of Japanese automaker Nissan Motor. “But if he is going to have a market- place that has a global footprint, he needs to put a system in place to protect international trademarks.”

That’s the riddle for Ma: Can he crack down on fakes enough to be viewed globally as someone who respects the sanctity of brands sold on his sites—but not enough to sink the small-time sellers who remain his rice bowl?

The longer Ma talks, the more it’s clear where his sentiments fall. The second-richest man in China thinks the very idea of luxury retail—selling belts and accessories and the like for thousands of dollars—is inherently absurd. “How can you sell Gucci or whatever branded bag for so much money? It is ridiculous,” he says. “I understand the branded companies are not happy, but I also say that’s your business model. You have to check your business model, too.”

The ascent of Jack Ma and China itself are inextricably entwined. In 1999, the former English teacher founded Alibaba with 17 colleagues in his apartment in Hangzhou. His first venture was the business-to-business site Alibaba.com, which connects companies in the US and elsewhere with suppliers in China. Then, in 2003, he launched Taobao. As China grew into the world’s second-largest economy, Taobao, which translates to “search for treasures”, became the country’s premier internet shopping site. Some 50 percent of Chinese online retail flows through Taobao, according to consulting firm iResearch.

Ma himself lacked the standard traits that help businessmen get ahead in Communist China—political connections or an elite education. He barely made it to college. Yet he had the good fortune to cultivate high-profile business leaders at an early stage. While serving as a junior staffer at a government ministry, he was assigned to give a tour of the Great Wall to Jerry Yang, co-founder of Yahoo, which became an early investor in Alibaba. As did Japan’s Masayoshi Son, founder of Softbank, and Goldman Sachs. Ma has proved equally adept at handling the Chinese government, which still wields tremendous influence over the fate of private business. When China’s President Xi Jinping visited the US and the UK recently, Jack Ma was with him.

Accusations of rampant fakes dogged Alibaba and Taobao from the beginning, with Ma all along asserting he was taking a tough stand. But as the site grew, so did complaints from established brands, and in 2008, the Office of the US Trade Representative placed Taobao on its list of Notorious Markets, joining the likes of Baidu and PirateBay.

Counterfeiting in China is noth- ing new. Back in the 19th century American merchants would have cheap copies of paintings made in Chinese workshops. But the counterfeiting programme got exponentially worse after China began its historic shift toward free-market capitalism in the 1980s. In fact, Ma sees his issue with bogus goods as a direct outgrowth of China’s econom- ic ascent. As the slumbering giant woke up, factories making all sorts of consumer goods sprouted from the country’s rice paddies. Since the government paid little attention to protecting intellectual property—and the Chinese public developed a get-rich-quick fervour—China became a haven for the production of fakes. According to the US Department of Homeland Security, nearly $1.1 billion worth of counterfeit goods from China and Hong Kong were seized entering United States in fiscal 2014—88 percent of the total it uncovered.

Alibaba faced down a big scandal in early 2011, when it was revealed that some 100 Alibaba sales-people knowingly set up fraudulent sellers who accepted payments for but never delivered popular consumer electronics like laptops and flat-screen monitors. Ma gathered his senior executives in a bar in Hangzhou for some soul-searching, along with an investigation into what happened. The take was small, maybe $2 million, but it involved more than 2,300 fake storefronts. “The company was at risk of developing a culture of pursuing short-term financial gain at all cost,” said Savio Kwan, the lead investigator.

Alibaba.com’s CEO, David Wei, and Elvis Lee, its COO, left in the wake of the scandal even though neither was charged with any wrongdoing. That same year, Alibaba shut down a passel of counterfeiters on the site, sparking a protest by hundreds of people organised by the sellers outside of Alibaba’s headquarters. “We are probably the only company in China [where] senior management takes responsibility,” Ma told Forbes in his first interview after the scandal. “People think, ‘Jack, you do too much’. I mean, too drastic. But I believe China needs this.”

Alibaba began working more closely with brands to tackle counterfeits, and that was enough to convince the US Trade Representa- tive’s office to remove Taobao from its blacklist in 2012. But the company’s steps weren’t enough for a host of Western brands. Kering first sued Alibaba for trademark infringement and trafficking in counterfeits in 2014, but withdrew the complaint after the two companies agreed to discuss a settlement and a plan to combat counterfeiters. Within less than a year, however, the talks had gone nowhere, and Kering decided to sue Alibaba again. The second lawsuit alleges, among a litany of complaints, that 37,000 counterfeit Gucci bags were sold on Taobao in one month alone in 2014, from 2,731 different shops. (An Alibaba spokesman counters that the Kering complaint “has no basis”.) In an October study of marketplaces globally, the Trademark Working Group, whose 25 anonymous members include several major US companies, identified Taobao as “still the largest online platform for the sale of counterfeit goods”.

Even the Chinese government, which usually turns a blind eye to counterfeiting, has pressed Ma to tackle the problem. In January, the State Administration for Industry & Commerce, a government regu- latory agency, released a survey it had commissioned that revealed that only 37 percent of the goods it ex- amined on Taobao were authentic. Then the agency posted to its website notes from a 2014 meeting it held with Alibaba executives in which it reportedly criticised the company’s anti-counterfeiting efforts and other business practices. Alibaba, the report charged, was facing a “credibility crisis” as a result. Alibaba contests these studies. During an earnings call with investors, Joe Tsai, its vice chairman, lambasted the product survey for being “flawed” and “based on arbitrary methodology”. The government eventually yanked the meeting notes from the web. Though Alibaba claimed victory, it also agreed to cooperate with the agency to better combat fakes.

Juanita Duggan, CEO of the American Apparel & Footwear As- sociation, an industry group that represents many brands victimised by Chinese fakes, says her organisa- tion had been in intensive talks with Alibaba over ways the Chinese com- pany could better protect brands, only to face resistance. “We’ve been going around and around in circles with them, and we were going nowhere,” Duggan says. Fed up, her group wrote the US Trade Representative an official letter in April, accusing Alibaba of being “either not capable of or interested in addressing this problem”. It’s now campaigning to have Taobao return to the US government’s Notorious Markets list.

In a letter to the US Trade Representative, Alibaba’s vice president of international government affairs, Eric Pelletier, responded that it wants to cooperate with Duggan’s trade group but that many of its demands were “unreasonable and unworkable”. Most tellingly, Alibaba said that acceding to the footwear association’s wishes would force changes in its business model. “It is unreasonable to demand that Alibaba Group change fundamental aspects of our business model as the price of collaboration,” wrote Pelletier.

There’s a war room at Alibaba’s headquarters, a campus of glass-and-steel office towers on the outskirts of Hangzhou housing 16,000 employees. Three floors down from Ma’s office, a large, flat-panel screen shows a map of China, flash points popping up every second or two. In a country notorious for its cyber-espionage, particularly when it comes to business and trade secrets, Alibaba is spying on itself.

More specifically, it’s operating what is likely the largest private task force in the world devoted to fraud- ulent merchandise—2,000 strong, all of them employees of Alibaba, which spent a combined $160 million in 2013 and 2014 on this effort. Head count is up fivefold since 2011. If we’re to judge Ma by his actions rather than just words, this is the place to start. “If I say no tolerance of counterfeit products,” he says, “then we mean it.”

Ma’s minister of defence is Polo Shao, a 20-year veteran of China’s police, who excitedly shows off the “big data” computer system Alibaba uses to sniff out counterfeits. The map’s flash points denote Taobao transactions based on attributes such as a suspiciously low price, poor photo quality and the length of the product description. Transactions flagged as suspect get a follow-up look before a decision is made to take them down.

The system tallies the number of counterfeits pulled from the site—tens of thousands that day alone. Other software can compare snapshots posted by sellers on their stores’ sites against official photos of the original goods in a quest to uncover illegal replicas. Shao claims the company removed 100 million infringing products from Taobao in the past year alone, up from 14 million in 2010. Ninety percent of those were found by Alibaba’s own team, he says. “We are proactively discovering these problems and solving them,” Shao says.

Even with advanced anti-fraud software and 2,000 sets of eyes, Alibaba is still playing the world’s biggest game of Whac-A-Mole. Some 100,000 new Taobao shops are approved each day, and Shao says Alibaba can’t always know what they’re up to until they start sell- ing. “We are far from perfect,” Shao admits. That’s why Alibaba has also expanded its war into the real world. Two years ago, Alibaba increased its cooperation with China’s police to help track down the people making and distributing counterfeit goods. The police have assigned two officers to the Alibaba headquarters and are jointly developing software with the company to identify the sources of counterfeits, based on Ma’s data. Man Niu, director of the economic-crime investigation division of the public security department in Alibaba’s home province of Zhejiang, says that he rounded up 300 suspects in 160 counterfeiting cases with the aid of Alibaba just since mid-summer.

Alibaba has for years had a process by which brands can file take-down requests when they spot fakes, but brands grumbled that it was too confusing, the necessary paperwork too burdensome and Alibaba’s response too lethargic. So in July, Alibaba opened an English-language website through which brands can file take-down requests; previously the platform was not entirely in English. Since April, brands with a strong record of accurately spotting counterfeits have been allowed into a “good faith” programme with simplified and speedier processes to help pull fakes more quickly. Alibaba says the programme reduces the time it takes to remove a listing from three to five days to one to three days. That’s still a far cry from eBay, which says that it handled 92 percent of the complaints it received within 12 hours in 2014. “We are very open to partner,” Ma says. “We are the military fighting against the counterfeit terrorists. [The brands] have to work together with us instead of killing the soldiers.”

Since New Balance joined the “good faith” programme, Dan McKin- non says, taking down suspect products has become much more efficient, with thousands of listings being removed. But he calls that “a drop in the bucket”. McKinnon claims that at any given moment there are an average of 130,000 listings of New Balance products on Taobao that he deems to be counterfeit or highly dubious. Alibaba’s executives “want the brands to be happy, but they don’t want only the brands to be happy,” he says. “They want the users to be happy and the consumers to be happy.”

Duan Gang, assistant to the CEO of Chinese apparel company Trendy International Group, says the number of shops peddling counterfeits of its Ochirly-branded clothing dropped by two-thirds to 5,000 since it began working more closely with Alibaba in October 2014. The Washington-based International Anti-Counterfeiting Coalition signed a memorandum of understanding with Alibaba in 2013 to develop a special project to remove counterfeits from Taobao. The coalition hired two analysts and one attorney to review complaints from the then 20 brands in the programme before submitting them to Alibaba. The operation has successfully scrubbed 130,000 counterfeit list- ings from Taobao. The programme is a “great partnership,” says Bob Barchiesi, the coalition’s president.

The project is now up to 26 brands. “People have expectations that [Ali- baba] should be handling this right away. But it is a learning curve.”

Nissan’s William Forsythe is less impressed. He wraps his brand vigi- lance in the cloak of safety concern: Specifically that counterfeit auto parts, sold over Alibaba’s platforms, may hurt Chinese consumers—and make their way into body shops and automotive stores in the US. “They are counting the money with their left hand,” says Forsythe, “and covering their eyes with their right.”

Alibaba needs to deal with three constituencies: Brands, sellers and, of course, the end buyer. “One fake product is going to make us lose five customers,” says Ma. “If we don’t control that, the more customers we lose.”

To ostensibly protect them, Taobao has an enforcement sys- tem: Merchants are penalised with “strikes” and “points” for various transgressions. Selling counterfeits earns a “strike”, and after three or four “strikes”, Alibaba shuts the shop. However, the confusing system gives a seller ample opportunities to stay in business.

For instance, unless a seller accumulates too many points in a year, his record is eventually wiped clean, allowing all but the most overt wrongdoers to keep their stores open. Those who get banned can just re-register their stores under a different name and resume their sales.

The Chinese merchants who hawk counterfeits on Alibaba’s platforms concede that the company is getting tougher—but not enough to discourage them, and they still market their illegal goods with near impunity. Take, for instance, S Zhai, 30, who operates two Taobao stores selling counterfeit handbags and clothes from brands, including Prada, Fendi and Balenciaga. Her products come from the very Chinese factories that manufacture the authentic items. Quality control officers yank handbags and other goods made for the brands off the assembly lines for some sort of defect, then pass them out the back door to Zhai. Some counterfeiters also collect discarded fabrics, leather and other raw materials, ship them to their own factory, hire workers from the official manufacturer and assemble these pieces into replicas of the real thing, which Zhai says she also sells on Taobao. On a good day, she can rake in $11,000 in sales.

Zhai’s counterfeits should be easy to spot. They are exact copies of the original, complete with brand logos, yet she sells them at discounted prices and states on her Taobao storefront that they are not official goods. Yet Alibaba has done a poor job of stopping her. Soon after she began selling these items in 2010, one of her suppliers got nabbed, and Alibaba shut down her first shop. But a few months later, she was able to reopen under the same registration and shop name. After buying Alibaba employees some nice dinners and gifts, it lifted the ban, and she went back to selling the exact same counterfeits. (An Alibaba spokesman says the company has a policy of “zero tolerance on fraudulent activities by our employees”.) Despite her record, Zhai says, Alibaba salesmen have offered services to help promote her site.

Five years passed before Alibaba caught up with her again. In mid-2015, her second shop was shuttered. This time, reopening its virtual doors hasn’t been as simple. She complains Alibaba is now forcing her to submit stacks of paperwork to challenge the company’s penalty. But Zhai’s first store continues to market as many fakes as ever.

C Di, 28, has endured less pressure from Alibaba. She readily admits that she copies designs from major luxury brands like Gucci, Fendi and Ferragamo, then hires a factory in China’s Guangdong province to manufacture the handbags for her. Di opened her Taobao shop in 2013 and began making so much money that she quit her job as a civil servant. Each month, Di sells some $30,000 worth of rip-offs, bringing her more than $1,500 in income.

Nevertheless, Di has been penalised by Alibaba for intellectual property infringement only once—the company asked her to stop selling a near-replica of a Ferragamo bag. Granted, she has gotten smarter at avoiding detection by tweaking the designs to make her products appear slightly different from the originals. But some of her wares are still obvious copycats. She recently offered a Michael Kors handbag with the interior clearly covered with the company’s logo. In her product description, she openly declared that the factory that made the handbag got fined for infringement of Michael Kors’s intellectual property. “Taobao has its own rules,” she says. “A veteran seller would know how to better avoid risks.”

Zhai and Di may be crooks to the likes of Gucci and Nissan, and millions of customers. But Ma’s great pride is to have provided an opportunity for millions of poor Chinese to start their own businesses. He feels responsible for all those Taobao sellers—the little guys—striving to lift their fortunes in a still-poor China. And if upholding intellectual property rights comes second, well, so be it. “It’s not white and black,” Ma says. “If you just say, ‘Take that down,’ it is unfair for that guy [the seller]. We have to also protect these guys, not only the branded businesses. You have to care about all the people, their rights.”

The us-first attitude is encoded in Alibaba’s filings with the US Securities & Exchange Commission. In one document for its 2014 initial public offering, Alibaba insisted that “we maintain a ‘no tolerance’ policy with regard to counterfeit and fictitious activities”. But the next sentence reads: “Because many sellers doing business on our marketplaces depend on us for their livelihood, we have generally eschewed a ‘shoot-first, ask questions later’ approach to handling complaints” from brands.

Ma is too powerful, too rich and too in-demand for even the angriest of brands to arm-twist him to change. And while millions of customers are, in theory, getting ripped off by Taobao’s sellers, millions more are in on the racket, getting a cheap way to project luxury in a country  obsessed with it. Domestically, the easiest path for Ma is to maintain the status quo. Internationally, the most prudent course is to demonstrate seriousness on this issue. It’s classic Chinese political thinking, seeking a harmonious resolution, only this time it’s among business interests.

And remember the fate of the original Ali Baba of “open sesame” fame. He, too, had trouble with a band of thieves. He, too, had to deal with all sorts of divergent constitu- encies—the greedy brother, the loyal slave and the angry thieves.

In the end it was Ali Baba who wound up with all the gold.

(With reporting by Jane Ho)