Everything about the Chinese e-commerce company Alibaba is enormous.   Filings for the September IPO provide incredible insight into the company that does four times the sales volume as Amazon and ships more packages to customers in a year than all the traffic through UPS. The IPO is shaping up to be the biggest business news story of the year and nearly every media outlet has an angle to cover: the largest stock sale in history, the threat to American Big Tech, the new era for Chinese transparency and corporate governance, and the seeming boon for U.S. small businesses looking to connect with foreign suppliers.

bazaar

While Alibaba has expanded into many sectors, their shining star remains their B2B platform to connect Chinese manufacturers to buyers all over the world.   As the company’s presence in the U.S. continues to strengthen, a huge number of U.S. entrepreneurs and small business owners will begin to ask themselves: Is Alibaba right for me?

Love at First Sight

To an entrepreneur, Alibaba’s B2B platform looks like an indispensable offering. It disintermediates, simplifies transnational transactions, facilitates supplier review, and, of course, offers unbeatable unit costs. Prominently displayed on every Alibaba page, unit cost represents the price a U.S. buyer will pay for a finished good. The true business brilliance of Alibaba is their use, like a tool, of a cognitive bias called the ambiguity effect.

ambiguity effect

As a single and readily available number, unit cost serves as a shortcut to the incredibly complex and inexact process of selecting a foreign manufacturing partner. Equally important but entirely less quantifiable decision inputs are hard to find and in some cases not available at all.  While most entrepreneurs understand the presence of hidden and inexact costs in their design, production, and supply chains, it’s nearly impossible to appropriately weight the gleaming unit cost as a factor when selecting between on- and off-shore suppliers.

Trending

Another incarnation of the ambiguity effect is the lop-sided media exposure informing the off vs. on-shore decision. A small business owner undertaking a partner selection process is significantly more likely to be exposed to information supporting off-shoring and, as of late, about the wonders of Alibaba. By no means is this conspiratorial, but search result composition can be a countervailing force to the specific content therein and search result quantities can be mistakenly viewed as independent votes of confidence. Meanwhile, on-shoring represents a journalistic desert and has a dearth of advocates who can match Alibaba’s IPO welcome party invitations.

welcome

Time-to-market, the ability to accommodate design changes, payment terms, and risk management related to customs, IP, and quality are all partner-selection inputs where an on-shore partner may likely have the advantage over a foreign partner. Depending on product complexity and production volume, each start-up will need to weigh these categories differently, but tools exist to inform the process. For example, the Total Cost of Ownership Estimator at ReshoreNow.Org provides a 36 question tool to compute a fully-baked cost on imported goods. They even include questions related to due diligence and quality visits. The expense and, often more importantly, the time associated with sending key decision makers to China a couple times a year is extremely easy to underestimate.

By how much might real costs differ from advertised unit cost? No software will be a panacea for off-shoring decisions. It will remain an inexact and complex process, but contract manufacturing experts like Harry Moser suggest that hidden costs for a low complexity product may be 20-30% of the unit cost. As product and design complexity increases, so will these percentages. Furthermore, for a product still undergoing engineering changes and with highly variable order sizes, these percentages will be even higher. Why? Even if the offshore partner can accommodate design complexity, the difficulty to communicate changes, to coordinate with upstream foreign suppliers, and to adjust long lead-time processes make offshore partners significantly less nimble. As a start-up, will your quoted unit cost turn out to be a third of the real cost required to get your product how you want it and to your warehouse?

huge port

Alibaba is a tremendous gateway for start-ups to benefit from global labor arbitrage and tap into engineering and manufacturing ecosystems that are anemic in the U.S. For certain products and services, it’s a no brainer. However, if you’re early in your product life-cycle and complexity is high, find a local partner that can accommodate changes, serve in a consulting function, and can be reached easily and quickly. Conduct a thorough Total Cost of Ownership analysis and remain cognizant of the ambiguity effect as it relates to unit cost and media exposure. While Alibaba will become a household name in the U.S. (especially as their consumer retail offerings grow), this shouldn’t be mistaken as an actual improvement in finding partners offshore and conducting business globally.

I look forward to any comments or discussion at dburseth [at] mit.edu

-Daniel Burseth