EBay Heads East

Michael Cai grunts as he rummages through a pile of 500 stuffed animals in his Shanghai storage locker. "It's in the back here!" he says, pushing through a stack of plush Winnie the Pooh and Tigger dolls. Finally, he locates what he's looking for: a pink pillow in the form of a pop-eyed pig. He unfolds it--and it turns into a blanket. "It's the best-selling item we have abroad!" he beams. "Foreigners love it!"

Two years ago, the 24-year-old Cai was a brand-new college graduate just hoping to eke out a living. Now he runs a tiny international business, buying toys from local factories at ultracheap prices and hawking them on an eBay store (51Toy.com). Last winter, he was pulling down $6,000 in monthly sales, with a profit margin as high as 40%, which puts him in the top fifth of earners in China--better than most white- collar workers. Almost 90% of his customers send their payments to him online. "The Internet," he says through a translator, "is how I reach the world."

Meet the next wave of Chinese capitalism: the microretailer. It used to be that we only bought "Made in China" goods from commercial giants such as Wal-Mart or Target. But as e-commerce takes hold in China, the country's retail sector is democratizing, and mom-and-pop stores are getting into the game, selling goods directly to folks in Boise, Idaho, pinging e-cash back and forth across national borders. The old China was the soccer ball of dubious provenance that you bought at the mall; the new China is a friendly guy named Zhang with an apartment full of custom-made MP3 players and 2,000 positive reputation points on eBay.

"This is going to be enormous," says Mary Meeker, a Morgan Stanley analyst who wrote a report on the Chinese Internet last year. "China is already one of the most entrepreneurial societies around. This is supercharging it."

Trust, But Verify

The revolution began in 1999, when one of China's first online auction houses, EachNet, opened shop. It was slow going at first, because online commerce was completely foreign to the national culture. As it is in much of the world, Chinese retail has tended to be combative. Buyers like to inspect merchandise in person and then haggle over the price. But the dynamics of online commerce are precisely the opposite: You agree to buy something based on a picture, and an auction drives the price up. What's more, the Chinese thought the whole arrangement smelled fishy. Sellers worried they'd get screwed if buyers didn't pay, and buyers worried they'd never see the goods they paid for.

All of which was exacerbated by a creaky Chinese banking system that made it incredibly difficult to move money from one person to another. Virtually no one in China has a checking account, and only 1% of the population has a credit card. Debit cards abound, but they often work only regionally: Travel outside your province or try to buy something online from a far-off merchant, and the deal may never happen. As a result, commerce in China still relies on seemingly quaint payment methods that vanished from the United States long ago: cash-on-delivery and wiring money. Some businesspeople literally "walk around town carrying huge bags of money," as one Hangzhou Internet executive says, only half-jokingly.

"The barriers were all about trust, not technology," says Bo Shao, the 32-year-old Harvard-educated founder of EachNet. "People just didn't feel comfortable with the Internet. We had to teach them."

To that end, EachNet developed an escrow system similar to eBay's. When someone bought an item, it held the payment itself until the goods arrived, essentially policing the transaction. (Impressed by the company's success, eBay bought EachNet for $180 million in 2003.) Alibaba, a Chinese e-commerce company that runs a competing auction service called Taobao, also introduced an escrow service. Between the two, they seem to have proved their point: By last year, consumer-to-consumer sales online had shot up to $1.7 billion, an increase of 200% over the previous year, and both companies took the final step toward frictionless commerce by launching online payment systems--PayPal for eBay and the rival AliPay system for Taobao. (Neither company will release figures on how much money they're moving on their networks.)

It is a winner-take-all battle because, in the long run, people will want to deal with only one market--one auction house and one payment system. And the fight has grown pretty heated, with each company trying to undercut the other. EBay, for example, originally charged sellers a fee to list items, but Alibaba, which is 40% owned by Yahoo, countered with free auctions, forcing eBay to reduce those fees last winter. And according to Analysys International, Alibaba's maneuvering has paid off: eBay's dominant share of the auction market two years ago had by this year eroded to 34%, versus Alibaba's 57.74%.

Garden-Variety Capitalists