By Sherman So and J. Christopher Westland

Editor's note:
This article has been adapted from Red Wired: China's Internet Revolution co-authored by Sherman So and J. Christopher Westland. The to-be-published book is aimed at helping readers gain a firsthand understanding of how the Chinese combined successful components from their Western counterparts with innovation, to accommodate the unique characteristics of the Chinese market.

Many believe Taobao beat global online auction king eBay in China by being free,  but not EachNet founder Bo Shao who sold the company to eBay in July 2003. A key catalyst was "migration", the decision to terminate EachNet's homegrown technology platform and move all EachNet users to the eBay US platform, said Shao. 

On the day of the migration, traffic to eBay China dropped by half. Despite the serious customer losses, Meg Whitman, then CEO of eBay, only learned about it a month after it occurred, on a visit to Shanghai.

Whitman was shocked and very upset. Apparently, even the head of eBay International at the time, who was one of the most ardent proponents of migration, did not tell Whitman about it. 
 
By 2003, eBay's global expansion plan had reached China. It completed its acquisition of the country's dominant auction player, EachNet, for $180 million in July 2003. EachNet at the time had more than 2 million users and about 85 percent of the market.

EachNet's market dominance was so strong that Shao started charging listing and transaction fees in 2001, despite the existence of free competing sites. He believed that as long as the site had the most buyers and made money for sellers, the sellers would be willing to pay. According to Shao, fees did not affect user loyalty; in fact, EachNet's dominance increased after it started charging. 

After the acquisition, Shao retired from daily operations of eBay China and moved to the US in late 2003 with his family. eBay sent in a number of expatriates from Germany, the US, Korea, and Taiwan to run the China division and hired a number of senior executives from other multinational corporations in China. 

The company thought everything would be fine. After all, EachNet, now eBay China had an overwhelmingly dominant position and it planned to spend an extra $100 million to improve its technology platform and promote eBay's brand in China. Any new competitors would be easy to crush.

However, nothing went according to plan. A new rival came out of nowhere and eBay retreated from China four years later.

Rise of Taobao

After Alibaba started making profits on its main B2B site, its founder Jack Ma took aim at the potentially much bigger C2C (consumer-to-consumer) market. Ma gathered a small team working in secret. By May 2003, the website Taobao, which means "looking for treasure" in Chinese, was launched.

While eBay was busy consolidating EachNet into its global operation, Alibaba was plugging Taobao as a new online shopping destination. And unlike its American-owned competitor, Taobao was free!

But levying listing fees and transaction fees was not the only reason eBay lost its dominance to Taobao, said EachNet co-founder Shao, who, after selling the company to eBay in July 2003, stayed on as a consultant for over a year.

"At first, even with Taobao making a lot of noise, our users and traffic did not change much," said Shao. 

Despite having to pay fees, the larger user base of eBay China was more than enough to keep sellers coming. Similarly, most buyers stayed on, as there were more sellers and products offered. 

In fact, latecomers seldom posed a serious threat to the dominant online auction player. They might capture some market share, but rarely a big chunk. Latecomer Yahoo's free auction service in the US had scarcely any effect on eBay's market dominance.  

What really caused eBay to lose its dominance in China was its decision to move its technology platform from China to the US, said Shao.

Internally, it was called "migration", which was the project to terminate EachNet's homegrown technology platform and move all EachNet users to the eBay US platform in October 2004. 

Whitman, then CEO of eBay, had a vision – she wanted all eBay users, wherever they were, to be able to trade with each other. For example, users in the US could be able to see products offered by users in China and bid for them.

To implement her global vision, eBay's technology platforms in different countries had to be moved to the headquarters, consolidated and put under the control of the company’s chief technology officer.  

The former EachNet management supported the vision, according to Shao, but felt that it was premature to migrate EachNet users to the US platform, which was not yet flexible enough to accommodate the China-specific features that EachNet needed to compete in China. EachNet's technology team was also concerned about transmission speed issues across the Pacific. Such concerns, however, were downplayed during the eBay technology team's presentation to Whitman.

The beginning of the end

"On the day of the move, traffic (of eBay China) dropped by half," recalled Shao.

What had been information flow within China now became traffic across borders and across the Pacific Ocean. However, the Internet infrastructure between China and the US was not very good. The loading speed of eBay China's webpage, one of the most important user issues, slowed dramatically.

What's more, the Chinese government by then had built its "great firewall" to block any traffic of which it disapproved. The censorship was quite tight – anything that looked suspicious would be blocked and the foreign computer server that processed the problematic information would be banned for anywhere between 24 hours to several days.   

The slow and unstable services frustrated users and caused them to leave eBay China in droves. The presence of Taobao as a better alternative, further sped up its popularity.

But, the news did not get to Whitman until a month later, said Shao. The head of eBay International at the time was a major proponent of migration and did not tell her about the crisis. It was only when she visited China with Shao and met with the local team that she learned the truth.

Whitman cared a great deal about China and treated eBay China as a strategic priority. Shao recalled that Whitman was shocked and upset when she found out about the problems.

Moreover, the move of the technology platform brought the development of eBay China to a screeching halt.

"In order for the eBay US platform to catch up to EachNet's China-specific features, development on the site was frozen for a year before the platform was moved," said Shao. For an entire year beginning in October 2003, EachNet could not develop any new features or make significant changes to existing features.

After the move, the local team lost most of its control on the site. "It took nine months to implement any major changes and nine weeks to even change a word on the website as everything had to go through the headquarters technology development team," said Shao.

"This is unthinkable," said Shao. "Fast reaction to user demands is crucial in this market."

eBay's downfall

Taobao, meanwhile, was quickly adding new features and making its design more and more appealing to the Chinese users. It added an online chat function that allowed buyers and sellers to communicate virtually before trading. It implemented an online payment solution called Alipay. It made its page design more feminine to appeal to a growing number of female users.

Slow and unstable services and a lack of updates caused eBay China to lose users fast.  Three months after the platform moved, eBay China's market share had dropped to the almost the same level as Taobao, said Shao.

"After that, there was no more reason for users to stay (with eBay China)," said Shao.  eBay China had fewer users and worse services than Taobao, and it charged people too.

Six months after the move, Taobao turned the tables on eBay China, capturing 60 percent of the market while its rival languished at 30 percent.

eBay significantly cut its prices to try to compete, and in late 2005 it stopped charging altogether, but it was too little too late. Its market share dropped from 85 percent when it purchased EachNet in 2003 to about 30 percent in late 2005.

By the fall of 2005, although eBay still had more registered users, Taobao had 57 percent of the market transaction volume to eBay's 34 percent, according to Beijing market research firm Analysys International.

After investing nearly $300 million ($180 million for acquiring Eachnet and $100 million as extra budget for its China push), eBay all but threw in the towel. It folded its China operation into a joint venture with Tom Online, a leading mobile value-added services provider in China at the end of 2006.

Tom Online could not turn the situation around, either. eBay’s market share had shrunk to 7 percent by the second quarter of 2007, while Taobao held 82 percent of the market, according to Analysys International.

Chart: Market share of C2C market (2008)

Source: Analysys International
Note: by transaction volume

Chart: Gross trading volume of China online shopping market (2004-2011)

Source: iResearch