March 1, 2011, 12:00 AM

Buyer Beware

A fraud scandal at a major Chinese marketplace underlines the importance of picking good suppliers.

Lead Photo

It involved only about 1% of the suppliers on its global online marketplace, but the word from Alibaba.com last month was startling to retailers who pore through its web pages looking for products to buy at wholesale: More than 2,300 of Alibaba's supposedly trustworthy China Gold Suppliers in 2009 and 2010 engaged in fraud, ringing up on average about $1,200 per claim reported by buyers.

The fraud, uncovered by an internal investigation by China-based Alibaba, often involved the sale of popular consumer electronics products at unusually low prices with low minimum order requirements, Alibaba said last month. About 100 of Alibaba's sales force of 5,000 were complicit in the fraud, the company said.

In an attempt to save face with its customers, Alibaba said on Feb. 21 that CEO David Wei Zhe and chief operating officer Elvis Lee Shi-Huei had resigned, even though the company said they were not involved in the fraud and had tried to address it. In their place, Alibaba named as its new chief executive Jonathan Lu Zhaoxi, who will retain his other positions as executive vice president of parent company Alibaba Group and CEO of sister company Tao Bao Holding Limited.

With the change in the executive ranks, Alibaba said it was sending a strong message that it was reversing what it described as a "systemic breakdown in our company's culture of integrity."

Rebuilding confidence with buyers may also require changes in some of the fundamentals of doing business with suppliers through marketplaces where buyer and seller often never meet in person, retailers say. Although there are more suppliers than ever—and more easily available than ever on the Internet—retailers must take extra steps to ensure they get honest treatment from suppliers who can provide the right quantity and quality of products at the right price and level of service.

"When you have a trusted marketplace like Alibaba and something like this happens, it just goes to show that no matter how good you think a supplier is, you have to do your homework, your due diligence in checking them out," says Matt Scriff, co-founder and president of 3Gorillas.com, a web-only retailer of home furnishings and appliances.

A dangerous game
And fraud in foreign e-marketplaces is not e-retailers' only concern regarding suppliers.

"The market is incredibly flooded with suppliers who think they can get the job done, but only about 10% can," says Phillip Crane, co-founder and partner of Pure Modern, a web-only retailer that relies on a constantly updated stable of some 300 wholesalers and other suppliers of fashionable home furnishings and accessories ranging from wristwatches to travel gear. "It can be dangerous for people like us to find suppliers," he says.

For example, Crane recalls one provider of what appeared to be an unusual and highly attractive line of computer bags and wallets. "They approached us, were super nice, and asked if we would represent their line," he says. "But 60% of the orders we took for their products couldn't be fulfilled because they didn't have the products available. That usually angers customers, especially if they came to us looking for a unique product—and then they never come back."

Adds Scriff: "We reach out to a variety of wholesalers as well as manufacturers, do our evaluations and see what works. But we have to constantly weigh the risk versus the reward." He constantly seeks new suppliers to find products that will give him an edge and provide good profit margins, but worries that suppliers may not provide good quality or deliver on time.

"When testing a new products supplier, you have to ensure it ships on time so you don't miss your selling seasons, and confirm terms and conditions of payments," says Christina Bieniek, a partner at retail consultants Kurt Salmon who specializes in sourcing strategies.

Many options
The online wholesale industry is served by a number of major players including Dollar Days International Inc.'s DollarDays.com, which offers new as well as overstock and closeout products ranging from apparel to household furnishings and consumer electronics. Alibaba.com also operates AliExpress.com, which can provide small businesses with quick shipments of appealing products from overseas suppliers. (AliExpress was not named in the recent fraud investigation.)

Other major online sources of products include Liquidity Services Inc.'s Liquidation.com and Genco Inc.'s GencoMarketplace.com, which both specialize in selling overstock, closeout, salvaged and refurbished merchandise from manufacturers as well as other retailers.

Another option is a firm like etailSales Associates LLC, which matches Internet and catalog retailers with wholesalers and manufacturers, often helping to set up drop-shipping arrangements for merchants who don't want to hold inventory. Rand Koryga, founder and president of etailSales, says he caters mostly to retailers doing from $1 million to $10 million a year in sales.

There are many more wholesalers and other suppliers operating online and offline. But finding the most useful and reliable ones can be difficult, retailers say. "We get random solicitations every day, so we're exposed to a lot of people who don't necessarily know what they're doing," says Crane of Pure Modern, who uses etailSales to find some of the roughly 25 new suppliers he takes on each year. The trick is to find the ones that can come through on product type, quality, price and on-time availability.

Due diligence
At both Pure Modern and 3Gorillas.com, the process typically starts with a query to the Better Business Bureau, checking references with other retailers, visiting trade shows to meet wholesalers in person and, increasingly, searching for mentions of a wholesaler on online social networks and blogs.

"With all the social media sites and blogs about products, there are a lot of sites where people don't hold back on comments," Scriff says. "And if I do a Google search on a wholesaler, it will give me information I need to know."

After recently finding tablet computers available over the Internet from a foreign supplier with whom he was unfamiliar, Scriff did a quick web search to find a U.S.-based wholesaler of the same product and placed an order."There's a certain comfort there, to use a local wholesaler," he says.

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