February 21, 2011, 3:34 PM

China’s Alibaba discloses fraud on its marketplace that supplies web retailers

The marketplace connects Asian suppliers with buyers around the world.

Lead Photo

Alibaba.com Ltd. has disclosed widespread fraud on its online marketplace that connects Asian suppliers with buyers around the world, including North American e-retailers. Alibaba.com’s two top executives have resigned in the scandal.

The company disclosed that more than 2,300 of its suppliers engaged in fraudulent sales, ringing up an average value of about $1,200 per claim reported by buyers. The company has paid more than $1.7 million to buyers who bought from fraudulent sellers, and says that likely accounts for most of the fraud that occurred.

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 says. About 100 of Alibaba’s sales force of 5,000 were complicit in the fraud, the company said.

The seriousness of the scandal was underscored by the company’s announcement 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. 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.”

“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. Scriff says he has looked into suppliers on Alibaba.com but chosen not to work with them.

Fraud like this is not common on the online business-to-business exchanges where retailers find overseas suppliers, but it will shake up other web marketplaces, says Tat Koon Koh, a doctoral student at Carnegie Mellon University’s Tepper business school who studies these exchanges. “This is going to rock buyers’ and suppliers’ confidence in other exchanges as well,” he says. “I expect many exchanges to comment on how their verification services are credible in the next few days.” 

The fraud disclosed today involved about 2,300 of the 108,000 mostly Chinese manufacturers and wholesalers that sell to companies outside of China on Alibaba.com. But it was more damaging because the suppliers involved had obtained the certification of China Gold Supplier, which means they are Chinese companies that had been certified as legitimate by an outside auditing company.

“We have found that the fraud incidents were an organized attack by professional fraudsters,” an Alibaba.com spokeswoman tells Internet Retailer. “They circumvented our verification procedures by, for example, submitting fake business registration licenses. Obviously, the incident has taught us a lot about the deficiencies of our own system, and we have a good grasp of how to take preventive measures in the future.”

In its statement today, the Alibaba board noted that senior management was aware of a growing rate of fraud claims by international buyers beginning in late 2009. Although the company began addressing the problem in the third quarter of 2010, resulting in the opening of fewer new fraudulent seller accounts, the board “considered that the systemic nature of the problem required a recommitment to the company’s core values.”

The company says 1,219 of China Gold Suppliers who signed up in 2009 and 1,107 who registered in 2010 engaged in fraud. Those sellers represented 1.1% of the China Gold Suppliers at the end of December 2009, and 0.8% a year later.

Alibaba has paid $1,734,250 in partial or full reimbursement to buyers who have filed claims. The company made the payments out of the Fair Play Fund it created in 2009 to provide for reimbursement in the case of seller fraud.

“If a buyer suspects fraud from a Gold Supplier, they should contact customer service immediately at tradesecurity@service.alibaba.com,” the Alibaba spokeswoman says. “The customer service team will then provide instructions on how to verify the fraud and apply for the fund." She says as a result of the complaints that have come into the fund most of the suppliers who were signed up by the 100 Alibaba sales representatives involved in the fraud have been removed.

In order to prevent future fraud, the spokeswoman says the company now mines data in its system to highlight high-risk suppliers. “The new management we put in place will review and revamp the relevant reporting structure and policies to ensure independence of the supplier qualification function.”

Alibaba is a significant source of products for retailers and wholesalers around the world, including North American e-retailers. Alibaba reported $221 million in revenue in the third quarter of 2010 when it had 14.9 million registered users of its online marketplace and 1.6 million storefronts. Yahoo Inc. in 2005 purchased a 40% stake in Alibaba.com, which also owns the consumer-facing marketplace Taobao.com, often called the eBay of China.

The fraud disclosure is sure to make North American web retailers even more cautious about buying from overseas suppliers. And many already were skeptical.

Scriff of 3Gorillas.com says after he recently found tablet computers available on the Internet from a foreign supplier with whom he was unfamiliar he 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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