Why Alibaba Threatens Amazon's Bottom Line

Amazon.com has faced little resistance as it has grown to become an online retailing behemoth, undercutting brick-and-mortar rivals and upending the retail industry. It is by far the largest online retailer in the United States, and while it earns very little profit from its endeavors, the company is still growing at double-digit rates.

Online sales represent just a tiny fraction of total retail sales in the United States, around 6%, so a tremendous opportunity remains for further growth. But the first real threat to Amazon's expansive retail empire is looming, with Chinese company Alibaba expected to raise tens of billions of dollars in one of the largest initial public offerings in history. Alibaba has already launched one website in the United States, 11Main.com, and it's safe to assume that the company is just getting started.

Acting as a middleman
One of the most profitable parts of Amazon's business is its third-party marketplace. Amazon allows third-party merchants to sell items directly on Amazon's website, charging a percentage fee when the products sell. This is basically how Alibaba's various websites function, as Alibaba only acts as a middleman that connects buyers and sellers.

The enormous amount of web traffic that reaches Amazon's site each month offers third-party retailers something that they could not generate on their own. This comes at a price, however, as Amazon's fees can be extremely high. Referral fees range from 6% to 25%, depending on the category, and on top of that sellers also pay a per-item closing fee. If a third-party seller wanted to sell a video game for $50, for example, Amazon would get a cut of nearly $9 based on this fee structure.

It's no wonder that this third-party marketplace is so profitable, but these high fees represent an opportunity for Alibaba. Alibaba is charging sellers on 11Main a 3.5% sales commission, significantly lower than the fees of Amazon. While 11Main appears to be more of a threat to auction site Ebay than Amazon, given its focus on high-quality merchandise aimed at upscale shoppers, it is likely just the beginning of Alibaba's push into the United States.

Ebay has become the standard auction site in the U.S., with enough traffic for items that lack large markets. Ebay also owns PayPal, which allows the company to charge even more fees to process payments. Ebay charges a 10% fee for most items , and Paypal charges an additional 2.9%. Sellers of higher-end items may be drawn to 11Main to avoid these high fees, saving quite a bit of money in the process, and that's not good news for Ebay.

One issue that could eventually drive third-party sellers away from Amazon is the fact that Amazon often sells the same products. Third-party sellers not only have to pay large fees to sell on Amazon, they also have to compete directly with Amazon on price. That makes turning a profit by selling on Amazon even more difficult. Alibaba doesn't actually sell anything, so this conflict of interest doesn't exist on its sites.

Amazon's advantage
There is one thing that Amazon offers that Alibaba does not, and that is an extremely efficient network of warehouses. Amazon offers fulfillment services to its third-party sellers -- merchants ship their items to Amazon, and after they sell Amazon fulfills the orders. This also allows third-party merchants to make their products Prime-eligible, which gives Amazon Prime members free two-day shipping. Due to the efficiency of Amazon's operation, this could result in cost savings for the third-party seller.

This does give Amazon an important advantage, but if Alibaba launches a site selling a broader selection of goods than 11Main with a similar fee structure, the difference in costs for sellers may be enough to negate any advantage of Amazon. Amazon may need to lower its fees, and that would eliminate an important source of profit.

The bottom line
At this point, Alibaba remains a hypothetical threat. But there's no doubt that the company is eyeing the U.S. market, and 11Main is the first step. Amazon has been able to charge high fees to sellers because very few e-commerce sites have so much traffic. I suspect that as competition increases, from Alibaba and potentially others, Amazon will not be able to sustain these double-digit commissions. The fact that Amazon competes directly with its own third-party merchants may be enough to drive sellers to alternatives, and that certainly won't help Amazon's bottom line.

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The article Why Alibaba Threatens Amazon's Bottom Line originally appeared on Fool.com.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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