Many merchants in China sell their products across multiple e-commerce platforms. However, a recent Financial Times report claims that Alibaba (BABA 0.28%), the country's top e-commerce player, is asking merchants to choose between its Tmall marketplace and its discount rival Pinduoduo (PDD -0.18%). Merchants who refuse to shut down their Pinduoduo marketplaces would reportedly lose their listings on Tmall.

Alibaba's most vocal critic is Chinese home appliance maker Galanz Group, the world's largest manufacturer of microwaves. Galanz claims that after it signed a partnership with Pinduoduo last May, Alibaba started diverting traffic away from its Tmall store and removing its product listings. Galanz claims that Alibaba's move halved its sales year-over-year in June.

Alibaba's corporate campus in Hangzhou.

Image source: Alibaba Group.

During Pinduoduo's last conference call in November, VP of strategy David Liu warned that over 10,000 of its stores were being forced to pick one platform over the other. Liu didn't call out Alibaba by name, but noted that Pinduoduo faced "prolonged pressure exerted by dominant platforms on merchants to take sides." Liu warned that strategy "ultimately hurts the consumers."

Alibaba denied the accusations in a statement to Financial Times, claiming that it was "understandable that smaller platforms with fewer and limited resources and services, who can't match what we offer, feel overwhelmed." But if you take a closer look at Alibaba's past, you'll notice that it's deployed these strategies before -- and they could spark a regulatory reckoning in the near future.

Alibaba used the same strategy before

Alibaba's rivals (JD 0.20%) and Vipshop (VIPS 0.07%) filed complaints with regulators in 2017 over similar practices. Neither company called out Alibaba by name, but they issued a joint statement declaring that a major competitor was asking their merchants to "pick sides" -- to either shut down their shops on JD and Vipshop, or be cut off by the larger competitor.

JD and Vipshop's complaints fell on deaf ears, since China's original antitrust laws -- which were initially enacted in 2008 -- mainly targeted foreign firms. But last May, Hu Yunteng, a judge of the Supreme People's Court of China, warned in a lecture that China's dominant e-commerce marketplaces were locking merchants into exclusive deals.

Earlier this month, China started revising its anti-monopoly law to target domestic firms with harsher penalties and higher fines. The proposed revisions will allow regulators to impose fines of up to 10% of a company's annual revenue or 50 million yuan ($7.2 million), whichever is higher, if antitrust laws are violated.

These new rules could tighten the government's grip on dominant tech companies like Alibaba, Tencent (TCEHY 0.10%), and Baidu (BIDU -0.56%), which have dominated the e-commerce, cloud services, payments, social networking, gaming, search, and advertising markets for years. That shift strongly indicates that the government could eventually fine Alibaba and force it to allow merchants to sell their products on other marketplaces.

Why is this bad news for Alibaba?

Alibaba is still the top e-commerce company in China by revenue and annual active shoppers, which hit 693 million last quarter. However, the growth of its core commerce business is decelerating as rivals like Pinduoduo and JD attract more shoppers.

Tiny parcels in a small shopping cart on a laptop keyboard.

Image source: Getty Images.

Pinduoduo surpassed JD in total shoppers (but not revenue) last year, and finished last quarter with 429.6 million active buyers. JD generates more revenue than Alibaba or Pinduoduo, since it's a direct retailer, but it ranked third in shoppers with 334.4 million active buyers last quarter.

Alibaba needs to keep growing its core commerce business, since its higher-margin revenue subsidizes the growth of its unprofitable cloud platform, digital media, and innovative initiatives businesses. To widen its moat, Alibaba is opening more brick-and-mortar stores, investing in cross-border and overseas marketplaces, and launching new platforms for lower income markets -- including its Juhuasuan flash sale platform and its Taoxiaopu platform for dropshippers.

Most of these strategies generate lower-margin revenue than its main Taobao and Tmall marketplaces, which charge merchants listing fees and commissions. Simply put, Alibaba seems willing to sacrifice its margins to counter rivals like Pinduoduo and JD -- so the recent complaints about platform-exclusive deals aren't all that surprising.

The bottom line

Alibaba will likely remain the top e-commerce and cloud company in China for the foreseeable future. However, pressuring merchants to choose one marketplace over the other is blatantly anti-competitive and might violate China's new antitrust regulations. Investors should consider this paradigm shift to be a brewing threat to Alibaba's core profit engine, which could in turn threaten the growth of the smaller businesses, which rely on its e-commerce profits.