Taobao Mall has delayed for nine months a sharp increase in fees designed to improve the service quality of merchants operating on the business-to-consumer website following last week’s noisy protests by small online retailers.

At a press conference today in Hangzhou that included an appearance by Jack Ma, the chairman of Taobao’s parent, Alibaba Group, Taobao Mall officials said that after discussions with merchants, it was decided to allow for a transition period before service fees jump by at least five-fold. The company also is delaying a requirement that merchants put up hefty security deposits that could be forfeited if independent sellers fail to live up to the platform’s product quality and customer service standards.

The increases were set to take effect on Jan. 1, but now most existing merchants will not have to pay the higher rate until Oct. 1, 2012. “We have been listening to our customers and we are willing to listen,” said Taobao Mall President Daniel Zhang. “It seems that our merchants need more time to adjust to the new policy and we are making adjustments to help our merchants to get ready for the change.” The transition period does not apply to Taobao Mall sellers who rank in the bottom 10% of customersatisfaction rankings.

To ease the transition, company officials announced the formation of a RMB $1 billion fund to help pay for refunds to consumers who are unhappy with Taobao Mall merchants’ goods and services. The fund, which will be managed by the Bank of China, is designed to compensate buyers in cases where refunds are not issued by sellers or covered by security deposits.

In addition, Taobao Mall said it would spend RMB $300 million on brand-awareness marketing. The company also plans to provide a total of up to RMB $500 million in loan guarantees to help qualified small businesses borrow from banks if they are having difficulties paying higher service fees.

Taobao Mall, which today hosts more than 50,000 registered businesses, was spun off from the giant Taobao online marketplace in 2008 as a separate website offering higher quality merchandise and branded products from major Chinese and international retailers and manufacturers.

Last week, several thousand small merchants launched cyber-attacks on some of Taobao Mall’s major retailers to protest new policies aimed at improving the quality and service of independent merchants operating on the platform.

Among the changes was an increase in annual technical service fees from RMB 6,000 ($939) to two new packages costing RMB 30,000 ($4,697) and RMB 60,000 ($9,395). Taobao Mall also started requiring merchants to put down security deposits of up to RMB 150,000 ($23,487). The service fees are refundable if retailers achieve certain sales volumes or high positive-feedback levels from customers.

Small merchants complained that the new fees are punishingly high given their revenue streams, while larger retailers with high sales volumes are better able to absorb the increases. They vented their anger by ordering goods from large merchants then demanding refunds and otherwise trying to disrupt Taobao Mall business.

More than 100 merchants were hit by the attacks, which were carried out by nearly 5,600 people, Zhang said during the press conference. A group of 17 people were identified as leaders of the protest, he added, noting that about half of them did not have stores on Taobao Mall and the rest had previously seen their stores shut down because they were selling counterfeit goods or otherwise violated the platform’s policies.

Company officials said they were not bowing to pressure from the protesters by delaying the fee hike.

“The media has made a big deal of the price increase, saying we are driving out the smaller sellers,” Ma said. “We admit that there were problems with our decision making and we didn’t do a good job in communication.”

But “We won’t compromise our principles and we won’t bend under pressure,” he said. “Our principle is to safeguard e-commerce integrity, to fight against fakes and IPR infringement.”

The controversy drew the attention of China’s Ministry of Commerce. In a statement posted on the MOC website, government officials expressed concern over the protests against Taobao Mall, saying the ministry would try to defuse the conflict in order to stabilize prices and support small businesses.

“I believe our measures are in line with MOC’s requirement,” Zhang said in response to a question from the media at today’s press conference. He estimated that up to 5,000 small merchants might ultimately leave Taobao Mall due to the policy changes. The company plans to help many of them switch over to Taobao Marketplace, which charges no fees and is geared for small businesses and sales between consumers.

Ma—who last week blogged that he was very upset by the protesters, describing them as “hurting the innocent by shouting ‘Eliminate all, destroy all’ “—explained that China’s export-led economy faces tough challenges as the global economy slumps, making it increasingly important that the country’s growth is supported by domestic demand.

E-commerce can play a role in that shift, he said, but only if there is a reduction in the fraud, counterfeit merchandise and shoddy service that often plague China’s online marketplaces. “E-commerce is the best solution to increase domestic demand and increase jobs,” Ma said. “We believe that e-commerce in China needs to be upgraded.”