Have you ever seen a kirana shop owner whose store does brisk business but loses money month after month, and for years? Unlikely, because after a couple of years he would have shut shop and tried another business. Yet, that’s exactly what is happening with the e-commerce business in India. Indeed, the flip flops over Flipkart’s recent valuation markdowns, mask a very dangerous precedent that is in the making. An entire generation of new businesses in India is being built on a model that defies gravity: India’s hottest new companies are busy losing money by the fistfuls, even as they continue to grow.
Of course, new is a bit of a misnomer. Flipkart is in its ninth year of existence as is Myntra the company it bought in May 2014 for $330 million. Snapdeal, another of the e-commerce scorchers, is six years old while Quikr and Zomato have both been around for eight years. Housing.com, which has made news for all the wrong reasons, is already four years old and its losses have mounted with every passing year. Profits have become a four letter term as these companies race to grow the gross merchandise value of the goods they sell, while keeping a hawk eye on their valuations.
In the process, every aspiring young entrepreneur is learning to focus on eyeballs and customer acquisition, to the total extinction of the bottom line as a business objective. Young men and women with fire in their bellies have two goals – funding and then valuations.
India’s best companies of the last 30 years showed the way to setting up businesses with sparse capital, generating cash from operations to grow these business and then rewarding stakeholders. It wasn’t always easy. Within a few years of setting up, Infosys was forced to drop one of its early businesses, selling imported software packages. Yet, it didn’t load up debt. In its first year of operations, the company’s revenue was a paltry Rs.11 lakh and net profit Rs.3.8 lakh. By 1987, as revenues grew to Rs.1.9 crore, net profit was up to Rs.38 lakh. It was a pattern the company maintained through its foundational years. It was the same with most of India’s IT giants, all of who are debt-free companies.
In a sense, the constraints in accessing capital contributed to the growth of India’s IT services industry. In his book “The Living Company”, business theorist Arie De Geus explored characteristics of the few large companies in history that have lasted hundreds of years. Among the defining features of long-term successful companies is this: “Long-lived companies were conservative in financing. They were frugal and did not risk their capital gratuitously.”
Of course, the argument toted out by these firms as well as their backers, VCs who invested in them, is that it is a matter of time and that they are in their early years, so the cash burn is inevitable. Problem is, corporate longevity isn’t what it used to be. A study of European firms some years ago, revealed a corporate life expectancy figure of a mere 12.5 years. While numbers aren’t available for India, they are unlikely to be very different. Which means that most of these start ups are already half way into their corporate lifetimes.
It is evident that the Indian ecosystem for these e-commerce start-ups closely imitates the US model where VCs use the scatter gun method, essentially shooting small amounts of capital into many start ups and needing just a fraction of them to come good to realize massive returns. The quest really is for the next Amazon or Ebay.
The trouble is in a capital-deficient country like India, that’s a highly wasteful model. CB Insights which maintains venture capital and angel investment databases, put together financing and valuation data to figure out the capital efficiency ratios of various unicorns (companies in the billion-dollar valuation club). Its findings were revealing. Enterprise tech companies see higher average and median capital efficiency ratios than consumer tech companies. Significantly, e-commerce companies on the list see lower capital efficiency ratios, mostly under 2x. In fact, the bottom three among the unicorns from a capital efficiency perspective, are all e-commerce companies. Unfortunately, that’s the bucket in which most of India’s hot new start ups fall. The CB Insights list highlights Snapdeal’s 1.9x capital efficiency ratio, when the average for e-commerce companies is 5.9x. Since 2011, the company has received total funding of $1.7 billion.
There is no doubting that ordering online is an irreversible trend that will continue to grow in India. The advantages in terms of choices and ease of transactions are overwhelming. But the passage to the customer’s pocket cannot be built merely on irrational and often insane discounting. What these firms will have to develop are revolutionary new ideas in customer management. Yes, the dealer of laptops in Hyderabad can now count among his potential customers, buyers in Delhi. But that would hardly qualify as a truly breakthrough idea.
As entrepreneurship takes roots among India’s young professionals, we would like to see more capital-efficient start-ups that are not burning cash rapidly and have a real plan for building sustainable and profitable businesses.
Sundeep Khanna is a consulting editor at Mint and oversees the newsroom’s corporate coverage. The Corporate Outsider will look at current issues and trends in the corporate sector every week.