It’s been an unusually busy season for startups. Investors flocked and entrepreneurs jump started new ventures. As companies attempt to crack the profitability math amid intense competition and investor pressure to eke out profits, the question that begs is who’s losing and who’s staying.
The summer of 2016 may be one of the hottest for all of us, but for internet-based startups in the country, Winter is coming.
The phrase, popularised by US television series Game of Thrones, implies ‘warning and constant vigilance’.
Internet-based start ups in India, particularly, e-commerce firms may well be shuddering, a la the dramatis personae of the TV show, at the thought of what lies ahead.
For sometime now, companies have been spending a fortune (read borrowed capital), but barely clock profit. Those who claim to be making operational profit, are chasing growth by ploughing back earned income into business.
This ‘revenue-now-profit-later’ strategy resulted in the nemesis for firms, during the dot com bubble. So it is not surprising that investors are getting restive, and want firms to book profit now.
“There are two concerns. Funding is drying up and two, will companies be profitable soon? Both these concerns are real and the first is related to the second,” says Mukul Gulati, co-founder & managing partner, Zephyr Peacock India, an India-focused private equity firm.
He adds, many e-commerce firms have unsustainable business models, where the businesses are not only unprofitable at an aggregate level, but also at a unit level. “This implies that the more products they sell, the more money they lose. Funding is drying up due to profitability concerns and intense competition,” says Gulati.
In last few years, the segment witnessed an unusual growth in both, investors flocking in and entrepreneurs starting new ventures. But the past few months also saw unsettling developments. A slew of hyper-local startups like TinyOwl, Grofers, Foodpanda, InMobi, LocalBanya, Shadowfax and Zomato have either shut down or scaled back operations. This comes amid growing concerns that the sector is in a bubble waiting to burst. Add to this, investor Haresh Chawla’s recent critical analysis of Flipkart, dissecting the firm’s financial and strategies to prove it is in the middle of a crisis, because of its own making.
Lack of profitable business models is the key issue. This is because the e-commerce sector gained market share away from offline retailers and each other due to low prices. There are marketing costs and logistics costs to be funded.
So the price of the products sold has to reflect the cost of the product plus logistics and overheads. “The industry needs to address unit level profitability urgently,” reasons Gulati.
These investor concerns are not without a reason. For one, most e-tailers, including those doing business for over 6-7 years, have red ink on their balance sheets. Yet, valuations continue to be sky-high.
“There are three challenges the industry is facing. The foremost of them all is, keeping consumers intact, while building a profitable business. Next comes consistency in acquiring new customers and retaining them. Furthermore, the inadequate support functions like logistics are also adding to the woes of the industry,” says Manu Agarwal, Founder & CEO, Naaptol, an online store that’s into home shopping.
Amid all the euphoria, of the 1.3 billion population, ironically, just over 190 million access internet — the holy grail on which e-commerce businesses survives. Worse, of this 190 million, just about 50 million are active users and only a fraction make purchases online.
These businesses are riding on hope that internet penetration will boom. A Boston Consulting Group report pegs internet users in India to cross 550 million by 2018 and rural consumer base by five-fold from 60 to 280 million, while urban base will double from 130-300 million.
“The Indian market isn’t bad. What businesses need is a strong business model that will help gain consumer traction, geographic spread and give decent returns,” explains Vinay Sanghi, Founder CEO, Cartrade.com, which counts JP Morgan as one of the investors.
The Profit Mantra
Experts say, first, one has to be profitable on a gross margin basis. Then make profit on a EBITDA basis, where gross margins are strong enough to pay for marketing and other overheads, and finally the company has to be profitable to overcome depreciation expenses and generate cash to fund capital expenditure. All this take 5-7 years or more. But will hyper-local startups namely TinyOwl, Grofers, Foodpanda, InMobi, LocalBanya, Shadowfax and Zomato that have downsized operations either due to fund crunch or lack of revenue in less than two years of operations, survive that long? It’s anybody guess.
Now, the Going Gets Tough
- Startups saw $5 billion funding, almost $100 million weekly, while over 1,200 tech startups were born in 2015, according to Nasscom
- Active investors rose 220 in 2014 to 490 in 2015
- As of December 2015, eight startups — Flipkart, Snapdeal, Ola, InMobi, Paytm, Quikr, Zomato and MuSigma — form part of the ‘Unicorn’ club — having valuations greater than $1 bn
- Ironically, most of these players are all deep in the red. Flipkart’s losses widened from Rs.344.6 crore in FY13 to Rs.719.5 crore in FY14, while Snapdeal saw its losses mount from Rs.120.1 crore in FY13 to Rs.270.7 crore in FY14
- Flipkart took pole position with a gross merchandise value (GMV) market share of 45% followed by Snapdeal at 26% and Amazon at 12%, as per Morgan Stanley report
- Flipkart's valuation shot up from $1 billion in October, 2013 to $12.5 billion as on March, 2015. Similarly, Snapdeal saw its valuation rise from $1 billion to $5 billion in just a year.