Flipkart-Snapdeal: Through the Looking Glass

A year is a long time in Indian e-commerce. It all looks very different now. Amazon has sucked all the oxygen out, leaving everyone else gasping for breath. Suddenly, the visions of a multi-player, multi-year battle have evaporated and all the venture capital and private equity players have fled the battle scene. It is now Amazon versus the rest. The ‘Rest’ clearly coalescing around SoftBank/Alibaba with Tencent as the supporting cast.SoftBank, in its second coming, is everywhere. After announcing a $1.4 billion commitment to Paytm, it is expected to invest a similar amount in Flipkart while forcing a merger with Snapdeal. Walmart is the shy wallflower, smiling at everyone but refusing to dance.Flipkart has finally managed to raise $1.4 billion – from Tencent, eBay, and Microsoft – with the promise of more to come from SoftBank. Flipkart has clearly modeled itself on China’s JD.com; as a controlled marketplace with a focus on electronics, apparel (Myntra/Jabong) and appliances.Interestingly, Flipkart has become the go-to place for e-commerce businesses after they die – LetsBuy, Flyte, Jabong, eBay India and now Snapdeal. Snapdeal has turned into a Greek tragedy, albeit one in which the founders and even some of the investors have made decent returns, leaving the others to rue their fate. Once again, disproving the ‘too big to fail’ adage.Paytm has split its payment and e-commerce businesses, with Alibaba taking control of the latter. While still a work in progress, the initial capitalisation and chatter seem to indicate a more controlled launch with direct sourcing from China and focus on deals on those products. ShopClues has had a tough year and seems to have lost the plot a bit, hit hard by demonetisation due to a high cash-on-percentage and vendors’ cash-flow woes.Who Moved My Cheese?There is a bigger problem. The market, which rapidly reached $13 billion in 2015, grew only by 12 percent to $14.5 billion in 2016, as per Red Seed Consulting. While there were factors – like reduction in discounts (due to regulation, cash burn) and demonetisation in November 2016 – this suddenly made previously optimistic long-term forecasts of $50 billion, $80 billion, and even $100 billion by some point in the 2020s look like something out of a fairytale.The magnitude of the capital invested in the businesses is surreal at over $10 billion. Most folks are confused and some are angry. Was this all a mirage? Can these companies really hire and fire thousands of employees in just a few years? What about their loans and installments? Who will pay their vendors? Will these companies ever make money?The pundits are out in full force. It seems that the business models were all wrong. Changing habits is costly and not a worthy goal. The companies should have always focused on profits. A lot of mistakes have surfaced.The market was smaller than expected – think between one crore and five crore shoppers and not 120 crore shoppers.Capital was wasted on customer acquisition, marketing, over the top salaries. India is really three countries and the cost of doing business is high. Phew!Also Read: It’s Easy to Criticise Snapdeal, But...Take a Deep Breath And Exhale!Let’s go back to first principles and answer two questions.First, can online commerce be a large business in India?Second, is there a sustainable business model for an e-commerce company that has a hope (or prayer) of making money in India?Of course, the two questions are interrelated in that if there is no sustainable way of addressing the market opportunity, then it really doesn’t exist.Potential For Online Commerce In IndiaAt face value, this seems an easy question to answer. Retail in India is a market around $630 billion (or Rs 40 lakh crore) in size, growing at 8-10 percent a year (around nominal GDP growth) of which only around 9 percent is organised, and only 2 percent is online.Intuitively, the growth prospects of online commerce look bright with the lack of physical retail and the slow pace of fresh real estate development. Given the vastness of the country, one can easily see e-commerce being the more efficient solution to even address the availability issue for many goods.The table above, put together by Kalaari Capital, illustrates the opportunity beautifully. It is quite difficult for organised retail to reach Tier-II and beyond. These are also the cities where smartphone and data penetration are growing the fastest. Anecdotally, both Amazon and Flipkart talk about these cities as the engines of their growth. In China, these already account for a majority of the e-commerce market.While everyone recognises that the next hundred million internet users will be different, they continue to be addressed in the same way except for some lip service with language translations.This is not an English language issue – when deals are good, Indian consumers figure out a way to buy.The real issue is the cost to serve them and the buying process as these consumers come from a different context. They need to be helped – think videos, buying guides and much better and relevant filtering. The industry understands these issues but has been engaged in a brutal war for survival, so there has been no time to implement plans yet. This should change with time.Sustainability Of E-Commerce In IndiaThis, of course, is the more difficult question. Let’s break this down into a few parts:Experience so far.Willingness of the players to keep burning.Global experience, does anyone ever make money in e-commerce?Organised retail experience in India.Almost $10 billion has been invested to generate around $14.5 billion of gross merchandise volume (GMV).To put this number into perspective, $10 billion spread over 50 million consumers means $200 (around Rs 13,000) over-and-above what they have paid for the product. We can quibble with the math but clearly, this is not a sustainable pace and the equation has to change.The good news for the industry is that despite the overall burn coming down since the summer of 2016, GMV growth returned to 20-40 percent year-on-year from October 2016, and is continuing into this year. Amazon seems to have capped its burn at $80-100 million per month and Flipkart at $40-50 million per month.Willingness To Keep BurningThis takes us on to the second point – the willingness to keep burning at these high levels on the part of Amazon, Flipkart and Paytm. Amazon has signaled that it is willing to keep going at these levels ($1 billion or so a year) but despite the slew of new initiatives – Prime Video, payments, grocery – there appears to be recognition that going beyond this is unlikely.Flipkart has raised $1.4 billion, with the promise of more to come, and is expected to have about $2 billion to manage the next few years with. We can clearly see 3-5 years of market growth even if players don’t make money.The Global ExperienceIt is clear that the leaders – Amazon and Alibaba – make money at scale. They leverage their business model to make money not as much directly from retail (as in buying and selling) but from services – advertising/logistics/listing in the case of Alibaba, and Amazon Web Services/Prime in the case of Amazon.However, things get murkier when you move past the leaders and even very large players with GMV over $100 billion like JD.com continue to lose money (JD.com just reported its first profit in the January-March 2017 quarter but has indicated that it could slip into the red again).That said, the scale of burn for the level of GMV achieved in India is historic, to say the least. Amazon has raised less than $7 billion in equity and Alibaba a similar amount while delivering hundreds of billions of dollars in GMV.Flipkart has raised almost $5 billion, while barely achieving GMV of $3 billion.Organised Retail Experience In IndiaOrganised retail does make money even in India. Even in e-commerce, it is only the platforms that lose money hand over fist; the other participants – vendors and logistics players make some money. You can argue that they have no choice but to make money as they are not funded by venture capital.The empirical evidence is always the best way to resolve such issues. Fortunately, the recent listing of D-Mart has given us a company with comparable scale, comparable growth rates yet with a significantly more profitable business model.Therein lies the rub. Having a lower gross margin can still be explained away (early stages of the industry, habit change etc) but the killer is spending 5 times what D-Mart does on the overheads (marketing, delivery, employees).The whole point of e-commerce is to avoid paying for rent, sales people, store fixtures and instead leverage economies of scale to offer a huge selection, lower prices and deliver directly to the consumer.This is also where the waste shows up in the form of crazy spending on marketing, overpaid and just too many employees. Either the e-commerce companies have to deliver 5 times the volume or reduce costs dramatically.There is also a clear valuation disconnect – D-Mart, despite its other-worldly $7 billion valuation is a steal compared to Flipkart’s $11.6 billion valuation.Also Read: How Flipkart-Snapdeal Deal May Unfold As SoftBank Plays MatchmakerView Through The Looking GlassIn the blink of an eye, e-commerce has become a big boys' game with no room for young founders, venture capital or private equity funds.The battle for the Indian market is clearly between Amazon and Softbank/Alibaba.There are some wildcards – Walmart, Tencent (6-7 percent stake in Flipkart is just a toe in the water) and perhaps, the big Indian business houses – Reliance, Tata, Birla.Also, make no mistake, Flipkart or rather its investors need SoftBank’s capital – the backing from the $100 billion fund is why they would ever consider the merger with Snapdeal. This creates a logical long-term exit option for these investors given the SoftBank-Alibaba relationship.Many have discovered that investing in Indian e-commerce is a bit like invading Russia – easy to enter but tough to exit alive!SoftBank is now the king of the hill again despite a disastrous first innings with a $2 billion written off in Snapdeal, Ola, Grofers, and Housing.com. Masayoshi Son is back with a renewed vigor and with an even bigger cheque-book.The next phase will see Flipkart and Paytm getting closer, driven by SoftBank. Amazon will continue its relentless march and bring its entire product range to India. Jeff Bezos has sunk his teeth into the India bone and is not going to let go.Amazon has taken the ‘habit’ stand, positioning itself as the nation’s store “India ki Dukaan” for all things big and small.Flipkart has taken a differentiated position as the store for (mostly) high-value electronics, appliances, and apparel – betting on a large number of first-time buyers in these categories who care about price and service leaving the costly business of habit-creation to Amazon. This seems plausible, as JD.com has shown, but Flipkart must be really sharp in differentiating itself as Amazon is really leaving no white space.Consumers will have to get used to lower discounts and a few more trips to their neighborhood malls as prices normalise online and physical retailers start becoming good value again. We are still in Wonderland though. The world’s largest companies are willing to continue spending billions of dollars a year to please Indian consumers. Enjoy it while it lasts!Also Read: Snapdeal Guarantees Better Pay for Employees Amidst Merger Talks(This article was originally published on BloombergQuint. Sarbvir Singh is an experienced venture capital investor in India and was the founding Managing Director of Capital18. The portfolio of companies that he has worked with include BookMyShow, Yatra and Webchutney among others. You can follow him on Twitter @pen5ta. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)

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Flipkart-Snapdeal: Through the Looking Glass

The battle for the Indian market is clearly between Amazon and Softbank/Alibaba.

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Topics: Snapdeal Alibaba SoftBank