E-com firms: where’ll they be when the music stops

Post 2008-9’s global financial crisis, the central banks of the developed economies eased liquidity and pumped stimulants into the financial markets to boost spending and demand in their economies. In 2009, the US Federal Reserve lowered effective fund rates to near 0%, which continued till 2016. This was complemented by its quantitative easing (QE) program, under which it bought bonds worth nearly $2 trillion between November 2008 and October 2014. Similar stimulants were pushed by the Bank of England, Bank of Japan and the European Central Bank. Consequently, this freed-up capital encouraged an appetite for risky assets in emerging markets, including India. According to a Venture Intelligence blog, early stage investment in the Indian start-up space reached $2 billion in 2015.

With a potential value of $200 billion, the Indian e-commerce market is among the most attractive destinations for investments due to many factors, including growing internet penetration, young population and rising income levels. The fear of missing out compelled investors, hitherto unfamiliar with India, to invest fervently. A petri-dish, for many smaller but similar e-commerce start-ups, manifested. Propped up by heavy funding and pushed by intense competition, e-retailers offered heavy discounts, resulting in high gross merchandise sales but negative profits. Take for example, in 2015-16, Flipkart Internet Pvt Ltd made a loss of Rs 2,306 crore on revenues of Rs 1,952 crore. In 2017-18, Flipkart Internet Pvt Ltd and Flipkart India Pvt Ltd together lost Rs 3,226 crore. Similarly, Amazon India’s loss in 2015-16 were Rs 3,572 crore, which were followed by losses of Rs 4,831 crore in 2016-17 and Rs 6,287 crore in 2017-18.

Increasing realisation of losses made start-ups to look for cost rationalisation and diversification. For example, discounts were replaced by cash-backs, which could only be used to buy company products. Some e-retailers collaborated with banks to fund discounts on purchase through bank credit/debit cards. Free deliveries, which used to be common inducements, were curtailed. Manpower was replaced by automation for better customer service and driving logistics cost down. Many investors even insisted on having more influence over decision-making, recruitment and wage expenditures.

Yet, even by 2016, profits were nowhere in sight for Indian e-retailers. Meanwhile, the US started to taper its QE program. Interest rates started rising globally, leading to a correction in the global stock markets, which spilled over to the Indian private equity market.

Consequently, insane valuations were replaced by selective funding. In November 2016, Flipkart’s valuation came down to $5.6 billion from $15.2 billion a year ago. As the funding tap began to slow down, smaller start-ups had a choice -- to either be shut down or be swallowed by well-funded ones. At the same time, larger players began looking for acquisitions to fuel inorganic growth. In 2014, Flipkart acquired Myntra, a fashion e-retailer, for nearly $300 million, followed by acquisition of Jabong and PhonePe in 2016. Similarly, rival Snapdeal, which started as a ‘daily deals’ platform acquired a list of companies, including Freecharge and grabbon.com. In August 2017, Snapdeal shelved its plan to merge with Flipkart.

More recently, in May 2018, US retail behemoth Walmart acquired 77% in Flipkart for $16 billion. For all its size, Walmart has been unable to dominate the evolving e-commerce market like the way it dominates the physical retail space. It has a tiny market share of 4% in the US e-commerce market, compared to Amazon’s 48%. Walmart’s attempts elsewhere have similarly failed to take-off. In markets such as China and Mexico, it has shown sluggish growth at best. Other than China, India seemed a lucrative market for Walmart. In its 2012 filling, Walmart disclosed that it had spent $25million to lobby the Indian government to open up the retail sector. Acquiring Flipkart instantaneously makes Walmart a force to reckon with in the Indian e-commerce market. A Forrester Research report says Flipkart, along with Myntra and Jabong, owns a market share of 39.5%, compared to Amazon India’s 31.5%.

Now that Walmart, a strategic investor, has acquired Flipkart, it will look to slow down its acquisition spree and rationalize its business model. Theoretically, the company can stabilize its bottom-line by giving up some of its market share and gaining profit margin by reducing costs and increasing prices. But a more realistic approach will be to diversify away in high growth sectors and follow Amazon’s footsteps.

Amazon’s annualised returns over the last one year, five years and its lifetime are 14.5%, 27.4%, and 36.2%, respectively. In comparison, NASDAQ Composite has delivered -9%, 8.8% and 7.5% annualised return over the timeframe. While it’s difficult to pinpoint the exact reason for Amazon’s success, smart moves with innovative, diversified products have helped its case. In 2017, its spending on technology and content increased by 41.0% year-on-year, signalling a pivot towards being a technology-driven company. Amazon is now not only a consumer goods e-retailer, but also an operator in a wider range of services, such as digital content (Prime video), online digital movie database (IMDb), and online payments processing service (Amazon Pay). Some of these services are freely accessible in return for personal consumer data, handing Amazon more control over how consumers experience the internet. This information can be monetized by e-commerce companies by creating a personalized dashboard based on one’s profile, which is a $200bn dollar industry globally.

To reach Amazon’s level will require a heavy, protracted investment strategy toward innovation and diversification. The early stage investors in Indian e-commerce forged returns due to an exorbitant tide of investments during the early days of e-commerce, but for late stage investors, a key concern looms that this growth, fuelled by organic and inorganic means, will slow down someday depending upon which of the two -- market potential or the investor’s ability to bleed -- is breached first. The question is, when the music stops, will the investors be left with an organized venture with a sustainable bottom-line or a disillusioned unicorn monster.

(Tuhin is an investment adviser and writer; Ankit is an investment banker)