Friday, January 13, 2017

The e-commerce debacle in India

When the traditional value investor looks at the financial statements of e-commerce companies such as Flipkart, Amazon, and Snapdeal, he's forced to rub his eyes in disbelief. Even though these companies are burning cash and losing money hand over fist, they keep on spending on advertising in order to acquire new customers.

This seems to defy all business logic. They are actually losing money on each order, and yet they want to acquire even more customers so that they can continue losing even more money? What business sense does that make ? When is this madness going to end? Do they ever plan to make any money? How and when ?
Sometimes you feel as lost as Alice in Wonderland must have been. If these CEOs are able to raise millions of dollars from VCs , they must be very smart, which means there must be something in the big picture which you are missing. After all, the mysterious ways of VCs who distribute millions of dollars are beyond your limited comprehension . This is why the average observer is forced to conclude that what's happening in this space is beyond his understanding.

We all agree that VCs are the financial wizards of the world , and are much smarter than you and me. They must see value in these companies, which is why they continue funding them.

   The standard explanation is - " this time it's different" - famous last words which older investors have heard many times in the past . However, sometimes you wonder whether the Emperor has any clothes . This is especially true for senior citizens, who heard very similar stories during the internet dotcom boom days.
   In one sense, the dotcom bust validated some of their concerns, and they can't understand why VCs have such short memories , and why they are willing to make the same mistakes all over again. Perhaps this is because this is a younger set of VCs, and institutional memory is short .

The problem is that most of these companies are copy and paste clones who don't have much of a moat. Because they are fighting so intensely for the loyalty of the small fraction of wealthy Indians who can afford their services, they're bleeding to death competing with each other.

   I'm not a fortune teller, and I can't predict when it will end ; or who remain standing once the circus stops. Obviously, the survivors will do well. However, even this is not guaranteed, because the moment you become the dominant player, there will be a new cohort of startups who will come and challenge you - this is what keeps the cycle of creative destruction going.

The winner in these battles was the Indian consumer , who benefited as a result of all the freebies and the cashback offers which these companies offered. Effectively, we have seen a net transfer of wealth from the VCs to the smart cost-conscious Indian consumer hunting for bargains. This is not sustainable, and something has to break.

When it does collapse, then we can all look wise and say, "I knew this was going to happen" , and " I told you so ! " The bottom line is that companies cannot afford to ignore unit economics and profitability for ever. While gimmicks such as full page ads and discounts can fool some of the people some of the time, they will not allow us to create a sustainable business.

Part of the problem is that this is such a hypercompetitive space that it's easy to find a greater fool, which is what allows VCs to keep the valuation game going . When it reaches unrealistic levels, it's a question of waiting to see who comes to their senses. However, because there is so much money at stake , VCs will wait to see who blinks first in order to protect their reputation, rather than acknowledge they made the wrong bet. They are riding a tiger from which they can't get off.

So was all this VC money wasted ? While some VCs will lose money, they are big boys who understand that this is part of the game , and they will bounce back. The good news is that this funding has had salubrious effects on the Indian economy. It introduced lots of Indians to the convenience of online shopping , and because it made digital payments popular , the government now finds it easier to get citizens to move towards a "less-cash" India. The companies also catalysed the creation of a robust supply chain, which delivered goods reliably to people living in Tier 4 cities. Finally, they have helped to stimulate the growth of the startup ecosystem in India . Thanks to the media adulation the founders of these companies received, they have become heroes for the young, who now aspire to follow in their footsteps - they have made entrepreneurship fashionable !

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