New Delhi/Mumbai: Up until last year, private equity (PE) and venture capital (VC) investors were engaged in a frenetic race to fund Indian e-commerce companies as they sought to tap a market seen to have enormous potential for growth.
Now, investors and experts are warning that the country’s e-commerce story is at risk of losing its sheen as online retailers ignore the sustainability of their business models and chase market share to drive up valuations.
Urvashi Sahay, founder of Excluzen, which offers customized luxury products and deals, goes to the extent of comparing the e-commerce scenario in India to the dotcom boom that turned bust in the West more than a decade ago. Sahay watched that collapse from close quarters, having spearheaded Vodafone Group Plc.’s Internet initiatives in Europe.
A flurry of new online retailers has made it possible for Indians to buy everything from books to washing machines with just a few clicks. But is the fledgling industry headed for trouble?
“I see India where Europe was 10 years ago and I see some people making the same mistakes all over again,” said Sahay.
“There are absolute comparisons between then and now. It’s like seeing the mirror twice over. Firms were spending millions on advertising. Valuations were touching the roof. They kept ballooning as venture capital funds were buying from each other based on notional estimates. But, when the time came for VCs to exit, no real shareholder wanted to invest,” she added.
There are early warning signs of the fading appeal of e-commerce ventures for investors. In the first six months of the current year, the sector saw 27 deals valued at $103.6 million while the same period last year saw 18 deals valued at $177.83 million.
The entire 2011 calendar year saw 38 deals worth $392 million, according to VCCEdge, which tracks PE and VC activity.
Over $750 million has been invested in the e-commerce sector by PE and VC funds over the last five-six years as investors attempted to ride a predicted boom in the online marketplace.
E-commerce transactions touched Rs 8,146 crore in 2007, more than doubled to Rs 19,688 crore in 2009, and crossed Rs 45,000 crore in 2011, according to estimates by the Internet and the Mobile Association of India (Iamai).
The value of transactions is expected to touch at least $70 billion by 2024-25 and could even rise to $260 billion if all factors remain conducive to growth, the association said.
Digital marketing research firm comScore Inc. tracked 1,264 websites under the online retail category alone in May 2011. The number shot up to 1,877 in May this year, said Kedar Gavane, director, comScore.
Those rosy numbers prompted enthusiastic investors to back e-commerce firms with cash, but the hard questions are being asked now.
For instance, India has not seen any real, successful exit of investors from the e-commerce sector so far, Sahay said. That’s excepting the travel website MakeMyTrip.com, which listed on the Nasdaq two years ago.
“Last year, we were spending 100% of our time on making e-commerce investments. Now we are spending half of our time on building these companies,” said Mukul Singhal, vice-president of SAIF Partners, a stage-agnostic investment firm that has invested in e-commerce firms such as firstcry.com, an online store for baby products, and inkfruit.com, an Internet retailer of clothing, footwear and accessories.
Tough questions are now being asked about the long-term profitability of e-commerce firms, and if their current business model is sustainable. Consolidation is a topic of debate.
“There is a bit of introspection going on,” said Mohanjit Jolly, managing director of VC firm Draper Fisher Jurvetson (DFJ) India. He added that issues such as lack of time and shortage of talent required to create a firm in the highly competitive environment are cropping up. “It’s a natural progression that two or three big players will emerge.”
For those who are not able to raise funding, there are two options—perish or get acquired, he said.
Started in June 2010, with a funding of $1 million, Indian e-commerce site Taggle.com ended operations late last year. Not successful with offering service deals, it moved to offer products before, finally, downing shutters.
“The only way to sustain the business at this time is to get into a price war and burn a lot of investor money and try to outdo competition in a ‘last man standing’ game. This practice goes against our philosophy of building a sustainable and profitable company. Hence, we’ve decided to go back to the drawing board to figure out the best way forward,” was the goodbye message it posted on its website.
There could be more Taggles in the near future.
It is now becoming a commonly known fact in the industry that none of the ventures are making any profit, not even the top sites.
Harish Bahl, founder and chairman of Smile Group and a serial entrepreneur who has investments in zoomtra.com, bestylish.com and fashionandyou.com, said there are two options for e-commerce sites—start figuring out ways to be profitable after a firm has hit a critical mass of users or continue on the path of market share grab.
“Currently, optimization is priority No. 2 for most entrepreneurs,” he said.
The effort of garnering more visibility for their portals is leading to a spike in the cost of customer acquisition. Sahay noted that for some brands, the cost of customer acquisition is as high as Rs 4,000-5,000.
“Anything above Rs 350 per customer acquisition is not sustainable,” agreed Kunal Bahl, chief executive of Snapdeal.com, which claims to be India’s largest shopping website.
Bahl, who has used mainstream advertising to promote his portal, said e-commerce firms are grappling with the high cost of inventory. Most online retail stores mirror the model of offline stores—that of placing orders with brands and storing them in their warehouses. While this increases their real estate costs, it also throws up multiple challenges of inventory management and unsold goods.
Pros and cons
Some firms follow the so-called marketplace concept where they only procure from vendors after a customer has placed an order or ask vendors to make the delivery directly to customers. This throws up another set of challenges centred on timely delivery and product quality; sometimes the vendor may lack delivery capability. Both models have their proponents.
Ashutosh Lawania, co-founder and head of sales at Myntra.com, an online retailer of apparel, footwear and accessories, says the former model gives a firm more control over its operations. Bahl of Snapdeal counters that the latter takes several overheads off the retailer’s books even if it comes at the cost of losing some key vendors.
“The verdict is still out on which is the most efficient and best format,” said Harish Bahl of Smile Group. “For procurement of Banarasi sarees, the former is better, while for mobile phones the latter. Maybe both the models will coexist.”
The delivery of products is proving to be another significant cost to the firm.
While some leading firms such as Flipkart.com have built their own army of delivery men, others such as Snapdeal prefer outsourcing to courier firms. Lawania said the former adds to the “overall experience of buying from an e-commerce site as it gives them a point of touch” along with other advantages of timely delivery and quality assurance.
For others, it’s a moving away from the core of what an e-commerce firm should be focusing on and lack of efficiency in the industry as everybody is trying to build its own force.
According to India Goes Digital, a report by Avendus Capital released in November 2011, the cost of outsourcing delivery is higher if aspects such as handling cash (when customer pays upon delivery) are included. Currently, most companies that have delivery men on their payrolls follow a hybrid model of delivering locally themselves and outsourcing for smaller cities.
For every bear, a bull
Bahl of Snapdeal says that once volumes increase, courier firms will build scale and capabilities, making the business more cost-effective. Currently, a 500g packet will cost a firm Rs 70 to deliver by courier, plus Rs 35-45 for cash-on-delivery (COD) charges and another Rs 40-55 in case the product is returned.
Brand loyalty is another concern. “People used to do window shopping earlier; now they do coupon shopping. Brands have very little loyalty and everybody is trying to have everything for everybody with no clear focus,” said Bahl of Smile Group. “An average e-commerce website runs the risk of finding out one morning that its customers have migrated to a rival which was offering a discount of Rs 10.”
Investors are taking cognizance of these issues. “There will be softening in investments for both new companies as well as follow-on rounds,” said Kanwaljit Singh, managing director, Helion Venture Partners. On the losing end will be firms that are “me too” and those which have been funded earlier and have not grown.
COD is another “necessary evil” for the industry. All e-commerce firms are promoting COD to win over customers who are not comfortable making payments online.
The Avendus report says 40-60% of overall transactions are through COD. However, its cost is higher than that of an online credit card payment (due to the collection charge of Rs 35-65 per transaction and a delayed cyclical settlement period that stretches two-three weeks). However, the biggest risk with COD is of returns.
While most e-commerce officials quoted above claimed their return rate (the percentage of products sent back by buyers) is in single digits, they have all heard of firms whose rates are as high as 30-40%.
Even as the opportunity for e-commerce in the country is huge, over 80% of it is made up of travel bookings.
This is set to change with the expected jump in the country’s Internet penetration with third-generation (3G) and fourth-generation (4G) telecom technologies, along with the government’s plan to connect every panchayat (village council) of the country with high-speed broadband by 2014.
According to Avendus, e-retailing will catch up with online travel by 2015.
“E-commerce is skipping the evolution of one generation of retail in the country as organized retail is still underdeveloped in India and people in small cities and towns are leapfrogging to buying online,” said Bahl of Smile group.
So, will e-commerce sites be able to seize the opportunity for growth and also make money for themselves and their investors? The Avendus report has one answer: “For every bear, there is a bull out there.” “Winner takes all,” say some. “The defining trend of our times,” say others.
Vidhi Choudhary and Suneera Tandon contributed to the story.
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