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Business News/ Opinion / Have online retailers come of age?
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Have online retailers come of age?

Fulfilment and customer-acquisition costs lie behind the deep losses faced by online-only retail firms

Photo: Ramesh Pathania/Mint Premium
Photo: Ramesh Pathania/Mint

The big business story coming out of India last year has to be the spectacular valuations placed on the online retailers such as Flipkart and Snapdeal. The e-commerce fever in India makes one recall the dotcom boom and bust of 2000 in the US.

The excitement for e-commerce is easy to understand. Customers love the convenience, selection, and the fact that it is often also cheaper. The trade-offs of buying online, giving up touch, feel and see as well as immediate delivery, are well worth it for a large segment of consumers. The proposition becomes stronger when physical stores are hard to reach or unavailable. Non-metros now account for 60% of online retail in India. Estimates may vary, but e-commerce is expected to account for a substantial share of retail in the next five years. Given its potential and the risk to physical stores, many brick-and-mortar retailers have set up an online presence. It becomes an additional channel—sometimes substantial, as in the case of Tesco UK. Still, in India, traditional retailers find it hard to get excited about online sales given the price emphasis of the channel and the need to ensure profitable sales. As a result, they under-invest in the online channel, and in turn, fail to excite consumers. The latter end up buying the same brands from the pure-play online retailers.

The largest Indian pure-play online retailers are Amazon, Flipkart and Snapdeal. Unlike the brick-and-mortar retailers, these firms pursue a valuation game. They sacrifice profitability to build scale. And, the capital markets seem to reward them with handsome valuations. These high valuations are based on the belief that online retailers will be very profitable as they scale up. In addition, it is expected that they will compare favourably to the profitability of brick-and-mortar retailers since online models do not need to invest in real estate and distributed store inventory.

The two Indian online retailers, Flipkart and Snapdeal, are pursuing different models. Flipkart has a copycat Amazon model. It is committed to customer service enabled via heavy investments in warehousing, logistics, customer relationship management, call centres, and customer-facing technology upgrades.

On the other hand, Snapdeal follows a marketplace model that is committed to making it easy for unorganized suppliers to get online. Unlike Flipkart, it owns no inventory and uses third party logistics providers. On account of regulatory constraints in India, Amazon is forced to follow a model closer to Snapdeal. The results for all of them in terms of profitability are poor. Estimated losses for the last financial year are 700 crore on sales of 3,000 crore for Flipkart; 320 crore on sales of 170 crore for Amazon; and 265 crore on sales of 155 crore for Snapdeal. The reasons behind the deep losses for online-only firms are troubling—fulfilment costs and customer-acquisition costs.

One underestimates the fulfilment costs of online retailing. Even if Indian labour costs are cheaper, each order has to be picked up and delivered. Brick-and-mortar retailers do not bear these fulfilment costs. With an average order size of 3,500, the gross margin generated in rupees becomes a crucial indicator of profitability. Globally, gross margin of 25% is the maximum a general merchandise retailer can hope for and they are still stressed for profits. Unfortunately, in India, electronics currently accounts for the majority of sales, where gross margins are half of that.

Conceptually, there are four categories of products that can be sold online.

• Products that are digital and require no physical handling such as music, software, e-books, airline tickets and insurance. A very profitable business online and also convenient for the customer. Consequently, in time, will move mostly online.

• Products that need physical delivery but the cost of the delivery is relatively small compared with the price of the product and gross margin generated by the average order—expensive watches, handbags, jewellery, gold coins, clothes and automotive. The customer segment that does not need physical touch, feel and see increasingly moves online. The other segments search online before buying offline. For example, the number of dealers visited in the US when purchasing a new car has fallen from average of 4 plus to 1.2. Profitable online model.

• Products that need physical delivery and there is a substantial cost of delivery but consumers are used to paying for delivery at brick-and-mortar stores. Examples are large-screen televisions, white goods and furniture. The segment that does not need physical touch, feel and see increasingly moves online and pay for the delivery unless online players offer free delivery. Showrooming, examining product in physical store and ordering online is substantial in these categories. Relatively profitable online model

• Products that need physical delivery and the cost of delivery is relatively high compared with the gross margin dollars generated on average order. This includes physical books, DVDs and the mother of all online loss-making businesses—groceries. In groceries, the maximum gross margins dollars can be $25 ($100 order with 25% gross margins is unrealistic on average). You may just about break-even on this order as three supply chains are involved—ambient, fresh and frozen. The costs of picking up the order, assembling it and then delivering it in a time window acceptable to the customer are prohibitive.

Nirmalya Kumar is member-group executive council at Tata Sons. These are his personal views.

Comments are welcome at theirview@livemint.com

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Published: 27 Jan 2015, 06:52 PM IST
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