Photo: Mint
Photo: Mint

Is ‘cashless’ the new VC gold rush?

If VCs are going to back payment companies attacking the 'cashless' opportunity, they would be well advised to look beyond growth

For venture capitalists chasing the next big thing, demonetization seems heaven sent. It is oozing ingredients of a great investment thesis: A large potential user base, and huge revenue potential. After all, everyone needs to spend money. And the massive push for a ‘cashless’ economy by the government only seems to be getting stronger. 

So investing in start-ups targeting a cashless economy ought to be a slam-dunk. Or is it? 

Let us back up a little and think about what makes a great investment. Corporate finance 101 tells us that value creation (aka ‘multiplying your investment’) requires two things: growth and profitability. Note two things. Not one. 

Yet, what do we hear VCs talk about? Growth. That is the only God they pray to. Implicitly we assume that somehow companies will manage to become profitable. But profitability is not an accident. Nor is it a given. In fact, experts argue that meaningful profitability is very hard for Internet companies to achieve. And here is why. 

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Many industries struggle to be decently profitable, sometimes perpetually. Airlines are an oft-quoted example, but are not the only ones. Among the factors are product differentiation and customer stickiness. If many players are offering similar products, customers will switch between them for the smallest price differences. It can quickly become a race to the bottom. 

Besides, the massive scalability of Internet companies, which makes them attractive in the first place, itself makes profitable elusive.

“In a brick-and-mortar world, you are typically competing against local peers but not those in another city or state. But Internet businesses know few such boundaries. Which means a Paytm is your competitor regardless of where you are based. Since a Paytm can grow to acquire millions of customers, it will pose a competitive threat to every start-up regardless of location," said an investor-turned-entrepreneur. (Paytm claims its user base has grown over to 160 million.)

So it means only the last man standing is going to win. “Which means the competitive struggle is a life and death fight, not a friendly match," this person added.

Furthermore, once companies have huge growth prospects, they get heavily (often ridiculously) funded. Inevitably, customer acquisition (growth) gets prioritized over everything else. After all, it is a winner takes all market. 

Also, if you are not giving the lowest price, other companies will steal your customers and you will die. We have seen this story play out in e-commerce—a space which saw disproportionate amount of funding and is now seeing a slowdown. The last two years have seen high levels of funding activity in start-ups focused on digital commerce ($1.85 billion in 2014, $ 4.26 billion in 2015 and $1.79 billion in 2016), according to a Grant Thornton report.

If VCs are going to back payment companies attacking the ‘cashless’ opportunity, they would be well advised to look beyond growth and address some basic questions. There is no denying that there is a huge investment opportunity. Over the past four years, mobile wallet transactions have jumped from Rs1,000 crore (60 million transactions) in 2012-13 to more than Rs49,000 crore (600 million transactions) in 2015-16, the report said.

Instead of throwing money on all and sundry start-ups, VCs should carefully consider seeking answers to same questions which they dole out on what makes a great investing opportunity in their media interviews: Is there sustainable differentiation? What happens if a better-funded player copies the business model? Is there a real innovation backed by defensible IP?

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Investors can ignore these at serious peril. If they do, we will again see the spectacle of Flipkart and Snapdeal like players, which haemorrhage for years.

But if you are not a VC, should you care? Unfortunately, start-ups should. When VCs lose big money systematically, it erodes the confidence of their investors and less capital is available for entrepreneurs. It is bad for everyone. 

Also, if investors focus on innovation and differentiation, consumers are better off. They get more nuanced products, which better meet their needs. To illustrate, instead of generic ‘payment’ products, we could see customer segment specific variations. For instance, a vegetable vendor needs daily liquidity to buy his vegetables but a software engineer has no such requirement.

Will investors avoid the gold rush mentality? Unlikely. If history has taught us anything, it is that greed prevails over logic. After all lottery tickets will sell though the odds of winning the jackpot are negligible. 

If investors chase the gold rush blindly, it will prove only one thing: Unicorns are not real. Ironically, that is the whole point of being a unicorn. They were not meant to be real. Alas.

Shrija Agrawal is Mint’s deals editor. Due Diligence will run every week and cover issues in India’s venture capital, private equity and deals space.

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