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Is quick commerce a sustainable business?

This category of work force had already been exposed to the risk of accidents the day affluent folks like us began enjoying the convenience of home deliveries. The clock cannot be turned back on this.  (Photo: Mint)Premium
This category of work force had already been exposed to the risk of accidents the day affluent folks like us began enjoying the convenience of home deliveries. The clock cannot be turned back on this.  (Photo: Mint)

  • 10-minute deliveries are the flavour of the season. Making the model viable will be a herculean task
  • The last mile delivery cost for quick commerce companies is likely to be twice that of the regular ecommerce platforms. Smaller the order size, more the number of trips required.

BENGALURU : This is absurd! It’s going to put undue pressure on the delivery personnel, who are not employees and who have no benefits or security, who have no bargaining power with Zomato," Karti Chidamabaram, a member of Parliament, recently tweeted.

He followed this tweet with another one: “This is a 10-minute-long gamble with a gig worker’s life".

On 22 March, Zomato announced a 10-minute food delivery plan, bringing the idea of quick commerce and that of road safety back to centre stage.

Zomato had anticipated such questions around the safety of delivery personnel and had put out a detailed note describing why safety wasn’t being compromised. This didn’t cut any ice with the audience and social media went ballistic.

After cryptocurrency, quick commerce has been the flavour of the season. Besides the higher risk of road accidents, a second debate, and one that is perhaps more important, involves the need for such an offering—is the need real or contrived?

All new ideas were probably scoffed at when introduced for the first time, including by those who swore by them after they were successful. Probably, there is an element of this in the response to quick commerce. It certainly fulfils a latent need, but the question I’ll try and answer here is whether a large and sustainable business can be built around this idea.

First, let’s compare the economics of the two models—quick commerce and the traditional full-service ecommerce—by looking at their building blocks.

Procurement

In India, the selling price of products is regulated by the concept of a maximum retail price (MRP). Since retailers have no leeway on the maximum price they can charge consumers, they have focused on buying efficiently.

Therefore, procurement teams at retail companies spend a significant part of their time negotiating favourable terms of trade (ToT) with manufacturers and distributors.

Margin, the spread between their buying price and the sales price to customers (MRP less discounts), is probably the most important ToT that is holy-grail in the retail world. This is by far the metric that has the biggest impact on a retail company’s bottom line and is part of every CEO’s scorecard.

Retailers have a few more aces up their sleeve when it comes to squeezing additional margins from manufacturers. By controlling which products their customers have visibility and access to, retailers can play one brand against the other and charge brands a fee for prominent display. And, depending on whether the retailer is an ecommerce company or a physical retailer, the prominence of display could be in-app or in-store. Therefore, ‘margin’ plus ‘display income’ forms the revenue line for a retailer.

Unsurprisingly, the margin that brands are willing to part with, depends on the buying heft of the retailer. Higher the buying volume, higher the margin that a retailer commands. So, it could take many years before a new retailer could expect to earn margins that more established retailers, with higher buying volumes, would command.

To start with, a new retailer is likely to make a margin that is about seven percentage points lower than what an established retailer would make, and this is a very significant gap given that the total margin plus display income is expected to be around 25% give or take a few percentage points.

To cut a long story short, if a retailer with a new business model achieves a rapid product-market fit, they would scale quickly, and their margin structure could soon be in line with that of the established retailers.

However, if the volumes continue to remain low, there is little that this retailer could do to compensate for the margin shortfall because there are no levers available that have not already been tapped into and squeezed dry by large retailers. Margin expansion is an arduous task that needs meticulous attention to detail and dogged persistence. It doesn’t happen overnight.

Another big lever that large retailers have used for boosting margin is the idea of ‘private labels’, also known as ‘store brands’.

The tussle between the power of brands and the power of distribution has been an old one. This tussle is between ‘pull’ created by a brand and the ‘push’ that a retailer can make by controlling shelf space. Over the decades, as large retail chains began emerging, store brands began making a presence. With mounting real estate costs, retail chains had to think of innovative ways of improving margins. Store brands started by establishing their presence in categories where differentiation was difficult like staples and other food products. As someone once observed, ‘after mastering the art of selling everyone else’s stuff, retail chains and marketplaces began persuading shoppers to buy their own stuff’.

A new retailer may take many years before being able to create credible private labels. Hence, this lever for margin expansion is likely to be unavailable in the initial years for a new retailer, and it requires a lot of hard work and investment to create meaningful private labels. So, if quick commerce does indeed survive the initial hiccups and challenges, it has to go down the same path of creating private labels to make the business sustainable. The path to sustainability is a long one. No shortcuts.

Warehousing

Every large retailer needs to operate a chain of warehouses. When a retailer does not have its own warehouses, it would need manufacturers to deliver merchandise directly at the stores (could be front-end stores that customers walk into or dark stores that are used as fulfilment centers for last mile home deliveries). Besides causing interference in store operations, this approach would require outsized stores with excessive rental costs, to carry high inventories.

High inventories are inevitable in the absence of warehousing because manufacturers have a replenishment schedule that optimizes their logistics costs rather than the inventory carrying cost of the retailer.

Therefore, on the face of it, it appears that the warehousing costs are no different for the two models. However, one can argue that since quick commerce companies carry a much lower assortment, anywhere between 1,500-2,500 stock keeping units (SKUs), versus 10 times or more that number for the regular ecommerce companies, their warehouses would be more compact, and could be operated more efficiently. But this is more than offset by the need to open a large number of ‘dark stores’ across the city at prime locations. Netting the two, the warehousing cost for a quick commerce player could be a percent or two higher than in the full-service ecommerce model.

Assortment

The importance of assortment can never be underestimated. It’s not without a sound reason that asset-light marketplaces for grocery like ZopNow and Localbanya, despite all the initial hype, disappeared as quickly as they came.

Asset light models which leveraged hyperlocal supply to deliver groceries to customers failed spectacularly simply because they didn’t deeply understand that the reason a customer shopped online was because she wanted to avoid a visit to a physical store.

Therefore, if a customer wanted 12 items, it meant that you couldn’t deliver 11 items and force the customer to visit a physical store for even one item. Then she could as well buy the remaining 11 from the physical store. The implications of this customer insight were tremendous. It meant that dry grocery would never be a differentiator. Anyone who could crack the wicked supply chain for fruits and vegetables (F&V) would have a huge advantage. F&V constitutes a big chunk of quick commerce and this is a tough category to crack and needs patience and commitment.

One could argue that mom and pop kirana stores don’t carry the kind of assortment that either modern retail or traditional ecommerce companies do. True, but then no one orders online from a mom-and-pop store. These stores cater to a different kind of customer base altogether. Though some of the kirana stores have been doing home deliveries to retain customers, the priority is always in-store customers.

The last mile

The last mile delivery cost for quick commerce companies is likely to be twice that of the regular ecommerce companies, and here is the simple math: The average order value in quick commerce is around 300-400 and the delivery cost is 30-40. The delivery cost is therefore 10%. For a mainstream ecommerce grocery company, these numbers could be in the range of 1,000-1,400 and 50-70 respectively. The delivery cost is 5%. Smaller the order size, more the number of trips to deliver the same value, the more inefficient is the delivery.

In summary, the difference is 7% in margin and 5% in last mile delivery cost. This adds up to 12% and that is extremely difficult to bridge. Therefore, even if quick commerce scales rapidly and derives economies of scale in procurement, it would need boatloads of money to be burnt for acquiring customers. And the moment customers need to pay what it takes to make this business profitable, the market size would shrink. A classic catch-22 situation.

High last mile delivery cost is inherent to the quick commerce model, and this will be its proverbial Achilles Heel. The reason why the kirana stores have thrived is because they have done away with last mile delivery costs by getting customers walk to the store.

One can of course argue that quick commerce companies can charge their customers a delivery fee that will help them make up this gap, but then many customers would wonder why they can’t wait a little longer and get the same items in an hour unless they’ve run out of something urgent, like say baby diapers. What’s the tearing hurry to get stuff in 10 minutes? It’s not as if it’s a medical emergency. At a price point that makes this model viable, the market opportunity is unlikely to be anywhere as big as is being projected in the internal business plans of the quick commerce companies.

Real or contrived?

This brings me to one of the points we started off with and that was whether the need for this offering is real or contrived. I will stick my neck out and say it is contrived.

In my opinion, a need is contrived when the marginal utility of fulfilling that need, as perceived by the customer, is significantly lower than the cost of fulfilling that need for the service provider. A persistent gap is what makes a product or service eventually unviable. The proof of the pudding will be when quick commerce companies begin to take steps to make their operations profitable, and the flip to profitable growth at some point is inevitable.

That brings us to the question whether quick commerce puts the delivery personnel at greater risk of accidents. This model does not necessarily increase that risk. The risk of accidents in any home delivery is just about the same. Delivery personnel in every model, including those where deliveries do not have to be made within a defined time slot, are working to maximize their earnings because of the way the incentives are structured. So, whether the deliveries are made within 10 minutes or 30 minutes, the pressure on earnings is just the same. Irrespective of what anyone might claim, the harsh reality is that this category of work force had already been exposed to the risk of accidents the day affluent folks like us began enjoying the convenience of home deliveries. The clock cannot be turned back on this.

Some years back, grocery subscription business was the flavour and several startups garnered funding around this idea. But it was obvious from the word go that the model was not viable on a standalone basis. However, as one of the offerings of a full-service ecommerce company, it made economic sense. Eventually, every startup that built a subscription business in grocery was acquired by a large online retailer. In similar fashion, there is a need for 10-minute delivery but that need is not sufficiently big or attractive enough for a standalone business to be built. This need can be serviced profitably by full-service ecommerce companies.

(T.N. Hari is an executive at BigBasket and advisor at The Fundamentum Partnership)

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