4 min read.Updated: 15 Nov 2021, 11:30 PM ISTAjit Ranade
These are logic defying times but there is plenty that can explain this online retailer’s mega success
There is a nice little orchard for sale, with many delicious fruit-bearing trees, on a fertile piece of land. Not much upkeep is needed except for watering the trees. You can be assured of an annual income of around ₹100,000 from the sale of fruit. How much is the asking price? Oh, just ₹160 million. Your eyes popped out? At that price, it would take 1,600 years just to recover the price you paid. Oh, rest assured, maybe the yield and price will grow over the years. That growth had better be incredibly exponential, you say. You may be right. But do know that this is actually the price-to-earnings ratio that emerged from the spectacular debut of a fruit-bearing tree called Nykaa. Such was the frenzy to buy its limited stock on public offer that on the very first day, its astronomical price shot up further by 80% and its market value crossed ₹1 trillion, equalling storied old companies like Tate Steel. How to explain this insane optimism?
This column usually keeps miles away from equity analysis and is not going to attempt to justify these seemingly crazy valuations. These are logic-defying times anyway. Andy Kessler recently wrote about an electric air-taxi service to be launched in 2024 that is already valued more than Luftanasa, Easyjet or JetBlue. And a fledgling pea protein company valued more than the entire pea production of the planet. But Nykaa’s performance (not just its stock price) is extraordinary for several reasons, and hence deserves special attention.
Firstly, unlike most other recently-born unicorns, Nykaa is actually making a profit. This means it is generating cash, keeping costs below revenue. Secondly, its recent growth is exponential and likely to sustain. During the pandemic year of shrinkage in gross domestic product, Nykaa actually grew its business. There could be several factors that worked favourably. Forced savings on other services (like eating out or recreation and travel) during the pandemic might have nudged people to spend more on beauty, cosmetics and fashion. Its customers increased their average ticket size of spending. Nykaa’s bill size per customer (the equivalent of ‘average revenue per user’ in the telecom world) is twice that of its nearest competitor. This leads us to the third factor, customer satisfaction. Nykaa spends a lot on customer education through its ‘how to’ videos, social media and influencers.
Nykaa’s founder Falguni Nayyar said in an interview that she was once completely floored by an experience at a beauty store abroad, with its free trials, makeovers, vast choice and so much information under one roof. It was like a woman’s paradise, something Indian buyers had no easy access to. Nykaa fills that gap very well and in turn manages to earn loyal customers. It is not dissimilar to an old-fashioned sari-buying experience in Lucknow or Nasik, where the shopkeeper might indulge potential buyers by unwrapping dozens of expensive Kanjeevarams, Paithanis and chiffons, urging them to examine the spread even if there’s no sale at the end. This experience leaves the customer wanting to come back. The fourth factor working for Nykaa is that it can and does invest in inventory. Unlike other tech platforms that are constrained by regulation in case of foreign ownership, Nykaa is able to hold and invest in inventory, and even own and develop private-label brands. How it manages the potential conflict between its own brands and the premium third-party brands that it also sells is part of its secret sauce. Nevertheless, it is unconstrained by online marketplace rules, which are currently being debated and contested by other online biggies. This freedom to hold inventory is probably another factor that Nykaa investors have considered.
The fifth reason is the size of a huge and untapped market. Not just city-based millennials, but ordinary folks across rural and semi-urban India aspire to buy beauty products. Rising expenditure on personal care and beauty parlours had shown up in national sample surveys as a prominent item long ago.
Foreign brands are too expensive, while local brands need to build trust capital. In beauty products, especially cosmetics, you worry about side-effects like skin rashes. Brand ambassadors help, but endorsements by satisfied users help more in evoking trust. Also, a marketplace is needed where one can ‘browse’ all brands, get free trials, do comparison shopping and evaluate options through user feedback. All this and more is fulfilled by Nykaa’s e-commerce platform, which is supplemented by more than 80 physical stores. Nykaa will need to exert itself some more to sustain its first-mover advantage, but the market size is large enough to support growth for years. Interestingly, Nykaa’s success among aspirational women buyers is in sharp contrast with India’s two decades of declining female labour force participation.
The sixth factor is its execution capability, especially as a tech platform. This speaks volumes about the talent it houses and its constant attempt at innovation. Of course, it is also diversifying into fashion, apparel and other adjacencies. As Harveen Ahluwalia of Morning Context writes, “Nykaa has a first mover advantage in beauty products, but everywhere else is a crowded marketplace with terrible economics." A final major reason is luck: Being in the right place at the right time. The world is awash with liquidity while bank deposits earn negative returns amid a glut of forced savings. Stock market momentum beckons. Is it any surprise that the orchard got to sport a sky-high price? Best wishes for this newborn unicorn!
Ajit Ranade is chief economist at Aditya Birla Group.