Online Retail – The Revolution?

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In a commerce class in school, I was taught that the point of a business is to earn a profit. Online retail startups have certainly caused me to question this notion.

 

Money, money everywhere; not a cent to be earned!

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I find it quite amazing that there is immense investor confidence in a business that is unable to turn a profit even with millions of users on board. The best (perhaps the only) analogy for the current online retail scenario would be the airline industry.

When airlines started flying people in the 40’s; there was a lot of excitement about growth opportunities, and the loss-making nature meant that governments owned most airlines – more as status symbols rather than viable businesses. Eventually, private companies got into the game and operating running airlines as well. At the time, it was believed that with increasing connectivity between several cities as well as an increasing number of people using airlines, it was expected to become a viable business and a profitable business. But, as time progresses, we can see that this expectation has not been met. On every occasion, other reasons have been blamed for the lack of profitability in the sector: SARS, 9/11, hijacking, disappearing planes, and so on. Nonetheless, airlines have not been able to consistently turn a profit. This has resulted in many mergers and acquisitions, amalgamations, and even bankruptcy.

The only type of airlines that have been successful are the ones which have specialised in a very specific segment (corporate/business customers) or geographical region. The sad consequence is that one of the bigger airlines always acquires the profitable operation and tries to scale it, resulting in its inevitable decline.

Online retail, by comparison, is a far more recent phenomenon. Ideally, it should be compared with retail, which is what it promises to replace. To date, the success (in turnover) of online retail has relied on discounting. Walmart also relies on discounting, and by relying on any means necessary (paying extremely low wages, providing hard terms to manufacturers, etc.), they have managed to run a business that is highly profitable.

With Flipkart securing a funding of $1 billion, followed instantly by Amazon announcing to pump $2 billion, there has been a lot of commentary about online retail and the opportunities that lie ahead.

I think the point of a business is to create value, and that value creation results in profits. A retailer makes it easier for you to explore a multitude of products, compare brands and buy them. The online retail industry provides nearly the same service offering, along with the added convenience of being able to shop from home. The only difference is that the retailer sources the goods at a lower price than the one at which it is sold to you. Unfortunately, the selling price of products on online retail platforms is lower than their purchase price.

 

US Airways Amazon

Is it not amazing how similar the profitability trends seem? Essentially, there is none.

US Airways Vs. Amazon

Different industries, same struggle.

 

Now, I understand that for certain businesses, in order to be profitable, you need to have a minimum base of customers. Social Networks are shining examples of how that works. Having said that, if you cannot make something work profitably with 20 million customers, how will ramping that number up to 100 million make any difference? Even if you do make a profit, the margins are going to be in the low single digit percentages. I find it hard to justify investing billions of dollars to generate a profit in the millions (and most likely tens of millions, and not hundreds).

 

WACC

This chart sourced from an IATA’s 2013 report shows how well the returns have worked out for the airline industry. Investor value destruction!

 

I believe the online retail industry is headed the same way, at least from the point of view of “all-under-one-roof” retailers.

Similar to the case of airlines, there is some oasis of hope. There are online retail firms, not unlike the airline industry, which specialise in a very narrow segment of product offerings. DollarShaveClub, Bonobos, NastyGal, Diapers.com, and closer home, Myntra.com, are examples of models that work well. Unfortunately, similar to the airline industry, these smaller firms, which will never have very high turnovers, are acquired by larger players, since it makes for a nice press release and helps keep investors at bay. At the time of acquisition, the larger firm tries to “integrate the business” and benefit from the “synergies”, and end up running the business to the ground. If they leave it alone, it may just work – it has shown success in its current form after all! This has happened time and again in the airline industry; it remains to be seen how it plays out in online retail.

So why the investments? Well, if we come back to Flipkart, the investors invest a large sum of money into the company because it furthers the company’s chances of an IPO. If the company is sitting on $500 million in cash in 12 months’ time and files for IPO, they will certainly be able to sell through the IPO and exit neatly. The CEO, on behalf of the investors, made clear the hopes that would be sold to IPO investors – A $100 billion valuation. So, even if they project a $20 billion valuation at the time of listing, which would be close to three times the valuation at which the funds were raised (if rumours are to be believed); as compared to $100 billion, it will still appear as though there is still more value to be unlocked. And as far the current investors are concerned, 300% in 12 months is not too bad a deal, is it?

If Amazon were to be used as a benchmark, the possibility of running an online retail business with decent profit margins seems remote. To add to that, Amazon itself has always been ready to enter into a price war with anyone who strays into its territory, since its investors seem quite satisfied even if the company posts a loss. Therefore, if profits ever exist, they will always be extremely low.

Will Flipkart be able to keep hopes up without turning a profit? Well, only time will tell!

 

Startups Club Demo Day

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We as a part of Startups Club organise a Demo Day every year. It is an event which promises great opportunities to network with like minded people, while at the same time providing participants an opportunity to mingle with the special invitees who are a part of the event. We assemble a set of speakers, who have been a part of the industry and the startup eco-system and are able to provide a great deal of perspective to one and all. This event also provides 10 startups the ability to pitch their idea to the guest panel and the audience to secure much needed validation and perhaps the opportunity to seek out funding for their venture.

In order to organise and produce this event, we need funds and the entire sum cannot be drawn out of our members since that would put undue burden on them. But the show must go on…

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So in order to make this possible, we seek sponsors and partners who are able to provide us money as well as the support that we need in order to make this day possible. We are privileges this year to have some excellent sponsors and partners who have made this day possible.

VIT-TBI – The Vellore Institute of Technology – Technology Business Incubator has been supporting entrepreneurs for over a decade now. The TBI has some of the best facilities and is extremely well suited for those who are seeking to start a technology business. I have been associated with them for over a year now and the effort that the Incubator commits to its incubatees is phenomenal.

Luxaire Designer Fans – Luxaire is a company based out of Bangalore which took the bold step of introducing luxurious fans to the Indian market. The company has some pretty amazing names in its client list though it is a startup which is just over a year old. They cater mostly to clients with a discerning taste for luxury.

Droog House – Droog House is a cosy and homely serviced apartment located on Nandi Durga Road in Bangalore. The family run property has served as venue for the Bangalore meetup of Startups Club on multiple occasions. They have extremely well appointed rooms and are a wonderful choice for business travellers especially since they are extremely affordable.

StartupBRICS – StartupBRICS is a french blog that covers startups in the BRICS countries. We developed a close relationship with them while we were travelling across France to get an understanding of the eco-system. They have helped promote the Demo Day internationally. We hope to do great things with them in the days, months, and years to come. Stay tuned on this one!

College Fever – A college kid wanted to find out all of the college events going around in India, there was no way of finding out. This frustration resulted in thecollegefever.com. The website aspires to become a platform where all of the college events would be listed and students across the country can find the events that most suite their interest. The site is up to a strong start!

Siam Computing – The company has been involved in the process of offering the services of mobile and web development to various companies in India and internationally. They have used the learnings that they have gathered over the years to develop Hisabing which is a accounting cloud based service.

Trivium Creations – A design house based out of Bangalore, this company aspires to be a design power house. They offer a variety of designing services, though they are best known for their website designs. They sponsored the website for Demo Day and we were really happy with the work that they have done for us. If you need a great website, I would definitely recommend them.

Eyes Envy Media – A photography and videography startup which is in its first few months of operations is sponsoring the photography and videography for the Demo Day. A set of extremely talented and passionate individuals. Check out the pictures of Videos of Demo Day that we post (not on Demo Day, but after). If you like the work, get in touch with them!

Ginserv, TiE, IAN and Hub for Startups are eco-system partners who have been providing us all of the support for promoting the event and provide the guest panel.

We are extremely happy to have had the support and association of all of these wonderful organisations who have made Demo Day possible.