Online retail - A sunrise industry..Or A sunset business!

Go through any industry articles or job fairs or articles on business or Private equity websites...one thing which has created the highest buzz is  e-commerce / online retail. Here is a sneak peek into the industry and my views on it and how I feel that this industry is somehow going to spell doom to a lot of industries before eventually spelling its own doomsday.

A. Only industry which has not made money before getting sky rocketing valuations

Lets look at any industry in the world which was in a start-up phase. (Oil industry, Automobile, Engineering and construction or even services industry like IT, financial services etc.) Not even a single of the current biggest global industries currently started up with a business plan which would burn the pockets of their own investors without having any substantial revenues. Most of the e-commerce companies in India offer only a single value add - Lower prices !! That is essentially because they are burning their own cash. Its like, I buy something for 100 and then sell it for 85. Obviously, there will be a huge demand for it because I am myself making a loss to ensure that I get customers. No single industry which has survived since inception, has had such a business model. Look at any of the biggest companies across the world for that matter, all of these companies have serious revenues and operating profits not because of their cost competitiveness but because of their ability to cater to a certain market demand at a price which does not make them lose their own money. Funnily though, venture capitalists and private equity funders are going crazy assuming that they can sell it later to someone who is crazier!

B. Almost negligible revenues for some companies valued at a billion dollars

On one side of the spectrum are some giant e-commerce companies like flipkart, snapdeal or amazon who have few billion dollar revenues whereas on the other side there are a lot of e-commerce companies who have negligible revenues and are still commanding really huge valuations. The other day I was looking through zomato numbers - their revenues 30.6 crores (5 Million dollars) and operating loss 41 crores! wow...revenues lower than operating losses and the company commanding a valuation of nearly a billion dollars! Even a novice would say that this is absurd!

C. Huge overheads

Though these companies claim that they have lesser overheads in terms of store space etc, they have serious overheads in terms of employee compensation and rentals that they pay for their plush offices. Most of the employees in the middle and top management are grossly overpaid due to the huge amount of funding that they have got. Also most of these employees have little or no knowledge of the industry as the industry itself has just started building. An MBA employee with 2 years work experience in these companies would be paid at least 3 times higher salary than a 5 year work experience MBA at a company like L&T or Infosys.

D. Funny discounts vs spreads

Typically the spread between a retail outlet and an e-commerce website selling products is 5-7% considering the costs of real estate vs courier. This spread narrows when we move into tier 2 cities in India as the cost of real estate is lower whereas cost of courier remains almost the same. So an average of 5% lower prices is justifiable. Most of these websites offer 20% discounts and on some days even 40-60% discounts! Unjustifiable!

E. Retail killers

Their self destructive model is not just burning investor money but also killing a lot of smaller retail players who would not have deep pockets to keep burning such money. Hence some of them are already closing down and in time most of them would. Essentially this would not only lead to destruction of their own industry but also that of the traditional retailers.

F. Price sensitivity

The Indian consumer is very price sensitive. If for some reason, any of these e-commerce websites start commanding a premium for their services, there is zero switching cost to another retailer. That would mean that however hard they try, they will never be able to generate a loyal customer base. So the typical valuations which come from sales ratios or per customer numbers are all likely to go for a toss as soon as they try to command a premium.

G. Burning pockets

The pockets of these investors are burning rapidly and it would be soon that they would run out of cash. Most of these investors are able to survive currently due to perceived increase in valuations which would collapse as soon as the non sustainability of this business model becomes apparent.

H. Other stakeholders

A successful business not only generates revenue for itself but also for other stakeholders in the business. For example, TCS would not only make money but will also give solutions to their clients which would help them save/ make money. On the other hand, other stake holders in this business like the local vendors or sourcing agents in this business themselves are losing money thanks to seriously huge discounts they tend to offer. So it would soon run out of this support system too and would make it even more difficult for them to survive.

I. Not even operating profit

Not even a single company has been able to clock Net Profits in this industry. Forget Net Profits, they cant even have operating profits! Some companies are more than 5 year old and few are as old as 8-10 years! If they cant even clock operating profit, how will they ever get into net profit considering their ever increasing over heads. Had this industry been funded by debt rather than equity, all these companies would have filed for bankruptcy by now!

J. Market stagnation

The current size of Indian online retail is around 4.5 billion dollars compared to the total retail size of 500 billion. That is around 3%. Even in US which has higher internet penetration, more urbanization, greater net literacy, the online retail size is less than 2.5%. Considering that Indian retail industry penetration has exceeded US, it is likely that over a few years, the industry will go stagnant. Tier 2 and Tier 3 cities in India are less likely to be penetrated by them considering the above mentioned background about the real-estate vs courier cost spread.

Looking at the above factors, I feel that this bubble of valuations of e-commerce is likely to burst and with it, it would lead to serious crises in cash and credit markets considering the amount of investments that have gone into this black hole sucking cash at a rapid rate!