It was not too long ago when stock market investor Rakesh Jhunjhunwala in a TV interview asked his fellow investors Ramesh Damani and N Jayakumar this question. "Where is Flipkart's complete business model? Forget about valuation. I want to know Flipkart’s business model. I want to know how you will be profitable?" questioned Jhunjhunwala.
The zooming valuations and ease at which e-commerce companies have been able to raise money have given rise to such questions of business viability of various players. These companies have been burning capital at the same speed at which they are raising them.
Is the e-commerce sector in India a bubble waiting to burst?
A recently released UBS report titled ‘Is India in an eCommerce bubble? A framework for assessing emerging markets’ e-commerce’ seems to answer this question.
The report says that investor concerns about e-commerce being a bubble in India are misplaced. UBS says that according to its estimates the sector will start making operating profits by 2020. They have analysed the supply chain of offline retail by category and found out there is adequate margin for e-tail in future. The inherent operating leverage and a 700 basis point discount, as a percentage of Gross Merchandise Value (GMV), lower discounting should lead to operating profits in 2020.
According to UBS, Indian e-tail market will grow 10 times by 2020 to $50 billion. This projection is based on a study of the accessibility -- internet penetration, affordability – income levels, adaptability by different categories and accountability.
The key drivers for e-commerce in India will be significant percentage of young population (below 35 years of age) with higher acceptance of technology; growing middle class, multi-fold increase in internet penetration driven by mobile (3G and 4G) and availability of capital to fund the initial growth phase.
The Internet & Mobile Association of India (IAMAI) estimates the Indian eCommerce market currently at $16 bn. E-tail is the most recent segment but with highest growth rates and potential. The marketplace model, according to UBS should gain prominence, given that it is scalable and requires less capital and time.
Out of the current market size of $16 bn, travel bookings with $9 bn has the lion share of the market. Airlines accounts for 56 per cent, rail 34 per cent and hotel and others 10 per cent. The best example of successful Indian e-commerce is a government venture. The Indian Railways booking site IRCTC had $ 3 bn GMV in 2014 with online bookings now accounting for 43% of all bookings. Its success indicates that the Indian consumer is willing to accept technology if it is a compelling value proposition.
When it comes to e-commerce, it is generally said that India will mirror China in growth. According to UBS, internet penetration in India in 2019-20 will be similar to China's in 2012. India's population is comparable with China's but only in total size and not by income level segments. While China's e-commerce began growing in 2007, a similar trend in India might not be obvious, given a much smaller middle-income population.
UBS says that India’s middle class in 2020 of around 66 million will be smaller than what China had in 2008, which was 75 million. Further, Chinese companies like Alibaba benefited from a relatively closed economy in China. India, however, will benefit from technological advances and more powerful analytical tools, which was present in China’s e-commerce growth years. There is another differentiator in India. Indian consumer wallet spend is different from consumers in China and the US. Grocery forms a significant proportion – 65 per cent of the retail market in India.
E-tail in India is at a nascent stage and companies are concentrating on growing as fast as possible rather than being profitable. This is aided by capital availability, leading to aggressive discounting, which is driving up GMV. UBS says that this does cloud objective analysis and many investors as well as offline retail companies view it as a bubble which will burst shortly.
But this does not seem to be the case, as per the report. E-tail is basically replicating the role of distributor/wholesaler and the retailer. If margins of these two components of the supply chain currently in offline is adequate to cover the operating costs of e-tail (including logistics), then e-tail is definitely a viable business. E-tail operating costs (ex-discounting) range from 10 per cent to 15 per cent of GMV in various categories and its viable categories are those that have low handling and logistics costs but higher margins for distributors and retailers, such as apparel, footwear and personal products.
As for Rakesh Jhunjhunwala and his fellow investors, they will have to wait till 2020 to invest in a profitable e-commerce company. But in the meantime, investors can participate as per UBS in logistics providers, mobile internet providers, online classifieds and travel companies and companies selling premium products on the internet.