India e-commerce: Sink or swim

Of the 193 e-commerce sites that were operational in India in October 2012, 89 have either shut down or merged with other retailers, essentially wilting under pressure from high operating costs.

Acquisition targets include Sequoia Capital-backed Shopo.in, an online marketplace for Indian handicraft products, which was bought by online marketplace Snapdeal. The transaction was motivated by access to a network of sellers in a niche that would generate incremental value in terms of sales.

"We realized, surprisingly for us, that 95% of their sellers were not on Snapdeal," says Kunal Bahl, Snapdeal's co-founder and CEO. "It was purely incremental for our platform and we were able to offer a very ‘Indian' assortment to buyers."

In another e-takeover, Flipkart acquired Letsbuy in order to deepen its catalogue of electronics products, while online babycare company Babyoye merged with competitor Hoopos in a demand acquisition play, as the companies targeted a similar customer base. Both were backed by Helion Venture Partners.

There will be more strategic acquisitions as the sector consolidates - with those that do have traction consuming those that don't, and filling gaps in their product offerings in the process.

Money continues to flow into the sector as online retailers race to scale up and achieve profitability - around $491 million has been invested in the sector this year according to AVCJ Research. One of the biggest players in the sector, Flipkart, closed a record $360 million Series E funding round to help expansion, on top of the $180 million already invested in the six-year-old company. Younger rival Snapdeal has raised $50 million from eBay and VC, bringing its funding kitty up to $177 million.

Both aspire to reach $1 billion in annual gross merchandise value (GMV) by 2015. Both claim to be already halfway there.

"The goal is to build a platform that aggregates the supply in India's largely fragmented retail sector and connects it with demand across 4,000 towns and cities," says Bahl. Only 7% of the country's $490 billion retail sector is organized and no single lifestyle brand has more than $200 million in annual sales.

Issues of scale

But scaling up has proved a challenge. Of the 137 million internet users in the country, only 25 million are online buyers, according to a report by the Internet and Mobile Association of India and KPMG. By comparison, China has 270 million active e-commerce users. Most of India's online shoppers spend INR500-2,000 ($8-33) per transaction, while only 7% purchase items worth more than INR5,000.

There are also other barriers to making money. "Typically with online retail, even before the goods leave the warehouse, the money is with the retailer," says Milan Sheth, partner at Ernst & Young. "In India that cycle is reversed."

A cash-on-delivery option, introduced to win over new customers wary of ordering online or without credit cards, accounts for a majority of sales. But 10% of dispatched merchandise is rejected on reaching its destination, and the company must still bear the delivery charge.

No retailer has managed to break-even but companies are adapting to meet the challenge. "We do believe that in the next 12-18 months some of them will get to operational profitability," says Subrata Mitra, partner at Accel Partners. His firm has backed Flipkart, among others.

Unreliable third-party logistics and supply chains add to the cost. Flipkart is part of an earlier wave of inventory-led e-commerce companies that started in 2008-2009. It was one of the first to develop its own in-house platform to handle warehousing, packaging and delivery, and needed a lot of working capital to buy inventory. It is estimated that the liquidation costs of even 15-20% excess supply can wipe out margins.

This year Flipkart switched from online retail to become a marketplace where third-party suppliers and merchants, rather than the company itself, bears the cost of inventory and storage in selling products to shoppers.

ShopClues and Snapdeal, both founded in 2011, already follow the marketplace business model. "When we started building out our business, we had the benefit of hindsight looking at the inventory-led companies - while they were growing fast, they were growing inefficiently with respect to the capital invested," says Snapdeal's Bahl.

There are three components to the marketplace fee structure - a platform fee of 5-20% of transaction value, shipping charges and payment collection charges. If a company earns a certain fee level on all transactions, as sales grow so will the total amount of absolute money being made. The main cost becomes marketing.

"If we turn back the dial on marketing we can get profitable in one or two quarters," Bahl continues. "However, that is not the right decision for the company because if we don't invest to grow the market, then we don't grow in the long run either."

Transportation solutions

There are now delivery companies with systems tailored to work with online retailers, such as Delhivery and Ecom Express. However, even with the marketplace model, companies have developed systems to make logistics efficient.

Snapdeal, for example, intermediates all its shipments through a platform called Safe Ship, which automatically match sellers and screened, verified courier partners. It has also built a network of fulfillment centers across the country where sellers can drop off high frequency products for faster deliveries. Similarly, ShopClues has a large proportion of sellers first ship to its fulfillmentcenter and from there packets are shipped to customers.

Snapdeal is now looking to go one step further, working on acquisition opportunities with companies that possess supply chain technologies. The firm has also entered into a commercial partnership with eBay, allowing the US company's India subsidiary to promote its products to Snapdeal's users and vice versa. eBay will also have access to the Indian retailer's logistics software and distribution network.

In part reflecting the increased focus on logistics, most e-commerce firms no longer offer free shipping to all customers, only to those that reach a minimum spend threshold.

"Right now that minimum bar is still below their average bill value," says Rahul Chowdhri, a director at Helion Venture Partners, an investor in ShopClues.com. "Soon they will start pushing that minimum bar because it doesn't make sense to encourage customers to order below the average bill value that you want."

With the larger operators in expansion and consolidation mode, VC firms are looking beyond the mainstream to verticals where consumer demand has yet to be tapped, such as healthcare and furniture. The logic is that verticals tend to be more profitable than horizontals.

"Horizontal plays are likely to achieve much bigger scale, and therefore need more funding for customer acquisition and building out infrastructure," says Accel's Mitra. "Vertical players need to be sharper in their product differentiation with better margins coming from private labels and own brands."

BabyOye, for example, already has its own branded apparel, as do a number of apparel specialists such as Accel-backed Myntra.

The biggest problem with private labels is finding out what sells - online retailers who get it wrong will be left with stacks of unsold inventory. "Once you get a good sense of what consumers want, then your own brand will start building into the revenue and start contributing to the margins" says Helion's Chowdhri.

And success in a niche could provide investors an exit through M&A.

 

SIDEBAR: FDI rules - The workaround

India allows 100% foreign direct investment (FDI) in online marketplaces, business-to-business e-commerce and single brand retail, and 51% foreign ownership in multi-brand brick and mortar retail. However, last year the government clarified that "retail trading in any form, by means of e-commerce, is not permissible for companies with FDI."

India's e-commerce sector has received $1.5 billion worth of investment, according to AVCJ Research, and a number of start-ups have adopted new business structures to get around the ban. "The alternative they have sought is to split the value chain into customer facing and back-end," says Milan Sheth, partner at Ernst & Young.

Business models have pivoted, with online retailers becoming marketplaces that merely provide a platform for vendors to sell to consumers.

In February, Flipkart sold WS Retail Services, its front-end operations unit, to a group of Indian investors. It then set up Flipkart Holdings Singapore, an offshore entity, to own and run the technology and the back-end. A licensing agreement between the Singapore entity and its foreign investors was put in place. The company also shifted from buying and selling inventory to a marketplace model.

Snapdeal also runs its wholesale operations as part of Jasper Infotech, while its order-taking business is called Spinel Tradecom. Amazon too follows the marketplace model in India, although it handles most inventory and storage itself in other parts of the world.

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• Topics
• Technology
• Consumer
• Venture
• South Asia
• M&A
• TMT
• Consumer
• India
• Helion Ventures
• Accel Partners
• Venture
• Exit