Fables of E-Commerce

After the Facebook fallout and a nearly disastrous IPO (the trading price as and when I write this is about $33.10), I am but not amazed at the E-Commerce revolution in India. From services like 24 hours alcohol and beverages supply to Shoes and fashion clothing at “unbelievable” discounts is something which I can’t digest. This unprecedented growth followed by mindless stake buys by the biggest names in the PE industry is giving shape to a new story. Though I agree that the big brother push (PE’s, Bankers and policies) is required to germinate a solid foundation for any industry, however, the economics are astounding and make me wonder how the firms are surviving.

My approach is based on following platform of ideas:

1)     The customer acquisition (fabrication)

2)     Big Discounts – myth or a short-lived opportunity

3)      Huge money being pumped (again the FB story wherein an asset is being tossed after a good story at a fat price on someone else’s balance sheet)

I will focus on the Fashion/ Clothing/ Households products etc. in this blog. Though I know the potential for services is huge, however, the big push is in the E-tailing industry and this blog essentially focuses on perils of the same.

Lets start by focusing on why will I buy a particular brand?

a.      It gels with my persona

b.     It augments my persona

c.     It is value for money (again to augment my persona)

d.     I trust the brand

The value offered by a brand is exactly the price is comes for, this I learnt from a renowned professor during my one off interaction at a seminar. And I kind of stick to this story, i.e. the price I pay at the start of a season is always high due to the exclusivity offered. As the season progresses, the value of the product or a style always diminishes and finally goes on a discount, unless it becomes like a Tote from Gucci or the signature LV bag. The economics works like this, a brand always tries to unlock its investment and at least 50% of the target return in the first few weeks of a season of say 4 months. Post this; whatever the stock left is either bundled with the new marketing campaign or sold off slowly at a discount starting from 10% or more, again depending upon the brand strength. Eventually when the product or SKU reaches the clearance stage, it is the eccentric sizes/ colors/defected pieces which are left on the shelf.  However, a brand which sells at a discount from Day 1 or tries to sell eventually becomes a discounted brand, it not only loses its sheen for the false volumes it generates, but also dies out with time. For e.g. Cantabil, Reebok and numerous others opened up factory outlets and were on sale 12 months a year in the recent past. A brand usually goes on sale to either clear out its inventory or unlock the value to generate cash in order to meet its expenses. We did witness that most of the brands went up on sale last year during slowdown, in order to meet their expense and debt obligation and also to give some momentum to its products off the shelf.

The E-commerce revolution in India, as they say is on the customer acquisition spree, thereby luring the customer with mindless discounts. I know websites where the high end brands are being offered at more than 50% discounts in addition to the margins the websites selling them are making, thereby further reducing the cost of procurement. The following are the circumstances which can make this happen:

1)      These brands are not original – However, these websites guarantee the authenticity of the brands and will be tangled in litigation issues if they are doing so and sooner or later someone will notice.

2)      There are export product lots which do not meet company’s specifications and are auctioned or sold off to clear the inventory (If this is the case then the products mentioned on the websites should clearly mention Export surplus)

3)      The discounts are coming out of the company’s budgets to promote their website and acquire more and more customers. However, the basic premise of any such e-commerce portal is the range and the ease of purchase. These services can easily be replicated and the basic premise is built on a discount price platform. Therefore, once the website stops offering discounts, the customers will move elsewhere.

4)      The brands are selling off the products to clear out their inventory. In this situation the brand in question is either a sub standard discounted brand or has a nincompoop manager who though generating volumes is moving towards the black hole of discounted brand. This will not be sustainable in the long run, as the lower rung brand which offers less exclusivity and will be low on margins will cease to exist or the high margin brands with continuous discounts will lose its sheen. In either case, the traffic of customers will lose owing to less exclusive brands being offered and bread and butter will be less exclusive low margin products being offered on discounts, which is neither profitable and will commoditize its business soon . Eitherways, again there will be another change of hands for equity to continue the mindless bargains or there will be corners cut in terms of products being offered, thereby yet again making the model unsustainable.

There is a free hand given by the stakeholders and management to acquire as many customers and add to the bottom-line, while adjusting the profits. These stakes will eventually be offloaded to some other PE, Bank or listed, thereby de-risking own portfolio and offloading on someone else’s books. People argue with the case of Amazon, however, Amazon offered discount on books by bridging the gap between the publishers and readers, thereby biting away the margins in between.  There were no exclusive publisher stores and its different story with brands. Though Amazon expanded to other categories as well, however, the core offering is reflected on margins made on books.

Fashion and clothing is a different ball game altogether. There is plethora of businesses and websites, which have closed their shops or lowered their offerings substantially, like The Private sales, Fetise, etc. Once the cash runs out or the money from stake sale or equity of owners dries up, a company should and will have to focus on bottom-line or atleast EBITDA. Else, the money thrown in will go in a bottom-less pit, with cash being pumped in through reselling of stake until someone realizes it is a loss making proposition. The same happened with Facebook and Real estate bubbles, wherein an underlying asset is being tossed from one balance sheet to other, not because of value addition but just because the interest rates are low and there is excess money being pumped in the economy.  With the slowdown in the Indian economy, growing penetration of Internet and online banking, over leveraged balance sheets of conventional companies and huge cash piles of unutilized cash has prompted a flurry in this sector (e-commerce). Everyone wants a piece of the pie and after the news of Instagram being sold off at $1bn, thinking theirs might be the next big revolution.

However, the financial model is not so easy as it seems to be. The Cash on deliver model (or COD as they call it), which is another convenience factor, is indeed a twin edged sword.

1)      It not only leads to a lag in collection and cost in terms of keeping a tab on collection, but also adds to the pressure of cost of inventory. This is due to the reason that, as opposed to the start of e-commerce business wherein the products were delivered only when a certain number of sales were achieved by the seller, the websites are purchasing the inventory and storing it in the warehouse, thereby further increasing the costs and reducing the margins.

2)      For e.g. A product worth INR 5000 is sold on a COD model and the margin on the product is 15% i.e. INR 750(to make it simplified, let us assume there is no cost of logistics). The collection agency will take a minimum of 15 – 30 days to transfer the money from the date of sale. If everything goes normal and the product is satisfactory, the margin is reduced by INR 42.5, 46, 50 and 53; given interest rates are 12%, 13%, 14% or 15% respectively.

3)      Add to the above the cost of rent of warehouse, labour, electricity, water, etc. and the margins are pressurized further.  

4)      The cost of discounts as added, not by the bargaining power, but though marketing budgets may also be another deterring factor to the fundamental business sense.
T
T   Things were different when the sites were procuring their merchandize based on number of orders from their clients, however, with setting up of infrastructure to expand, more and more costs are being added, while competition is further squeezing the margins.  

A sustained business model cannot be built on discounts offered. Websites have to steer clear of being as only discount driven sites to offering exclusive products. There is no ‘Points of differentiation’ being offered by these neo-sites apart from convenience, which also have inherent flaws in terms of wrong products being shipped (these are initial hiccups though and can be overcome in the long terms with better backend integration). However, still I would wait and see how sustainable and scalable the model is after a couple of years to eventually believe in the e-commerce story. Till then, enjoy the mindless discounts at the expense of others while I do the same.