Much of the recent growth has been funded by a high influx of capital to drive penetration. The business model, running on deep discounts and high customer acquisition costs, is unprofitable
In his now famous letter to the shareholders in 1997, Amazon founder Jeff Bezos started by saying, “it is day 1 for the internet.” Since then, he has written 17 letters and repeated this statement in every single one of them. While at a philosophical level this is indeed true globally, in India this is literally true as well.
It would be an understatement to say that the Indian e-commerce market is booming. Revenues are growing in multiples and not percentages, valuations are sky-rocketing, and private equity and venture capital funds are flowing. The Indian customer, lured by deep discounts, is rapidly moving her spends online. Online retail, which was spearheaded by simpler categories such as books and music, has now made inroads into penetrated categories such as electronics and fashion, and is starting to show up even in areas such as grocery, homes and cars. In the midst of the action, industry pundits and soothsayers are drawing parallels with the dot-com boom at the turn of the century and are predicting an implosion in the near future.
Let us separate the two questions. (1) Why is e-commerce gaining and what will be the shape of things to come? And (2) are the valuations justified or is the froth clouding the view? The latter, frankly, is a multi-billion-dollar question and we will leave it to the investor community to wrestle with. The former requires a look at the fundamentals, which is what this article focuses on.
Available data suggests the country is at a structural inflection point in its digitisation journey. Internet penetration is expected to increase from 17% in 2014 to 45-50% by 2020, on the back of an increase in the number of smartphones from 120-140 million in 2014 to 600-650 million by 2020. Telecom companies will have a critical role to play as they continue to slash data prices and invest in building network infrastructure, especially in smaller cities and rural areas.
For customers, online retail offers a fundamentally superior value proposition by allowing them to shop for anything, anywhere, anytime … and that too at lower prices. Broader assortment (have you seen Amazon’s “aur dikhao” advertisement?) and greater convenience (remember the Flipkart ads where it was so easy that kids could do it?) at higher discounts (difficult to recall an ad here—everyone seems to be offering it!) have compelled customers to rapidly switch to online modes. Complementing this demand-side pull, traditional barriers such as payment channels and last-mile logistics are being constantly attacked by innovative and well-funded players. While cash-on-delivery has been the industry norm, prepaid cash instruments and mobile wallets are starting to become meaningful. Similarly, while some online retailers have invested in building their own logistics infrastructure, the emergence of specialist logistics players has started to make last-mile deliveries in tier 3 and tier 4 towns much more streamlined.
While the action is really heating up, the numbers are still somewhat modest. As per BCG estimates, online product sales were in the range of $3.5 billion to $4 billion in 2014. In a market where the size of total retailing is $550 billion, this is but a sliver. However, the pace of change has been dramatic and online product sales are estimated to be in the range of $35-40 billion by 2020. Services, where online penetration is already as high as 28%, are expected to witness a more moderated growth from $12-13 billion in 2014 to $35-40 billion in 2020. Indian e-commerce will lead the US and Europe on this growth trajectory. However, here it is important to note that, even by 2020, Indian e-commerce will be a mere speck compared to the Chinese e-commerce market of $450-500 billion in 2014.
So, is everything picture-perfect? Not really. There are three fundamental questions facing the industry.
First is the question of capabilities. Organised retailing itself is a relatively new sector and continues to face a talent challenge. People and processes will be imperative to fuel the kind of growth being witnessed in e-commerce—else it will lead to consumer dissonance—in fact, there have already been some signs of it. E-commerce players have a long way to go in both recruiting talent with deep retail experience and institutionalising efficient internal processes.
Second is the question of a sustainable business model. A large part of the recent growth has been funded by a high influx of capital to drive penetration. The business model, running on deep discounts and high customer acquisition costs, is unprofitable. Valuations have zoomed and expectations are even higher to deliver cash flows in the future. It is a bit reminiscent of the land-grab in India not even a decade ago when brick-and-mortar retailers paid premium prices to block prime real estate. Some of those players are gone and many remaining are still picking up the pieces.
Finally, there is an overhang of regulatory uncertainty. Some observers have argued that brick-and-mortar and e-commerce players do not have a level-playing field. Even though the previous government had technically opened up FDI in retail, the restrictions on multi-brand retailing are so severe that there has not been a large influx of capital or expertise. On the other hand, e-commerce companies continue to raise foreign money at rapidly rising valuations. Issues of taxation further increase complexity.
While the players themselves have to figure out the right answers for the first and second questions, the government must proactively solve the third. Policy-makers have to find ways to encourage investments in network infrastructure, especially in smaller cities and rural areas. It is not surprising that the disproportionate increase in internet penetration in China in 2010 coincided with a push on broadband infrastructure by the government.
Additionally, streamlining logistics to ensure cost-efficient last-mile delivery and simplifying regulations for payment instruments can significantly enhance the ease of doing business.
While Indian e-commerce is off to a great start, it is nowhere close to the end of that beginning. It is, as Bezos says, still day 1 for internet in India. With the right moves from the players and a proactive approach from the government, could day 2 really be around the corner?
Amitabh Mall is partner & director and Parul Bajaj is project leader, the Boston Consulting Group. Views are personal