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Clear and present danger
Wheeled by aggressive discounts, Flipkart's business model is now in question as it buys sales with hard cash

Kripa Mahalingam

In a comic sequence in Vishal Bharadwaj’s recently released movie Haider, actor Shahid Kapur, who plays the titular role, illustrates the meaning of the old Yiddish word chutzpah with an example. Haider narrates the story of a man who robs a bank and has the gall to go up to the cashier and ask her to open an account for him to deposit the stolen loot. “That, my friends, is chutzpah,” he says. Throughout the movie, Kapur’s character uses the word (albeit pronounced wrongly to closely resemble a Hindi swear word) to express his displeasure against the imposition of AFSPA in the valley and vent his frustration at his inability to find his father. Chutzpah soon became an internet sensation, best used by customers all over social media to describe the debacle that was Flipkart’s The Big Billion Day Sale. Angry consumers complained of site crashes, deals going out of stock seconds after the sale went live, orders disappearing from shopping carts and cancellation of orders after payment. “In its hurry to be one-up on Amazon, I think Flipkart bit off more than it could chew and this has hurt its brand very badly,” says Harminder Sahni, managing director of retail consultancy firm Wazir Advisors. Flipkart declined to participate in the story.

Harminder SahniTo celebrate its journey in the Indian market so far, Flipkart had decided to host a single, one-day sale to eclipse all festive sales — October 6, 2014. The date held a special significance for founders, Sachin and Binny Bansal — 6-10 marked the number of the flat they started their blockbuster website from. Billed as the mother of all sales, Flipkart advertised Big Billion with promises of flash sales across 70 categories, lucky draws every hour and unprecedented offers and discounts. The consumers’ disappointment, then, was only understandable when not only did the discounts vanish within seconds but, in some cases, prices were hiked hours or days before the sale kicked off. 

The sale soon snowballed into a big PR nightmare, forcing the Bansals to send an apology to the company’s customers. “We did not live up to the promises we made and for that we are really and truly sorry,” the Bansals said in their email. “We realise that this breaks the trust our customers have put in us. We are truly sorry for this and will ensure that this never happens again.” While Flipkart had deployed over 5,000 servers and entrusted 10,000 field staff with the responsibility of ensuring that deliveries were made on time, things didn’t go quite as planned and the company acknowledged that it was not adequately prepared for the scale of the event. “To brand it as the mother of all sales when it actually was a clearance sale, now that is chutzpah,” says a disgruntled consumer who tried to buy a TV during the sale. The real question, then, is whether it was just the Big Billion sale that was an act of chutzpah, or is that the way the Bansals are shaping up Flipkart?

The big bang 

In the English language, chutzpah is often used to describe the audacity, brashness and supreme self-confidence that allows a person to take risks without the fear of failing, much like the way the Bansals function. How else do you explain the Big Billion Sale hoardings that were put up near the international airport and along the highway in Bengaluru as part of what the company called the ‘Welcome Mr Bezos’ campaign on the eve of Amazon founder Jeff Bezos’ visit to India recently? The Bansals are well known for pushing the boundaries for employees as well. 

Flipkart corporate structure

“Flipkart is a very highly performance-driven organisation, where you always over-commit and over-deliver. Its ambitions were always large. There were no baby steps and no concept of establishing proof of concept; it was more like all or nothing. Inside Flipkart, the message was always better done than perfect. It was okay to try and fail instead of spending too much time deliberating,” a former employee says. 

To say that the Bansals are ambitious would be an understatement at best — everyone involved agrees that the high-achieving businessmen are definitely men in a hurry. “You don’t get too much time to prove yourself either. If the desired results are not delivered within six months, then you will be in a different role,” the ex-employee says.

You wouldn’t really get fired but some of the employees couldn’t handle the pace of change. From being a two-member start-up in 2007 with an initial capital of ₹5 lakh to being the market leader that delivers 5 million shipments to 22 million registered users on a monthly basis, Flipkart sure has come a long way. The Bansals — school friends who are now in their early thirties and are known to finish each other’s sentences — are also quite unlike each other. While Binny opens up more easily and is more extroverted, Sachin is more introverted — a stereotypical bania who just wants to do his dhandha. “They are definitely a bunch of smart guys but what makes them stand out is their single-minded ambition to change how India shops. I remember telling my colleague back in 2009 after meeting the duo that these guys will make it big,” says a venture capitalist who eventually lost out to Accel Partners in Flipkart’s first round of funding, where the company raised $1 million. 

With both the founders being techies at heart, Flipkart’s DNA at the time when it was launched was that of a technology organisation. “It was very clear that engineers were seen as the heart of the organisation. In fact, employees of all the support functions always used to complain about how the engineers always had well-stocked fridges while they had to make do with whatever was available,” says the former employee. 

As Flipkart scaled, a lot more people from the retail business joined the company, helping the Bansals get a better grip on that side of the business. Though the Bansals have clearly indicated of late that they look up to Jack Ma and Alibaba as their role model, it is clear that their previous employer — Amazon — did shape their thinking early on. In fact, in one of their interviews in 2011, they had gone on record to say that they wanted to become the Amazon of India. “In their early days, it was clear that they idolised Jeff Bezos and were hoping to implement a lot of what they had done at Amazon, with a slight tweak to suit Indian conditions,” says the former Flipkart employee. 

In fact, when they began operations, the Bansals followed a hybrid model where they would hold their own inventory as well as source products from other vendors, much like Amazon did in the US. But in February 2013, Flipkart moved to the marketplace model, as FDI regulations did not allow investments in online multi-brand retail.

A lot of features that the company has introduced since are along the lines of what Amazon has already done over the years. Take, for instance, its annual membership fee-based service called Flipkart First, built along the same lines as Amazon Prime. Offered services include free shipping for all orders, same-day delivery guarantee at a discounted price, a 60-day replacement policy and priority service from customer support. In July 2014, Flipkart also launched its own brand of tablet under the brand name Digiflip — much like Amazon’s Kindle — and has gone on to add a whole host of electronic accessories as well. 

Flipkart, which currently has about 14,000 employees on its rolls, is also looking to increase its headcount to 25,000 by the end of the year. Its engineering team alone will have 1,200 people on its rolls by the end of 2014. It is looking to increase the number of sellers on its platform, which, at 4,500, is much lower than the 10,000 sellers Amazon India and 50,000 merchants that Snapdeal have on their respective platforms.

Flipkart is looking to increase that number by 12,000 by the end of 2014. Though the company moved to a marketplace model last year, nearly 70-80% of its goods are sold by its former subsidiary WS Retail. 

In March 2014, the company announced that it had hit a gross merchandise value (GMV), which is the value of goods sold, of $1 billion based on its February monthly sales.

According to Flipkart, it is well on its way to achieve an annual run rate of $3 billion by the end of fiscal 2015 on the back of its exclusive tie-ups with mobile manufacturers such as Motorola, Xiaomi, Huawei and its increasing market share (55%) in the fashion category post its merger with Myntra. In an earlier media interview, Mukesh Bansal, the CEO of Myntra and now head of fashion at Flipkart said fashion as a category currently clocks about $700 million and is on its way to becoming a billion-dollar business for the company.

Flipkart acquired Myntra in May 2014 in a deal estimated to be around ₹2,000 crore. It helped that the companies had common investors, Flipkart had the access to funds that Myntra needed and Myntra could help Flipkart achieve its goal of being the market leader in this category. All these factors made for a very convenient marriage. One of the key reasons why Flipkart was looking to increase its presence in this segment is because apparel and footwear come with healthier margins of 30% compared with electronics such as laptops, mobiles and cameras, which enjoy a modest margin of 10% and make up nearly two-thirds of the market.

The apparel segment, on the other hand, currently makes up 25-28% of the market. So, though e-tailing has been one of the fastest growing segments in India, with an average growth of nearly 60% over the last five years (2009-2013), it has primarily been a low-margin business that depends on large volumes to offset margin pressures. And making things worse are players competing among themselves to offer deep discounts to land many more customers.

 Discounting game

It’s a harsh reality — the Indian consumer is far more price-sensitive as compared with his global counterpart, which means that low prices continue to be the most important driver for online shopping in India. According to industry reports, it costs anywhere between ₹1,000-1,500 to acquire customers online, and even this cannot guarantee customer loyalty. A report put out by VCCircle in October says that this year, Flipkart has reportedly spent ₹650 crore on advertising across TV, print and online media in its bid to attract more consumers. Customers are only too happy to move from one site to another at even the slightest hint of a difference in price.

Alok Kejriwal, CEO, Games2win believes that with a lot of me-too players vying for the same consumer in the e-commerce space, deep discounts are not going away anytime soon. “Though Flipkart is the market leader, the deep discounts offered by the other players will limit its ability to raise prices,” he says. Flipkart came under a lot of fire from offline retailers such as Future Group and online vendors for selling some products below cost.

On its Big Billion sale day, Flipkart claimed to have sold over 20 lakh products to nearly 1.5 million shoppers, grossing $100 million in sales. “You can’t build a sustainable business on discounts in the long term. In the end, you are only hurting your brand,” says J Suresh, managing director, Arvind Lifestyle Brands. 

During its recent Big Billion Day sales, the discounts were almost borne entirely by Flipkart where sellers were reimbursed for the shortfall. Amazon and Snapdeal also follow a similar practice. But despite the fast and furious scale in revenues, Flipkart is said to be losing an estimated $10 million each month due to the discounts being doled out to its customers. Their deep pocketed investors, have funded many of these discounts.

The stakes have only gotten higher with each round, leading to increasing concerns about whether this capital-fuelled growth is sustainable and, more importantly, if this is the most efficient way to build a business. For instance, after pumping in about $1 billion, Reliance Retail finally managed to garner revenues of ₹14,496 crore and made cash profits for the first time only in FY14, nearly seven years after being in business. At the end of FY14, the company had 1,691 stores across 146 cities, spread over nearly 12 million sq ft. “If, without a physical network of stores, Flipkart needs to pump in just as much money to generate revenues on the same level as an offline retailer, then where is the benefit of technology following through,” asks a venture capitalist. With the company’s latest financials not in the public domain, it is unclear just how much of its investment has gone in creating assets and how much has gone to fund its cash burn.

Paper value

In its latest round of funding, Flipkart raised a jaw-dropping $1 billion from its existing group of investors — Tiger Global, Naspers, Singapore’s GIC and Accel Partners — who were also one of its earliest investors. It was the biggest amount raised by an Indian start-up, second only to Uber’s $1.2 billion round of funding in June 2014. While Uber was valued at $18 billion, Flipkart’s valuation is estimated to be around $5 billion-7 billion. Since its launch in 2007, the company has raised $1.78 billion in funding from various investors (see: Billion dollar baby). “The Bansals are like the pied pipers of the e-commerce space. Every time they play their flutes, investors bring out their cheque books,” says a venture cap investor requesting anonymity.

Billion dollar baby

The company’s rise to a multi-billion dollar valuation has been rapid, a little too quick for comfort, in fact, as some would say. For instance, when Flipkart raised $210 million from Russian billionaire Yuri Milner’s fund DST in May 2014 — post its Myntra merger — the firm’s valuation was pegged at $2.6 billion; in the space of less than two months, valuation had more than doubled.

The company had raised $150 million in August 2012, at a time when it was valued at $1.04 billion. By 2013, it had raised $360 million, translating into a valuation of $1.6 billion. But investors are not too worried. “Neither do we focus on what others are saying about valuation, nor do we think about valuations in the near term,” says Sameer Gandhi, partner, Accel Partners US. “Flipkart is an investment for the long term, because we think the company will be the market leader for the next generation of commerce in India, which is set to be one of the largest economies in the world,” he says.  

The founders remain unperturbed about profitability.  Sachin Bansal has said that the firm can be profitable if it chooses to but it was a strategic decision not to do so. And he has the investors vote. “Our belief is that Flipkart is doing exactly what it should be: investing substantially in building the foundation for long-term success,” says Accel’s Gandhi. To back its $1 billion dollar revenue run rate, Flipkart has raised around $541 million in six rounds of funding so far. The latest round of funding would be enough to help the company get to a run rate of $5-6 billion, which could get it a valuation of $25-30 billion. “We will have to wait and see whether venture capitalists will continue to have the appetite to keep funding this cash war,” says Kejriwal.  

So far, the cheques have been flying in thick and fast. “Flipkart has primarily become an investor-driven company. If I were a hedge fund investor, my focus would be on the valuation and how to bump that up, not on profits. That’s why there is so much buzz about valuation,” says a VC investor who did not wish to be named. 

In the past, Accel Partners and Tiger Global have been beneficiaries of high-profile IPOs and dizzy valuations. As early investors in Facebook, they saw its valuation increase from $10 billion in 2010 to $104 billion in 2012 when it listed.

“Investors are a peculiar bunch of people. They are paranoid about missing a deal and the possibility of making an extraordinary return. In this case, the moment Tiger made the second round of funding, the others followed, with the logic being that maybe Tiger spotted something that they might have missed,” says an investor who chose to stay out of the bidding war.

But things could change overnight. “It is important to know that capital is not always going to be cheaply available.

Markets could turn on a dime and liquidity can vanish as easily as it was once available,” says US-based angel investor and Junglee founder Venky Harinarayan, who helped Amazon build its marketplace model. “It is important to build a business model that can sustain itself during tough times. That is possible only if your contribution margins are positive. You can scale back your investments in fixed assets but if you are selling at a loss at the unit level, then it would be hard to sustain the business,” he adds. 

For Flipkart, the next round is likely to be an IPO, because no strategic investor would be willing to pay that high a price for an entry into India. Amazon is cementing its position in the local market with much less and hopes its planned $2 billion investment will help it move ahead faster in this race with Flipkart.

 It’s different

While a US market listing seems to be on the cards for Flipkart in a couple of years, investors would likely weigh any potential investment in Flipkart against Amazon and the recently listed Alibaba. And though Amazon has rarely stayed in the black in its 20-year history, it has more than made up for that with its track record of making great pay-offs on its investments — be it Amazon Prime, Kindle, video streaming and its cloud service AWS. Which is also why investors have been so patient with Amazon — they are fairly certain that when the company invests, its decision results in increased cashflows in future.

One of Amazon’s key strengths has been its ability to invest in growth without raising any money. Over 2001-2014, the company raised $623 million as debt while repurchasing shares of $1.28 billion, making its net external financing negative $685 million. Over the past 10 years, Amazon has generated free cash flows of $14.38 billion after all its investments. It has a market capitalisation of $133 billion and its revenue in 2013 was $74 billion and profit was $375 million.

Chinese internet giant Alibaba, on the other hand, made its debut on the American stock market recently, raising $21.8 billion. The IPO, which was priced at $68 per share, valued the company at $168 billion. Post the 38% gain on listing, the firm’s valuation was bumped up to $230 billion, greater than the total market cap of Amazon and eBay. Alibaba dominates online retail in China, accounting for nearly three-fourths of the market. In GMV, it is bigger than Amazon and eBay combined and, more importantly, is rolling in profits, unlike most e-commerce players.

In 2013, its revenue was $7.5 billion, with profit at $3.56 billion. With only about half of China’s 1.3 billion-strong population online, compared with 90% of the 300 million US citizens, a lot of investors are willing to bet on Alibaba. Part of the reason why the company dominates the e-commerce market in China is because it controls the entire value chain present in B2B and B2C markets, as well as the payment systems. Combined with regulatory support from its government, Alibaba has been unbeatable in the Chinese market. 

While a lot of bets are being placed on the Indian market evolving like the Chinese market, the reality may not be as rosy. “While the Indian market is expected to mirror the potential of the US and Chinese markets, the reality is quite different.

In the US, you have customers who are willing to pay a premium for good products and in China, regulatory support makes it difficult for foreign players to make a dent in the domestic market, helping Chinese entrepreneurs build winner-takes-all kind of businesses. In India, it is difficult to do business and make money as increasing competition means that such price wars will continue,” says Wazir’s Sahni.

In China, the marketplace model makes up 90% of the e-commerce market, whereas in the US, it makes up around 25%. In India, marketplace models are tough to execute due to several reasons — most vendors are not very comfortable with the digital platform and that, coupled with large gaps in the logistics infrastructure, has led to poor service levels. “With the rapid growth of the marketplace, there have been complaints about inconsistencies in delivery, customer service and quality,” says Pragya Singh, associate vice-president, retail, Technopak.

According to Technopak, the percentage of cancellations in India across players is 10-15%, compared with mature markets in the West, which have cancellation rates of 2-4%. While some of these are thanks to customer cancellations, a large chunk is also from the vendors’ side, thanks to non-availability of products due to poor inventory management and inadequate IT infrastructure. Now, leading players such as Flipkart, Amazon and Snapdeal are trying to mitigate that by adopting a managed marketplace model by which they control the last-mile delivery, thereby ensuring a better customer experience but increases overall costs.  

Boom or bust?

Organised players have an 8% share of the overall retail market in India and their share is projected to reach 14% by the end of 2020. At $3 billion, online retailing forms a mere 0.4% of this market and is projected to reach $32 billion, or 3%, of the total retail market by 2020. A key reason for this is that online retail penetration in India is just one-fourth of the total 245 million internet users in India. The total number of net users is set to rise to 550 million by 2020, so even if penetration does not rise proportionately, the sheer number of people logging on to the internet will drive growth for e-commerce players.

Internet users growth in India

India has been one of the fastest growing markets for Amazon ever since it went live in June 2013. “We have never seen this kind of growth in any of the markets we have been in and Amazon India has reached the billion-dollar mark in record time,” says Amit Agarwal, VP and country manager, Amazon India. In a bid to win the e-commerce war, Amazon has announced that it will invest $2 billion over time to expand its presence in India. “We wanted to make this kind of investment to reiterate to our vendors and customers that our flywheel is working fast. We continue to see a lot of potential in the Indian market.”

In most of the markets it operates in, Amazon runs both inventory and marketplace models because the inventory model allows it to take advantage of economies of scale. But in India, it only operates as a marketplace, as FDI regulations do not allow foreign firms to start wholly-owned subsidiaries to sell directly to consumers. It has two fulfilment centres, in Mumbai and Bengaluru, and is adding five more to improve its distribution network. Amazon manages the entire warehousing, logistics, packaging and customer service for vendors through its Amazon Fulfilled Service, and delivers the goods from the vendors to the buyers through Easy Ship. Flipkart and Snapdeal also offer similar services to their vendors; Snapdeal has 40 fulfilment centres across the country, while Flipkart has six warehouses and has engineers working on improving the last-mile delivery between the warehouse and the customer.

While technology-led innovations will improve the customer experience, e-commerce remains a capital-fuelled game and the one with the deepest pockets will be the last company standing. “There are no deep pockets in any business, only happy investors who indulge you. Once the smiles vanish, the deep pockets will vanish as well,” says Kejriwal. While the next couple of years will go without too many funding worries for Flipkart with the backing of its investors including a sovereign fund, they will have to sustain this growth momentum to justify their gravity-defying valuation and execution on a large scale can become challenging as was seen on the Big Billion Day sale. 

While e-commerce is the next step in the evolution of retail, it remains to be seen how efficiently online players can build their business. When organised retail made its debut in India, there was a big hue and cry about how it would displace the unorganised players. Several years down the line, unorganised players still make up more than 90% of the market. The reason why organised players didn’t make as big a dent in the market as expected was because most of them were not running efficient businesses.

Similarly, while there is a definite value proposition that comes with the e-commerce business — convenience, a wide range of products — these businesses are unable to charge for this value addition thanks to intense price wars. Companies like Flipkart are working on borrowed time and have to prove themselves in a hurry if they want to keep raking in investor moolah. After all, throwing good money after bad is not a sustainable strategy in the long term. 

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