Acquisitions by e-commerce firms: the way forward
Are acquisitions a faster way to growth or should they focus on internal growth to survive?
Last week Flipkart India Pvt Ltd, India's largest e-commerce firm, bought online fashion retailer Myntra.com for an estimated price of over $330 million, mostly in stock, to help it extend its lead over rivals Amazon India and Snapdeal.com. Professor S. Raghunath, Corporate Strategy & Policy, discusses the implications of the deal on the e-commerce sector in India
India's largest e-commerce firm Flipkart India Pvt. Ltd has bought Myntra, so how does the deal redefine ecommerce in India? Do you see it as the best thing that can happen for customers?
Yes, customers are the real winners. In fact, the online retailers generally offer a huge range of product selection along with attractive discounts that the brick and mortar retailers find hard to match. These online stores offer much more product information which help prospective customers better understand product's features and choose products that best fit their preferences.
Even as the media cheers the big-ticket deal, fact is that a decision to acquire and run a company that's one-fourth its own size in valuation is a huge risk for Flipkart and Bansal, isn't it?
The Myntra acquisition helps Flipkart extend its portfolio to higher margin merchandise where a large challenger like Amazon does not yet have a presence. Whether Flipkart will succeed with its Myntra acquisition and other acquisitions in their drawing board will be based on how Flipkart will continue to leverage online advantages such as: achieving parity on selection and price with offline competitors, ensuring high quality service which means consistent stocking, user friendly site design, reliable delivery and responsiveness to customer inquiries and user friendly site design. Personalization of offerings will increase customer affinity and will therefore improve customer retention rates.
Flipkart recently crossed the $1billion sales mark. Would you say scale is the barometer that demonstrates the fact that they have built a good company?
Flipkart does benefit from some scale economies, as most of its cost before marketing expenditure varies directly with revenues including the cost of goods sold and a substantial share of distribution and customer service costs. Volume growth leads to increasing purchasing clout with suppliers and therefore Flipkart has to continue to grow as much as possible, as fast as possible, to reap scale economies. Volume growth leverages fixed cost elements in warehouses and in website development and administrative functions. Flipkart must capture a large share of its total addressable market in order to achieve significant cost advantage. However the magnitude of potential scale economies will vary with each product category.
The fact is that Flipkart is the biggest online retail venture from India which has a promising growth story for the global investing community. It has struggled and demonstrated the ability to grapple with efficiency, logistics and fulfillment issues and attained growth in the face of a nascent online market, a stubborn cash-on-delivery oriented clientele showing little interest in credit and debit card payments.
Does this kind of M&A activity in e-commerce bode well for the sector as a whole?
M&A activity is increasing as funding is available from private equity firms. The expansion of the market in India for smart phones, availability of digital payment platforms and use of social media has strengthened the opportunity base for ecommerce. So M&A activity will continue to attract funding from venture capital firms even when they believe that valuations are over the top as long as they think they have a reasonable chance of cashing out before the inevitable market correction. A company like Flipkart would move from its venture capital rounds through to IPO. Hence the venture capital firms have a basis for believing that they have a goodchance of reaping IPO riches in excess of their original investment. The only downside is if the firm they invest in turns out to be an "also ran" the firm is likely to sell out to the eventual winner and the investors will receive valuable equity in exchange.
Sachin Bansal, quite the man of the moment, when asked whether his aspiration for Flipkart to be the 'Amazon of India' replied that they'd rather be 'Alibaba of China'. What do you think caused that big change in business model from say 4 years ago?
Like the homegrown company, Alibaba in China, that was able to penetrate the domestic market and grow its operations , Flipkart hopes to create a similar business model riding on internet penetration in tier two cities and villages, taking advantage of the change in shopping habits of the population in the 25- 32 years age group and appropriating a sizable wallet share based on the increase in the disposable income of this age group and their willingness to pay. These antecedent conditions have propelled the topline increase for companies like Flipkart and created marketspace, where earlier, none existed.
Are the real battle lines drawn between domestic players, not international ones? What is the future of the ecommerce companies in India on the profitability part?
For battle lines to be drawn, there has to be enough ammunition with the rivals. The question to ask is: do these companies, domestic or international have quick access to enough capital to fund expansion? When technology, regulation and political changes open up markets, they not only create humungous opportunities for entrepreneurs and established domestic players, they also attract foreign investors and bring in large capital pools.
As e-commerce growth strategies may also be fueled by speculative investment, it is possible to conclude that the ecommerce companies can only succeed while investors are showering them with capital, as capital investment precedes revenue growth. These companies, like Flipkart, will compete hard to secure market leadership and to be first in that category to complete an IPO. The Indian capital market is in a bullish phase and in this phase of the capital market cycle, valuations can be at very healthy multiples offering an excellent return on heavy investment in marketing. These companies will then infuse fresh cash in the bank and build a war chest to decimate laggards in their markets pace.
Profitability in the ecommerce space is predominantly based on whether a company benefits from cost related scale economies where it can leverage fixed cost over a growing revenue base. Leverage could be greater if variable costs represent a small percentage of revenue and the variable contribution margins are high.
Acquisitions by e-commerce firms: the way forward
Are acquisitions a faster way to growth or should they focus on internal growth to survive?
Last week Flipkart India Pvt Ltd, India's largest e-commerce firm, bought online fashion retailer Myntra.com for an estimated price of over $330 million, mostly in stock, to help it extend its lead over rivals Amazon India and Snapdeal.com. Professor S. Raghunath, Corporate Strategy & Policy, discusses the implications of the deal on the e-commerce sector in India
India's largest e-commerce firm Flipkart India Pvt. Ltd has bought Myntra, so how does the deal redefine ecommerce in India? Do you see it as the best thing that can happen for customers?
Yes, customers are the real winners. In fact, the online retailers generally offer a huge range of product selection along with attractive discounts that the brick and mortar retailers find hard to match. These online stores offer much more product information which help prospective customers better understand product's features and choose products that best fit their preferences.
Even as the media cheers the big-ticket deal, fact is that a decision to acquire and run a company that's one-fourth its own size in valuation is a huge risk for Flipkart and Bansal, isn't it?
The Myntra acquisition helps Flipkart extend its portfolio to higher margin merchandise where a large challenger like Amazon does not yet have a presence. Whether Flipkart will succeed with its Myntra acquisition and other acquisitions in their drawing board will be based on how Flipkart will continue to leverage online advantages such as: achieving parity on selection and price with offline competitors, ensuring high quality service which means consistent stocking, user friendly site design, reliable delivery and responsiveness to customer inquiries and user friendly site design. Personalization of offerings will increase customer affinity and will therefore improve customer retention rates.
Flipkart recently crossed the $1billion sales mark. Would you say scale is the barometer that demonstrates the fact that they have built a good company?
Flipkart does benefit from some scale economies, as most of its cost before marketing expenditure varies directly with revenues including the cost of goods sold and a substantial share of distribution and customer service costs. Volume growth leads to increasing purchasing clout with suppliers and therefore Flipkart has to continue to grow as much as possible, as fast as possible, to reap scale economies. Volume growth leverages fixed cost elements in warehouses and in website development and administrative functions. Flipkart must capture a large share of its total addressable market in order to achieve significant cost advantage. However the magnitude of potential scale economies will vary with each product category.
The fact is that Flipkart is the biggest online retail venture from India which has a promising growth story for the global investing community. It has struggled and demonstrated the ability to grapple with efficiency, logistics and fulfillment issues and attained growth in the face of a nascent online market, a stubborn cash-on-delivery oriented clientele showing little interest in credit and debit card payments.
Does this kind of M&A activity in e-commerce bode well for the sector as a whole?
M&A activity is increasing as funding is available from private equity firms. The expansion of the market in India for smart phones, availability of digital payment platforms and use of social media has strengthened the opportunity base for ecommerce. So M&A activity will continue to attract funding from venture capital firms even when they believe that valuations are over the top as long as they think they have a reasonable chance of cashing out before the inevitable market correction. A company like Flipkart would move from its venture capital rounds through to IPO. Hence the venture capital firms have a basis for believing that they have a goodchance of reaping IPO riches in excess of their original investment. The only downside is if the firm they invest in turns out to be an "also ran" the firm is likely to sell out to the eventual winner and the investors will receive valuable equity in exchange.
Sachin Bansal, quite the man of the moment, when asked whether his aspiration for Flipkart to be the 'Amazon of India' replied that they'd rather be 'Alibaba of China'. What do you think caused that big change in business model from say 4 years ago?
Like the homegrown company, Alibaba in China, that was able to penetrate the domestic market and grow its operations , Flipkart hopes to create a similar business model riding on internet penetration in tier two cities and villages, taking advantage of the change in shopping habits of the population in the 25- 32 years age group and appropriating a sizable wallet share based on the increase in the disposable income of this age group and their willingness to pay. These antecedent conditions have propelled the topline increase for companies like Flipkart and created marketspace, where earlier, none existed.
Are the real battle lines drawn between domestic players, not international ones? What is the future of the ecommerce companies in India on the profitability part?
For battle lines to be drawn, there has to be enough ammunition with the rivals. The question to ask is: do these companies, domestic or international have quick access to enough capital to fund expansion? When technology, regulation and political changes open up markets, they not only create humungous opportunities for entrepreneurs and established domestic players, they also attract foreign investors and bring in large capital pools.
As e-commerce growth strategies may also be fueled by speculative investment, it is possible to conclude that the ecommerce companies can only succeed while investors are showering them with capital, as capital investment precedes revenue growth. These companies, like Flipkart, will compete hard to secure market leadership and to be first in that category to complete an IPO. The Indian capital market is in a bullish phase and in this phase of the capital market cycle, valuations can be at very healthy multiples offering an excellent return on heavy investment in marketing. These companies will then infuse fresh cash in the bank and build a war chest to decimate laggards in their markets pace.
Profitability in the ecommerce space is predominantly based on whether a company benefits from cost related scale economies where it can leverage fixed cost over a growing revenue base. Leverage could be greater if variable costs represent a small percentage of revenue and the variable contribution margins are high.