VC investments in Indian E-Commerce

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Internet Commerce Valuations: Pay for strong fundamentals, not for hype – Deepak Srinath

(This blog was first published on the VC Circle blog on 29 July 2011)

There is a raging debate in the US tech and financial media about the ‘tech bubble’ we apparently are in the midst of. Every journalist, blogger, VC and academic is either painting doomsday scenarios or vehemently denying there is a bubble. Either way, we’re seeing unprecedented valuations for social media and social commerce startup’s, both from VC’s and public markets.

US tech valuations seem to have had their affect on the Indian startup scene too. A few days ago The Economic Times carried an article on Snapdeal’s next round of funding – ‘sources close to the deal’ are quoted as saying that the deals site is raising INR 200 cr at a valuation of INR 1000 cr. Rumors are doing the rounds that Flipkart is raising its next round at a billion dollar valuation. If these valuations are halfway close to the truth, we’re talking multiples of 10 to 15 times their annualized run rate or Gross Merchandize Value-GMV (i.e., their current monthly sales multiplied by twelve). Are investors justified in paying such valuations? What about margins and net income, have they become irrelevant?

This debate about VC’s over paying for e-commerce startup’s is particularly important in the Indian startup context. VC funds in India, barring a handful, are still going through their first or second investment cycles and very few of them have seen big exits yet. Most early stage funds have significant exposure to e-commerce and need to show good exits in order to raise future funds. It may not be an exaggeration to say that the early stage ecosystem will suffer if VC’s have overpriced these investments and don’t make good returns.

I actually don’t think these valuations are as crazy as they are made out to be.

E-Commerce companies take a long time to become profitable. Amazon took seven years to turn in its first profitable quarter. Even today Amazon’s net income is small compared to Google or other tech giants. The market values Amazon (P/E of 82) for the kind of profitability it will deliver in future. If you take a closer look at investments in the internet commerce space in India, it is only the category leaders who command such valuation premiums. E-commerce worldwide is all about becoming the no. 1 or no. 2 player in a category and dominating it. So investors are essentially taking bets of firms who have demonstrated early traction and paying in anticipation of what they hope these companies will grow into in two or three years.

However, investors must be wary of paying valuation premiums based on GMV alone. GMV spikes can be achieved by deep discounts or cashback schemes and these will ultimately prove unsustainable unless you build loyalty and repeat purchases. Critical success factors in the long term are low Customer Acquisition Costs and high Customer Lifetime Value (CLV). Profitability will ensue if these two metrics are under control. Investors should be very careful not to pay for hype. As long as premiums are being paid for real fundamentals, all of us will be fine in the long run.

Cash on Delivery- The catalyst for E-tailing in India? – Deepak Srinath

I often hear people saying that e-commerce entrepreneurs in India have it easy when it comes to ideas for their startups- they simply have to look at what has worked in the US and copy that model. Group Buying sites inspired by Groupon are the favorite examples used to illustrate this. Sure, E-commerce startup’s in India are by and large inspired by successful US models – Group buying for services and products, private sales for fashion, flash sales for electronics and accessories, category specific sites such as baby products or shoes…you name the e-commerce startup in India and there is a corresponding US model. However, it would be massively unfair to Indian E-commerce entrepreneurs not to give them credit for the clever and sometimes subtle adaptations to suit Indian markets and consumers. Perhaps the most significant and game changing of all these innovations is the ”Cash on Delivery’ (COD) payment option. In fact, I will stick my neck out and say that the e-tailing business in India owes its explosive growth to COD.

For a long time any discussion or article on E-commerce in India centered around the twin problems of low internet penetration and low debit/credit card base. Add to this the perceived ‘trust issues’ of Indian consumers for transacting online and it was believed that e-commerce in India would take years and years to scale. As recently as 18 months ago, while the online travel model was relatively well established, it was difficult to imagine how e-tailing or online purchase of physical goods would take off anytime soon.

And then the e-tailing revolution happened, and how! Flipkart and Infibeam led the charge, starting off with categories such as books, music CD’s, etc which were easier to sell online. As reports of their phenomenal growth came in, the trickle turned into a flood and at least a hundred e-tailing startup’s sprung up across the country across all possible categories. VC money started pouring into these startup’s and valuations based on annualized Gross Merchandize Value (GMV) multiples became the norm. Hygiene factors such as internet and card base reaching critical mass had helped but the real reason why sales took off was perhaps a small innovation in the payment model called Cash on Delivery. It allowed internet consumers to ‘order’ without paying upfront and allowed them the luxury of seeing the product (or at least the packaging box 🙂 ) before they paid for it. Logistics companies such as Bluedart and Aramex supported this model and trained their employees to collect payments. COD entails an extra charge of Rs.75 to 100, but consumers don’t seem to mind. Suddenly the limitation imposed by card base or trust issues for online purchase were redundant. Moreover, India has a large parallel ‘cash economy’ which has its own dynamics and cash payments are the preferred mode for all non salaried professionals. It’s a win-win situation for e-commerce firms and consumers and the only flip side to the e-commerce firm is an increase in working capital requirement.

So what % of e-tailing happens through COD? E-tailers I’ve interacted with say that 50% to 80% of their sales come from COD and rejection rates upon delivery are lower than 10%. I’m not sure whether COD was the brainchild of a single e-commerce firm or whether it evolved naturally as a solution to the payment problem based on a facility logistics partners anyway provided. Nevertheless, this collaborative innovation in business model and it’s impact on e-commerce in India should be the subject of a business school case study.

The Cloud – why is this space interesting? – Uday Disley

Few things have happened in the last few weeks and days which pretty much sums up the excitement that may be in store in the cloud computing space. While the buzz might have been around for a while in the enterprise computing space, but with Amazon launching their cloud music service and Apple launching iCloud, and the impending launch of the Chorme OS the cloud seems to have become very relevant for the regular consumer on the street (or the internet). This clearly indicates few points (not in any particular order)

  • Increase in the consumption of digital content (worldwide digital music revenues were pegged at $ 67.6 Billion constituting approximately 20%-25% of the market)
  • The increase in usage of multiple devices (PC, tablets, mobile phones) for consuming the same digital content
  • Applications which enable access to ‘paid content’, having to converge on these devices
  • Wide spread penetration and usage of broadband internet (again through multiple networks), be it 3G, WiMax, wireless and wired broadband
  • At least three of The Gang of Four (Google, Apple and Amazon) are betting big on this space for enabling true mobility and making substantial revenues on the side

So how does this play out; let’s say you bought some songs on Amazon and downloaded it to your PC, but then you realized that you had a blackberry and an iPad, which you would like to interchange for listening to music at your will. In the old times you would have to wade through various compatibility issues, spend considerable time on syncing, moving it from one device to another and backing up somewhere in case you fancied buying the latest version of the iPhone. If you are looking at a market worth upwards of $150 Billion for digital content consumed by people like you and me (music, games, movies, newspapers and magazines), then having products/services to address the issue of convergence starts making a lot of sense.

While all the three players have their own take on the opportunity, Apple having launched iCloud, wants to bet on the ‘have any Apple product and have everything seamlessly synced’ theme, Amazon has its device agnostic service with ‘cloud player’ and ‘cloud drive’ and Google has its lose your device, but not your data theme with Chrome OS. But essentially the cloud is the common thread that runs across these services and a lot is riding on these products becoming popular (and making money on the side to hold everyone’s interest).

It would be interesting to see how these products/ services will take off in India, given the fact that consumption of ‘paid digital content’ is negligible and penetration of multiple devices even more so. But going by the availability of Bollywood songs (in plenty) on Amazon and apparent (large) plans of Netflix to enter India, there seem to be more people excited by the prospects than just me.

Why 2011 is not 1999 – By Alap Bharadwaj

Are you nervous about internet valuations yet? If you aren’t, then you might want to consider checking out this fabulous article on dealbook called – Investing like its 1999! The article discusses the possibility of a new tech bubble and is interesting as it highlights both the similarities and differences between the situation in ’99 and ’11. There are some great anecdotes on some of the more notorious failures from the bubble era and these indicate why it might be different this time around. My personal take is that while the fundamentals are a lot stronger this time around, the problem centers around applying the same valuation exuberance that Facebook, GroupOn and Zynga (companies with proven scale in terms of BOTH users and revenues) command to companies that are in their growth phase.

Investment opportunities in Digital Entertainment – Alap Bharadwaj

A quick analysis of the entertainment sector that is served via technology in the US reveals three main areas of interest – Music, Gaming & Video.  Music & Video can be further divided into purchased and radio/streaming and Gaming into console and handheld, all of which are doing fairly well in the west. Given India’s status as a late adopter, the question remains – Will the country’s entertainment focused technology companies see the same success that their American counterparts have?

The answer varies for all three subsections and in my opinion hinges on a critical difference in the engagement propensity of users when interacting with these different mediums. Beginning with music, I don’t believe tech companies focused on this space, be it pay and download or radio, will have much of a future. The average internet consumer in our country has gotten used to downloading music in ‘lossy’ (mp3, etc) compressed formats and widespread piracy of the latest music both in Hindi and English hardly provides much incentive to switch to paying. Hard evidence exists in the form of Apple’s continued reluctance to open their blockbuster iTunes music buying service to the Indian public.

Additionally the problem with offering a radio service in India is plagued with its own issues. The ability to listen to internet radio at work would be disabled for the majority of India’s working public (due to strict work policies against such actions) and the poor quality plus high cost of India’s 3G networks make streaming of radio and on demand music a distant dream. While a case for exception can be made for technology companies focused on providing cloud services for people’s personal music collections, these too would suffer from the access problems mentioned earlier. Above all music as an entertainment medium might have many consumers but suffers from the critical flaw I mentioned earlier – the users are not engaged, thus reducing inclination to pay for such content.

Gaming and Video however do not suffer from this flaw. Both sections boast scores of engaged users with the inclination to pay. The gaming market has largely been tapped and conquered by the Xbox360, Playstation 3 and the Nintendo Wii, but what off the online video market? This is the area I believe with the largest chance for growth. Indian GEC and Bollywood content has virtually no presence online and any exceptions are pirated content that regularly get booted off websites like YouTube. Indian content is crying out for a desi version of NetFlix or Hulu backed by demand across India and more importantly abroad. Investors would queue up for companies that would be able to offer a high quality offering in this space as the model has both a proven growth strategy and significant exit potential due to the availability of appetite from retail investors for public equity of this nature as well as global acquirers.

I strongly believe that video will be the space to watch in the coming years on a variety of fronts. Content aggregators (a la Netflix) as well as companies focused on enhancing the viewing experience and constructing analytics and software for the unique conditions in India will flourish in the coming years. Investors have already backed certain players – Althea Systems, that makes a social video browser called Shufflr, raised US$ 3 MM from Intel Capital in November 2010 and Apalya Technologies, that specializes in Mobile video streaming, has raised three rounds of funding, the latest in January of this year. Given that the video focused technology space has seen investment, we now expect to see significant investor appetite for players in the content aggregation and video destination space.

For your viewing pleasure: Digital Cinema – Aravind G R

A quick number crunching gives me a figure of 25-50%, this is the ‘proportion’ of opening weekend collection to the total gross a movie makes through its theatrical run. Now, if I’m a producer (studio in case of Hollywood), I would focus most of my energy & money to make sure that these 3 days work out well for me.

If I want to cash in on these three days, I better maximize the number of theaters I’m running my movie in. But, there’s a problem- each movie print costs about 3-10 lakhs, limiting my ability to cover the entire country at the same time. So, I usually try to use them multiple times, it goes to the multiplex in the city for the first few weeks (months, I hope) and then I ship the same ‘print’ to tier-2 towns like Raebareli.

To the rescue

Now this is creating two problems for me, even though the weekend market for me is a potential 4000-5000 screens (I produce bollywood blockbusters); I can barely afford 1,000 prints. Also, by the time these 1000 prints reach Raebareli, most kids there have already bought pirated camera prints of my movie on CD’s for 20 bucks.

Along came technology to my rescue. I can reach Raebareli & Chicago the same day and each ‘print’ costs me a few thousand rupees.

Distribution today happens over the airwaves; encrypted digital copies (Mpeg files) of movies are delivered directly to multiple screens (through VSAT). The exhibitor then unlocks the files before playing the movies; I also get to keep a track of how many times the movie was actually shown, lending me better control & accountability.

The digital projection & storage systems do cost 4-10 times more than film based projectors, so naturally the exhibitors resisted. Many companies (third parties) in the past have taken up the job of setting up digital systems for exhibitors and have come up with many models over the years to counter the cost issue and have seen varying degrees of success.

Cinema models

There are two basic models that have been adopted (a) D-Cinema (b) E-Cinema:

D-Cinema: The funding (to go digital) could come from a party within the system or outside. Within the system major studios who were convinced about the digital system agreed to finance (partly) the purchase of digital equipment through the Virtual Print Fee (VPF), a funding mechanism where it pays the savings it makes from digital prints over film prints.

In India, Scrabble Entertainment finances (major part) the DT equipment purchase (& installation) and recoups this investment from the negotiated VPF that the studio pays it ,each time a digital print is released to the exhibitor. The company founded by Ranjit Thakur & Manmohan Shetty (Adlabs/WalkWater), in return also gets exclusive rights to exhibit the movies from the studios at these screens.

E- Cinema: UFO Moviez (UFO), part of the Valuable Media Group finances & installs digital equipment & recoups the investment by charging a  per screening fee. UFO also manages the distribution (MPEG-4 video format) based on VSAT technology, so in essence it is a supply chain for movies across the 2000+ screens it has converted, aiding the production houses to reach all such locations simultaneously without investing heavily on film prints (opening weekends!). The equipment is not necessarily of the highest quality and has found takers mostly in single screen theaters in C&D centers.

Then, D or E?: The lower cost & the fact that UFO could invest heavily in purchase & installation of digital (quasi-digital, in most cases) equipment has worked well .The company has achieved significant strides by converting 2000+ centers in a span of just 2-3 years. They have essentially changed the game of distribution and will be a very disruptive force in the entertainment industry.

However, we at Viedea believe the way forward is more towards enhancing the cinema viewing experience and hence higher quality (DCI Systems) systems would find more takers. We expect many more companies to join this bandwagon once (a) the studios start the VPF discussions in full swing and (b) the noise around un-availability of DCI compliant equipment settles.

PS: I just read that Golmaal 3 made $25 mn in its first weekend. That’s as good as any Hollywood movie!

Internet startups: The path to success – Alap Bharadwaj

With the e-commerce and internet space gaining steam over the past few months, the Viedea team decided to put together a business development exercise that focused on the new entrants into this arena. After speaking to in excess of 30 companies, analyzing their business models and understanding their challenges, I noticed some important trends.

1. The “me too” bane: I’m not sure if there is a dearth of good ideas out there or that Indian entrepreneurs lack creativity, but an increasingly large trend that has taken over the internet space is the proliferation of clones of successful websites from the west.

For example the success of Groupon in America has led to a slew of discounted, daily deal, group buying services based websites in India jostling for market share in an arena where they can only be 2 to 4 players that will succeed in the long term.

In my opinion if you cannot significantly differentiate your offering or provide a compelling platform, the mere aping of a foreign trend will lead to nothing but a failed venture.

2. Hygiene Factors: It still surprises me, how many aspiring Internet business fail to get the nuts and bolts right. You log on to a website that promises you the sky and the earth, but are unable to navigate, search, order, browse in a clear manner. When site design turns out to be poor a visitor is even less inclined to return.

The attitude that “if craigslist did it with plain forgettable site design, so can we” has got to go. Craigslist is a one in a billion company, and that story will probably never repeat itself.

A clean, crisp and engaging design is a must and should not be put off for later. Other factors like 100% functioning payment gateways, customer service numbers, bill generation, clear transparent reporting of extra charges etc are also overlooked just because entrepreneurs believe the “concept” is strong. The concept will get a venture no-where without the hygiene.

3. Business Plans: In today’s world of venture capital investments and blockbuster IPO listings it still surprises me that most young internet companies fail to build out strong forward looking business plans.

As an investment banker the question I look forward to asking most entrepreneurs is where will you be in five years in terms of revenues, profits, manpower resources and funding?

The largely collective lack of enthusiasm to provide an answer to this question is only second to the slipshod, half baked, not thought through, generic response of “$100 MM company”, in terms of disappointing interactions one can have with a burgeoning company.

Vision and holding your company to that vision are key in terms of success not only in driving business but also attracting investors and raising funds, even if the vision is realistic and conservative.

4. Angel Investment: Another surprising trend is the misplaced confidence most entrepreneurs in this space have in the belief that their ventures will be able to raise venture capital funds.

The tech world is not what it used to be and VCs are done splurging on anything and everything remotely connected to the Internet. Unless you are a second or third time entrepreneur with at least one very successful exit behind you, the odds of raising venture money are slim at best. Why so many entrepreneurs miss out on raising money from high profile angel investors is beyond me.

Angels are much more inclined to part with money for first time entrepreneurs, plus they bring in much needed experience on both the operational and execution fronts. Finally the value a high profile Angel adds to your company becomes immediately visible once the venture approaches VCs for their Series A.

Most VCs feel a much larger degree of comfort with an industry veteran on board and this actually leads to an acceleration of the entire fund raising process.

There are many tiny things that differentiate a successful venture from another, but making the four on top are taken care off will go a long way in ensuring the growth and success of young internet companies.

Finding supper in “Gateways” – Aravind G R

The last time, I bought a movie ticket queuing up in a theater was three years ago. I have never visited telco offices to pay my bills. If only they had managed to sell clothes and shoes online (in a neat environment though), I would have bought them online as well. I hazarded a guess on how much of our economy today is captured by online transactions, I am trying to include not just ‘e-commerce’ but all ‘online transactions’ such as paying bills, buying airline tickets to transferring money to other bank accounts online. I could not find any ‘authentic’ source to support me on this; however, estimates ranged from 0.2 percent-3 percent of the economy. That throws up a large absolute number -$ 2.4 bn to $40 bn market.

All these transactions go through a ‘payment gateway’. The gateway authenticates and routes payment details in an extremely secure environment between various parties and related banks. It functions in essence as an “encrypted” channel, which securely passes transaction details from the buyer’s Computer to banks for authorization and approval. On gaining the approval, it sends back the information to the merchant thereby completing the “order”, and providing verification.

Payment Gateways in India charge a service fee called merchant discount ranging from 2 percent to 7 percent on every transaction plus annual charges of up to a few lakhs every year. This translates to system wide gross revenue of $ 500-600 mn (range of $80 mn to $1.2 bn based on the absolute number above). Now, one would assume that the market with a size of $ 500-600 mn a year will be severely competitive with a host of companies trying to out-do each other. However, our research suggests that a major share of this market is currently being served by only four major players in the market.

Except for an investment by Greylock, the sector which is quite obviously a greater play on e-commerce growth in India, hasn’t seen a single investment or an M&A transaction in many years. Are investors missing out on a great opportunity? For one, companies are growing at an incredible pace- according to Deloitte Fast 500 list, one of the companies in the space has grown by 350 percent Y-O-Y over the past 3 years on a decent base. Also owning a payment gateway will boost net margins by 2-3 percent. This becomes a very attractive proposition for companies in the internet domain- E.g. an airline aggregator who makes wafer thin margins on large volumes –wonder what Makemytrip would have been valued at, if it was profitable at the time of its IPO?

We at Viedea have been working with a few players in this space and have witnessed significant interests from both the buy-side and the sell-side. With a certain large & harassed ‘pal’ on the lookout in India, we are expecting a ‘crazy’ if not a large transaction in the next few months.

Gucci and Me – Namit Goel

I have asked myself this question lately, how did premium fashion brands use online private sales to make this concept the latest shopping trend in India? Brands have struck the right chord with bargain-hunting fashion aficionados who wish to own prêt-a-porter at a very low price and also sell off their excess inventory by tapping the aspiring market. What more, since it does not have a negative impact on the brands’ image from a consumer standpoint, a variety of luxury brands ranging from apparels, home furnishings, bags and shoes can be bundled and sold quickly. It is however a private club and you need to be invited.

It works like this; private shopping sites buy excess merchandise directly from premium brands and designers; then they mark up the price for a profit and offer them at a heavy discount only to approved members. This membership is available by invitation from current members who have registered online or by applying online and then being subjected to a wait list. The product catalogue is then exclusively mailed to the approved members according to the buyers’ interest and buying behavior. This is gauged through social networks such as Facebook and Twitter. Since the merchandise is available for a limited time period during a sales event, I found the shopping experience to be fun, exciting and fast-paced. I saw deals on products disappear fast. It sounds like a very good business model, but sheer shopping popped another question in my head. If the idea is to make it available only to a limited range of members, how does this business scale and make money?

To find answers to my question I called up one of these websites and they told me that the number of members is not important; it’s all about having the right members who are passionate about the product offerings and are willing to buy them. I feel the answer to my question can be found in value added features that private shopping sites offer. These sites have started monetizing and increasing the business through viral invitations where each member will earn reward points per new member brought in. There are special clubs for premium members who have a propensity to buy lots online and they will receive extra discounts. A well thought of technical representation of the shoppers, their demographics and economics will be streamlined at the beginning of the event to stimulate impulse purchases. Special social recommendation systems will be set in place to up-sell and cross-sell based on purchases and browsing pattern of the customers.

Of course, all these features will soon fade away as more competitors arrive; but it all depends who will aggregate a large spectrum of luxury brands and designers on to their side. I believe this space will be red hot soon and will see a series of fund raising transactions at a mind-boggling valuation, followed by a period of consolidation in 3 to 5 years time. Sounds like its deal time, doesn’t it. But it will be great to hear your thoughts about the same and I would suggest talk to your chic friends, they will probably know what websites I am talking about.

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