Should ecommerce businesses build for profits or for exits?
What leads to the contradiction:
Most eCommerce businesses today are focussed on growing at any cost. This leads to excessive spending on both marketing and operations – this in turn leads to growth without much profit or at a loss. The reason for this is that revenue generation directly impacts market valuation. Most eCommerce companies are funded by investors – who of course want to see the valuation grow – so that eventually they can exit their investment at a profit. Their profit expectation isn’t meager. Since the investors concerned are mostly venture capitalists and private equity players – they would want their investments to grow manifold.
There is thus a clear contradiction between what’s best for investors (grow fast at any cost) and what’s best for business (pace your growth, but grow profitably).
So which path should a business take?
The easiest way to conclude would be to look at the captable. If external investors have sufficient stake – they can dictate terms. On the other hand, if the founders decide to bootstrap or retain most stake – they can take a conscious call to grow profitably.
This leads us to the next question: How important is the role of external investors in the growth story of ecommerce companies?
Profitable Amazon Sellers and Loss making Unicorns:
Let’s break down the fund requirements of an ecommerce company. There are 4 key areas of fund utilization :
- Technology Cost
- Marketing & Customer Acquisition Cost
- Cost of maintaining inventory
- Operations and supply chain cost
Now let’s consider the case of a hypothetical Amazon seller. For this seller, there is no technology cost involved. There is however a cost of listing which is fractional in comparison to the cost of building new tech. In terms of marketing, Amazon commissions is the main contributor. This is a variable cost and doesn’t require investment. Inventory investment would be needed but can be minimized by using dropshipping or sale-or-return models. Operation and supply costs can also be managed by piggybacking on Amazon’s delivery system.
For this hypothetical seller, there is not much investment required to run a business. There are many such sellers across the globe who are making a decent living by selling goods
profitably on online marketplaces. In fact, Eunimart started with the goal of helping such sellers scale across multiple marketplaces and multiple geographies.
On the other hand, there are larger D2C brands who have raised funds at millions of dollars of valuation but are unable to turn a profit.
These brands have spent millions on marketing (to build a brand), handling operations, hiring top talent, operations and supply chain and finally building jazzy workplaces. Unless the founders of such businesses have deep pockets, they would need the help of VCs to manage such kinds of spends. This money comes in exchange for a commitment to grow rapidly!
In the pre-pandemic times, ecommerce penetration was limited in most geographies. Consider the case of India. Ecommerce companies have been operating in India since the early 2000s. Now defunct, Indiaplaza, happened to be the first known Indian ecommerce company. We have seen well funded startups such as Flipkart, Myntra, Bigbasket, Grofers and many others. These platforms have, over time, pushed ecommerce businesses to try all the tricks in the book to grow faster because it led to growth in their GMV.
They offered deep-discounts to the extent of not recovering COGS, spent millions to buy primetime TV slots, sponsored everything that led to mass appeal such as cricket & movies, ensured delivery to more than 30k pin-codes (including the rural hinterlands) and also tried to get rid of all potential barriers to adopt ecommerce by offering lavish return policies along with flexible payment options such as cash on delivery.
Despite the all-in approach of these platforms, ecommerce failed to grow beyond tier 1 and 2 cities to any major extent! There are 2 factors that finally propelled the mass adoption of ecommerce. First, the easy availability of high speed internet at a throwaway price pioneered by Jio and, secondly, the great pandemic of 2020!
During the pandemic, the social distancing norms along with restrictions to offline retail forced consumers to turn to ecommerce. Even the turnover of the government’s own marketplace – GeM, which enables online procurement of goods and services by government ministries and departments – topped Rs 1 trillion this financial year, the highest in a 12-month period since its launch in 2016!
Now, the challenge is no longer about attracting people to the platform. Instead, it’s about getting them to stick and make repeat purchases.
So we can expect a future where companies may not need deep discounting like before. However, to turn profitable (and reduce dependence on VC funds) , ecommerce companies need to do more than just that.
The Road to Profitability
Brands like Tesla and Apple have taught us that customers don’t mind paying a premium so long as they value the brand above their competitors. It is important for the brand to identify the right tactical and strategic moves to remain at the top of their customers’ minds through creative customer retention and unique user acquisition plans. So far, for ecommerce, marketing has been more tactical than strategic. Neither Tesla nor Apple, is focussed on selling to everyone. They have a realistic target market defined and are playing their best game within that. To turn profitable, ecommerce companies also need to adopt such a strategy – where focus is no longer on growing customer transactions but maximizing revenue per customer.
Supply chain management is another area that requires quite a bit of work for most brands. Smart category teams must create supply chain efficiencies from sourcing to delivery to meet their goal of improving gross margins.It is also important to have partnerships in place. The ecommerce ecosystem is pretty mature with powerful tech players focused on solving specific issues. Instead of reinventing the wheel, it makes more sense to partner strategically.
Cash on delivery (COD) COD is another aspect that many brands are reevaluating today. Due to the presence of this option, most ecommerce stores experience 90% of their revenues being generated through Cash-on-Delivery. Cash-on-Delivery is expensive to manage & burdens the working capital required. New research suggests that letting go of COD will definitely impact revenue but it may not be as high as anticipated. For example, even in a COD driven market like India, most ecommerce buyers have the means to pay digitally post UPI. Very rarely will customers refuse to pay if they genuinely like a product. However, at the very early stage of their brand journey, it may not be feasible to move completely off COD.
Most ecommerce brands looking to scale rapidly come to the realization that choosing the right technology suite is critical to being able to minimize manpower, operations inefficiencies, supply chain costs and maximize revenues. This is where choosing the best technology platform from the very beginning as they build the brand becomes critical. While many brands believe that they can change their technology once they scale, tech debt prevents companies from changing as and when they want to, stymying growth. Moving to a “composable” architecture will help brands scale tech, without burning a hole in their pockets.
Resource wastage needs to be minimized by focusing mainly on elements that the customer sees or experiences. So investing towards establishing great systems, processes or technologies that impact customer experience is critical, while spending on fancy workspaces may be great for PR, but not great for finances.
Yes, the road to profitability is not an easy one. It will take time and a whole lot of effort and differentiated thinking by the top management.
Since the other alternative is hard, in all likelihood ecommerce companies will need to continue raising more and more money, even during market slumps and keep offering deep discounts to attract customers. Unfortunately, this gives market leaders of the likes of Amazon the perfect opportunity to arm twist them taking advantage of the enormous amount of market influence and customer data that they command. In order not to be over dependent on Amazon, ecommerce brands need to think out of the box and also look for scalable solutions. Raising capital to fund discounts is not the best solution (even with major funds like Softbank or Tiger Capital on your side) because Amazon can out-fund and out-discount as well as driving outsized loyalty through their Prime customers.
With so much money already plugged into the system, it will not be easy for investors to suddenly move away from ecommerce nor do they want to move away. However, it would be imprudent to continue to invest without end in sight in unsustainable enterprises in particular. Post COVID, ecommerce growth has normalized to the same growth rate as seen pre COVID levels. However, all things considered, ecommerce is poised for an exciting period of unprecedented growth over the next few years. And this growth spurt is expected to lead to substantial investments in supporting infrastructure as well as innovative and game changing business models – whether they build for short term marketing and investment oriented exits or for long-term growth oriented profits.
At Eunimart, we have been asking questions and framing problems on behalf of brands, retailers and supply chain companies. Our vision is to help companies generate more revenue with a futuristic approach and growth trajectory. We have built a full stack of AI tools to bolster revenue, supply chain and omnichannel distribution combined with an incredibly flexible and advanced open source platform equipped with multiple tools to empower the next generation of entrepreneurs who dare to dream, irrespective of whether it is for a profitable exit after a short term stint in the market or for the long haul.