Category Archives: startups

FLIPKART NEEDS SOME PATIENT, PERMANENT CAPITAL

The markdowns are flowing thick and fast for Flipkart. There’s a lot of noise out there painting a picture of doom and gloom. But should valuations cause so much consternation? Isn’t there a larger story waiting to be told? In the last few days I trawled through old reports, news stories and information available in the public domain to make sense of the proceedings. I also had the good fortune of catching up with Haresh Chawla, Partner at India Value Fund Advisors, and a keen observer of and commentator on the Indian e-commerce sector.

The nuance that most media reports seem to have missed out is that it is not a simple question of whether Flipkart will get future funding or not. We need to dig deeper, because Flipkart will get funded – there aren’t too many Indian e-commerce players at that scale. The real issues are: (1) the kind of investor that Flipkart needs and (2) how soon that can happen.

But first things first: what is a markdown?

There can be both a markup and a markdown. It is only a way of denoting the fair value of an asset or liability on your balance sheet. In other words, because market conditions change all the time, your books should present the truest picture possible. But it’s subjective and is further complicated by incomplete information or over-optimistic/over-pessimistic expectations.

Should we be bothered?

If you are wondering why, simply look at the markdown exercises and the implied valuation after that.

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Do you note that essentially none of them are in real agreement as to what the valuation of Flipkart should be? There is a huge deviation.

Now here is where a lot of people are running around either screaming doomsday or smirking on Twitter. In fact, some unnamed experts have been quoted as saying that if the valuation isn’t marked up soon, then Flipkart may have to accept a significantly lower valuation than its “preferred” $15 billion.

Let’s set the record straight. The figure $15 billion is obviously bigger than $5.5 billion, but to say that that is the “preferred” valuation would be wrong. It was what the market and investors expected based on the $10 billion of GMV projected by the company itself in June 2015. Mukesh Bansal, Head of Commerce, Flipkart, had told The Economic Times, “Flipkart will sell goods worth $10 billion during fiscal 2016, and nobody will be even half of that… There is not a shred of doubt based on all the market numbers we have today.” (You can read it here: https://goo.gl/FQKGy4 and here: https://goo.gl/a9UArZ)

According to Haresh, “It was expected and I have been saying it for some time. Flipkart announced that they would deliver a GMV of $10 billion and, clearly, on that expectation investors gave it a 1.5x multiple and valued it at $15 billion. But the company fell drastically short of its GMV target. The actual figure was only about $4 billion.”

In fact, it wasn’t only Flipkart that went wrong with its projection. Even the fund houses overestimated Flipkart’s GMV clout. To jog your memory – This Morgan Stanley report from early 2016 (Read that here: https://goo.gl/WWXLaa) said that in 2015 Flipkart, Snapdeal and Amazon together accounted for $13.8 billion in GMV or 83 percent of the market. That implied a market size of $16.6 billion. The report further said that Flipkart’s market share was 45 percent. That implied Flipkart’s GMV to be $7.5 billion – a gross overestimation, versus the $4 billion that Flipkart actually is said to have delivered.

Haresh pointed out one of his earlier peeves on the same issue, which he wrote about on Medium (Read it here: https://goo.gl/b1k7JW). At that time, he had noted, “Imagine when you extrapolate this error to the future. This has ended up muddying the waters, and misreporting the market share numbers.”

So, what happens next?

Let’s face it, valuations are a mix of many things – market environment, risk appetite, a fund manager’s own biases, the hot new trend, the fear of missing out, the multiples comparable companies are commanding, and of course, expected cash flows and margins. Of these, the last two are the most important and the most difficult to wrap your head around in an environment where you have to constantly burn money to stay in the game. So if an investor needs to justify why he/she is jumping onto the bandwagon he/she will constantly look at data that confirms his/her biases. Therefore, valuation is only a large headline figure; it’s not what decides your success.

Haresh concurred, “Currently, the world over, most of these companies are valued at 0.8-1.2x of GMV. Even with the markdown, Flipkart is still valued at the higher end of this range. But these valuation figures don’t reveal much. What matters is sustaining the business. The battle with Amazon will be fierce, but valuation has no relevance to Flipkart being among the top two in India.”

That’s the trick. Sustaining the business – according to data available in the public domain, while FY15-16 revenue grew 143 percent to about Rs 1,950 crore, expenses grew at an equally rapid clip of 128 percent from a much higher base. Expenses for FY15-16 were a little more than Rs 4,250 crore and losses more than doubled, to a shade over Rs 2,300 crore.

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An analyst at a VC fund that I spoke to, on condition of anonymity, pointed out that for every incremental Rs 100 of revenue, Flipkart spends Rs 200. He was also quick to point out that the losses seen in the public domain don’t add up to the “ostensibly” $2.5 billion (Rs 15,000 crore) that Flipkart is said to have lost or sunk into its business so far. Therefore, it would be safe to say that we don’t know what lies waiting in Flipkart’s balance sheet, which most people wouldn’t have seen.

But, enough said, ladies and gentlemen! This business is burning Rs 6.3 crore a day.

The management has been trying its best to cut its burn, focus on the right categories and rationalise headcount – though there have been many versions of exactly how many were let go during July 2016. (Read it here: https://goo.gl/XMXgJZ)

Haresh has a slightly different take. He feels Flipkart is doing a good job of it, given the tightrope it needs to walk. “Any drastic decisions to cut burn could result in a spiral down in marketshare making it even more vulnerable… The only option is to become lean and hold your fort at the same time – that would be the investors’ mandate and they seem to be doing a good job of it,” he said.

But, hey, existing investors have nothing to be worried about

It is unlikely that investors will lose money. The sum total of money that has been invested in Flipkart till date is about $3.4 billion. To that extent, as long as the valuation doesn’t drop below that level there is no reason to be concerned, because early investors would be protected by special rights like liquidity preference.

Haresh noted, “As far as the VCs go, they are unlikely to ‘lose’ money. Liquidation preferences protect them from any value destruction that may arise. But the wait for exits will be long. However, this protection may not be available to investors who may have entered secondary deals with founders or very early-stage investors at the higher valuations.”

Tying back to that magic $15-billion figure

So, here goes: The ‘$15 billion’ figure that people are talking about is not written in stone. It means that investors are taking a call that if Flipkart does exactly as well as they expect it to the maximum valuation they would give is $15 billion. It also means that they expect the future to be brighter than that $15-billion figure (because if someone were to invest at $15 billion valuation, they would expect much more than that in return, right?).

But, in the same breath, if the call on future valuation is not as bullish, there is nothing to stop a potential investor from adjusting it downward.

For example, if Flipkart’s GMV is $4 billion and one were to attribute a generous 1.5x multiple, then the valuation would be $6 billion. Sure, it would find buyers at that valuation, but it is unlikely that any of the previous investors would take any hit depending on the rights agreed upon during earlier funding rounds.

Therefore, it really is a question of what Flipkart needs right now

1) A control on costs – this is a given, so let’s park this for now.

2) The right kind of investor – strategic and very long term – someone whose investment horizon is a multiple of the 5-7-year typical VC horizon. That’s because Flipkart needs to take on the strategic money that Amazon has. Consider this: Amazon generated free cash flow (Amazon Annual Report: https://goo.gl/sYUIoz) of $7.3 billion for the year ended 2015 (that in itself is a multiple of Flipkart’s GMV). It can just dig in its heels in India, a market it can’t afford to lose.

Haresh said, “While they have taken steps to cut the burn, the biggest issue for Flipkart is who will buy? The company needs permanent capital on its balance sheet to take on Amazon, which has deep pockets and possibly infinite patience to win in India. When will this happen, on what terms and who it will be remains to be seen, because any investor with permanent capital, the likes of Walmart, Alibaba or JD.com, will not be interested in a minority shareholding – they will seek a path to control.”

But will Flipkart’s existing investors be willing to leave a clear path to control? They just might, because there’s definitely more to gain that way.

In a way Tiger bringing back Kalyan Krishnamurthy in a key role at Flipkart is evidence that the investors had a crisis of confidence in the team and hence are seeking to put the house in order. This allows them an opportunity to seek strategic sale with transfer of control. Remember, no VC, Tiger included, will be in it forever – they all have to provide their investors with an exit. (Also read: Saving Private Flipkart https://goo.gl/AIzsm6)

In the end, this series of markdowns has and will continue to cause a few flutters in the market, and may also affect the fundraising plans of smaller players. But the big boys may get by because there are enough strategic global investors interested in doing deals; and if they can get in after a series of markdowns, why not?

There’s huge merit in the space Flipkart occupies. We have barely scratched the surface of e-commerce in India. Flipkart is definitely India’s biggest calling card in the sector; it has inspired thousands of entrepreneurs and brought to the forefront a new way of doing business. But, Flipkart, on its part, will have to find ways to make its way deep inside customers’ wallets by constantly cross-selling and up-selling, while at the same time tightening its own belt.

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India’s Tier 2: Incentivize Hidden Liquidity

I’m back from a yet another trip of one of India’s holiest cities – Allahabad – a city with deep historical and mythological underpinnings, yet fast trying to embrace modern India’s newest fads. It’s a city I grew up in and therefore I have had the chance to observe social and economic opportunities first hand. On this trip it seemed that everyone in the place was buzzing with the promised conversion to a “smart city”.

However, what could easily derail any “smart city” dream is the lack of basic necessities, infrastructure, education, growth mindset and talent drain. Sure there is enough economic growth as anecdotal evidence from local business that are proxies of consumer spending & confidence like entertainment, food, consumer goods, etc. suggest. But the growth is ad-hoc and haphazard. There has been growth in transactions and economic activity, but not HDI. I don’t think a “smart city” can be made without effecting change in fundamental mindset, infrastructure and employment dynamics .

But here’s an idea. Why can’t such mid-sized cities build an eco-system which nourishes a variety of new businesses spanning areas like social, infrastructure, education, medical, consumer, entertainment, information & media, transport, etc? Why not put the huge amounts of idle cash/hidden cash to good use by incentivizing the hoarders of such money?

The problem is that this liquidity is either invested in real estate through legal and illegal means or it is spent on consumer purchases & entertainment outside the city (typically in big cities or abroad). But hardly any of it is ploughed back to be reinvested for the good of the city.

It is my belief that such liquidity can fund a lot of new start-ups in a variety of areas – there are plenty of higher educational institutions churning out bright students. But lack of exposure to new ideas, the absence of a viable guiding platform and the fear of such cash coming under the taxman’s scanner are holding back many bright ideas. Therefore for the youth, the only way to progress is to move out of the city after graduating.

So when one can have tax amnesty schemes like voluntary disclosure of incomes, why can’t we have another such amnesty scheme which mandates the pooling of money into an fund that bankrolls new business ideas that will make a difference to the city, generate employment, discover new talent, change mindset, and truly prepare the Allahabad to usher in the “smart city” tag.

E-Groceries: Changing Consumer Behaviour

I recently read an article, which said, “Online grocery stores require large investments, deeper technology and complex supply chain. Hence it does not pose a wide start-up opportunity.” Since, I have had the opportunity of working very closely with some companies in this space, it set me thinking. To start with I don’t agree that this business does not pose a wide start-up opportunity. Same as in any emerging business, there are various models at work, which will get fine-tuned as time goes. But at the heart of it is achieving a change in consumer behaviour which will contribute to scale.

Yes, you need to have a strong technology backbone in order to process ordering, picking, packing & delivering, but that is not insurmountable. In many ways, technology has today become commoditized – in the sense that there are plenty of solutions that you can buy and tweak as per your requirements, or if you know a good techie or two, you can get it done on your own. And, if you are far-sighted enough you would have spent upfront on a technology that is scalable and hence requires minimal repeat spends as you grow.

At the heart of any business working or growing profitably is scale. Online grocery is no exception. But executing scale, while holding inventory, can be a stress on capital expenses. Imagine having to keep on adding warehouses at each location. The asset light model employs inventory management that procures stuff only when they have been ordered. In other words: Just-In-Time. Stock a tiny fraction of the fastest moving SKUs and pick from large wholesalers only what your current lot of orders requires. The same goes for perishables. You can instantly cut out not just warehouse cost, but also cost of large scale industrial-level air conditioning.

Supply chain is also something that is slightly more complicated in the case of an asset light model, compared to an inventory-based or offline model. But, there are ways to make it work right and it all boils down to scale. So even though you might not want to take the capital costs of the delivery infrastructure on your own books, you can sweat each inbound & outbound vehicle that much more as your scale grows. In fact, a mobile hub and spoke model is something that is being experimented with. You don’t really need to have tie-ups with offline store to be efficient. Yes, some big players are entering the market with that model, but they will have to work very hard to maintain consistent service levels across the entire network of offline stores.

While one would have to agree that most of the online grocery businesses have been city specific, these are only early days. I have no doubt that templates being set in one city are highly replicable in the next. Also, apart from the traditional arguments of overcoming inconvenience, a few of the biggest advantages of online grocery retailing are (1) Unlimited shelf space, leading to thousands of SKUs being available at no large real estate cost; (2) Ability to dynamically upsell and/or generate offers based on user profiles & past purchases; and (3) Ability to offer deliveries at any time of the day, as per the consumers’ preference (with so many double income households, late-night deliveries are now very prevalent). Yes, you have to be patient with any business in the beginning. This is a business which is disrupting consumer behaviour. In its current avatar, a lot of regular purchasers will obviously be the more savvy lot. But we’ve seen from other ecommerce models, that it didn’t take long for others to catch on.

Changing consumer behaviour was never easy, but it has always yielded good returns. Therefore, upfront costs on marketing & brand building are perhaps going to be much higher in the case of these organizations. But behaviour once changed, is tough to go back on. And when you combine that with a repeat-purchase habit like grocery shopping, it would only yield ever increasing volumes. Owning the consumer also leads to many other related revenue streams.

It’s still early days for the space. As in every emerging sector, not everyone might crack the model. But those who do would not only have made a lot of money for their investors, they would have created a completely new market. And that, to me, makes a suitable case for a start-up opportunity.

Fundamentals Of A Good Business Plan

In my line of work, clients, business partners and prospects often ask me what a good business plan looks like. I don’t have a straight answer to that because each business, each category and each industry has its own idiosyncrasies and it’s hard for me to generalize. I’m sure that I could offer a standardized answer if I put my mind to it, but I like to feel my way into engagements rather than check off items on an objective list of things-to-be-done.

My work is a delightful mix of business development, strategy consulting, category creation, market expansion, brand management, forging partnerships, financial analysis, and portfolio management. All of it becomes even more exciting given that I am not constrained by any sectors. Hence, my belief in co-creating businesses by fusing my lateral experiences with the vision & mission of the entrepreneur.

Very often the most basic issue with business plans is that owners fall in love with their product and/or ideas so much that they fail to justify the existence of the business from the prism of an investor. And that’s very crucial. There’s nothing wrong in really believing in your business, but one should always strive to answer a few critical questions:

What unmet needs are being addressed? Why now? And, what is really different?

There are many I’ve met who believe that their product/service is the best or first of its kind or not replicable. But what is the main customer pain point that you are addressing and is the time ripe for it? Many businesses die an early death simply because they are ahead of their times, or because an ecosystem to support the business or expand the market has not matured adequately. For instance, online grocery shopping may not have worked in India five years ago, but today with technology, logistics, payment mechanisms in place it seems to be a viable method.

However, the toughest part, and the one that requires maximum attention, is to identify the one or two strongest customer propositions. This is what defines your business in the market place; this is what your entire business strategy will be based on; this is what each and every employee in the organization will align towards.

Do you understand the chosen industry and competitors well?

Are you trying to be an entrepreneur because it’s sexy to be one, or are you entering this having done the necessary research? Passion is important, but that alone doesn’t pay the bills. It goes without saying that unless you do understand the forces at play, the outcome will at best be mediocre. Will you be able to both open up a new market/category and sustain market share? Or will you be the guy who opens the market, educates the audience, only to see others with deep pockets rush in and edge you out?

What are the key factors that will keep the business in business?

You obviously know where the revenues will come from and may have even formed very scientific assumptions to predict future revenues & costs, but you might have to consider every tangible and intangible aspect that will keep you going. You need to be adaptable to evolving needs; in fact you should be able to proactively cause people to change their needs & habits. That’s a very important skill. For example, if you are a healthcare company, are you going to choose only the unwell as your target client, or do you want to inculcate a habit of regular check-ups among the larger population and thereby create a much larger catchment area for yourself. Similarly, you should be aware of how government policies can affect you, what wind is blowing politically and how that could shape the policy environment. Is your universe of target audience expanding or shrinking; and what adjacencies to explore?

Do you understand your potential investor?

The potential investor is probably reviewing several plans simultaneously. She/he may not have the time to do detailed research on the businesses at this early a stage. So try to present her/him with as many relevant information nuggets as possible, with due reference. If you are presenting a certain market size & dynamics and you got the numbers from Report XYZ; please do mention – after all you don’t want anyone to think that those numbers were pulled out of thin air. Tell the investor why you are the right person to back, who are the others that take decisions in your company and what are their backgrounds. Support your financial projections with rational assumptions and go into as much detail as possible.

And don’t forget the most important aspect that any potential investor looks at – a successful exit. Every investor will want to engage with a player who has a definite plan to provide an exit – whether through buybacks, IPO, trade sale. So it comes to 3 things: Ability to Scale, Ability to Execute and Ability to Exit.

The list can go on, but the fact is that a well-researched business plan, that showcases the entrepreneur’s passion and gumption, always wins. The trick is to tell a compelling story, grounded in rationality, which excites everyone!