Everything you need to know about India’s startup bubble

Source: http://www.livemint.com/Companies/vtqiTC9VgJgnUfOAH2QdiL/Flipkart-still-Indias-top-startup.html

One of my friends showed this chart to me during a cocktail conversation about excessively funded and overly valued Indian startups. At first I was like, “Sure yeah, this is a huge problem. There’s another dotcom bubble like situation going on. Next rounds of funding will be hard to acquire. Major round of consolidation is going to take place soon.” But the more I looked at this, the more I was glaring at the disturbing implication of how the basic definitions of business and entrepreneurship was toyed with over the last 3 years.

Yes these are all Indian startups. It’s not like they’re in their first or second year of operations wherein you could expect such consistent losses with hopes of breaking even sometime in the future. Most of these companies have been around for 4 or more years and are still showing no signs of stability in near future. In total, the 41 startups listed above have incurred almost $2.1 billion in losses. Oh and just let me point out the fact that this is happening in a third-world country, where that amount of money can be used to feed and clothe naked, hungry slum kids easily for next 3 generations.

So as soon as I got home I fired up my excel sheet to calculate some ratios for an in-depth comparative analysis. For this I chose — Flipkart, BookMyShow, Snapdeal, OYO Rooms, & (the brightest of them all) Grofers.

Value Created Per Sale & Loss Per Sale

Ideally you’d want to use Price to Earnings ratio to judge how successfully a company is operating but these are all private companies so P-E ratio is not a viable option.

For this analysis, I decided to choose Enterprise Value to Revenue (EV/R) ratio and Profit Margin (most of these companies are making losses so let’s call this Loss Margin instead). These ratios indicate how much value a company is creating per dollar of sale and how much loss a company is incurring per dollar of sale.

1. Flipkart

Flipkart’s valuation was fluctuating very quickly in the beginning of 2016 — it reached a peak valuation of $15.2 billion in 2015. However, recently it was reported that after months of struggling, Flipkart raised $1 billion at a valuation of $10 billion. Valuation slashed down by $5.5 billion in less than 2 years — first hint that something might be terribly wrong with the system used to value start-ups.

Compared to the others, Flipkart has the most sober ratios. For every $1 worth of sale, Flipkart generates a value of $3.6. Generating value is a subjective matter — no one can entirely measure how $3.6 worth of value is generated per sale but this is what Flipkart’s valuation of $10 billion implies. Furthermore, for every $1 of sale, Flipkart also loses 32¢.

2. Snapdeal

Snapdeal is one of the top 3 names in the India’s ecommerce industry — lagging behind after Amazon & Flipkart. This is exactly why it’s in the most dangerous spot at the moment. When I have to purchase something online, I usually go to Amazon first to check the price & availability (global brand, highly trusted — it just feels right), then compare it with what’s there at Flipkart. Usually I find something worthwhile at one of these 2 places so I don’t ever go to Snapdeal to check over there. However, my behavior isn’t indicative of how an average Indian consumer behaves.

For an average Indian consumer, shopping is an important activity in their lives. It’s a way for them to get out of their houses on weekends and go roam around in the malls or shopping complexes with their family & friends. They will not necessarily buy something, but it is an irreplaceable weekend experience for them nonetheless. Ecommerce companies are trying to replace this behavior, which holds a huge amount of social value in the consumer’s life, with a complete online experience. An Indian consumer will only tend to buy a certain thing online when they know exactly what they want and if they’re getting a good discount on the same. This implies that the Indian ecommerce market is not generating enough value for three billion-dollar companies to survive — this is the simplified reason behind all the Snapdeal’s woes. Most of the Indian ecommerce companies are replicating the business models of their counterparts in US which does not give them an opportunity to truly understand the mindset of an Indian buyer.

Currently valued at $6.5 billion, Snapdeal currently generates a value of $29 for ever $1 worth of sale. This is hugely inflated as they also lose $2.3 for every $1 worth of sale. If Snapdeal was truly generating that amount of value per sale, it would not need to fire 30% of its staff over the course of 2 months. This is what happens when you highly inflate your cost of customer acquisition by bringing in high net-worth celebrities as your brand ambassadors and running primetime TV ads daily without even having a sustainable business model. Recently there was news about how Snapdeal is in talks with Paytm & Flipkart for a possible merger or acquisition but Paytm pulled out due to valuation disagreements. However, the biggest investor in Snapdeal has realized the dark times ahead, SoftBank is now pushing hard to sell the company to Flipkart. This move will end up creating the biggest ecommerce entity of India with twice the miseries of both the companies.

3. OYO Rooms

I actually have very less to say about OYO Rooms’s business model. I do believe it is a really unique concept and has been proven to be beneficial for a lot of low and medium budget hotels around the country. Consolidating these highly dispersed budget hotels under one umbrella helped OYO offer rates at really low prices which ultimately helped in bringing in the customer loyalty of frequent travellers. However, this model was easily replicable and posed a huge threat to hotel aggregator as well as online travel websites. This led to few similar players entering OYO’s territory such as ZO Rooms and FabHotels. In addition to that, Indian online travel websites such as MakeMyTrip, GoIbibo, and Yatra.com decided to delist all the hotels associated with OYO Rooms as it was eating up their own margins. This significantly lowered the visibility that OYO rooms had initially achieved.

Furthermore, OYO Rooms’s ratios are highly inflated as well. OYO was valued at $500 million after its last round of funding in 2015. For every $1 worth of sale, it generates a value of $232 and loses $25. Even though OYO Rooms’s business model comes across as quite sustainable, its valuation is still highly inflated as the value of $232 per sale is not currently justified — this might change in future if OYO is able to further diversify its offerings in upcoming months. However, if it fails to justify its inflated valuation soon, the most possible consolidation scenario (I feel) would be an acquisition by a bigger hotel chain that wants to expand into the budget hotel segment in India.

4. Grofers

Online grocery delivery has always been an uncertain area, largely because a lot of customers prefer to touch and feel and pick out their own groceries before purchasing. This is again an irreplaceable activity that an Indian customer undertakes from time to time. Grofers is a hyperlocal grocery delivery startup that helps in delivering the stuff available on the supermarkets & stores around you. The only problem here is that if you call the store near you directly with your grocery requirements, they will be more than willing to send their own delivery boy to you for no extra cost. Why do I need Grofers again?

Grofers does offer huge discounts on the products available at these stores if you buy it through them. I personally ordered from Grofers once to see how the service worked exactly. It was quite an interesting experience because they bought the groceries from the store right outside my place and accidentally left the original receipt in the grocery bag. I paid Grofers $10 for the purchase, while Grofers purchased all the same things for $17. This is a huge customer acquisition cost and the only customers you acquire with such tactics are discount whores (like me) who will quickly change their ways once Grofers starts lowering the discount rates to look for more sustainable ways for survival.

Grofers was valued at $400 million in 2015, the number which probably has only increased by now. For every $1 worth of sale, Grofers creates a value of $4407 and loses $103. I am still unable to understand the logic through which your company can lose over $100 per sale and still manage to create a value of over $4k per sale — the losses your company is incurring is 100 times your revenue. This was clearly not what I was taught in business school. The cost of customer acquisition for Grofers is also extremely high due to the heavy discounts it’s currently offering and the non-stop primetime TV ads it does to reach out to new customers. In case of major industry consolidation, the most plausible scenario for Grofers would be an acquisition by a key player in a similar industry like Amazon or Reliance Fresh. Softbank, a major investor in Grofers as well, is in for a bumpy ride ahead.

5. BookMyShow

Save the best for last, right? BookMyShow is the only unicorn out of the 41 listed in the first chart that’s actually making a profit. As of Summer 2016, BookMyShow had a valuation of almost $460 million (Rs. 3,000 crore). For every $1 worth of sale it creates a value of $12 and generates a profit of 1.2¢. It’s not much but it’s an indication that BookMyShow is on an upward trajectory of the legendary hockeystick growth curve.

It should be noted that unlike most of the companies mentioned in the chart, BookMyShow has been around for more than a decade. It was started in 1999 as a ticketing and POS software for large-scale cinemas and multiplexes. They were the only solution of its kind available in India at that time, which allowed them to gain a strong foothold in this segment. As internet and smartphones became commonplace in India, BookMyShow launched an online ticket aggregator and later diversified into all kinds of live events such as concerts, music festivals, theatre plays, cricket matches, exhibitions and so on.

Now India’s leading ticketing platform, BMS has a huge amount of data and, therefore, a solid understanding of how live events work. This has enabled them to be a #1 choice for event organizers to plan in terms of logistics such as box office management, gate entry management, ticket printing, wrist band printing, F&B management etc. This, my friends, is what makes a platform successful — years of persistence and strong grasp of your continuously evolving market.

This is not what I was taught in business school!

Few years ago, in-around 2014, Indian startup sector had this sense of boundless optimism. There was a new startup born every other hour. People were quitting their stable jobs and dropping out of their colleges, just to start their own startup. It’s not like they all had the next big idea for a new Facebook, Microsoft, or Apple. Most of these startups were either online ecommerce store or food/ grocery delivery and they all were replicating successful business models in US. Running your own startup became the next “get rich quick” scheme — it was a way to escape the constant hustle that life is all about to start a company with the ultimate goal to get funding, get a high salary, and get famous. That’s not what entrepreneurship is — ROOKIE MOVE!

But this trend was not just triggered by inexperienced entrepreneurs. VCs and Angel investors played an equally important role in adding fuel to the fire. In 2014, a total $5.2 billion was invested into the tech startup ecosystem — which was an increase of 400% from 2013. This reached its pinnacle when a grand total of $9 billion was invested in 2015. If this is broken down into individual deals and spaced out throughout the year, it shows that an Indian startup got funded every 8 hours in 2015. This sounds ridiculously familiar right? This is what happened during the dotcom bubble and also during the housing crisis. This is exactly how economic bubbles are formed: when we pump a lot more cash in a system than its intrinsic value. This leads to inconsistencies in valuations which becomes impossible to justify (what just happened in case of Snapdeal & Grofers).

Of course bubbles are easy to identify in retrospect. Some may argue that this was entirely a ‘black swan event’ and now I’m just trying to rationalize how obvious this was with the benefit of hindsight. Nonetheless, pumping money in a system at this rate should be harmful regardless of when and how it happens.

All the commonly funded startup founders became the poster children of the great Indian success. What was their success again? That they were able to raise constant rounds of funding without really paying attention to the sustainability of their business models. The only logical move with that much cash inflow was to fill your company with superior talent without any scope of survival. The amount of work in the organization stayed more or less the same but the labor grew 10–20x — hence, the inefficiencies crept in and these startups were now being run like corporations. The investors too had to rope in more investors to preserve their investments and keep the vicious circle going.

All the well funded companies started hiring fresh college graduates at ridiculously high salaries and this caused an imbalance in the salary structure throughout the country. It was reported that due to the recent lack of funding and profitability, these companies had to fire all the high paid employees (with relatively less experience) they initially hired. Now when those employees go out to look for new jobs, other employers expect them to take huge pay cuts compared to their previous jobs. No other sustainable companies can afford to match their previous pays. More details on the salary bubble in this news article.

This is what happens when you use aggressive expansion tactics without paying equal amount of attention to your product or offerings. Traditionally, the idea of running a startup was filled with uncertainties — the inflow of cash depended on how hard you worked and it only happened after you had reached your successful period. But now, cash came in a lot before you were successful. As a result, all the employees as well as the CEOs felt somewhat entitled to their high salaries — there was no direct reward associated with the risk of running a startup anymore. Startups were termed as the next fads.

Very recently it was reported that travel bookings website Stayzilla’s CEO was arrested for shutting down the company with non-payment of dues to its vendors. This incident has sparked an outcry amongst the Indian startup lobbyists. Although I do respect their cause, I do believe that such episodes are necessary to bring the Indian startup scene back to harmony. People need to change their perceptions and realize that running a startup is a serious business (pun intended) and it should not be glamorized. Paying your vendors and employees is the basic necessity every company needs to fulfill and if an entrepreneur does not take that seriously then they don’t deserve that label of ‘entrepreneur’ in the first place.

This is the biggest threat to entrepreneurship we have ever faced. My college always asked us to define entrepreneurship in our own ways. The idea was that there is no right definition of entrepreneurship — it is purely what you make of it. Entrepreneurship is not just about running a business or making money, it’s about bringing a positive change in our surroundings. As entrepreneurs, we have a social responsibility to uplift our communities and bring a better change in lives of people we touch. However, what is currently happening in India is not entrepreneurship — it is a much self-centered and materialistic outlook towards it. Entrepreneurship is about hardship and survival — it’s not about getting rich overnight.

This was one long post, wasn't it? Well I did say I use Medium to vent out my thoughts and attain my peace of mind 😛

But if you’ve actually read this far then you’re really my hero and I hope you were able to relate with at least few of the things I said. Please hit that green heart below to let me know 💚