B2B commerce opportunities in Indonesia

Despite the challenging funding environment, B2B commerce remained one of the most active spaces for startup fundraising in Indonesia during the first half of 2023. Over 10 startups funding rounds were announced with a cumulative of $170M.

Strong tailwinds such as global supply chain diversification due to the China+1 Strategy also benefited Southeast Asia countries including Indonesia, and we’re seeing a continuous increase in foreign direct investment, job creation, and new export business opportunities.

List of Indonesian B2B commerce startups fundraising announced in H1 2023

My framework of assessing B2B marketplace opportunities in Indonesia

Having spent a fair bit of time looking at B2B commerce at Saison Capital, I’ve become a strong believer in this space, especially in vertical B2B marketplaces. As each sector faces its own supply chain challenges, a verticalized approach provides better customer experience by:

• Solving supply chain challenges of logistics, payment, and financing
• Providing deeper supply chain integration with key stakeholders
• Building a network effect within the ecosystem

Inspired by Piyushi at Vertex Ventures, and Anant and the team at Bessemer who have provided excellent insights about Indian B2B marketplaces, and my colleague Visa who explores the role of working capital when examining the margin profile of B2B marketplaces, I use the below framework to assess the B2B marketplace opportunity in Indonesia:

Assessment of different B2B sectors in Indonesia

The color coding green, gray and red indicates attractive, neutral, and unattractive, respectively. For margin capture, I follow Bessermer’s benchmark which defines attractive, neutral, and unattractive as Gross Margin: >15%, 10–15%, <10%, and Contribution Margin: >8%, 3–8%, <3%.

Market size is undoubtedly one of the biggest factors when we assess any investment opportunity and there is no exception here. I want to discuss other factors that are equally important in making a B2B commerce opportunity attractive by using one sector as an explanatory case study.

1. Margin Capture: The Case of Construction Materials

Margin measures the willingness of the marketplace participants to pay the marketplace for its services and this is often a factor of the complexity of the supply chain, competition in the market, and the value created by the marketplace (providing credit, easing payments etc.).

For example, the construction sector is often characterized by thin profit margins, due to competition, low barriers to entry, volatile material prices, and high operational cost.

Example of a construction materials supply chain

Take a public company, PT Catur Sentosa Adiprana (CSA), for example. CSA is one of the largest construction and building materials distributors in Indonesia with over $1B in annual turnover. CSA’s Gross Margin stands at 17% — this may seem high at first, but there’s usually an Accounts Receivable problem in B2B commerce, and CSA is no exception. 3% of CSA’s sales are unrecoverable Accounts Receivables that should be excluded from its Gross Margin, which makes its “realizable” Gross Margin of 14%.

Once we take into consideration its operational expenses, the Operating Margin stands at only 3–4% (this would have been 7% if we don’t take into consideration the effect of unrecoverable Accounts Receivables) — bear in mind that this is a company that operates with economics of scale and 40 years of expertise in the industry, and it will be a lot more challenging for a new-comer startup player to capture the same level of margin as CSA.

CSA’s financial performance over the past two years ($M)

CSA’s performance suggests that a pure transactional approach might not work in the construction space especially for start-ups that are at a much lower scale than CSA. Marketplaces in construction might need to create value by doing one of the following:

• Supply Chain Consolidation: This improves efficiencies by supplying construction materials directly from brands or distributors to the contractors, resulting in faster turnaround times, and lower margin leakage to middlemen. However, supply chain consolidation can also significantly increase the operational cost of the marketplace (because of logistics and inventory costs). It is also not easy to convince brand principals, who are used to dealing with large distributors, to onboard. In emerging markets, it’s important to bear in mind that these principal-distributor-customer relationships have existed for decades and relationships are usually difficult to disrupt for marginal / incremental improvements.
• Private Labels: Private Labels lower the search costs and ensure high product quality and availability. This is especially important for the contractors who value product and service availability over price. Marketplaces building private labels should focus on non-commodity products (such as chemical and polymer building materials) because availability of commoditized products (like cement, steel) is not really a problem that needs to be solved. While launching of private-label products can improve the overall margin profile and improve customer loyalty, there’s a high risk of failure as it requires a significant amount of upfront costs, inventory, working capital, and branding efforts.
• Credit via Embedded Financing: Credit solves working capital constraints for contractors whose money is usually tied to the completion of the project. Access to credit for contractors is constrained by their size (these are typically SME/MSME) and the inability of a bank/financial institution to underwrite them effectively without increased operational costs. Marketplaces have an edge in underwriting and collections given that, at scale, they collect unique data on the contractor’s transaction history via the marketplace platform. Marketplaces might also be more effective at accessing credit given the size of their aggregate loan book across all contractors.

2. Market Concentration: The Case of Poultry Farming

Another factor we always consider when assessing B2B commerce opportunities is the concentration (or fragmentation) of the market. Markets where suppliers are highly concentrated not only make it hard to penetrate but also make value creation more difficult, as buyers already know the suppliers well, have a preferred brand or established relationship with the suppliers, and there is no information asymmetry.

Take chicken farming for example, a sector that has captured investors’ interest in the past two years. A typical chicken farm supply chain includes three components:

• Upstream: feed mills and breeding farms sell chicken feed and days-old chickens (DOCs) to chicken farms;
• Middlestream: chicken farms sell live birds to slaughterhouses or meat processors
• Downstream: slaughterhouses and meat processors sell chicken meat to customers

Example of a chicken farming supply chain

If we look at the upstream of the chicken farming supply chain, it was predominantly controlled by a few conglomerates — 80% of the chicken feed and breeding farms are controlled by 5 players including CP Group and Japfa. These conglomerates also hold an unfair advantage in importing key ingredients such as soybean that make up chicken feeds, making it difficult for new comers or farmers to produce chicken feeds themselves.

Market share of chicken feed and days old chicken in Indonesia

Hence, we are seeing startups in the chicken farming space tackling different problems to solve for the farmers such as:

• Increasing Production Efficiency: This aims to help small farmers (many of whom don’t have professional facilities) reduce the mortality rates and produce more output. Mortality rates of as high as 10% are commonly seen during the chicken farming process. With IoT devices on temperature control and smart feed hoppers, startups can drastically reduce the mortality rate for the farmers to as low as 2%.
• Enabling Farmers to get the Best Price for the Chickens: Compared to the concentrated upstream, middlestream and downstream distribution are more fragmented and therefore open more opportunities for new players to capture. Traditionally, once the chickens are ready for offtake, farmers face pricing pressure as they only have a very short window to sell the live birds (this could be as low as 1 or 2 days). Startups can help farmers expand their buyers’ network to fetch a better price and give the farmers more negotiating power.
• Stabilizing Input Costs and Output Yields: Contract farming models solve for the cost of inputs and price fluctuation of chickens during offtake. It is estimated that currently, only 10% of the chicken farms in Indonesia are under contract farming agreements. Contract farming guarantees the price and quantity of the offtakes, creating a win-win situation. The farmers worry less about selling and focus more on taking care of the chickens, and the startup is guaranteed a supply of chickens to build economics of scale to sell onwards to slaughterhouses.

3. EXIM Opportunity: The Case of the Fishery Industry

A strong export / import angle also makes a sector interesting. As one of the fastest-growing sectors in Indonesia, fishery trading presents an intriguing EXIM angle with its substantial export volume. According to recent OEC data, this sector exports $6B worth of products, driven by robust international demand for fish and aquaculture products from especially from the US, China and Japan.

Market size of Indonesia fishery sector ($B)

However, as most fish farmers don’t operate at a scale, they can’t directly sell overseas. This creates an opportunity for startups to create value as a marketplace via supply aggregation or demand generation. Higher margins in the export market also mean better margins for an export-focussed start-up versus a start-up focussed on the domestic market.

Furthermore, approximately 95% of the fishery exports consist of frozen or processed fish. This is a complex supply chain given the transportation and storage requirements (cold chain logistics are required for its meticulously controlled temperature environment, specialized refrigeration equipment, and efficient logistics to preserve the products’ integrity). Most fish farmers are too small to manage this complex supply chain in a cost-effective manner. Startups aggregating supply can build economies of scale to provide this as a value-added service and corner more margin.

Breakdown of Indonesia fishery export by category GMV

In the past two years we have witnessed strong tailwinds driving the export business growth in Indonesia:

• Indonesia is having a breakthrough year of Foreign Direct Investment into the country, with sectors including metal, chemicals, pharmaceutical and manufacturing all benefiting from it. And global manufacturing giants such as Foxconn are setting up new factories in Indonesia via joint ventures. These investments will significantly help with local job creation, technology advancement and upscaling in the workforce, and more export business opportunities.
• With the political tension between China and the US, growing ESG concerns, and rising labor costs in China, companies that used to heavily rely on China as their manufacturing hub are seeking alternative countries to diversify the supply chain risk. This is commonly referred to as “China+1” strategy. Southeast Asia and India are emerging as winners due to their rich labor force and low cost base, especially in lower-end manufacturing sectors such as apparel, consumer electronics, and furniture.
• Indonesia has 16 free trade agreements, one of the most comprehensive trade network in among all Southeast Asia countries. Indonesia is also in the process of negotiating new trade agreements with Eurasian Economic Union (EAEU) which will focus on halal products and food products. These trade agreements give Indonesia unique advantages in market access and staying competitive in global trade.

Conclusion

We remain bullish about the B2B commerce space, and actively look for founders with the following key skillset to stand out:

• Domain expertise about the particular sector, especially the challenges, pain points and opportunities within the supply chain
• Communication and partnerhsip skills to onboard, manage, and retain relationship with sellers and buyers at scale
• Adequate finance knowledge about not only P&L, but also balance sheet, working capital (account receivables and collection); for founders that are planning to monetize via embedded credit, underwriting and risk management mindset is also essential

If you would like to exchange ideas about investment opportunities in B2B commerce or look for funding, feel free to reach out at ziheng@saisoncapital.com.