Yeah! Got a double spread in the Economic Times today (24th Aug 2014) for an article that was one the MOST challenging for me to write (researching and contextualising the data) & eventually the MOST satisfying!
I hope you enjoy it and comment liberally! (Complete text appears after the image)
If you haven’t seen the 1997 cult movie ‘Face/Off’, then you must! It's a classic thriller starring John Travolta (good guy) and Nicolas Cage (bad guy) and how they transplant each other’s face to get even with each other. The movie keeps you on the edge till the very end.
As a keen observer of the digital space, I have been ruminating about how the e-commerce and airlines business dangerously resemble each other and how tragically deceptive they both can be. These are my reasons:
The Business of People
In 2014, about 3 billion people in the world will take a flight to go somewhere. Given that airlines have existed since 1909 (The Great Yorkshire Show Airline), it has taken about 100 years to get 3 billion people to fly or 30 million per year cumulatively.
In 2014, almost 1 billion people will buy something online. Amazon launched in 1994, whereas most of the other e-com sites began later (Flipkart started in 2007). If you consider the years 1997-2001 as the base period of the dot com boom (and yes, bust), it’s taken about 15 years to get 1 billion people on the e-com bus. Now that's about 60 million people per year cumulatively or double the people who started flying each year!
It's a no-brainer to figure that if 30 to 60 million people start doing something each year and the earlier ones don't stop either (the concept of cumulativeness), then you have a real business! And it’s not difficult to imagine why. I mean, no one will take a boat to travel from Mumbai to London; or go to Lamington Road anymore to buy a flash drive. Travelling by plane and buying essentials online is as obvious as seeing potholes in Mumbai city.
If so many people are so interested in these two businesses, then what is the outcome of the companies that operate in these industries? How has destiny behaved with them so far and what fate awaits the newly born?
The Treachery of Profits
Warren Buffett infamously (in jest) said that if he had the opportunity, far sightedness and spirit, he would have SHOT DOWN the first flight of man – the plane that Orville Wright flew which landed at Kitty Hawk (and spawned the airline industry). Buffet went on to say, “I owe this to future capitalists – to shoot him down. I mean, Karl Marx couldn’t have done as much damage to capitalists as Orville did.”
Haven’t got the message yet? There’s more! If you were to put the balance sheets of all the airline companies of the world together, ever since they started up, you would find zero profits in there. The airline business has never made money since inception!
Now recap the numbers: “In 2014, 3 billion people will take a flight somewhere” - can you believe that it will still be a zero sum game?
The fact stares at you as solidly as those ‘moth balled’ Kingfisher planes that were parked all across Indian airports some years ago. Today, they are nowhere to be seen. Collectively, airlines in India have an accumulated loss of Rs. 49,000 crores (and counting) and these include strugglers like SpiceJet, big winners (and losers) like Jet Airways and our favorite airline – Air India.
Nothing sums up this predicament better than Richard Branson’s classic quote: “If you want to be a Millionaire, start with a billion dollars and launch a new airline.”
E-commerce has a similar story! Amazon has barely made profits (although a deep analysis reveals that Jeff Bezos ‘invests’ a lot of the free cash flow into expansion) and Indian e-com companies routinely get re-financed every quarter to keep going.
If we add Flipkart’s 1.5 billion raise + assume another 1 billion across other e-com sites in India, we are looking at a cumulative loss of Rs. 15,000 crores in a business vertical that is barely 7 years old!
The similarities of the movie ‘Face/Off’ with E-com and Airlines now begin to look even more real (oops eerie) than ever!
Everyone likes to Serve People
There are over 300 independent airlines in the world currently. These are fully operational companies. 300 airlines exist for 3 billion people. That's about 1 airline for about 10 million people. If you consider India’s population base of 70 million passengers, we should have about 7 airlines – which is what we have.
The point gets expanded in the competitive markets. Let’s examine USA which has a population of about 300 million people. Logically there should be about 30 airlines operating there. But there are over 150! In the past 50 years, at least 50 American companies have come and gone (declared Chapter 11 or bankruptcy, revived or simply closed down).
In India, we all remember the bankruptcy of ModiLuft, Damania, East-West and the shady deal of Sahara Airlines.
Where 3 billion people live, many will come to serve. And that is exactly where the problems of over competition arrive!
The scene in the e-commerce space is frightening!
Over 190,000 e-com websites in the world are alive and kicking with a Magento Shopping Cart application (a popular e-com platform to manage e-com websites).
Using refined metrics, RJMetrics (a popular blog site dedicated to e-commerce), reveals that there are at least 1 million e-com sites serving consumers all over the world. By applying these metrics and minimum revenues (US$ 100k per year = 60 lacs approx), the number of meaningful e-com sites clocked in the world are about 100,000.
Now, if 100,000 websites are going to serve 500 million people, that's just 5000 consumers per website! Is that even viable? Obviously not! Of course, the biggies – Amazon in USA and Flipkart in India own massive consumer share. But there are just too many wannabes trying to capture a share of the e-com space that makes it appear similar to the airline industry of many years.
People are Disloyal. Period.
Let me ask you, how loyal are you to an airline? Given the many choices, it’s fair to assume that you shift loyalty to suit your requirements. Also, for overseas travel, it gets more complicated. Juggling routes, days, landing & take-off schedules and obviously price; make you consider different airline options apart from the one you flew last.
The same applies for e-com websites. I just typed “I want to buy a Nexus 5 phone in India” on Google and got more than a hundred meaningful results. Many were blogs and price recommendation engines, but they all led to some e-com site.
When you travel, you go from one city to another and choose an airline to carry you. When you buy a product, you choose an e-com site to ‘carry’ that item from the seller to your house. In e-commerce, this is further established by the fact that most e-com businesses are now ‘marketplaces’ that simply list buyers, selling their goods. The e-com sites deliver these products to you (along with Cash on Delivery payment risks).
Honestly, both businesses resemble courier businesses and nothing more. And courier businesses rarely rely on loyalty to remain relevant. They deliver on service. To this point, Michael O'Leary, Ryanair CEO was quoted saying, “Air transport is just a glorified bus operation.” If that doesn't sound convincing, then Harvey Mackay (a world renowned author) says this of Southwest Airlines (the only, almost consistently profit making airline in the world): “Southwest Airlines is successful because the company understands it's a customer service company. It also happens to be an airline.”
External Shocks can and will happen
The biggest shock for the airline industry in the recent years has been the 9/11 terrorist attack (which imploded air travel) and the incessant rise of fuel cost.
Consider the price of Crude Oil Brent (in US$ per barrel). Airlines paid $38 per barrel in 2004 – they are now expected to pay $108 in 2014 (almost 3 times). Similarly Jet Kerosene Fuel (in US$ per barrel) that cost $49 in 2004 will now cost them $124 in 2014! (almost 3 times)
These costs kill given the fact that the ARPP (average revenue per passenger) in the airline trade rose modestly from $140 in 2004 to just about $180 in 2014.
In e-commerce, the cost of ‘consumer acquisition’ is clearly the equivalent of the airline oil shock. Today, it costs anywhere between Rs. 1000-2000 to acquire an online ‘consumer’ via online ad spends. The more ambitious (and better funded) advertise on television to acquire users but that is an extremely cost inefficient model (remember the Kingfisher television commercials before it went bust?). Most buyers go to Google, type their purchase wish and look at the plethora of options to choose from.
Google is the Middle East of the Internet. Everyone in the world goes to Google, every day. It owns the ‘consumer’ wells. It sells ‘crude traffic’ which is like crude oil and can determine the price of this critical input as it likes.
If Google or noisy competition substantially increase the cost of online ads (especially for specific keywords via bidding or otherwise), a lot of smaller e-com businesses will get into trouble – like the hundreds of airlines that constantly go broke.
Investors love Top lines and they will buy!
If airlines and e-commerce companies have so much at risk, how do they survive? Who funds them? Why on earth do we see new e-com sites every day and new fancy airline carriers with new routes and offerings?
The truth is that capital chases the BIG. Airlines will turn US$750 billion in revenues in 2014! That's a lot of money. Now hold your breath. E-commerce will top US$ 1.5 trillion this year (this also includes 50% of airline revenues that are now being booked online!). That's a lot of revenue that has massive outcomes.
For the airline business, return on funding has been pathetic. Consolidated balance sheets reveal that the return on capital has ranged from 2.9% to 5% over the past years. That's hardly exciting! A Marwari like me will tell you that if you don't get 25% per annum, you're a fool with your money.
It’s no wonder we hear quotes such as, “This industry attracts more capital than it deserves.” - Stelios Haji-Ioannou, founder of easyJet and “People who invest in aviation are the biggest suckers in the world.”— David G. Neeleman, after raising a record $128 million to start New Air (the then working name for what became JetBlue Airways).
However, if you meet Ivy Leagued VCs who have poured their millions into e-commerce you will hear songs of praise, glory and a vision that may sound like the establishment of the next Exxon (which by the way is a single company that makes more money than all the airlines of the world put together). And there is a reason. Amazon which barely makes money has a market cap of $154 billion and the soon-to-list Alibaba will break all records.
The trick and challenge like in ‘Face/Off’ is to figure out who is what, when and where. And then decide to buy, sell or just be a happy, happy consumer!
Please do comment and share !!
What is your view on Taxi business in India, looks similar to me.
It's an awesome article with good analysis.
Sir todays paper then 24th I guess
thanks for picking up the typo arpit!!! i've corrected it for alok :)
Great article. Points well supported by data.
Superb comparison, invoking the fear of another developing bubble burst..(E Commerce)
Great Insights there Alok sir , However, I want to add something ... Actually, Ecommerce players have already started thinking like Customer Service Companies ... It's not about Acquisition any more, but it's about Customer Lifetime Value (CLV), the idea is to stick to the customer and make them purchase multiple times. And I am sure you would agree with me, Ecommerce has made life easier, so loyalty will not come in terms of Ecom brands or the brands I am buying, but it will surely follow in terms of service. I am ready to buy from Amazon and Flipkart over and over again, cos, I have used their service and find them reliable. And of course the valuations are based on CLV X number of customer acquired . My 2 cents
Well written post, Alok and nicely supported by facts and figures.
Super Informative and Interesting and feel like reading again and again...
Thanks for sharing
This might be true for large internet companies going through multiple rounds of funding and valuation....
however there are smaller and middle term players... self funded and then go on to Angel funding and stop there and organically grow. They should survive unless u just switch off the internet :)
Also, Airlines need large capital (unless someone comes with the most brilliant cheap and cost effective and time saving airline for travel between the high volume Mumbai-Pune route) and gives railways and bus operators a run for their money. Niche category e-com players might still be able to launch and do well in B2C
Also there is the huge B2B market in Internet which is untapped.
E.g. JustDial (Telephone... not DotCom)... has done very well for themselves and for B2B subscribers of theirs... I validate this as I get large leads and out of those few conversions for my Corporate Gifting business.
Maybe the next justdial on the web still needs to be born....
different views above... looking forward to reactions.