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Why I feel sorry for E-Commerce Investors

I was recently helping a major label to optimize their operations and cash-flows. A major chunk of their sales happened online but they wanted know if their stores were doing better.

So I set out to do their cost calculations which required assessment as to allocation of Fixed Costs to the Offline and Online Segments and the relative margins. In this encounter, I talked to one of the prominent E-Commerce Companies and understood their model in detail.

The data they shared gave a very complicated picture.

30% Annual Growth in E-Commerce 

E-Commerce is growing at 30% annually. This is no joke. It is a big thing and is going to keep getting bigger if they are able maintain the current price levels.

But same Price Level is a big kicker, because online shopping is a very price sensitive game with Same Brand Competitor Store Visit being super simple as compared to Offline Shopping.

Same Brand Competitor Store Visit (Offline)

Let me explain this in the words of my Client. When a customer visits a store to buy a particular Brand (eg. Adidas Shoes in Shoppers Stop), he/she has a huge disincentive to visit other stores for the same brand because of the effort required. (It takes time to go from one store to another and come back if that store doesn’t have the same design or is priced higher). To add to this the urge to buy immediately is massive because of the satisfaction value of completing your shopping instantly (Instant Gratification rocks). This disincentive of Effort + the Instant Gratification of Completion (supported by a Good Salesman who helps in selection) reduces the risk of Buyers hopping to another store to discover the price.

Same Brand Competitor Store Visit (Online)

Let’s now compare this to Online. If you choose to buy a pair of Adidas shoes, the satisfaction of completing a purchase is always going to be delayed till the time the goods are delivered in your Hand. And nowadays it’s getting worse with 9-10 days required for normal deliveries because of the poor Logistics scenario. Plus it’s on the internet so customers can easily discover the same product on competitors websites instantly. Nothing can be done to stop this.

The end result is E-Commerce Companies end up competing on the price. This means for E-commerce to grow, unless there is a monopoly, Prices are going to continue drive growth.

Impact of Price Inflexibility

The Price Inflexibility means that E-Commerce companies are asking brands to finance discounts because increase in prices is not feasible in a competitive scenario. Given the already horrible returns landscape and the onset of GST, it is highly improbable that brands will fund any discounts. As a result E-Commerce companies will be left with no option but to continue financing discounts.

Result of the Discount Financing

The result of discount financing from margins is that typically where E-Commerce companies have an on-paper 40% margin, their in-hand margin is around 10-15%

Cost of Logistics

Logistics is the bane of E-Commerce in India. Understanding logistics is vital to the entire E-Commerce Business.

Cost of Forward Logistics (Delivery to your place) – Rs. 120 – 150
Cost of Reverse Logistics (Rejected Delivery to godown) – Rs. 120 to 150 + Rs. 80 to 100 = Rs. 200 – Rs. 250
Cost of Reverse Logistics (Returns after Delivery Accepted) – Rs. 120 to 150 + Rs. 120 to Rs. 150 = Rs. 240 to 300

Split of Sales
Good Sales: 60%
Rejected at Door: 20%
Return after Sales: 20%

So for every 100 units sold 60 sales will be good, 20 will be rejected at the door and 20 will be returned after taking delivery.

This means that the cost of the rejections and returns has to be apportioned over the 60 good units. If we take the lower estimate of these costs which is Rs. 200 for rejected and Rs. 240 for returned total cost of reverse logistics is Rs. 8,800 (Rs. 200 * 20 units + Rs. 240 * 20 units) which has to be added to the 60 good units. This means Rs. 150 approx gets added to the Rs. 120. This brings the cost of logistics for a Good Unit to around Rs. 270.

Breakeven Average Sales Price for recovering Cost of Logistics:

To breakeven just with the Cost of Logistics, the Average Sales Price (ASP) has to be around Rs. 1,800 (Rs. 270 / 15% Margin)

Given that the Weighted ASP of Units in Ecommerce is around Rs. 2,000, this may seem at par. But this is just the cost of logistics. What about the Customer Acquisition Cost, Fixed Costs and Cost of Finance. Have investors tried to figure this out? Adding the cost absorption of these the breakeven ASP is around Rs. 6,000. It’s very rare that such a massive shift in ASP will happen anytime soon. So at the current levels the required time frame for Ecommerce to breakeven is at least 5 years.

Given that funding is going to become more and more difficult and market hitting saturation, it’s difficult to know what will be the situation 2 years down the line. Next day delivery, reducing cost of delivery, delivery delay penalties on logistics companies will help, but not sure if it will help enough to save the investment of E-Commerce Investors and their massive investments which makes me feel sorry for them because all this scale is useless if it can’t become profitable.

PS: Refusing returns in certain categories is the worst possible step some companies are taking. It would have been much better to offer individual discounts to customers who returned less, (like mediclaim companies have no-claim bonus)

Would love to hear your views.

Also if there is any advice you need for your business just write to me at abhishekbarari@gmail.com

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