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[Also published on VCCircle]
There has recently been increased discussion, and mainstream press reporting, on the adoption of a ‘marketplace’ model (vs. an inventory model) by e-commerce companies (e.g. these two articles in Mint: Mint 1 and Mint 2). This discussion reflects an underlying presumption that one model is better than the other. In framing the issue as a comparison of the two approaches, I think the dialog fails to address the more important question of why this shift is taking place and whether there are other approaches that can address the underlying challenges.
The shift towards ‘marketplaces’ is taking place as companies try to find a new balance between the following priorities:
- Maximizing capital efficiency
- Maximizing customer delight (selection, post purchase experience etc), and
- Minimizing logistical complexity (which helps to maximize scalability)
The need to find a new balance is triggered by scarcity of capital. As long as capital was freely available, most ecommerce companies focused heavily on the customer experience, which was best served by an inventory model. As capital tightens, these companies must now balance the need to delight customers with the need to build a viable business.
What are marketplaces?
Let me start by defining what I believe to be true online marketplaces. These are platforms that enable a large, fragmented base of buyers and sellers to discover price and transact with one another in an environment that is efficient, transparent and trusted.
- Efficiency is a function of liquidity (enough buyers and sellers) and an effective price discovery mechanism (e.g. an auction).
- Transparency is ensured by applying the same set of rules to all participants, and because buyers and sellers know who they are dealing with.
- Trust is provided by features such as buyer and seller ratings, reviews, and integrity / guarantee of payment.
Marketplaces are difficult to execute against because they require adequate and simultaneous liquidity on the buyer and seller side. Once adequate liquidity has been established and the ‘flywheel is spinning’, these businesses exhibit strong network effects (because a market that has the most buyers will attract more sellers, and the increasing base of sellers will in turn attract more buyers). So once a marketplace becomes dominant, it scales organically and often exhibits ‘winner take all’ characteristics. Additionally, because marketplaces are essentially technology platforms that provide tools for buyers and sellers to participate and a trusted environment that facilitates price discovery and transactions (vs. actually being responsible for fulfilling transactions), they can scale very rapidly.
We’ve seen all of these dynamics play out at close range as a result of our investment in the Indian Energy Exchange (IEX; www.iexindia.com). IEX operates an electronic market for power in India and has emerged as the dominant power exchange in the country with deep liquidity.
The take-away is that when you get marketplace business models right, they are profitable, scalable, defensible and highly valued. Which is why contrasting the inventory model with a marketplace model makes for an exciting debate.
The inventory model
In India, there is no question that being in control of the product (i.e. having physical inventory) enables a superior post-purchase consumer experience. If you have the product in your control, then (assuming your systems and processes are robust) you: (i) have visibility into your stock level, (ii) know where the product is physically located, and (iii) control the pick, pack and ship process. This means that you minimize the likelihood of accepting an order only to later discover that you don’t have the product. It also means that you can optimize dispatch time. The bottom line is that being in control of the product enables you to deliver faster and with higher accuracy, and respond effectively to customer inquiries about shipping status. Given the correlation between delivery times and return rates that we’ve observed (i.e. long delivery times are clearly correlated with high return rates), this is really important.
The problem is that being in control of the product has meant that companies compromise capital efficiency – because they buy product from vendors up-front, thus tying up capital in inventory, while at the same time exposing themselves to inventory mark-down risk. This can get ugly – which is why it makes sense to explore other approaches, one of which is a marketplace model.
Marketplaces in ecommerce – how different are they really?
The reality is that most of the marketplace models we see in ecommerce are not ‘platforms’, as described earlier. For example, in ecommerce marketplaces the prices are fixed, not discovered, and the ecommerce company is responsible (from the customer’s perspective) for several aspects of the post-purchase experience, such as fulfillment and customer service. The reality is that to the customer, many of these marketplace companies look identical to inventory-led ecommerce businesses. In other words, these models are simply one possible response to the constraints and challenges of traditional inventory models. And the marketplace model is not without its downsides – for example shipping costs are higher because multi-product orders are fragmented across vendors and shipped separately. And this in turn may lead to customer dissonance because a customer won’t receive their entire order at one time.
There are other solutions [Note that for purposes of this discussion I am not considering FDI related implications on company structure.]
Other possible ways of mitigating capital intensity while remaining in control of the product include (but may not be limited to) vendor credit, consignment sales (where products are in the possession of the ecommerce company but are not paid for upfront) or back-to-back purchasing (where the ecommerce company places the order on a vendor/supplier after receiving an order from a consumer). For example, ASOS, a UK-based online lifestyle retailer, has net working capital of less than 2% of sales while operating an inventory model. Similarly, Shoppers Stop in India has a negative working capital model – again despite being an inventory-led business.
Focus on the substance, not the glossy headlines
This is a meaty and critical subject for any company involved in online commerce. We’re encouraging our companies to experiment with strategies that resolve the trade-offs outlined in this post because we think companies that successfully do so will have more attractive scale and economic characteristics over the long-term. The purpose of the post is not to take sides on the inventory vs. marketplace model debate or address the pros and cons of each approach in detail – rather it is simply an attempt to surface the underlying issues that are driving the evolution of how ecommerce companies operate in India.
[Published in Medianama]
Ecommerce in India has gone through a cold spell, but there is hope for warmer days ahead. There appears to now be a clear focus on contribution margin and sustainability versus the previous race to buy topline. As Bejul explained in his post, customer lifetime value is a metric that Lightspeed believes is critical to measure and optimize.
The ecosystem is a key enabler of sustainability for an industry. For example, it is unviable for all ecommerce players to build end-to-end logistics and payments/wallet capabilities internally. Certain ecosystem trends are emerging which may help ecommerce businesses become more viable over time:
Capabilities of logistics service providers aren’t static
Logistics is where rubber meets the road, and ecommerce glamour meets the offline reality filled with dust, sweat and lost/wrong/delayed shipments. Some ecommerce specialist players now provide:
- End-to-end ecommerce solutions, including inward, racking, picking, packing, shipping and collection.
- Transparency into logistics company’s processes through APIs, which can reduce returns (and costs) and bring predictability.
- Variable warehousing bills (per order shipped) that help manage costs at lower scale, and a projection for reduction in per unit cost with increasing scale of the ecommerce business.
There are several new and old companies worth calling out:
- Dedicated ecommerce divisions within traditional players like Bluedart, Aramex, etc
- New ecommerce logistics specialists such as Delhivery, Holisol and Chhotu. These companies and teams tend to be more hungry, innovative and nimble than their traditional counterparts but are still building their capabilities. Also interesting is Mudita for bulk inter city shipments.
Payment gateways/aggregators are trying to address pain points
Payment gateway failure horror stories are common, with failure rates as high as 35%. This continues to be a lost opportunity, and a very expensive one, as it costs up to Rs 1,000 to get the customer to that point. Here are a few improvements/innovations that are coming up:
- Wrapper technologies that work with multiple banks to minimize probability of transaction failure.
- Deep analytics and visibility into customer’s intent to buy: For example, ecommerce companies can track a list of failed transactions (with customer and cart details) so that their teams can follow-up and close offline.
- PCI/DSS compliant widgets which simplify the payment experience for consumers.
- Capability to handle payments originated over mobile web.
There are traditional names like Billdesk, CC Avenues, EBS, who are incrementally adding value but the new teams that are coming up quickly are Citrus and PayU, in addition to GharPay which collects cash from consumers’ doorsteps when no physical delivery of goods is involved (e.g. tickets, collection in advance of shipping).
The industry is maturing
Some of the more recent trends I see are:
No-poach agreements: After the initial land grab in the OTA space, Yatra, Makemytrip, Cleartrip got into such arrangements. Leading ecommerce players are now discussing these. It is good from a talent pool perspective too, as people apply themselves to fix hard problems versus moving to the next job.
CoD Blacklist: CoD is a key part of Indian ecommerce. However, high CoD return rates (upto 25% in some categories) cause operational challenges and working capital burden. Some players are discussing creating an industry wide CoD customer blacklist – this can drive significant efficiency for ecommerce / logistics companies and a better experience for genuine customers.
Trust from OEMs/Brands: Brands/OEMs are putting more trust into ecommerce now. Eighteen months back ecommerce was not strategically important to brands/OEMs, but brands are now launching their own ecommerce platforms, and/or have a clear strategy for ecommerce as a channel. Senior executives with years of core category experience are now excited about ecommerce and are considering opportunities in this retail format.
These trends are still in their infancy but if they continue the situation will be very different a few years from now. The key question is to what extent and in what time frame will these developments move the needle in making ecommerce sustainable.
Some thoughts for ecommerce entrepreneurs
My thoughts for entrepreneurs building ecommerce companies are to:
- Assess if you can derive value out of any of these services / trends: For example, compare if your current logistics / payment provider (in-house or outsourced) is competitive with the changing environment or revisit if you can bring in top talent from the domain into your team.
- Step forward to support the ones you find relevant: For example, you would take risk when you test a new partner in your order flow (logistics or payment), or when you commit to not hiring from competition, but these partnerships can pay off very meaningfully in the long run.
- If you are a new startup, identify and focus on your core competence: Logistics and payments contribute significantly to direct costs but they are only necessary and not sufficient for success. So unless you plan to differentiate on these, leverage the ecosystem.
This list is by no means exhaustive, so please feel free to add more names / trends / thoughts in the comments section.
Here’s the presentation I gave at the IAMAI Digital Commerce event this morning:
[Published in Pluggd.in]
I am speaking at IAMAI’s conference on Digital Commerce later this week in Mumbai. I thought I would put down a few thoughts here that I believe affect ecommerce in India as an industry.
There has been an increasing amount of debate recently around the sustainability of ecommerce companies in India. I believe that a key driver of sustainability is a sharp focus on long-term customer value and a deep understanding of customer metrics. Delivering strong value to customers results in high repeat purchase rates and low customer acquisition costs, while an analytical orientation enables companies to measure key metrics and take important business decisions based on real data.
Everyone understands intuitively that repeat customers are good for business. Yet very few e-commerce companies develop a deep understanding of customer behavior, measure and analyze key metrics and tailor their business strategy and internal focus accordingly.
Understanding the value of a customer – and how to measure it – is perhaps one of the most important questions for anyone running an ecommerce business. If you don’t know what a customer is worth, you run the risk of not knowing: (i) how much you should spend on marketing/customer acquisition, (ii) how much you should spend on customer support (customer service, fulfillment etc), and (iii) the levers that drive an increase in the value of your customers (and therefore the value of your business). Companies that don’t understand customer value may be able to grow rapidly, but this will be unsustainable over time, because the costs they incur to acquire, reacquire and support their customers may greatly outweigh what those customers are worth.
All e-commerce entrepreneurs I meet share a repeat customer metric (indicating an appreciation that repeat customers are valuable), but more often than not these metrics don’t reveal insight into customer behavior. Some examples include:
- “33% of the orders last month were from repeat customers”, OR
- “50% of the customers that bought last year bought again this year”.
OK, this sounds great, but what does it actually mean and how is this data actionable for the business?
Let’s take the first statement: “33% of the orders last month were from repeat customers”. Take a company that has been in business for a couple of years and during that time served over 200,000 customers. Assume that they currently serve 21,000 customers per month. So this statement means that 7,000 customers (or <4% of their cumulative customer base) in the month had bought at some point before. Is that good? Bad? What does it mean? What actions should be taken? It’s tough to tell because this statement is meaningless without more context.
Let’s take the second statement and apply it to the same company above: “50% of the customers that bought last year bought again this year”. This implies that 100,000 existing customers bought again this year. I think we would all agree that sounds pretty good. But is it actionable? What did they buy? How much did they spend? How often did they buy again?
To help answer some of these questions and drive specific, actionable insight for an online business, it helps to think of customers a little differently. On the internet, a customer is like a store in the physical world – you need to make upfront investments (acquisition cost on the internet; capex for a physical store) which will yield a margin stream in the future. Understanding the ratio of the upfront investment to the expected margin stream, as well as how you can reduce the investment and increase the margin stream, is critical. Just as the operator of a physical store thinks about time to break-even and pay-back, operators of online stores can do the same with their customers.
Once you accept this premise, you can use cohort analysis to estimate customer lifetime value. Cohort analysis tracks the behavior of a specific ‘batch’ of customers (for example the January 2010 cohort means customers acquired in January 2010) over time. You can do this for multiple cohorts as follows:
The table below illustrates the behavior of the January cohort, which is the customers that were originally acquired in January.
The next table indicates the order value generated by the January cohort.
What we see is that the January cohort of 1,000 buyers spent a total of Rs. 29L during the year. If this business has a contribution margin (i.e. shipped revenue less COGS and variable costs such as discounts, payment gateway, shipping & handling) of 15%, then the cohort of 1,000 customers generated Rs. 4.35L of contribution margin in the year or Rs. 435 per customer. Because the number of transacting customers as a % of the starting base has begun to asymptote in 12 months, you can project this forward and calculate lifetime value over 2 or 3 years (note, this is NOT year 1 value multiplied by 2 or 3). Lets assume the 3-year lifetime value of a customer based on this analysis is approx. Rs 800. This should become the maximum allowable acquisition cost you pay to acquire a customer in steady state.
Many of the most successful e-commerce companies in our portfolio achieve lifetime value to customer acquisition cost ratios (LTV/CAC) in excess of 3:1, which enables them to grow rapidly and profitably through aggressive marketing. Since acquisition costs can only be controlled to a certain extent given media costs, competitive dynamics etc, they do this primarily by focusing on customer economics, and specifically increasing: (i) frequency of purchase, (ii) margins, and (iii) order values (through effective retention marketing and initiatives).
Most companies that measure this data carefully allocate more of their resources to retaining customers and improving customer economics than companies that don’t. After all, it’s much easier to ramp up customer acquisition if you already have systems in place to maximize the value of those customers than it is to change the DNA of an organization that focuses only on customer acquisition.