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Here’s Ashish Thusoo, CEO & founder of big-data-as-a-service company Qubole, speaking with GigaOm:
[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.
I think there is a lot of potential and hope, especially now, for founders to start online (only) services businesses. Indian consumers seem to be opening up to paying for online B2C services, where purchase and most fulfillment is online. This trend is a natural outcome of India’s increasing online population (>125M now) and familiarity with online as a channel (20M bought online in last 12 months, 7M of which were non-travel). Barring a few exceptions noted below, this space has historically been challenging but I hope to see that changing in future.
Successful examples of existing online services in India include matrimony (Shaadi and Bharat Matrimony) and also aggregators across categories like travel (rail, air, bus), movies and mobile phone recharge. While the aggregator segment has been more successful because of direct linkage to offline services, it is relatively less interesting (and more capital intensive) because of low absolute margin per transaction and dependence on offline delivery for scaling versus a service which is purely digital in nature.
Subject to a large potential paying consumer base being available, pure online services are fundamentally very attractive to entrepreneurs and investors because of:
- High capital efficiency (high gross margins).
- Become disproportionately valuable (given B2C/branded nature).
- Ability to grow quickly, since they are not constrained by offline buildout (not applicable everywhere).
Here are a few examples below in categories where we are anecdotaly seeing early growth in new online consumer services:
- Education: Online higher education, Online certification and Test prep (very nascent) are showing that consumers are willing to pay and consume online.
- Jobs: Linkedin’s Premium Membership, ABC’s Head Honchos and Naukri’s premium services are showing early signs of monetizing through consumers.
- Apps: Evernote, Apple iTunes/App store and Google Play are monetizing on an Indian user base – this could be a massive trend given the rate at which smartphones and mobile data users are growing.
- Financial Services: Previously, the web was used primarily for lead generation. Now, certain types of insurance (Auto, Life, Travel) that are delivered end-to-end online are gaining traction.
- Auto: Classifieds for used cars
It is still early days for these trends – but I hope that the growth continues. If you know of other online categories or businesses which are getting traction, I would love to learn about them – please add to the comments section below.
PS: While mobile operator value-added services (MVAS) is a great example of online services, in my opinion, these services have not really been B2C. As a result, I am not including MVAS in the list above. My list also does not include businesses which collect revenue from offline vendors (e.g. Zomato) or have large offline delivery responsibility (e.g. goods ecommerce).
[Also published on Nextwala]
The approach to mobile design and information architecture here in India has been haphazard at best and atrocious at worst. Perhaps this is caused by consumers just being happy getting economic value out of digital services, far outweighing their need for great design. Perhaps the backend-oriented outsourcing culture has made developers less savvy about creating world-class UI/UX. Perhaps the featurephone- and carrier-orientation of mobile services hasn’t required good design. Who knows.
I don’t see this as the future of design in India. There is an early but growing sense of good design and information architecture emanating from India-based mobile application developers. Many of these are competing either on a global level or are targeting smartphone users who expect well designed apps, such as they see from Facebook, Whatsapp, Flipboard, Kindle, Spotify and Youtube.
I like to see a solid design orientation in consumer-facing companies that I look at. This is an absolute imperative for Web and mobile. At Lightspeed, we have some companies that are focusing on delivering great experiences, including Fashionara, LimeRoad and Dhingana. Users are responding well to their designs.
As a benchmark, I think India-based Cleartrip, Zomato, Hike and CloudMagic really deliver on superb design and value. Kudos to the developers at these companies. I have included some screenshots below – hopefully the developers won’t mind me making use of their app images.