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Challenges in Indian eCommerce Market

eCommerceI have been closely following the progress of the Indian eCommerce industry for the last two years. I have attended multiple seminars and forums where the entrepreneurs and investors have been seen networking with potential partners. According to VCCedge, in 2011, there had been 87 private equity/venture capital deals in the Internet/mobile Internet space worth $750 million, double the amount in 2010. One would expect the party to continue but recently when I went to a seminar on eCommerce, the venture capitalists were almost absent (or represented by junior employees) and the mood was much more somber and realistic. The issues that were being discussed were not about the size of opportunity but were about profitable growth which in my opinion is much more grounded.

I myself have been evaluating options to take a plunge in the eCommerce space and hence have analyzed the sector very closely. I believe that the opportunity is large (larger than what analysts currently project!!!) but there are issues that require urgent attention. The top five concerns of the eCommerce market in India are as follows:

 1. High Customer Acquisition Cost

One area that most of the entrepreneurs consistently underestimate in their business plans is the cost of acquiring a customer. Most business plan assume heavy reliance on social media and internet advertising. The general myth is that the cost of acquisition on internet is very low. However, in my opinion, it is even higher than that of television advertising. Today cost per click is around Rs 15 and if the conversion rate (buyers to visitors) on the site is 1-2%, the cost of customer acquisition comes out to be Rs 750-1500. This is very high and requires repetitive purchases from the customer to recover the cost. Another way of validating the customer acquisition cost is the sops being doled out by existing sites on the member get member schemes. Overtime, when the customers start coming directly to the site, the cost of customer acquisition falls significantly but till that time, the business owners need to cover the cost.

2. High Churn/ Low Loyalty

I have heard multiple times that the Indian market is very large and we have just hit the tip of the iceberg in terms of customer adoption. I have no doubts on the size of Indian market but the problem is low loyalty. The big brands are yet to be created on the internet and hence the brand loyalty is very low. Consumers are currently bargain hunters on the internet.

In the high acquisition cost scenario, it is important to retain the customers for a long time. If the average ticket size on the internet is Rs 1000 with 10% margin, then the customer needs to buy at least 15 times to recover the cost of acquisition (assumed to be Rs 1500). Currently this is not happening. Most of the sites are getting high number of new customers every month camouflaging the high churn. The eCommerce companies are measuring the gross profitability and not the customer lifetime value. The moment the new customer addition drops, the profitability goes for a toss. This is what has struck the group buying sites like Snapdeal which saw fast adoption in the past. This is not limited to group buying sites and other eCommerce formats are also witnessing the high churn and low loyalty problems.

3. Cash on Delivery

Cash on Delivery (COD) has been touted as the innovation to counter the low credit card penetration and payment security issues on the internet.  COD is a substantial proportion of the sales today contributing to anywhere between 11% (for Perperfry) to 60% in most of the cases.

The COD is unsustainable as it pushes up the cost of transaction by Rs 30-60 per transaction. Given the low profitability and small ticket size on eCommerce sites, the entire gross margin gets erased by COD. On top of this the problem is that of high returns as the consumers often change their mind by the time the goods arrive. The returns are as high as 40-45% of all the COD shipments. COD also poses scalability issues for the eCommerce sites in the long term as the logistics companies would find it hard to scale to the required levels. The other problems associated with COD are long lead times before the revenue can be booked, fraud risks and higher working capital requirements.

What amazes me is the fact that there is no incentive for the customers to use electronic payment on sites like Flipkart. Why would I take any risk with electronic payment if I can get cash on delivery at the same price.

4. High Cash Burn Rate

The capital requirement for any eCommerce venture is very high contrary to the popular belief that it is easy to set up an electronic shop. At a recent conference, a venture capitalist mentioned that a niche vertical eCommerce venture needs $50 million of funding over time while a horizontal player would need $300-400 million funds. Leaders in the e-commerce space (ones that have raised money, have large teams and are aggressively pursuing growth) are spending $1-2 million (Rs 5-10 crore) a month, including on marketing, overheads and salaries. At this rate of burn, smaller firms with scant capital are unable to cope. In my back of the envelop calculations, a company would need to spend at least Rs 1 million per month in the first six months of existence even if it is bootstrapping. Therefore it is important to raise money early in the game.

5. High Inventory/ Poor Supply Chains

Most of the eCommerce venture are complaining of the excess inventory and absence of liquidation market in India. The poor supply chain compounds inventory problems due to unpredictability of the supply. The cost of carrying the inventory is very high and successful ventures would need to tackle the supply chain issues if they really want to run a scale business. The other problem is in unpredictability of delivery to the customers leading to higher returns.

Summary

I do not think any of the above mentioned issues are insurmountable. The opportunity is huge to let it go. Entrepreneurs need to be disciplined sticking to the basics of business without getting carried away by the rush of capturing the opportunity. Venture Capitalists would always push the companies to grow fast and faster but it is upto the entrepreneurs to focus on the long term growth.

I know this is a very debatable subject would like to hear the views of the readers on the potential and challenges of Indian eCommerce industry. Please do comment on this story.

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Disclaimer: The views expressed in this article are my personal views and do not reflect the views of my employer.

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