Why focus is the name of the ecommerce game
The rise of vertical players and aggregators points to a change in the largely horizontal game in the Indian online retail industry
When Mithun Sacheti received a LinkedIn request from Tiger Global in the first half of 2011, he didn’t even blink. It was probably one of the many that came in every day, he thought. Turns out, the chief executive and founder of CaratLane, India’s largest online jewellery store, had never heard of the international investment firm. (To be fair, Tiger Global does not have a website even today.)
A few days later, Sacheti learnt about Tiger Global’s credentials as an investment firm known for backing fast-growing local businesses worldwide. He did not waste a minute. A conference call was soon fixed up. But, put it down to happenstance and the busy life of an ecommerce honcho, Sacheti “forgot” to take the call.
Fortunately, the investment firm still didn’t give up on Sacheti and a meeting was set up with Lee Fixel, the media-shy partner at Tiger Global Management in New Delhi.
Two hours later, Sacheti left with a term sheet in his hand. And a month later (in June 2011), nearly $6 million were transferred to CaratLane’s bank account. The first investment by Tiger Global in CaratLane was in place. And last month, the startup announced that it had raised $31 million from Tiger Global, the fourth capital infusion by the fund in as many years.
Even a few years ago, this story might have sparked a gasp or two.
Not today.
The pursuit of Indian startups by global investors is no longer an exception, but rather the rule. And the more focussed the ecommerce vertical, the faster the chase. Just like Tiger Global first identified a category—jewellery—and, then, a company that was dealing in it exclusively—CaratLane. “People cannot discover the product in a giant website (a horizontal). Secondly, it (horizontal) doesn’t allow you to customise products,” says Sacheti, explaining why an investor like Tiger Global would prefer to back an independent online jewellery retailer instead of adding it as a category to the long product list of its large portfolio of horizontal ecommerce firms.
It is increasingly evident that investors in India have warmed up to ecommerce ventures that typically stick to a sharp vertical: Eyewear, grocery, aggregators for taxi and ticket services, financial products and so on. In 2014, 35 verticals were funded by investors who put in a total of $261 million into such firms, estimates VCCEdge, which tracks investment activity in the country. These niches are a far cry from horizontals (or marketplaces like Flipkart and Amazon), which engage in multiple categories and are generalist retailers.
Experts call this a step in the evolution of ecommerce in India.
There are currently three heavyweight horizontals—Amazon, Flipkart and Snapdeal—slugging it out for the top slot. They are all burning cash fast, have not yet reached profitability, have either deep pockets (like Amazon) or are backed by loaded investors and have left almost no space for a fourth undifferentiated, horizontal player.
But entrepreneurs have quickly realised that online retail is about more than the multi-product category play. The Indian ecommerce industry is likely to clock a compounded annual growth rate (CAGR) of 35 percent and cross the $100-billion mark in value in five years, a study conducted by The Associated Chambers of Commerce & Industry of India (Assocham) with PricewaterhouseCoopers (PwC) has said. According to the study, the Indian ecommerce industry is currently valued at $17 billion.
This expansion also means that, like those in other developed markets, Indian customers will scout for specialised offerings.
Investors, too, are keen on backing these ventures as they have better margins unlike the horizontals which are grappling with profitability issues. Also, many missed the ecommerce bus a few years ago as they either didn’t believe in the online retail business model or simply didn’t move fast enough. And now, valuations of existing big-ticket ventures have become too high for them to enter or compete against.
“Right now, one cannot get funding by competing against Snapdeal or Flipkart. It is not so simple to beat horizontals,” says Sasha Mirchandani, founder and managing director at Kae Capital, an investment firm, which has invested in HealthKart, an online health products store. “If you look at the US market, verticals have scaled up… take Zappos (a shoes etailer) or Diaper.com, for instance,” he says.
Verticals and horizontals tend to have different economics. Niche players need lower capital than a marketplace model does to scale up the business. Verticals also tend to burn less cash than their marketplace counterparts. “Verticals are interesting as margins are significantly better than horizontals,” says Niren Shah, managing director, NVP India, an investment firm which has invested in startups like FashionandYou and Pepperfry. “These companies are not much into discounts and, more often than not, these categories are inherently structured to support high margins; some of the gross margins are as high as 50 percent,” he says.
Verticals don’t have the scale of horizontals and not many of them will transform into multibillion dollar businesses but “they tend to become cash flow positive much faster”, says Shah, adding that furniture, home décor and grocery are the niches to look out for in the future.
Take Yepme, which retails its own brands online, and is looking at breaking even this year. “We operate after discount and coupons at a 48 percent margin because we are only private labels,” says Vivek Gaur, CEO and co-founder, Yepme.com, which started in 2011. The firm is now planning to take its offerings overseas.
The advantages notwithstanding, unlike for a horizontal, where a customer will find something of interest while browsing the site, the biggest challenge for a vertical is to identify an area which caters to a real customer need and is a real hook.
In the same context, creating entry barriers against cash-flush horizontals is a challenge for verticals as well. A few firms have, however, chalked out a thus-far effective strategy to combat the Goliaths. Lenskart, for example, not only ships spectacles, but also offers a number of features like home eye check-up programmes, a try-before-you-buy service, a virtual studio, new lenses in old frames as well as an exchange programme. The company also has 60 offline stores in the country. “Offline stores that do free check-ups are small outlets and mostly in tier-III towns. We believe the combination of stores and try-at-home initiatives complements our existing web platform. We are doing 500 home check-ups every day all over India,” says Peyush Bansal, founder, Lenskart.
Similarly, Pepperfry has planned an execution strategy that, he says, can’t be easily replicated by a horizontal. “Horizontals have built businesses on mobiles and fashion [categories]. They can create catalogues easily because the product exists and the brands are well known. For furniture, creating a catalogue is a mammoth task,” says Ashish Shah, COO and co-founder of Pepperfry, an online furniture retailer.
The good news is that investors are optimistic: They say verticals are here to stay as the purchasing power of the Indian customer is on the rise. Aspirations, ease of multiple shopping options, free home delivery are further fuelling the demand. “Verticals require a critical mass and a certain purchasing power of consumers. The market needs to mature beyond staples… India is getting there. Brands are being built in the space,” says Prashanth Prakash, partner at Accel Partners, a venture capital firm that has invested in firms like Flipkart (horizontal) and verticals like Babyoye (baby products), Bluestone (online jewelry), BookMyShow (movie and event tickets), Myntra (fashion, apparel) and Urbantouch (cosmetics). Prakash, however, has a word of caution. “A player’s ability to give a meaningful experience to the customer is most important,” he says.
This is particularly relevant as verticals in India are not just about products. Services have also emerged as a strong focus, both online and on the mobile. Aggregators like Ola (cab services), Housing.com (real estate), BookMyShow, CarTrade (automobile classifieds) and Policybazaar (insurance) have emerged as front-runners in their categories.
“There was a time when horizontal classifieds gained traction and most dealers concentrated on getting listed. Now in the second phase, verticals are gaining traction. Companies are building deep services. That is bringing more people to their sites,” says Alok Mittal, ex-MD at Canaan Partners, who led the investments in CarTrade and also sits on its board. According to him, the automobile classifieds segment is being identified as the next billion-dollar opportunity. “The used car market is growing faster than the new car market. The margins on used cars are about 5 percent, while on new cars they are zero.”
For verticals, the saying ‘what a needle can do, a sword can’t’ is most appropriate. But, at the same time, if a company’s definition of niche is too broad, it becomes a generalist. And if the definition is too narrow, there is a fear that it may not have an optimally-sized market to cater to. For example, in the furniture space, companies are also offering home furnishing, home décor and kitchen goods—areas within their purview of offering home solutions. Just offering furniture may not be enough —customers buy two to three pieces of furniture a year but need around seven to eight bed sheets annually.
“These are the reasons for my customers to come back to my site. Margins tend to be 30 to 40 percent,” says Ashish Shah of Pepperfry. “Horizontals build on ‘search’. We are built on ‘browse’. I don’t expect customers to enter an exact item in the search bar,” he says. Shah can afford to sound confident. In the US and Europe, home and furniture account for 15-17 percent of overall ecommerce businesses.
Shah says it is imperative for his kind of company to engage with customers on an ongoing basis. One mode of engagement for Pepperfry is through product trials—think cleaning chemicals, housekeeping items, ladders, and light bulbs, among others. These are products that people need on a daily basis and there are high chances of an impulse purchase when they are browsing through the site. “They bring customers to me every month: Fifty-five percent of business happens from repeat customers, 50 percent of traffic is organic,” he says.
Constant upgradation of their offerings, adapting to customer needs and some lucrative surprises will help build brand stickiness. “I think if we don’t spend over 70 percent of our time, effort, mind space on products, two years later, nobody is going to remember us,” says Ashish Goel, founder, Urban Ladder, an online furniture store.
Not surprisingly, verticals—thanks to their niche offerings and positive gross margins—tend to attract acquirers. Globally, Amazon has acquired niche business like Zappos and Diaper.com, two very large verticals. Closer home, Flipkart acquired Myntra to strengthen its position as a fashion retailer. In February, Mahindra & Mahindra, which owns Mom & Me, one of the country’s largest chains of offline stores for baby and infant products, acquired Nest Childcare Services, which runs ecommerce site Babyoye.com.
Two weeks ago, online marketplace Snapdeal acquired Exclusively.com, an online retailer of premium and luxury fashion, for an undisclosed amount. Snapdeal is looking to touch $2 billion in gross merchandise value in the fashion category this year.
There are multiple acquirers present now, says Shah of NVP India. Global firms like Alibaba and Amazon are keenly looking at options here as well, he adds.
In India, ecommerce has largely seen consolidation through mergers between common VC-backed ventures—and typically in the same line of business. “You can’t have three grocery chains online,” says Rahul Chowdhri, partner, Helion Venture Partners, a VC firm. “People will remember only one name. And consolidation of the ‘Myntra getting acquired by Flipkart’ kind will take a few more years. All category leaders are still scaling up.”
K Ganesh, serial entrepreneur and promoter-founder of Portea Medical and BigBasket.com, says verticals do have the potential of going public but Indian regulations regarding profitability may come in the way. “IPOs are still about five years away. In the meantime, you will see a lot of trade sales and mergers and acquisitions at great valuations,” he says. Ganesh says in the next three years, India will see 20 companies in the $1 billion range and 100 companies in the $200 million to $1 billion range. “It’s absolutely possible.”
While the economics of verticals make sense, these companies have their own issues. Over the last 18 months, the play in ecommerce product retail has been all about marketing and customer acquisition. “The cost of acquiring customers has ballooned and stickiness is quite low, so most of the previous customers have to be re-acquired like the new ones. With an average acquisition costing about Rs 500-1,000 per customer, you’re losing money on every transaction in low-value products,” says Devangshu Dutta, CEO, Third Eyesight, a retail consultancy.
Also, a few companies like Bluegape, an online merchandise portal, and Koolkart shut shop as they did not get enough traction. Access to capital is also often an issue.
For BookMyShow, payments continue to be a problem and it is planning to focus on that. “Talent acquisition is another area that we are looking at,” says founder and CEO Ashish Hemrajani. To that end, BookMyShow did a talent drive in association with Accel Partners at the IIMs, ISB and other B-schools.
All said and done, the lure of the verticals and aggregators is here to stay. As Anil Joshi, partner, Unicorn India Venture, an investment fund, puts it, “For smaller investors, verticals are the only option.”
(This story appears in the 20 March, 2015 issue of Forbes India. To visit our Archives, click here.)
