“The enemy of my enemy is my friend”
- The Arthashastra—a Treatise on Statecraft, 4BC
Just a few days ago, Flipkart announced it had raised $1.4 billion from a clutch of companies including Microsoft, eBay and China’s Tencent Holdings. It also announced that it will acquire eBay India. This represents another masterstroke for Tiger Global, the existing investor in Flipkart. It also sets the stage for a fundamental shift in the way Indian e-commerce will play out—in particular, the race with Amazon for dominance.
Before I go into the details of the impact this deal will have, here’s a little backstory: In part one of my two-part piece on the Indian e-commerce landscape, I talked about how Tiger had pulled off a veritable coup in restructuring and reshaping Flipkart in a bloodless fashion. New leadership, rejigged management decks, cut in waste and burn, and a back to basics homecoming—Tiger reversed the spiral the business had spun itself into.
In part two, I said that the battle for the dominance of the Indian e-commerce market will be fought between the Americans and the Chinese and Flipkart sorely needed “permanent capital” on its balance sheet to stay in the battle.
The battle has turned out to be even more spectacular—it’s not between the American and the Chinese. It’s Amazon vs. everyone else
Well, the battle has turned out to be even more spectacular—it’s not between the American and the Chinese. It’s Amazon vs. everyone else.
Tiger has befriended unlikely bedfellows and delivered a virtuoso performance in deal making. It crafted a transaction where everyone gets their cake and eats it too. Let’s see how:
- eBay, which had a flagging business in India and has worked through similar partnerships and swaps in other markets in the world, gets a winner by exchanging a flagging business for a stake in one of India’s top two e-commerce plays.
- Similarly, Microsoft in its renewed avatar under Satya Nadella wants to fight Amazon on the cloud business, gets a strong foothold in India as well as a large customer in Flipkart (in a way earning part of its investment back!).
- And finally, Tencent, which last week became the seventh largest company in the world in terms of market cap, walks into India along with its largest investor Naspers. Between them, they could become the largest shareholders in Flipkart.
Only regulatory filings for an initial public offering will reveal publicly the actual quid pro quo involved: What is the business deal with Microsoft? What’s the cash being paid to buy eBay India? What are the arrangements, if any, between Tiger and Tencent for a future buy-out?
Each investor got his pound of flesh and for Tiger, it is “mission permanent capital” accomplished
Each investor got his pound of flesh and for Tiger, it is “mission permanent capital” accomplished.
So, any analysis of valuation for such a complex manoeuver will be quite pointless since no one is privy to the actual math, except for the headline number of $11.6 billion post the latest fundraise and the deduction that the pre-fundraise valuation is $10.2 billion.
Between the services contracts, stock swaps, ratchets, potential anti-dilution obligations and special rights to earlier investors (who invested at the headline number of $15.4 billion), the true fully-diluted, all baked-in valuation is likely to be lower. I would expect it to be around 1.6-2X of gross merchandise value or GMV (estimated run rate at about $4 billion), which is more in line with prevailing multiples for strong e-commerce players.
The combined worth of its backers is now in the hundreds of billions and it is ready to fight Amazon
I have always maintained that too much ink is wasted on debating Flipkart’s valuation. What was important was that it get a new lease of life and strong backing. The combined worth of its backers is now in the hundreds of billions and it is ready to fight Amazon.
The proposed deal to buy Snapdeal—which its biggest investor SoftBank is pushing for—has very little business rationale. The firm is a subset of Flipkart on most fronts with massive overlaps, except for Freecharge which brings a big base of wallets. Integrating these companies and their management itself will become a huge source of distraction, which Flipkart can ill-afford at this juncture. Do that and it will give Amazon a chance to swoop into any space that Flipkart vacates.
Very simply, the Snapdeal deal is a chance to add SoftBank to Flipkart’s armoury, and it gives SoftBank a graceful way out of an investment it no longer believes in. If Tiger convinces SoftBank to invest in the combined entity as well as buy out some of Tiger’s original investment (about $1 billion), both SoftBank and Tiger can ride the upside in Flipkart to a whopping return with their residual stakes.
Just for perspective, if Tencent wanted to buy out all of Flipkart today in an all stock deal, it would just constitute an issuance of less than 4% of its shares. In fact, the resulting bump in Tencent’s market capitalisation would more than pay for the acquisition. Clearly, Tiger is playing for an upside here and will sell when Flipkart commands a higher valuation. Equally, Tencent wants to retain Tiger in the game—and have it continue navigating the business. Makemytrip’s staged acquisition by CTrip, Tencent and Naspers, and its market cap jump of 5X in under a year is an example.
The fact remains that even if Flipkart becomes a strong and sustainable No. 2 in the market, it is a hugely valuable asset, especially to Tencent which is steadily collecting assets in India and will use Flipkart as a base to launch a WeChat clone in India. With payment systems, Aadhaar-based India Stack (the layer of technologies like unified payments interface built around Aadhaar) and consumer awareness going up and given WhatsApp’s reticence to open up to commerce, India is another place to build a formidable WeChat “super-app” kind of business.
To conclude this part, Flipkart gets a lease of life and the hands on the table change to companies that together have balance sheets to rival Amazon’s bulk and commitment to win in India.
Net-net, Tiger has delivered a masterstroke. Fortunes have turned on a dime—Flipkart is backed with long-term capital. Competitive intensity goes down. Alibaba’s entry via Paytm is the only unknown Amazon and Flipkart both have to counter effectively (see box ‘Alibaba: The Joker in the pack’). For the moment, Flipkart is the only alternative to Amazon.
Amazon and (not versus) Flipkart
If you look back, what gave Tiger confidence was the way that Flipkart rallied ahead under the newly installed professional leadership. It managed a phenomenal festive season push, and then the double whammy of demonetisation and funding runway paranoia landed a hard blow to Snapdeal and the others. Suddenly, Flipkart and Amazon had pulled ahead of the pack, pushing Snapdeal, Shopclues and Paytm far behind. While the overall market growth stalled, the two players grew by eating into the share of the others.
Amazon has often been characterised as a villain of the piece and Flipkart the fallen hero who protests about the not-so-level playing field and unfair tactics—playing the victim almost. But that’s not the case.
Flipkart gave away the game to Amazon; it made unforced errors and self-goals. In my article from a year ago, Saving Private Flipkart—which led to a lot of debate—I had written how Flipkart’s fall was its own doing and not a result of anything that Amazon had done deliberately to hurt it.
The aces Amazon holds today are the ones that Flipkart has given it—Flipkart has not focused on content, habit creation, building regional language content and deep engagement, second-hand goods, creating a media offering, or creating loyalty/cash back programmes or wallets—all the aspects that could have been “defences”.
Not much has been written about the systematic and focused manner in which Amazon has gone about building its business in India. Flipkart will have to follow and learn the same game—it has to replicate not just Amazon’s interface and ideas but more importantly, it’s unrelenting focus on customers and making their journeys simple and seamless.
That said, Amazon and Flipkart are nearly neck and neck, but have very different plays in the market. Flipkart continues to push smartphones, appliances and apparel, while Amazon is singularly focused on building habit.
Now we enter the next phase of the war: A long battle of attrition that will play out
Now we enter the next phase of the war: A long battle of attrition that will play out. The initial noise and soundbites are over, the spectators will fall silent and all you will hear are the swords clashing. The fight will be long and hard, the battle will have more twist and turns. But the spoils are large enough for both to walk home with a bounty—a $200 billion estimated market in the next 5-10 years (depending who is your favourite analyst) and a 30-50% market share of the largest accessible consumer market in the world. The market will allow for three-four strong differentiated plays.
The sprinting is over. Both the players now need to conserve their energies like ultra-marathoners
The sprinting is over. Both the players now need to conserve their energies like ultra-marathoners. Running faster or ahead for a few weeks or months may grab the occasional media headlines, but both players know that it doesn’t matter. They are still in rough terrain and every move will have to be calibrated.
The market that vanished
The little known truth about India’s e-commerce market was uttered at a conference in Delhi a few weeks ago. Flipkart’s chief executive Kalyan Krishnamurthy said that there are only 10 million monthly active buyers on e-commerce in India. This confirms what I have been saying for two years now—the market is simply too small.
The fallacy is that we compare per capita incomes with other markets. That is, we are a billion consumers, a $2.25 trillion economy, have 450 million internet users, and we take our smartphone penetration (300 million and growing) as a proxy for spending power.
In an earlier piece titled “How India’s digital economy can rediscover its mojo” I had talked about how India needs to be seen not as one country but three. Simplifying it even more—I call it the 1T, 1T and Zero economy.
- The top 15% (India One) constitutes a $1 trillion economy that has disposable income and ability to spend. The desire and charm of online shopping appeals only to the India One audience, and that’s where it will be viable to service them. They are the perfect audiences to sell convenience and selection to—the real promise of online commerce. They are comfortable using English, and are time-starved, well-paid, confident-of-their-future Indians.
- Another $1 trillion is spread across the next 40% of the population (India Two), which supplies and services the India One economy. The India Two customers will take longer to cotton on to online shopping—and they will shop for basic needs and deals. Flipkart and Amazon will both find that expanding in this market will prove to be a drain on their resources with little payback. It will be unviable to service them unless they start leveraging the power of the existing traditional networks (kirana shops, wholesale trade routes and the neighbourhood entrepreneurs).
- The final half of our nation barely gets by. They live on the periphery of our economy—calling them consumers itself is a travesty. They have negligible disposable income. Any growth in their incomes goes entirely towards sustaining their lives—roti, kapda and makaan. The India Three customers are serviced poorly even by our traditional networks—tiny hole-in-the-wall shops with limited supplies service the poorer villages. Their lot will improve only once the nation uses digital tools to leapfrog the chasm created by lack of physical infrastructure and decades of neglect, and empower them with jobs and basic income and infrastructure.
(To get more on how income disparity runs deep in the Indian landscape, read this excellent piece on how the incomes of the three richest states are three times the incomes of the three poorest ones.)
How this changes Amazon’s and Flipkart’s plans
Clearly, they both realise the waste has been colossal. The math is staggering. The players have pumped in over $15 billion so far to woo a customer base of 10 million regular monthly transacting users. And most of these consumers simply “substituted” e-commerce for traditional retail because of the massive discounts on offer. Many of them will remain unprofitable customers—and their cost of acquisition may pay back only over a decade. I can wager that there is no other market in India that has absorbed so much capital and yielded so little by way of value.
To spend wantonly on penetrating India Two will be foolhardy. It will be an expensive exercise. So while it is crucial to win that market, you will have to calibrate your ambitions and grow it slowly. Else this market can keep absorbing billions and give no returns.
The consumption basket for India Two will be markedly different. The first spending after any growth in their incomes will be on kids’ education, on better food and groceries before they graduate to buying into the choice and conveniences that modern e-commerce offers. They require a different mindset to service—one that is focused on language, use of video to help them make choices and helping them discover ways of creating a better life for themselves. It would do well for Amazon and Flipkart to both think like home-shopping networks for this market—education, discovery and sales all rolled into an easy-to-consume offering.
I don’t see Flipkart touching its $1.4 billion war chest with the same abandon that it displayed earlier
The war chest that won’t be opened easily: As I see it, the first outcome of this consolidation will be lower competitive intensity. I don’t see Flipkart touching its $1.4 billion war chest with the same abandon that it displayed earlier. If anything, the drive will be for category profits and customer-level profitability, where Flipkart and Amazon will both choose carefully which consumers are going to be profitable to acquire. “Ship more, burn more” won’t hold sway anymore. No more GMV pressures—in the short term the market share ups and downs won’t matter, except for the purpose of giving soundbites to our technology media.
Flipkart may be fighting Amazon. But Amazon is not fighting Flipkart. Amazon is fighting to create habit
Flipkart may be fighting Amazon. But Amazon is not fighting Flipkart. Amazon is fighting to create habit.
What will matter is whether you’ve managed to create a habit. So, more than discounting, and spending money on ads in newspapers and hoardings, the focus will be on customer retention and lock-in. Amazon has already rolled out Prime as a vehicle to do that (Prime subscribers account for 30% of its orders), and now is ready to launch an integrated payments platform.
Flipkart will have to think of a counter strategy that creates a lock-in much like Prime. PhonePe (Flipkart’s payment platform) is looking promising and could be a way to kick-start a smart loyalty initiative.
The challenger mindset: What’s more crucial is what this funding round can do to Flipkart’s mindset. Gone are the pressures of maintaining the façade that they are far ahead of Amazon. Now clearly they are the underdogs and the challengers.
And we know, the challenger mindset actually sets you free.
Because you are there to break the rules, change the game, do things that may not seem logical. And you use the size and slowness of the giant against itself. It’s not easy to fight against what is believed to be the fastest and most adaptive company on the earth, but it’s not as if Amazon has won every battle it has fought.
Flipkart may now need to alter its strategy—let Amazon build the railroads into new categories and attack later
Flipkart may now need to alter its strategy—let Amazon build the railroads into new categories and attack later. The founders who called Amazon copycats will now find it sensible to allow Amazon to take the lead and open up pathways and segments and quickly follow. Become the guerrilla, not the soldier.
Flipkart may be able to strike alliances with a flexibility that Amazon may not find feasible. It can do deals with offline players, with labels. Flipkart clearly has to become the challenger brand, willing to do the unusual to keep Amazon on its toes and make sure they give it the space to thrive. As Avis (the car rental company) proved, you can, if you try harder.
This may sound as if I’ve already relegated Flipkart to No. 2. It may well turn out to be otherwise—Tencent can unleash capital plus knowhow and take it into a trajectory where it overtakes Amazon. But if you look at Amazon’s global arsenal and what it can potentially unleash, especially in an English speaking market, one would be circumspect.
The battle of the flywheels: The firms will now have to divide their market into heavy habitual e-commerce users and the rest. The only way to make money will be to win the 50-60 million core e-commerce heavy users—and at least for the moment, not vapourise billions trying to grow the market.
For the first segment, they will invest in whatever it takes to gain more stickiness and share of the consumers’ wallet. The flywheels will have to go to work—and to make these customers profitable they will find ways to cross-sell across the platform, and create white-glove services like Amazon Prime to woo and milk these now-habituated couch shoppers.
Tencent is a behemoth that has mastered the “internet holding company” strategy and we’ll soon see Flipkart mimic that
Tencent is a behemoth that has mastered the “internet holding company” strategy and we’ll soon see Flipkart mimic that and circulate audiences among its various brands—Myntra, Jabong, eBay and PhonePe. With enough funding and focus, they can be an explosive arsenal to effectively counter Amazon which primarily follows a monolithic, one-destination strategy.
On the product side, given the pincer of fixed MRPs and high logistics cost, private labels and brand partnerships will be the way to create higher margin offerings. India is under-served as far as brands go, and many traditional brands are just suppliers under the garb of a brand, and are ready for disruption by well-funded online plays.
Going offline may be a way to establish new brands in the market. Flipkart is trying that with Roadster and we’ve seen Lenskart create a national brand. It will require a unique set of skills to craft a winning offline-online play, and we’ll see many attempts falter before winners emerge.
Will the $1.4 billion round make a huge difference to the ecosystem?
I think not. The ecosystem will not change much. Flipkart’s funding is an indication of how everyone is betting, quite sensibly, that Amazon can’t own a 100% of the e-commerce market—that’s it. In fact, Amazon will be happy with a good competitor at this stage—it will grow the market and they won’t come under the glare of the regulators and the government.
This deal is not a validation of our market’s depth. India will continue to be a tough market
Venture capitalists (VCs) will continue to be fearful of e-commerce. This deal is not a validation of our market’s depth. India will continue to be a tough market and if you are selling something below your buying price, you better have a very good case for your VC.
It doesn't matter anymore when the new Flipkart—the China-like holding company—becomes sustainable. At 30%-40% market share and a growing base, it will be valuable—especially to the Chinese players and their consorts who have made their way into its balance sheet.
Investor activism will continue: Investors have had to step in and take charge in Housing.com, Flipkart, Snapdeal, Zivame among others, and we need a larger discussion about founders, their longevity and their maturity to induct talent. In three of the firms I’ve invested in which have grown rapidly, I’ve heard the founders say that they can’t handle the scaling beyond this, that they need help and are willing to step aside for a CEO. That’s heart-warming to hear. How much the egos interplay, how incentives are aligned and how governance and steering should be done are all questions that should be asked at our startup conferences rather than speeches by founders who are being labelled as successful based on their funding rounds.
This idea that a founder can spend crores of rupees to find out that the business model doesn’t exist won’t work anymore (Stayzilla spent Rs 180 crore and Grofers a multiple of that). That phase is over, barring the rare exceptions. Validation will be sought, faster and sooner. And you can’t claim you’ve learnt lessons if you took three years and $30 million to validate your business. The market simply won’t allow for such excesses.
You don't fight Amazon. You fight its relentless customer focus
You don't fight Amazon. You fight its relentless customer focus. Its transformation from a choice into a default. From a decision or comparison to a natural click to buy. It aims to “disappear” and weave into your life—I can almost see Indians say “I amazoned it” and that is what Flipkart has to fight. It has the funding. Now it needs the ideas and the wiliness to win.
As the battle goes on, Amazon will have to learn from Flipkart’s playbook and vice versa. Flipkart will have to keep a close watch on its metrics, and ensure that the duo of Tencent and Naspers (and potentially SoftBank) continue pouring in capital and settle in for a multiyear battle. If that happens, Flipkart will probably become the first board-managed “decacorn” (startups with valuations upwards of $10 billion) in the world. That in itself will a subject of case studies for time to come.
“The place where you made your stand never mattered. Only that you were there...and still on your feet.”