Deep discounting and huge cash burning business model – A recipe of “becoming Largest Market Player” or “Inevitable Crash”?

Deep discounting and huge cash burning business model – A recipe of “becoming Largest Market Player” or “Inevitable Crash”?

“PayTm gave Rs 588 crore of cashback in year 2015, the company reported revenue of Rs 337 crore with a loss of Rs 372 crores.”

PayTm is doing what Ola did. Offer huge discounts and force the competitors to shut their business. These huge discounts come with a huge cost. The story of misuse of Ola discount schemes is not hidden to most of the taxi drivers in India. Drivers did make approx Rs 5000-6000 extra by misusing the Ola’s ill structured promotional schemes. All this crap cost adds to genuine customer acquisition cost, and is making huge dent to investor’s pocket.

On a similar note, who can guarantee PayTm utility bill or recharge discounts are being passed on to real customer and are not being misused? This huge expenditure doesn’t get passed by investors unquestioned. It might be possible that investors will close their eyes on these leakages in the name of customer acquisition cost. The deep discounting models always aspire to gain major market share and once that is achieved the company switches to market price model or even higher price model and recovers all the cash burnt in the past. Can we really imagine in this world, that competition will really be curbed? Given, the inefficiency in models, are they really gaining market share.

The second expectation by PayTm is to make people habitual of making use of wallet service. All discounts offered by PayTm are credited back to PayTm wallet. This creates a reason for user to come back to PayTm wallet to use the credited cash backs. Is the customer getting habitual or surfing for a good discounted deal, is a big question. How many of these users will stick back once the discount taps are dried is a big question.

If we refer to recent news,

“Google shuts down its Great Online Shopping Festival”(4th November 2015)

Many e-commerce firms showed no interest in participating in the year’s Google Online Shopping Festival because of the high costs involved. This somewhere reflects the limited capacity of giants to funnel more money.

“After Grofers, PepperTap Shuts Down Operations In Major Cities including Mumbai, Lays-off Close to 400 delivery man”(9th Feb 2016)

“Foodpanda, hurt by reports of fraud and systematic discrepancies in India, fired 300 people, finds no takers even at $10m price tag”(28th Jan 2016)

“Zomato and TinyOwl together fired more than 500 people and have been scaling down operations”(28th January 2016)

“Flipkart shuts e-books unit as business bleeds”(11 December 2015)“Flipkart has reportedly approached Alibaba for Investment Opportunities”(6th Feb 2016)

Flipkart’s losses tripled to Rs 2,000 crore on revenue of Rs 10,000 crore. Alibaba is negotiating hard with Flipkart on valuation piece. Are investors, now putting a check on money outflow?

“Amazon Is Said to Be Planning an Expansion into Retail Bookstores”(2nd Feb 2016)

Are we witnessing a paradigm shift in approach of Amazon from online to Brick-n-mortar stores? No doubt, the Gross Merchandise Volume (GMV) for the company is growing, but is it really converting into bottom line. If we measure Amazon stock as a retailer, in terms of Price to Sales Ratio, then it is grossly, even ridiculously overpriced. It’s 5.3 times more expensive than Walmart, 3.6 times more expensive than Target and a whopping 9.8 times more expensive than Best Buy.

“Alibaba share falls as Sales Volume Slows, Adding to China Concern”(28th Jan 2016)

Pursuant to slow consumer spending in China, the Internet GMV YoY growth of company has fallen gradually to 22% in Q3 2105 in comparison to over 60% Q1 and Q2 2014 numbers. The peak price for the stock hit $120 and was seen as undervalued in November 2014 at that price. The stock has suffered subsequently. The closing price of share was $60.90 on 12th February 2016.

The companies in this space are banking on customer loyalty. But customer loyalty itself is an illusion. Forget loyalty. What does exist, at times, is a fierce affection for brands. But it’s fickle, clearly. It lasts exactly as long as the brand in question keeps doing the thing its customers love. The minute it stops, it’s over. If loyalty in any way enters into this, it’s from the brand to the customer, not otherwise. Marks and Spencer (M&S), was once the most beloved retailer in Middle England. And then suddenly, it wasn’t. In the blinking of an eye, everyone fell out of love, because M&S let us all down over the quality of its products. It has have never regained its former position in everyone’s affections. If the customer loyalty could have existed, M&S customers would have continued to shop there, waiting for the company to sort itself out. But that didn’t happen. When things got sticky, the customers bailed out. The company posted poor 2015 results in January 2016. The history is full of such examples.

 “Can someone keep operating at a loss? And how much loss can someone keep funding? Most global companies built on cash flows, not on investors’ money ”– Rakesh Jhunjhunwala

Will the basic mantra of valuation be ruled out wrong, will these negative value builders succeed in building valuation for them? Will investment gurus be ruled out wrong?

The early warning signals are noteworthy. Once the discount is lowered or dropped, customers will flicker to other player for a better deal. The sky-high valuations of these e-commerce companies are heading towards inevitable crash.