The document discusses whether there is an e-commerce bubble in India given the large funding and valuations of Indian e-commerce companies despite most being unprofitable. It notes that while e-commerce growth is promising due to rising internet access and disposable income, companies rely on unsustainable discounts and inflated GMV valuations rather than profits. High valuations may not be justified without demonstrated profitability models. The outlook is uncertain but e-commerce could be viable if margins cover costs, though a wait-and-watch approach may be safest for now.

1. Is There an E-commerce Bubble in India?
Do businesses run on profit or unique ideas?
The 1600s witnessed a surge in the demand for tulips.
At its peak, a single tulip was worth someone’s entire estate.
When it bottomed out, you could trade the once-lofty tulip for an onion.
It’s hard not to draw parallels with the dot.com bubble burst of the late 1990s, where investors and
venture capitalists threw caution to the wind and poured money into Internet firms in the hope they’d
turn profitable someday.
Nature teaches us that when things grow unbalanced or out of control, something must give in order to
restore equilibrium.
With the proliferation of smartphones, high speed Internet connectivity, and an abundance of e-
commerce start-ups plied with excess funding, it begs the question: are we heading toward an e-
commerce bubble in India?
Indian E-commerce Companies — Funding Landscape in 2015
The year 2015 was an investment bonanza.
Indian start-ups raised about $18 billion in investments during 2010–15, nearly half of which was in 2015
alone.

2. Of the $9 billion in funding pumped into Indian start-ups across over 1,005 deals in 2015, e-commerce
and m-commerce accounted for the majority of investments made in 2015. Indian “unicorn” companies
(start-ups valued over $1 billion) include firms such as Flipkart, Snapdeal, Ola, InMobi, Paytm, and Quikr,
which accounted for $3 billion, or 33% of funding in 2015.

3. E-commerce in India — Business Viability
With a rise in capital and subsequent funding, will e-commerce thrive in India?

4. About 20% of India’s population had access to the Internet by 2014 — a number slated to grow.
There’s still significant room for expansion with the emergence of new users from tier 2 and 3 cities. A
growing middle-income group will also prove conducive to expansion. This group not only has a large
amount of disposable income, but also boasts the willingness to splurge. Technological advancements
such as the introduction of high-speed Internet through 3G and 4G services is bound to further the
growth of an online consumer base in India as well.
Running an e-commerce business is pretty cost-effective.
A majority of a company’s investments are in technology, while capital expenditure is negligible. Such
firms’ operating costs primarily comprise of employee and administrative expenses, whereas inventory
cost is minimal.
E-commerce may be a viable option for both businessmen and investors.
Food-tech and grocery start-ups have recently gained large following among investors. Cash-back
schemes on the use of online wallets, attractive discounts when ordering online, free shipping, and a slew
of other offers are being leveraged successfully to augment customer retention and growth.
Key Challenges That E-commerce Faces in India
While the sector’s still ripe with possibilities, entrepreneurs and investors alike still have quite a few
hurdles to contend with.
Profitability of E-commerce Businesses
The e-commerce sector’s expanding markets and demand coupled with the easy availability of funding
makes it quite attractive to investors. On the flipside however, is good old profitability and returns on
investment.
E-commerce giants such as Flipkart, Amazon, and Snapdeal have bagged investor funding in the billions
— but are nowhere close to being profitable.
These firms are utilizing their funding to cover losses, acquire new customers via discounts, and pump up
the products on offer.
Rakesh Jhunjhunwala in an interview with CNBC-TV18 correctly stated “Where is Flipkart's complete
business model? Forget about valuation. I want to know Flipkart’s business model. I want to know how you
will be profitable."
This sentiment was echoed by the MD of Network18 Raghav Bahl, who said, “Ultimately, businesses run on
cash flows and profits and not on ideas that can be valued at astronomical figures.”

5. Let us analyze the other side of the coin for insights into the profitability of India’s three biggest e-
companies: Flipkart, Amazon, and Snapdeal.
Flipkart led net revenue with INR 1,790 million in FY14, while Amazon and Snapdeal generated INR 1,689
million and INR 1,541, respectively.
Flipkart’s net-loss-to-net-revenue ratio for the period was 2.23, which meant that for every INR 1 earned,
Flipkart lost INR 2.33. This was true for Amazon and Snapdeal as well, which lost 1.90 and 1.72,
respectively.
Flipkart’s current Gross Merchandising Value (GMV) is $4 billion. The company raised $2 billion in 2014
and $550 million in 2015 with a valuation of $15–16 billion, but it never booked profits since its inception
in 2007.
Haresh Chawla, Partner at India Value Fund, explained that in order to justify this valuation, Flipkart has to
generate $300 million in after-tax profits over the coming years. This figure would increase to $400 million
within the next three years, when its valuation would be around $20 billion. Currently, the cumulative sales
of Flipkart, Snapdeal, and Amazon amounted to $85 million — and their combined losses about $160
million.
Intense Competition and Low Customer Retention Rates
Another aspect to consider is the market share that these companies command.

6. E-companies compromise on profit and increasingly offering heavy discounts, cash-back offers, and
promotions to attract and retain customers. This strategy has gone from being a competitive tactic to
becoming the norm however, which has led to a rise in customers’ buying power, but not in the
company’s market share.
Despite strong efforts to capture and retain its customer base using attractive marketing strategies and
discounts, Flipkart was reported to have a mere 5% market share. This highlights the fact that price-
sensitive customers are free to move from one provider to another without incurring any switching costs,
something that’s made customer retention a significant challenge in e-commerce.
Lack of Well-thought-out and Detailed Business Plans
India’s Prime Minister Narendra Modi has supported online start-ups through his campaign ‘Start up
India, Stand up India’ to create employment for youngsters in India.
Recent events however, suggest all is not well in the world of online start-ups.
TinyOwl, Zomato, and Housing.com have been in the negative limelight since they sacked around 300,
300, and 600 employees, respectively. Even though these firms’ concepts are novel, they’re still in a
learning/nascent stage and will likely falter on their journey toward a viable strategy. This makes layoffs
and other cost-cutting measures justifiable, and sometimes inevitable, in order to sustain their business.
It’s easy to surmise that successors to these pioneering players would have shorter learning curves and
more robust business plans.
Another challenge e-companies have to consider is their digital identity and brand name.
With low barriers to entry and intense competition, creating a strong brand name in a truly global
marketplace, ensuring customer retention, and ultimately profitability, will pose a serious challenge to
competing players.
Why then, in spite of the numerous challenges plaguing the average e-commerce company, are they
valued at exorbitant multiples?
Are High Valuations Among E-commerce Companies Justified?
The answer’s in the multiples.
Any fundraising process depends on what stage in its lifecycle the start-up is at. As businesses grow,
returns on investment increase, and these businesses raise money at higher valuations. It is important to
note that these funds are deployed to generate returns after a specific period of time, unlike in e-
commerce firms, where they cover marketing expenses and overheads that results in higher cash burn
rates.

7. Unconventional e-companies are mostly valued by an unconventional metric Gross Merchandising Value
(GMV) multiple. GMV is a product of the price at which a good is sold to the customer and the number of
items.
For example, if product A is sold to a customer at INR 1,000 and there are 10 items of this product, the
GMV is calculated to be INR 10,000.
The flaw in using the GMV multiples to value a company is that it doesn’t consider the actual sales
generated by the e-company with respect to its profit margins. There’s no accountability for profitability
in GMV.
Let us consider the importance of using EV/GMV multiples for two of the big 3’s.
Companies such as Flipkart and Snapdeal rely on inflated GMVs to boost their valuations.
Taking into account the EV/GMV multiples, in FY 2011, both Flipkart and Snapdeal had high multiples
since their GMV value was less. For instance, Flipkart’s valuation in 2011 was $164 million and GMV was
$11 million; thus, its valuation was almost 15 times the GMV.
Over time, as a company’s GMV increases, its valuation multiple consequently decreases.
Flipkart’s GMV in May 2015 was $4.5 billion and its valuation was around $15–16 billion, which is around
three times the GMV. Similarly, Snapdeal’s valuation multiple declined from 20 times to nearly 2 times its
GMV as its GMV increased from $200 million in 2011 to $5 billion in 2015s.

8. Flipkart and Snapdeal are hot on the heels of international e-commerce giants such as Alibaba and
Amazon, with valuation multiples close to those of their international peers.
Another point to consider is Alibaba’s valuation, which is approximately 0.5x. Amazon’s on the other hand
is 1x since its EBITDA margins on GMV (2.5%) are higher than that of Alibaba (1.5%). This has led to a
higher EV for Amazon.
The EV/GVM multiples of Flipkart and Snapdeal may not seem attractive when compared to the likes of
Amazon and Alibaba. Alibaba and Amazon have reasserted a well-established fact —profitability matters,
no matter what business you’re in.
It’ll be interesting to see how much more capital funding Flipkart and Snapdeal can raise, and when, if
ever, they’ll turn profitable.
Outlook for E-commerce in India
There is no doubt that the e-commerce sector poised for growth.
There is an underlying uncertainty regarding actual profitability however.
According to UBS’s latest report “Is India in an eCommerce bubble?,” the e-tail market is expected to grow
10 times to $50 billion in 2020 from its current size of $5 billion in 2015, led by high Internet penetration,
technological advancements, and the prevalence of disposable income in a growing and affluent middle
class.

9. The UBS report states that e-tail, the fastest growing segment in e-commerce, had an aggressive
approach and was compromising on profitability to provide higher discounts and inflate GMV, all aided by
capital injections.
While this clouds objectivity and creates uncertainty in the minds of many who would think e-tail is a
bubble waiting to burst, UBS believes e-tail could be a viable business option if the margins obtained
from distributors/wholesalers and retailer are able to cover operating costs, such as logistics, adequately.
Aswath Damodaran, an authority on corporate finance and valuations, believes e-commerce companies to
be collectively overvalued; barring a few that may yet be valuable in the long run. Investors would do well
to identify such companies if they’re looking to invest.
Aswath also stated that social media and apps are not businesses by themselves; they need to have a
revenue model in order to become a viable business.
Some key questions that you ought to ask yourself before investing in an upcoming e-commerce
firm are:
 How do start-ups generate profit without users and downloads?
 How would the company deal with success and failure?
 How easily replicable is the company’s business model?
From a conservative perspective, a wait-and-watch approach would be most advisable.
If e-commerce businesses, and especially e-tailers, turn profitable by 2020 , any investments you make in
these firms are sure to be a safer bet.
About Aranca:
Aranca is a leading provider of high quality, customized and cost effective research and analytics to global
clients. Founded in UK in 2003, Aranca has a global presence including in the US, Europe and Middle East,
and a state-of-the-art delivery center in Mumbai, India.
Our research solutions are structured around four complementary business lines: Investment Research,
Business Research, Valuation and Advisory Services and Intellectual Property Research.
Over the years, Aranca has become a trusted partner to over 1500 global organizations including Fortune
500 companies, SMBs, investment banks, brokerage firms, asset management firms, consulting firms, PE
and VC firms, law firms, government bodies, trade associations and universities.