Would It Be Far-Fetched To Call The Indian B2C Internet Space A Ponzi Scheme?

Source – https://www.businesskorea.co.kr

A Ponzi scheme is one where the underlying project doesn’t generate any profit, and the existing members/investors are paid out of the money received from new members/investors. By this definition, the Indian B2C internet space can very well be classified as a Ponzi scheme.

In the Indian B2C internet space, the only way the investors are paid back is when new investor money comes in and not from the profits generated from the business. This cycle of investments and exits goes on while the underlying business shows no signs of achieving profitability. It sounds like a perfect Ponzi scheme, doesn’t it?

Market Potential

Don’t be surprised if you come across a presentation about a market opportunity in India which would go like this:

The per capita consumption of a product/service in the U.S is X, but in India, it is (1/100)X. Therefore, the conclusion is that the market has the potential to grow 100 times.

Companies have tried to sell this story for close to two decades now. Yes, no doubt India is growing, but we will never see a per capita consumption anywhere close to that of a developed country in our lifetimes.

India is a country where even basic needs, such as clean water, sanitation, education, and health care, are not accessible to the vast majority of the population. Most New Age internet companies target the cream of India. The value proposition of these companies is enhanced consumer experience. So their true market within this cream section is the people who are willing to pay a premium for convenience and are tech savvy. Young IT professionals would form a significant part of this segment. However, the entry-level salary for such professionals has been more or less flat over the last 10 years, hence rendering them poorer than their seniors when taking inflation into account.

As per the Credit Suisse Global Wealth Report 2017, only about 0.5% of Indian adults have a wealth of over 100,000 USD. We would use this as a benchmark for people who could potentially pay for convenience. Some might feel that 100,000 USD of wealth is too much money in India, so even with a more liberal 1%, the target market size would be a paltry 13 million, which is slightly more than the population of Belgium.

Challenges

There are a lot of cultural factors as well, which could mean lower consumption of such services. Indian consumers spend disproportionately more on marriage and education when compared to their counterparts from the developed world. Entertainment, eating out, travel, and other such discretionary consumption are not their priority.

Most of these companies call themselves tech companies. However, in reality, technology is only an enabler for most of them. Usually, they are very labor-intensive businesses, and hence, quality control becomes a massive challenge.

Source: MCA filings, VCCEdge, NightHawk Research

Dynamics of the Industry

I understand that a startup generally works at a loss for a few years, and the reason is the lack of scale to cover the initial fixed cost. In such a scenario, it is sensible to try to capture as much market as possible. However, in this industry, most companies offer such deep discounts and promotions that they generate losses even at a gross level. The losses are, in many cases, larger than the revenues, even for companies that are more than five years old. The supposed logic behind this strategy is that these consumers would eventually be able to pay the market price. However, this outcome has not materialized over the last ten years.

These companies point out that the other reason for implementing such a strategy is competitive pressures. Companies have always had competition, be it Coca-Cola or McDonald’s. However, traditionally, companies have consistently made sure that they maintained some level of sanity when it came to offering discounts and promotions, definitely not to the extent of making losses at the gross level. If one is to be successful in business, the competition has to be smart as well, and this doesn’t seem to be the case here.

Most of these businesses don’t have strong entry barriers, and neither is their client base sticky. The typical Indian consumer sees these companies as being nothing but an online deals website.

Source: MCA filings, VCCEdge, NightHawk Research

The Stakeholders

By projecting such huge market potential, the entrepreneurs get away with lofty valuations. This makes it a very attractive proposition for the entrepreneurs. However, for those entrepreneurs who want to build an enduring business, it becomes very challenging, as it is usually a race to who raises funding first.

The consumers, on the other hand, are having a great time as well, enjoying the deep discounts.

So is it a win-win situation? Then, who is the loser in this whole game?

It is the company’s investor at the time when this bubble bursts. All investors hope that the bubble won’t burst while they are invested in these ventures.

Since most of the investors are foreign PE funds, I don’t see a substantial systemic issue when this bubble bursts. These multibillion-dollar foreign PE firms have small exposure to India. So they are not overly concerned as well. The employees of these companies will feel a major impact, and it might have a cascading effect on the job market.

Conclusion

In conclusion, we believe there is a market in India for all these services. If the entrepreneurs can gauge the real market potential of their business and not go by the metrics of the developed world, they could very well build an enduring business for the Indian market.