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General Thinking

What makes a business, a ‘Startup’?

All too often I come across young entrepreneurs, who are just starting a business through which they intend to hawk their skills. Starting a business does not necessarily make it a startup. It makes you an entrepreneur certainly, but not a startup.

Anybody, who engages in any kind of business is an entrepreneur but only a few among them can be deemed startups. I can’t go around saying, I have a startup just because I setup a Dhaba on NH7!

Unless… the business meets certain conditions; I shall list them below.

 

Attack a problem that has not already been solved

When you attack a problem that has not already been solved, you are creating a market for yourself. The kind of solution that you offer cannot be bought off the shelf and hence it makes the offering compelling.

I know web development and hence I started a web development company. Well, sure you did! But the problem with that is, you are not solving anything new, you are invariably going to compete with the many thousands of web development agencies that are out there already. You lack experience and most certainly the manpower that some of the more established peers have. From that point forward, it is an uphill climb. Besides, since this is a well-worn path, many entrepreneurs have tested and tried all kinds of permutations and combinations of selling the product or service. I do not deem such a business a startup.

Unless… you have found a way of doing the business differently.

 

Building a business model which breaks convention

Take a company like Uber; it is able to get into a business that is as old as the motor vehicle and able to find scale like no other business has been able to, till date. Many companies have tried  running a taxi business. Invariably the biggest problem with running the business successfully has been that the incentive of the owners and the drivers has been misaligned. This has meant that there is no global taxi business; until, Uber.

Uber used a mix of technology coupled with a business model, which is unlike any that existed till then. Most importantly, the company does not own any inventory of vehicles unlike every other cab business prior to it. They own the platform through which they are able to generate demand and they manage to match that with individual taxi owners who are able to deliver a standard product quality.

Uber is just one of the examples of how an old world business has found a new avatar through an innovative business model.

Examples of such companies include Airbnb, HotelsTonight, Google, Spotify, Pandora

The success of each of these businesses hinges on the fact that they did things differently. They changed the way the business was done in the past. Before Google, all search engines used to push the sponsored listing up on the search results without informing the users; precisely why the ‘Don’t be evil’ motto was coined. Spotify and Pandora changed how music was consumed and thereby changed how users pay for them as well. Airbnb changed the ad-hoc renting market forever; not only for home-owners who wished to rent out their houses/rooms as holiday accommodation but also for travellers who seek for cheaper stay options. Each of them have been able to change the way business used to be done, which brought them leadership role in the market and helped them get recognised.

 

Ability to grow across geographies and scale, providing exponential returns

Most of the businesses established prior to the onset of computers usually consisted of certain assets, which cost a lot to replicate across countries, which in turn slowed down the growth of the business. In the case of most startups, one of the defining features is that they are easy to replicate in different geographies and hence lead to rapid expansion across not only domestic but also international geographies. [Caveat: Certain problems are country specific and therefore cannot be scaled in a similar manner internationally]

In all of the cases mentioned above the companies were able to quickly spread the same model across boundaries and ensure rapid growth of their businesses. The increase in scale means exponential returns for any investment that has been made in such businesses.

Despite being restricted by copyrights, companies like Spotify and Pandora have been able to expand to tens of countries resulting in very high turnovers for them.

Scale is by far the greatest defining attribute of a startup. Companies that can cater to a relatively large market can scale continuously and therefore generate greater value for the investors in the long run by unlocking value in untapped markets. Squeezing more money out of the same set of customers often proves challenging and also results in companies acting in a manner which is seem to be contrary to the interests of the consumer.

 

These three attributes are by far, the most important for the business to be classified as a startup.

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General Thinking

Online Retail – The Revolution?

In a commerce class in school, I was taught that the point of a business is to earn a profit. Online retail startups have certainly caused me to question this notion.

 

Money, money everywhere; not a cent to be earned!

amazon-logo-a-smile-black  VS main-qimg-6775e2918eef64f05db9bc95aa673606

I find it quite amazing that there is immense investor confidence in a business that is unable to turn a profit even with millions of users on board. The best (perhaps the only) analogy for the current online retail scenario would be the airline industry.

When airlines started flying people in the 40’s; there was a lot of excitement about growth opportunities, and the loss-making nature meant that governments owned most airlines – more as status symbols rather than viable businesses. Eventually, private companies got into the game and operating running airlines as well. At the time, it was believed that with increasing connectivity between several cities as well as an increasing number of people using airlines, it was expected to become a viable business and a profitable business. But, as time progresses, we can see that this expectation has not been met. On every occasion, other reasons have been blamed for the lack of profitability in the sector: SARS, 9/11, hijacking, disappearing planes, and so on. Nonetheless, airlines have not been able to consistently turn a profit. This has resulted in many mergers and acquisitions, amalgamations, and even bankruptcy.

The only type of airlines that have been successful are the ones which have specialised in a very specific segment (corporate/business customers) or geographical region. The sad consequence is that one of the bigger airlines always acquires the profitable operation and tries to scale it, resulting in its inevitable decline.

Online retail, by comparison, is a far more recent phenomenon. Ideally, it should be compared with retail, which is what it promises to replace. To date, the success (in turnover) of online retail has relied on discounting. Walmart also relies on discounting, and by relying on any means necessary (paying extremely low wages, providing hard terms to manufacturers, etc.), they have managed to run a business that is highly profitable.

With Flipkart securing a funding of $1 billion, followed instantly by Amazon announcing to pump $2 billion, there has been a lot of commentary about online retail and the opportunities that lie ahead.

I think the point of a business is to create value, and that value creation results in profits. A retailer makes it easier for you to explore a multitude of products, compare brands and buy them. The online retail industry provides nearly the same service offering, along with the added convenience of being able to shop from home. The only difference is that the retailer sources the goods at a lower price than the one at which it is sold to you. Unfortunately, the selling price of products on online retail platforms is lower than their purchase price.

 

US Airways Amazon

Is it not amazing how similar the profitability trends seem? Essentially, there is none.

US Airways Vs. Amazon

Different industries, same struggle.

 

Now, I understand that for certain businesses, in order to be profitable, you need to have a minimum base of customers. Social Networks are shining examples of how that works. Having said that, if you cannot make something work profitably with 20 million customers, how will ramping that number up to 100 million make any difference? Even if you do make a profit, the margins are going to be in the low single digit percentages. I find it hard to justify investing billions of dollars to generate a profit in the millions (and most likely tens of millions, and not hundreds).

 

WACC

This chart sourced from an IATA’s 2013 report shows how well the returns have worked out for the airline industry. Investor value destruction!

 

I believe the online retail industry is headed the same way, at least from the point of view of “all-under-one-roof” retailers.

Similar to the case of airlines, there is some oasis of hope. There are online retail firms, not unlike the airline industry, which specialise in a very narrow segment of product offerings. DollarShaveClub, Bonobos, NastyGal, Diapers.com, and closer home, Myntra.com, are examples of models that work well. Unfortunately, similar to the airline industry, these smaller firms, which will never have very high turnovers, are acquired by larger players, since it makes for a nice press release and helps keep investors at bay. At the time of acquisition, the larger firm tries to “integrate the business” and benefit from the “synergies”, and end up running the business to the ground. If they leave it alone, it may just work – it has shown success in its current form after all! This has happened time and again in the airline industry; it remains to be seen how it plays out in online retail.

So why the investments? Well, if we come back to Flipkart, the investors invest a large sum of money into the company because it furthers the company’s chances of an IPO. If the company is sitting on $500 million in cash in 12 months’ time and files for IPO, they will certainly be able to sell through the IPO and exit neatly. The CEO, on behalf of the investors, made clear the hopes that would be sold to IPO investors – A $100 billion valuation. So, even if they project a $20 billion valuation at the time of listing, which would be close to three times the valuation at which the funds were raised (if rumours are to be believed); as compared to $100 billion, it will still appear as though there is still more value to be unlocked. And as far the current investors are concerned, 300% in 12 months is not too bad a deal, is it?

If Amazon were to be used as a benchmark, the possibility of running an online retail business with decent profit margins seems remote. To add to that, Amazon itself has always been ready to enter into a price war with anyone who strays into its territory, since its investors seem quite satisfied even if the company posts a loss. Therefore, if profits ever exist, they will always be extremely low.

Will Flipkart be able to keep hopes up without turning a profit? Well, only time will tell!

 

Categories
General Thinking

The Big G – Growth

I work with startups and businesses which are trying to scale up, hence, soon or later, the question of ‘Growth’ arrives. 

When do we begin to scale up? How do we grow? What is the best way to grow? How much growth in manageable? How to manage during growth?

But every now and then, the most important question arrives. Do we need to grow?

Due to the success of tech startups and their ability to scale up, it has become a false assumption that every business must grow and if it does not grow, it must be doing something wrong with it!

Nothing could be farther from the truth. In fact, growth is a very personal question for every entrepreneur. Growth brings increased income, but along with that, it brings a new set of troubles as well. A greater demand on the entrepreneur’s time, greater management challenges, etc. From the point of view of an investor, growth means more returns on investment (or at least a higher valuation! Not all growth is good!) and hence they always prefer growth but from the perspective of an entrepreneur, it is up to the entrepreneur to set growth targets.

If, as an entrepreneur, one is satisfied with being able to meet his/her family demands and afford a good lifestyle, there is no need to grow any further. Any further growth will probably rob the entrepreneur of the extra time that he/she has at present.

There are those who open a grocery store in a neighbourhood and are satisfied with the income that they are able to generate from it. Then there are those who need to come up with the next big dotcom sensation; the next Million dollar App or a nation-wide yogurt chain. Each of them are right in their own place and addressing their respective needs.

The entrepreneur should know his/her appetite for growth. Knowing this allows them to plan accordingly and prepare for what is to come.