Indian e-commerce – Road to ruin.

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The only likely winner in India is now Amazon.

  • Snapdeal has ended merger discussions with Flipkart in a move that, I think, snuffs out the one chance the local players had to keep Amazon at bay.
  • At the same time Softbank is now looking at committing $1.5bn – $2bn into Flipkart in a move that I think will solve nothing because in a network economy, two halves do not make a whole.
  • I think Softbank should not put any more money into Indian e-commerce as the most likely winner in this market is now Amazon in which Softbank has no stake.
  • Snapdeal’s strategy is now to become a niche player and is cutting costs and selling assets in order to raise the capital required to reach profitability in its niche.
  • In my opinion, this strategy demonstrates a fundamental misunderstanding of how Amazon works and what it is likely to do to win the Indian market.
  • Most companies have a strategy that involves trade-offs such as offering high quality or low prices.
  • This is the route that Snapdeal is taking by deciding to streamline and focus on by giving sellers the best experience in India.
  • This is not how Amazon functions as there is no either / or in its vocabulary.
  • Instead Amazon goes for dominance and offers high quality and low prices or in this case the best experience for both sellers and buyers
  • How Flipkart will alter its strategy following the failure of the merger remains to be seen, but without the scale that Snapdeal would have given it, its chances of seeing off Amazon are greatly reduced.
  • Flipkart, Snapdeal and Amazon are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 20 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position, but it is not double the size of its nearest rival.
  • Furthermore, both will now have to contend with Amazon which is absolutely determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • I estimate that Amazon pumped $400m of losses into the Indian market in Q1 17A and roughly the same amount again in Q2 17A and I don’t think it will be afraid to up the ante from here if needed.
  • Amazon is not the largest in India but it can lose far more money for far longer than either of the other two.
  • Flipkart has around 35% of monthly active users but it will need to reach at least 50% before it is double the size of Amazon (7Park Data).
  • This is why a Snapdeal merger made sense, because adding Snapdeal’s users to its own would have got it pretty close to achieving that milestone.
  • Consequently, Amazon will now be able to grind its two main rivals down to the point at which they either exit the market or agree to be acquired.
  • Both of these scenarios are likely to result in much lower valuations than were being discussed as part of the deal.
  • Hence, I think that Amazon is the only real winner from the failure of this merger which I think raises existential questions for local providers of e-commerce marketplaces in India.
  • In the short-term this is unlikely to help Amazon’s fundamentals much and so I remain unenthused with an investment in its shares.
  • I continue to prefer Tencent, Baidu and Microsoft.

 

Xiaomi – Back in black

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Xiaomi is back but ecosystem nowhere to be found.

  • A monster quarter has brought Xiaomi back into contention as a major player in the smartphone industry but this recovery needs to be more than just a product cycle for it to stay there.
  • In a letter to employees, CEO Lei Jun has announced that Xiaomi has shipped 23.16m smartphones in Q2, up 70% QoQ.
  • Most importantly, this represents a significant gain in market share from 3.6% in Q1 2017 to as much as 6% in Q2 2017.
  • This looks to have been achieved through a combination of factors:
    • First: new products. The new flagship Mi 6 launched at the beginning of the quarter which was well received and looks to have been the backbone of the recovery.
    • Second: retail channel. I have long been of the opinion that Xiaomi ground to halt because it had fully exhausted the capacity of selling devices over the internet.
    • In order to address a wider slice of the market, Xiaomi has invested heavily in retail with 123 MI stores opened across China and the first results from this push are now being seen in the numbers.
    • Third: India and overseas: Investments in India are beginning to pay off with the Redmi Note 4 becoming the biggest volume smartphone in Q2 17, elevating Xiaomi to No. 2 in India.
    • By far the largest part of Xiaomi’s overseas fan base is to be found in India and this should help the fan base to grow further.
    • However, India can be one of the most fickle markets as it is so price driven and as many Indian brands have found, success can be all too brief.
  • This quarter will mean that its revenue target of RMB100bn in 2017 should be reasonably easy to achieve but the company also set itself the target to ship 100m smartphones in 2018.
  • This is achievable as long as the company can hold onto the share that it has so suddenly won back.
  • For me, this is the big question as if most the volume is coming as a result of its nice new products or very generous pricing (India), then this is unlikely to be sustainable.
  • This will result in a few very strong quarters as its fan base upgrades and then a drift back to baseline.
  • I think Xiaomi has a chance to avoid this with its growth outside of China and its push into retail but it will cost it dearly in profitability.
  • This is because amongst all of this success there is no mention of its ecosystem anywhere.
  • This leads me to believe that Xiaomi is still selling its products pretty much on the basis of good quality hardware at very attractive prices.
  • Only by luring users in and having them identify with Xiaomi software and services can Xiaomi ever really hope to make than a commodity margin in smartphones.
  • Hence, I still think that Xiaomi, like all of its Android brethren (except Samsung) is making 2-4% EBIT margins in the best instance.
  • This means that even hanging onto this level of market share in the long term would see EBIT generation of around $1.5bn per year.
  • This is not nearly enough to justify anything like the $45bn at which it last raised money, but it is enough for Xiaomi to remain independent.
  • The risk of being acquired by Tencent or Alibaba will decrease, should this new level of market share prove to be sustainable.

Amazon – A song of ice and fire.

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Project ice has nothing to do with phones.

  • After racking up nearly $1bn in losses from its last foray into handsets, one would think that Amazon would have had enough but it appears that it is at it again but for a totally different reason: India.
  • Project ice appears to be the development of another Android device but this time at the other end of the price spectrum.
  • One of the devices in the pipeline features a 5” to 5.5” screen with 2GB RAM, 16GB of storage, Snapdragon 435 and a cracking price to match at around $93.
  • The device is fully Google compliant with its ecosystem installed and set by default but I am pretty sure that at least Amazon’s core e-commerce apps will also be installed.
  • Amazon’s last set of results (see here) showed a big dent in profitability in its overseas operations that I think can be largely put down to its determination not to lose India as it lost China.
  • Alibaba wiped the floor with Amazon (and Walmart) in China and with developed markets maturing, Amazon’s long-term growth is at least partially dependent on history not repeating itself in India.
  • In the Indian market, Amazon is the underdog with around 23% market share compared to Flipkart on 35% and Snapdeal on 15%.
  • However, it is by far the best financed and if it comes to last-man-standing battle, it is likely to win.
  • However, Softbank, the backer of Flipkart is keen for it to merge with Snapdeal which if perfectly executed, would give the combined entity 50% share (see here).
  • According to RFM’s rule that to become the go to place to transact, a marketplace must have at least 60% market share or be at least double the size of its nearest rival (see here).
  • The combination could be enough to see off Amazon but never to back down from a fight, Amazon has a trick up its sleeve.
  • I have long believed that the internet in India has very little to do with fixed (like developed markets) and everything to do with mobile (like China).
  • Consequently, the ice device portfolio could serve as a way to encourage users to do their online shopping with Amazon rather than Flipkart & co.
  • Google has no e-commerce offering to speak of and so Amazon can produce Google ecosystem devices (which Indian users demand) and at the same time install its shopping apps, optimise them and set them by default.
  • Studies have shown time and again that having apps preinstalled leads to them working better and being used more, even if they are not as good as other apps that need to be downloaded (e.g. Apple Maps).
  • Hence, I can see Amazon selling ice devices at 0% gross margins in order to win over more affluent Indian users to its shopping proposition at the expense of Flipkart & co.
  • This is exactly the strategy that it uses with Fire tablets and Kindle with the money being made on the content sold over the device.
  • This example looks no different except that the strategy here is to gain share in e-commerce before Flipkart can reach an unassailable position through consolidation.
  • This is why Flipkart has to act promptly to consolidate Snapdeal as the longer it delays, the more share Amazon is likely to gain and the harder it will be to become twice Amazon’s size.
  • Amazon’s strategy to control the primary device, from which Indians will do their online shopping, only increases the urgency for it to act and act fast.
  • Winter is coming.

India e-commerce – The big if.

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Flipkart for Snapdeal looks increasingly likely.

  • The probability of consolidation in Indian e-commerce is creeping ever closer as Softbank, is pushing for the sale of Snapdeal to Flipkart at a valuation considerably less than the $6.5bn at which the company last raised money.
  • I think this move makes complete sense as on their own, both Flipkart and Snapdeal are likely to be crushed by Amazon should it decide to pull out all the stops in order to dominate the Indian market.
  • This is because, on their own, neither of them is large enough to keep Amazon at bay, but together, they might just have a chance.
  • Snapdeal and Flipkart like Alibaba and to a lesser degree Amazon are market places which bring together merchants and buyers in one easy to use location and from which they can take a small cut.
  • In effect, they are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 18 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rival to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position but it is not double the size of its nearest rival.
  • Data from 7ParkData shows that Flipkart has about 35% of e-commerce monthly active users followed by Amazon at 23% and Snapdeal at 13%.
  • As it stands today, not one of the Indian e-commerce players has established itself as the go to place to buy and sell goods, meaning that all parties are likely to be losing large amounts of money through aggressive competition.
  • If Flipkart is able to successfully execute the acquisition of Snapdeal and hold onto all of its users, then its share of MaU will reach 49% more than double that of Amazon.
  • This could give it just enough scale and momentum to become the go to marketplace in India making extremely difficult for Amazon to compete.
  • This is a big if and will require flawless integration, streamlining as well as customer service.
  • This is why I suspect Softbank is willing to take a substantial haircut on its investment as I think it has concluded that should Snapdeal remain independent, its investment could easily be worth nothing.
  • Amazon does not have a good track record in emerging markets as its performance in China vs. Alibaba was dismal and it does not seem to do much with its acquisitions other then leave them to their own devices.
  • Hence, I think the combination of Flipkart and Snapdeal has a chance but Amazon does seem to be determined not to repeat in India the mess it made in China.
  • Valuations are falling, highlighting the prospect of bargain hunting, but the high-level of uncertainty keeps me from wanting to be involved.

India e-commerce – Unicorns and Donkeys Pt. V.

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Flipkart likely to buy Snapdeal. 

  • The latest in a series of woes that has hit the Indian e-commerce market reinforces my view that in network based businesses, there really is only space for one player to do well.
  • This time around it is Snapdeal which is cutting costs by laying of 800 people, cutting the salaries of its founders to zero and exploring the sale of its mobile wallet FreeCharge at a big discount to what it paid for it in 2015 ($400m).
  • The founders of Snapdeal admit to spreading themselves too thin and not executing optimally, but I think that the real issue here is much more fundamental.
  • Snapdeal and Flipkart like Alibaba and to a lesser degree Amazon are market places which bring together merchants and buyers in one easy to use location and from which they can take a small cut.
  • In effect, they are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 18 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position but it is not double the size of its nearest rival.
  • Furthermore, both have to contend with Amazon which is determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • Amazon is not the largest in India, but it has the backing of the mothership meaning that it can lose money for far longer than either of the other two.
  • Flipkart has the best chance of reaching this hallowed status as it is the largest in India with around 35% of monthly active users but it will need to reach at least 50% before it is double the size of Amazon (7Park Data).
  • This is why I think it could end up acquiring Snapdeal, because adding Snapdeal’s users to its own would get it pretty close to achieving that milestone.
  • Without this combination, we are likely to be left with 2 unprofitable donkeys that are slowly ground out of existence by the vastly more powerful foreign player.
  • This uncertainty keeps me from recommending investments in either of the Indian e-commerce companies even at the discounts now being offered but if I had to go for one, it would be Flipkart.