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How startups crack the profits puzzle

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Key stakeholders, including foreign investors, remain bullish on the prospects of Indian startups. Increasing internet penetration, fast mobile internet connectivity and rising incomes will continue to drive capital into internet startups that are attempting to unlock the potential of the country’s large consumer base. India had 350 million monthly active internet users as of December 2019, according to internet consultancy RedSeer Management. This number is expected to increase to 500 million over the next three years.

However, after the disappointing public offering of Uber Technologies Inc. and the fiasco at WeWork Companies Inc., investors are increasingly becoming more cautious about backing startups everywhere, including in India. These events mark a turning point for startups, at least for the foreseeable future. It seems like the thoughtless spending and funding of losses is coming to an end. Now investors are pushing their portfolio startups to urgently focus on building sustainable business models, reach profitability and abandon a growth-at-all-costs approach.

This new push towards profits involves identifying the key levers for creating a sustainable business model, which can then lead to a transparent and shorter path to profitability. RedSeer believes there are three pillars to creating such a sustainable business model.

Targeted demand generation: Early identification of target customers and creating customer retention initiatives to ensure that revenue growth is sustainable.

Strategic supply: Early identification of the right suppliers or sellers and focusing on creating value for them. This would incentivize them to deliver excellent services and reduce the chance of losing them to rivals.

Optimized tech-led supply chain: Companies must ensure that they serve customers in a timely yet cost-efficient manner to keep cash burn under control. This is possible only through a tech-led supply chain that enables expansion more efficiently. Companies need to consider the use of offline channels and stores in certain product categories, and their back-end technology platform has to be robust enough to service this channel efficiently.

While it is challenging to execute on these three pillars, there are a few Indian startups that are proving it is possible.

Targeted demand generation

For a new startup, focusing on continually improving its attractiveness to its core customers enables retention. Certain Indian new-age startups have been mindful of this aspect.

One such example is business-to-business (B2B) e-commerce platform ShopX, which has been trying to resolve the challenges related to sales and inventory management for small retailers in rural India through a host of technology-led solutions. ShopX identified well-defined clusters with populations of around 100,000 to target retailers. Most business models operating in this sector use a large sales force to generate orders, which pushes up cost with scale. However, ShopX generates more than 80% of its demand digitally and for a majority of its customers, the ShopX app is the “third app” on their phone after Facebook and WhatsApp.

Another company that has done well here is 1mg. After starting out as an e-pharmacy in 2015, the company realized that in order to organize the Indian healthcare market, which has not been designed keeping the end consumer in mind, it needs to provide a one-stop patient-care tech platform.

1mg quickly added e-consultation and e-diagnostics services. Becoming an integrated platform early on allowed the firm to reduce its dependence on discounting for consumer acquisition and retention. This has led to improved margins as the company scaled up. 1mg has been able to reduce its customer acquisition cost to less than 17% of gross merchandise volume (GMV) in an industry where it is generally more than 25%.

Online beauty products store Nykaa is another company that is getting demand generation right. It achieved a high rate of customer acquisition and retention owing to its persistent efforts in digital customer engagement through subscriptions, marketing activities (sales events, video blogging) and tie-ups with influencers.

Nykaa’s personalized recommendation system and active customer support have allowed it to boast a net promoter score (NPS)—a key measure of customer satisfaction—of 35%. This would be among the higher NPS levels in consumer internet space.

Strategic supply

RedSeer recently concluded a study on brand monetization potential for digital platforms. After speaking to more than 40 brands across sectors, one common theme which came out was that brands are eager to partner those digital platforms that provide them with reach as well as additional value-added services like sales insights and relevant advertising platforms. The brands said they were willing to pay 4-9% more for such specialized services.

Many internet startups are marketplaces. This means they have two customers: the end user and sellers or suppliers. Attracting and retaining users is not enough; it is equally important to attract, train and retain sellers. Supplier stickiness is important for any new-age startup to ensure profitability. But it cannot be achieved by acting as a pure marketplace; being a value-added platform for suppliers and sellers is crucial.

Some of the more proactive digital platforms have made sure to consolidate their supplier base, so that there are a small number of high-quality sellers that drive large volumes of business. By offering training and value-added services to these sellers, these platforms have high retention rates of sellers. They have also diversified their risk and increased margins by introducing private labels.

Brands such as Nykaa and Purplle, also a beauty products portal, enjoy high gross margins by having sizeable private label sales. They also stitch up partnerships with renowned brands. For example, Nykaa has exclusive tie-ups with luxury brands such as Hermès, Etude House and Nyx Professional Makeup. Further, the company leverages its platform to cross-sell other products to existing customers. This has enabled Nykaa to achieve 30% gross margins, one of the highest in the industry.

Similarly, online food and grocery store BigBasket’s high-margin private labels contribute one-third to its GMV. Further, it sources directly from brands and farmers, leading to high gross margins. In the process, BigBasket gives these farmers and brands access to untapped markets and provides both consumer insights and a platform for targeted marketing to boost their revenues.

Online food and grocery store BigBasket sources directly from brands and farmers, leading to high gross margins.
Online food and grocery store BigBasket sources directly from brands and farmers, leading to high gross margins. (Photo: Reuters)

E-tailing firms are making millions of dollars today by providing targeted performance marketing platforms to their sellers and suppliers, be it through video, display or search-based ad services.

On the B2B side, firms such as ShopX have been clear on keeping its supply concentrated to a limited set of brands and sellers who are reliable, more efficient, and can provide better prices and availability rather than going after a long tail of suppliers.

Tech-led, flexible supply chain

Apart from providing value-added services to suppliers, the other crucial ingredient in driving unit economics is building a tech-led supply chain. This allows companies to deliver products faster to customers at lower cost, thereby ensuring higher consumer and supplier satisfaction.

This is further supported by a RedSeer study of about 1,300 consumers. The respondents cited a strong need for offline touchpoints, which would allow them to see and get a sense of the products they saw online. This will allow online firms to effectively reach out to target consumer segments in tier II+ towns, leading to scale with operational efficiency.

FirstCry, founded in 2010, provides a good example of how to work a tech-led but flexible supply chain. The company bet a few years ago that the mantra for success in the Indian baby care market is going omnichannel, as most Indian consumers, especially first-time buyers, prefer purchasing baby products offline.

The company operates 430 offline retail stores, which has not only increased its brand presence but also given a significant boost to its GMV. FirstCry’s omnichannel model yields significant data insights on consumer behaviour, which in turn allows the company to order and sell relevant products quicker across its stores.

FirstCry follows a franchise model, where it partners with retailers for a period of five years and allows them to keep 37.5% of the total GMV as their cut. In addition, it provides staff-training to ensure standardized consumer experience across the stores. To drive partner satisfaction further, it assists store owners in marketing along with site selection.

Fitness and lifestyle services firm CureFit has also crafted an omnichannel strategy. In order to boost its brand awareness, the firm has signed up with celebrity influencers. It regularly offers promotional activities at its more than 200 fitness centres, which helps attract new users.

Lifestyle services firm CureFit started out as a fitness chain but quickly added healthy food, meditation centres and medical services to its offerings.
Lifestyle services firm CureFit started out as a fitness chain but quickly added healthy food, meditation centres and medical services to its offerings. (Photo: Reuters)

Further, CureFit provides free trial classes to acquire clients and utilizes its wide array of services to garner a higher share of the wallet from its existing customers. It started out as a fitness chain but quickly added healthy food, meditation centres and medical services.

Given that most of its customers are digital natives, CureFit has been able to create its mobile application as the focal point of interaction. Clients book classes, order food and request a consultation through the app. In addition, it provides app-based training sessions to its customers to work out at home.

Finally, B2B firm ShopX has built a full-fledged digital stack called SupplyX with its own first-mile and last-mile apps, and end-to-end data tracking. Everyone in the ShopX supply chain ecosystem, including brands, distributors, wholesalers, retailers and consumers, use its proprietary technology.

This focus on using technology across its supply chain has allowed ShopX to have positive unit economics—the company makes a profit on every transaction. Its current annualized GMV is nearly $1 billion and even at this scale, the company has been able to keep its supply chain costs at less than 1% of its GMV.

In conclusion

The Achilles heel of unicorns is profitability. And that’s where the next wave of opportunity in India lies. The key question is how do we build unicorns with profit, or proficorns? Instead of focusing only on valuations and exits, can we actually build sustainable institutions based on new-age technology? Potentially the answer is “Yes”—if you execute on the three key pillars elaborated above.

Some or all of the companies mentioned above may be clients of RedSeer.

Abhishek Chauhan is associate partner at RedSeer Management Consulting Pvt. Ltd.

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