Model allows firms to save on storage costs, get access to FDI, but experts see moves as survival strategy

Virtual marketplaces sprout in e-commerce space

Model allows firms to save on storage costs, get access to FDI, but experts see moves as survival strategy 

Flipkart launched its virtual marketplace on Saturday and is offering similar services as those of eBay.

Flipkart.com’s entry into the virtual marketplace, where independent merchants sell products directly to shoppers, marks the latest in a flurry of online retailers in India shifting to a model made well-known by eBay, but the jury is still out on whether it’s sustainable.

In the past 18 months, more than a dozen firms including the likes of Amazon.com’s India business Junglee.com, Snapdeal.com, Infibeam.com, ShopClues.com and Tradus.com have started providing online services for buying and selling.

EBay, the world’s largest auction and shopping website, recently bought a minority stake in Snapdeal.com as it looks to aggressively expand in a market dominated by Flipkart, India’s largest online retailer.

Flipkart launched its virtual marketplace on Saturday and is offering similar services as those of eBay.

This business model allows e-commerce companies to save on storage and other inventory-related costs as the products are held by the merchants.

Equally importantly, especially as funding for e-commerce companies has shown signs of drying up, companies that choose the marketplace model get access to foreign direct investment (FDI). FDI is banned in direct online retail.

However, several experts, investors and industry executives said this move seems more like an immediate survival strategy for e-commerce firms that have been using up investor cash on chasing customers and sales volumes at the cost of profits.

They said such marketplaces have a better chance of succeeding in countries with efficient supply chains—an area where India lags the West and China.

“Even with the marketplace model, your customer acquisition costs haven’t changed. It’s more of a survival strategy; it’s not a proven success strategy in India. Right now, it’s a phase of experimentation,” said Deepak Srinath, who leads the technology and emerging sectors practice at Allegro Capital Advisors, an investment bank.

In many ways, including delivering a consistent customer experience, it’s more challenging to execute a marketplace successfully compared with direct online retail, said Rutvik Doshi, an e-commerce investor with Inventus Capital Partners.

“In pure-play online retail, where you’re holding inventory, the supply chain is under your control. Look at Flipkart, for example. They are able to deliver products consistently on time. To get this consistency in a marketplace, where you might have sellers in various parts of the country, is much more difficult. Your delivery time is likely to go up, the merchant is not listing stocks accurately, ensuring returns to customers—there are a lot of such risks. So choosing your merchants carefully is essential,” Doshi said.

India’s retail industry is estimated to be around $500 billion, according to industry body Federation of Indian Chambers of Commerce and Industry. Less than 1% of that comes from online retail.

A December report published by Allegro highlights how funding has dried up from venture capitalists (VC) and investors for the domestic e-commerce sector. According to the report, 70-80% of VC-funded companies are on “life support” and in dire need of funds.

“In the frenzy of 2011 and early 2012, VC firms may have overexposed themselves to e-commerce, without properly estimating the capital requirement of the sector. It is unlikely that any of these firms will invest in new e-commerce ventures,” Srinath and Aravind G.R. of Allegro, said in the report.

In the last three years, more than 50 e-commerce companies have raised nearly $800 million in VC funding, but barely a third have been able to attract follow-on investments, according to Allegro.

To be sure, the marketplace model has worked in countries such as the US and China. It’s much easier to build scale and size through the marketplace than direct retail due to the lower inventory costs. And because of their ability to add merchants quickly, marketplaces can offer a much wider range of products. Even Amazon.com gets roughly 40% of its sales from its marketplace business.

In India, there are pure-play marketplaces such as Snapdeal and eBay as well as part marketplace-part direct retail firms such as Jabong.com. Industry executives said that most companies will likely adopt a mixed model.

“The mixed model will evolve for most players because you don’t want to dilute the customer experience too much. I don’t think India is ready for a pure-play (model) because of the logistical challenges,” said Praveen Sinha, managing director at online retailer Jabong.com, which launched its marketplace platform late last year. “My sense is because of the easy scalability and the lower working capital costs related to marketplaces, they will continue to increase (their share of e-commerce).”

Increasingly, the product delivery time to customers is going to reduce and firms will also have to handle returns faster, said Arun Sirdeshmukh, chief executive at online retailer Fashionara.com.

“In the near future, it’ll be normal to receive your product in 48-72 hours. In that environment, the pure-play marketplace model will come under pressure. There is so much variability, the complications of logistics, given that both vendors and customers may be in remote locations,” he said.

Industry experts said that eventually, many pure-play marketplace companies will end up either shutting down or being bought at cut-rate prices by bigger players such as Snapdeal and Flipkart.

“Only a few marketplaces will eventually survive, especially the ones that build large consumer and merchant traction. Logistics is a huge challenge (in India), online payments are still a fraction of the business, and finally there is lack of depth in savvy merchants,” said Rajesh Sawhney, former president of Reliance Entertainment and founder of the Global Superangels Forum, a start-up incubator that has an accelerator programme for new ventures.

However, online marketplaces contend that their model is viable and even appropriate for India, where most e-commerce startups are run by people who specialize in technology rather than retail.

“If you look at most of the e-commerce startups, it’s clear that their strong point is technology. There are very few people who have a deep understanding of retail. So unless your Chromas and Pumas of the world come into the online space in a big play, it’s best for startups to focus on their strengths,” said Mudit Khosla, chief executive at online marketplace Tradus.com.

Creating a marketplace is about creating efficiencies based on technology,” Khosla said. “Leave the retail side to the sellers.”