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Value...not valuation.

Contributed by : Nitin
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Imagine when investors pump insane amounts of money into Internet-based startups, hoping that these fledgling companies would soon turn a profit down the road. These companies, which do not have a set business model that can survive the test of time, start burning the investor money in advertisements or acquisitions of similar firms. This causes their valuations to soar without having any respective value or product. In the rush to cash in on the boom, many investors ignore traditional investment metrics, such as the ratio of the current share price of the company compared to its per-share earnings (P/E ratio). Instead, they subscribe to a business model that favours building brand awareness and market share quickly, even if it requires offering services or products at discounted prices or free. However, their luck (cash) runs out. Since they do not have operating profits, they close shop. Everybody who invested their money loses it. Just so you know, I am not predicting the future, just merely describing the past, a.k.a. the dot com bubble. Although, the similarity of that with the present Indian Startup ecosystem is very similar. And this could be bad news.

Let us look at an example of a famous Indian startup, Zomato. It started as a restaurant discovery service and later added food delivery to its portfolio, which now accounts for a vast majority of its revenue. The food delivery business in India is a price-conscious game, i.e. where can I get similar food for the least price. Hence, it transforms into a discount battle in terms of food, delivery etc. The discount rarely comes from the source restaurant but from Zomato itself, where it burns money to acquire customers, hoping they stay loyal. Unfortunately, this cycle continues as customers, delivery vendors, and middlemen jump ship based on price, salary, and incentives. The discount dampens the firm's bottom line, prompting more money from investors. However, one positive thing is the brand image among the common public continues to rise with the rise in customers/popularity. It's catalysed further with celebrity endorsements. This brand image creates a mirage that the company is performing very well, as very few people go and check the balance statement. This year, Zomato banked on this image by going public. Their IPO, was initially a huge success, raising the price from approx 72 INR to 160 INR in just two months. But, the mirage always disappears. Then came the rude awakening after the earnings report, as the stock tumbled. It is still tumbling to the present date, with the stock trading at less than 60 INR. That has reduced the market cap of zomato by 90,000 crores. Almost all the middle-class people investing in the company brand have lost their investment. Staggering! Add to the list a failed loyalty program, failure in grocery delivery, loss-making raw material delivery business and a few more, all adding a significant burden to the balance sheet and widening the losses even further. Despite all this, the revenue continues to increase, due to an increase in advertising, the customer acquisition value remains absurdly high, and the overall losses keep on widening. It's presently valued at 5.6 Billion USD. Let us see how long this continues.

Another example is Cred, a Fintech company whose core service is a bill payment interface for credit cards. When you pay that bill, you earn coins, which you can then use to avail some special services (mystery). Although, the revolutionary thing as per Cred is that their goal is to create a network of financially trustworthy individuals and then use that network to drive various business models. The way to identify such trustworthy individuals is through their credit scores. The premise is those trustworthy customers are a goldmine for any business. Getting them together on a single platform allows CRED to overlay many different businesses on top of that network. As the founder, Kunal Shah says, "We are not a FinTech company, we are a lifestyle company". So, what businesses? P2P lending, rent payments or even helping users invest in real estate in a fractional manner. Well, they already offer the first two services! Apart from this, the fact that CRED has specific financial information about its user, can also help other businesses like financial institutions access the right users better. For example, in 2020, CRED launched a service that allows its members to borrow up to Rs 5,00,000. What's more, it does not require any forms, phone calls, or physical visits, Just three steps to get the money in your account. This type of model is what is motivation VCs to keep pumping money. Although, this accumulation of high worth individuals is more complicated than we think. This target is the reason that Cred spends outrageous amounts on Ads. Let us look at an example. IPL: Cred has spent approximately 500 crores this year on IPL ads. This expenditure has increased their customer base by 18 Lakh people (albeit temporarily). The customer acquisition cost comes out to be 2222 INR, which is insane. Most of these people will possibly not be engaged users, let alone revenue-generating users. Even if we consider 5% of them to be revenue-generating, each user will then have to generate INR 2222 / 5% = INR 44,440 in their lifetime for CRED to start making money off them. The company entices revenue from participating firms who provide services, but those companies want to see profits in future to keep their participation ongoing. Also, once the investor money runs out, will Cred be able to give discounts and cashback that they provide now. Also, once the cashback sinks, will the customers stay loyal to the service. These are vital questions for a company valued at approx 7 Billion USD, and their respective answers will determine if Cred is a revolutionary company or not!

My attempts are not to discredit any of these firms. It is just that they are valued in outrageous numbers wherein they are still unable to justify even a 10th of their value via its revenue. There is also a massive craze/public appeal to raising funds and increasing valuations, which removes the emphasis from the actual product. The entire customer base is established out of discounts/cashback which is funded by investors and not profits. Also, these services are unlike the core industry (cement, steel, automobile), where the barriers to entry are super high. Also, I would like to point out that I will be happy if I am proven wrong, as that will benefit the startup ecosystem, but I cannot sit about and ignore the ominous signs which are identical to previous technology bubbles.

P.S. If you wish to read about a successful Indian startup, please look into the workings and growth of Zerodha. Also, The reason for taking Zomato and Cred were because they are well-known brands throughout India due to their extensive advertisements. You can add PayTM, PolicyBazaar, Swiggy etc. to the same list.


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