This post first appeared on the VCCircle blog here
The easiest way to tell if a PE/VC investor has earned their chops in India or in the west is when within 15 mins of your conversation the former will ask you: “Now that you have created your distribution network in India (or plan to create it) what else beyond your present offering can you pump through it?” This test has never failed me! There is a lot of wisdom behind this bias because the toughest thing to do in India is to build out the distribution network. A US trained VC’s bias will be towards vertical growth within the same product suite, but an India trained VC will have a bias towards horizontal growth across multiple product suites. I would argue that the challenges of distribution are so huge in India that product innovation is secondary and it is more capital efficient to “import” products and figure out the distribution network rather than spend time and energy on innovation.
Today we are seeing an angel investing boom in the US. There is a lot of infrastructure in place that allows this to happen. Amazon Web Services and the ilk are often mentioned as the key enablers but what does not get mentioned as often are: variabalized sales/marketing costs through online marketing; reliable physical infrastructure; reliable courier services; an electronic payments network; trustworthy law enforcement; overall high level of trust in society etc. All these are different elements of distribution that have on a relative scale commoditized distribution for an entrepreneur so that she and her team can focus on the core product. In essence, it has freed up a lot of energy to focus on pure innovation.
In this post, through a comparison to the US market, I will simply highlight the unique distribution challenges of India. The key to success in India is to be aware of these challenges and develop plans to work within the constraints they force upon you. With present-day low levels of per-capita consumption, domestic consumption in India will continue to grow for decades and companies that address the India market at its own terms rather than following copy-cat business models are the ones that are going to capitalize on this growth.
Let me start with listing down the various elements of a successful distribution channel. I would say that the distribution channel for a brand has been setup if ALL of the following have been accomplished:
- TRUST: Consumers and channels have basic trust in the brand to try it out repeatedly and recommend it to others
- RELIABLE DELIVERY: The company has the ability to deliver the product/service reliably day in and day out
- ABILITY TO COLLECT: The company has the ability to collect money, which also includes ability to enforce a financial obligation (hopefully through legal means!)
- PROFITABILITY: At its simplest, this measures the firm’s ability to charge the right amount and the operational efficiency of the channels to keep costs down.
- SCALE: The business needs to have reasonable scale – exact revenue numbers will depend on the type of business, but north of $5-10M is a good first order estimate in the context of a VC- funded company
So let’s compare the challenges on all of these fronts between India and US.
Any time a new company is formed there is resistance to accept the new product or service and overcoming this through great delivery, marketing, sales etc costs a lot of money in every country. But a major issue in India is the low level of trust that exists in businesses due to daily poor experiences. Think of your favourite home service (plumbing, electrician, car repair) or banking services (“I will call you back tomorrow” – yeah right!) or horror stories getting medical care – the default starting point for the consumer is to assume “it will not work” or “s/he is lying or stretching what’s actually possible”. A consumer starts with a position of mistrust and then trust has to be earned. It is the exact opposite of what happens in the US. If I wanted to buy an expensive camera in the US, I would do a Google search, quickly find the best price and place the order. There is a 99% guarantee that the product I ordered will get delivered in the time committed and that I will have full protection for the 1% of the time there is a problem. I’d walk in to brand new restaurant on day-1 without any fear of falling sick.
In India, overcoming the very high level of mistrust at scale is at best extremely expensive and at worst takes a lot of time and staying power. It requires delivery at scale (which is a chicken and egg problem), advertising, marketing & sales at scale, and good corporate behavior at all company touch points.
The concept of “reliable” delivery means many different things in different businesses but let me take Canvera’s example of delivering photographic printed products to customers. We work closely with 15+ courier companies (not 2 or 3, but 15) that deliver mail-order product to 300+ cities. Over a 4 year period we have developed intricate processes to monitor each packet over and above the monitoring and tracking the courier company provides because in the end it is our responsibility to deliver the packet in a respectable timeframe and through experience we’ve learnt that we can’t rely on the courier companies. In a services business (think restaurants) in India scaling up is a huge challenge because of the quality of the available workforce and the training required (think hygiene in a restaurant). In the US, courier services are a given, no entrepreneur worries about them. And while finding high quality workforce in a services business is always a challenge, the size of the US economy itself provides a reasonably large trained workforce. It may cost a pretty penny, but it is available. Think of how quickly Groupon scaled its team of Inside Sales to 1000s of people and how many different businesses were able to reliably provide the services to consumers through Groupon.
ABILITY TO COLLECT
I have written at length about COD in an earlier post – that was more in the context of a B2C business. But there are other forms of collections including B2B, retail etc. FMCG businesses in India manage consumer collections by offloading them to the kirana store and managing their own collections from the store owner by creating enough demand for the product and holding back supplies if payments are not received. B2B collections are a nightmare in India that create massive cash flow issues with providers being forced to get in to the credit business since there really isn’t a legally enforceable collections framework and companies rely on personal relationships and holding back future services to enforce payments. No entrepreneur I know of in the US worries about collections as a bottleneck to business growth. It is a plug and play solution and largely a variable cost with a legal framework to fall back on.
Let’s examine the two aspects of profitability: Revenue and Cost. Take mail order businesses (or e-commerce); consumers in the US are willing to pay a little extra for shipping solely for the convenience – as the economy has grown and time becomes a premium, there is an appreciation for opportunity cost and value based services that save time and headache. On the cost side – assuming healthy gross margins, given a reasonable cost of RELIABLE shipping and reasonable cost of collections, each transaction can be profitable in the US. In India however it is a very big assumption that consumers will pay for convenience (this is a separate blog post altogether) – real and perceived opportunity costs are low and even if they increase, it takes a lot of time for consumer behavior to change at scale. So far, especially in e-commerce, all we have seen is what we know sub-consciously: price is all that matters. I am willing to bet that volumes will drop dramatically if Indian e-commerce companies start charging nominal amounts for shipping or if prices are raised to even a few % points higher than offline retail. And then on the cost front, as I have mentioned before, cost of collections is high and logistics are very inefficient. The combination of not being able to charge for convenience/quality and a high friction operating environment results in highly unprofitable transactions.
Finally, any company can overcome all of the above at a small size, the real challenge is being able to do this on a large scale: in multiple geographies, in multiple languages all over India.
Telecom companies are the best example of the power of distribution networks in India. This blog post by Abhimanyu Radhakrishnan summarizes it best:
The speaker line-up at the opening keynote … is the best evidence possible of the peculiarity of the mobile phone industry. The operator – the guy who provides you an easily commoditized, utility like service – has the biggest clout in the industry. Imagine the premier global conference for …umm… ‘Home Appliances’ having the CEOs of the electricity companies as the big draws.
How true! And yet the power is with the phone company because they have the distribution network. They have the trust of the consumer; they provide mVas players with a reliable delivery and collections mechanism which can in turn be profitable. And they have significant scale. No telecom player wants to be seen just as the dumb pipe. After having put in the capital and time to build out this network, they want a share of every innovative product that is distributed through it. It is a separate matter that their behavior and expectations are preventing innovation but the bargaining power is clearly in their hands (Side note: telecom companies are behaving like an investor in a capital constrained market who wants to invest at $0M pre-money. I digress).
This discussion is by no means suggesting that it is easy to build a business in a developed market or impossible to do it in emerging markets like India. In fact, the barriers of distribution that have been lowered in developed markets are lowered for all the entrepreneurs and therefore competition can be much higher as well. Product innovation and speed then become key differentiators. India is unique; India is not the US, nor is it China or Brazil. In India FMCG companies have shown how a leveraged offline model of using kirana stores to offload a lot of these distribution costs and last mile headaches can lead to big defensible, scalable and profitable businesses. There is much to learn from these success stories.
The one cautionary fact for all entrepreneurs and investors to note is that TIME is the biggest price to pay for the lack of infrastructure. It is extremely difficult to overcome the barriers through just capital. There are no shortcuts and setting up the foundation correctly is absolutely critical to building defensible scale. It has been done, it IS being done and my money is behind the people who are keeping their eyes open to these challenges.