How Do E-Commerce Companies Like Snapdeal And Flipkart Make Profits?

According to the report of Goldman Sachs, e-commerce companies like Flipkart, Amazon and Snapdeal need to raise Rs 1.27 lakh crore or $20 billion over next 5 years to sustain growth. According to the reports, Indian e-tailer on an average incurs 1.35 times Gross Merchandising Value (GMV) sold as expenses, which means they are incurring a loss of 35 percent.

So if you are wondering how do these companies make profits, the answer is they DON’T.

So now the question that arises is, if these companies do not make profits then how do they sustain? The answer is through investors. Now let us explore all the facts in detail.

Talking about past few years, there has been an unprecedented growth of e-commerce industry in India and industry is further expected to grow because of increased internet penetration and increased confidence among the buyers in e-commerce companies. According to Goldman Sachs, India will be second largest digital market in the world, after China, with e-commerce industry estimated to grow 15 times to $300 billion by 2030. Currently India is considered to be about 7 years behind China in e-commerce revolution. Number of online buyers in China had increased from 2.2 crore to 22.7 crore. Similarly due to increased internet penetration in India, the number of online buyers is estimated to increase from 2.5 crore to 15 crore in next 7-8 years. Also the number of online buyers as a percentage of total internet users is also expected to increase from currently 9 percent to 30 percent.

E-commerce companies work on marketplace based model, which means that they do not carry any inventory, and hence do not incur inventory holding costs. Also they do not have to maintain their stores and keep salespersons. This is how they save costs and give discounts in every item that they sell in their platform. Despite the high revenues being reported by most of the e-commerce companies, none of them are yet profitable. In fact they are deeply in losses. In year ending March 2014, Snapdeal reported a loss of Rs 264.4 crore on the revenues of Rs 168 crore. Flipkart also reported loss of Rs 281 crore on sales of Rs 1180 crore for the year ended March 2013. GMV data shows that Flipkart earns around 10-12 percent of GMV as revenue, but it’s cost of handling these goods are around 15 percent. Despite the losses, these giants spends huge amount on advertising and brand building so as to acquire more customers.

Companies could make profits and break even through volumes. Companies need to sell their products to as many customers, acquire new customers and build loyal customers to make profits. But these companies are not at all focused towards making profit, rather they are more focused on growth. According to Kunal Bahl, CEO of Snapdeal, it is more important to focus on economics rather than profitability. He says “Snapdeal could have generated profits by now, but that’s not the focus yet. If you want to grow faster, you need to delay profitability”. In an interview with Sachin Bansal, CEO of Flipkart, he said “Flipkart can be profitable from today if we want. We can stop investing in one area and start making profits. But we don’t want to remain a small profitable company”. So these companies reinvest the money back into their business and a major chunk of money goes into developing technological capabilities, specially on mobile front through acquisitions, which is evident from Snapdeal acquiring Freecharge. Also company looks to optimize supply chain and warehousing costs. Huge amount is spent on brand building through advertisements as they are very important to build credibility.

But if these companies are running on losses, then from where do they acquire money to reinvest into their business and to spend to technical advancements? The answer is through investors. These companies raise money through private equity investors. New investors suck as Steadview Capital, Softbank Corp etc are putting cash into larger e-commerce firms. But what instigates the investors to invest in loss making business? Investors usually considers the future value of the company before making investment. Factors like increased internet penetration, increased online purchases, favorable demographics etc promotes the investors to invest in their loss making business.

E-commerce companies must try to achieve growth and profitability in the near future so as to gain investors confidence. Not all the investors are investing into their business because investors need returns from the business which could be generated by positive cash flows, not through reinvestment into the same business.

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