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IS INDIAN E-COMMERCE A PONZI SCHEME??

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The eCommerce industry in India is growing at a remarkable pace due to high penetration of Internet and sophisticated electronic devices. However, the recent growth rate of eCommerce in India is far lagging behind than other developed countries.

The financial results of Indian eCommerce players for financial year 2014-15 turn out to be very interesting. As can be seen from the accompanying table compiled from various media reports, the losses of the major eCommerce players have gone up multiple times during the course of the year.

It certainly raises a question in our mind, regarding the business model followed by eCommerce players – where the losses of a company rise at a faster rate than its revenue?

Until now, the Indian eCommerce players have managed to survive because International Hedge Funds and Private Equity Investors have made a beeline for investing in them.

E-Commerce players offer huge discounts to lure customers to shop online. Since Indian consumer looks for the lowest price before making a purchase, the cost of customer acquisition is high for these companies. Moreover, since a large number of players offer the same products at the same prices, switching cost is non-existent. This poses a challenge for players in their effort to develop sound strategies to attract repetitive customers.

To tag Indian eCommerce as a Ponzi scheme would rather be a short-sighted, simplified perspective on the eCommerce industry's strategies, current state, and future projections. It would be more of a Ponzi scheme if newer investors' money was being used to pay off earlier investors rather than funding deep discounts and current operations. The latter being the case, it removes the benchmark trait of a Ponzi scheme - fraudulently promising and delivering sky-high returns to old investors using new investors' money - even if it is no more sustainable long term.

Regardless, players have been using the strategy for decades and still do for new, promising product lines, with considerable success. By selling products at a loss they build a loyal customer base, goodwill, brand awareness, purchasing power, investors/capital, scale and it eliminates competition, positioning the respective company to be much more efficient, at scale, with a host of competitive advantages when the time finally comes to use market pricing and turn a profit. They have built up operations to include a huge distribution network from warehouses to digital content and even web services, which provide data storage & management, web hosting and security, and leasing of servers, off which they make their own marketplace

Where they earn commission on every transaction, operating at a loss actually allows them to leverage their brand and goodwill to diversify into these other high-margin businesses.

From investors' viewpoint, even though the companies are taking losses and therefore not paying dividends, revenue growth, capital investment, corporate growth and brand recognition/awareness all leads to increased market capitalisation and impacts stock prices positively. This leads to capital gains, realised or not, and the chance to reinvest for greater growth potential or to higher income. In this sense, it makes a successful investment and can continue to be, unless investment dries up and the company tanks.

Authored By: CA Aditya Gupta


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