“I fear all we have done is to awaken a sleeping giant and fill him with a terrible resolve.”
- Japanese Admiral Isoroku Yamamoto on the 1941 attack on Pearl Harbor
Get ready for a battle royal in the Indian market, as the world’s largest retailer, Walmart, gets close to announcing a deal to buy a controlling stake in Indian e-commerce player Flipkart (the deal is most likely to be announced on Wednesday).
With Walmart’s entry into the Indian e-commerce space, the country’s retailing landscape will change. Before the ink could dry on the Indians vs. the Aliens petitions, we stand here with the bulk of our e-commerce owned by foreigners. The battle is now between three giants—Amazon, Walmart, and Alibaba. This is the score so far: USA 2, China 1. And India? Well, India is the stadia where the grand game will be played out—with our consumers cheering from the stands.
The only winners in the tournament so far are Indian consumers, and the founders and investors in Flipkart. The Man of the Match? Tiger Global, an investor in Flipkart, which engineered Flipkart’s turnaround, and landed a spectacular home run.
There are few contenders for silver and bronze medals in Indian e-commerce—Grofers, BigBasket, Shopclues, Snapdeal. And there are players who have decided to sit it out—for example, Facebook, which will probably regret that it hasn’t attempted to morph WhatsApp into India’s WeChat yet. And Tencent-Nasper and SoftBank, shareholders in Flipkart, who are also said to be selling nearly their entire stake to Walmart, are exiting the market with a few billion dollars gained when the game is just about to begin.
Still to walk into the arena: Reliance, DMart and Future Group—India’s home-grown offline retailers. They are a bit bruised from the wall of cash that online players threw at the consumer, but are holding their own moats built around food and grocery and their massive retail footprints.
For Walmart, this is the beachhead to establish in India. Regulation blocks Walmart from reaching customers offline. It has dabbled in business-to-business (B2B) in India, but its core is business-to-consumer (B2C) and the only route available is via e-commerce. For about half a year’s worth of cash flow, it gets access to nearly 50 million customers. From here, it can build a solid business by retrofitting offline retail—by stringing together a series of retailers or acquiring one of the top five retailers, as regulations on multi-brand retail ease off. People may argue Walmart is paying too much, but what’s a few billion dollars here or there when the prize is the fastest growing consumer market in the world?
But the contest for the Indian market won’t be easy.
Beware the Quicksand
Several months ago, I was addressing the leadership team at one of the top two online retailers. I said that the Indian market is a bog of shifting sands. You can keep pouring in capital and it’ll disappear without even a bubble. India may be the crowning jewel of accessible consumer markets around the world, but the fight here will consume several billion dollars before these firms start showing any meaningful profits.
And we’ve seen that. There is no end in sight to the investment burn of online retailers. So far, on investments of about $15 billion, we are still flirting with online retail sales (not gross merchandise volume) of about the same number.
The bet was that India will turn out like China, or even better. Smartphone penetration was on a hockey-stick trajectory, incomes and aspirations were rising, the government was gung-ho about opening markets for venture capital (without any thought about the destruction it could cause home-grown businesses!).
But that turned out to be a false narrative. India’s income pyramid is warped and the per capita disposable income makes it a tiny market compared with China. Even worse, the cost of doing business and high-friction infrastructure meant that e-commerce businesses had to build everything from scratch. Add to that the cost of acquiring and retaining a value-seeking Indian consumer who is easily wooed by the first sniff of cashback, and you have a recipe for a business that could suck away at capital endlessly.
Another illusion that persists is that because e-commerce is a tiny fraction of Indian retail, there is near-infinite headroom to grow. Of course, there is, but it will need waves of penetration.
In late 2016, in my article How India’s digital economy can rediscover its mojo, I had first delved into how India behaves like three different countries and how that has tripped up most consumer tech companies. The Economist later published this excellent piece that ratified that approach.
India One, which lives and breathes like a European nation, is already achieving meaningful penetration. Given that it is about half our economy (about $1 trillion), it will probably be the only profitable market for the next decade. Giving up market share here would be suicidal.
The India Two wave is just beginning, as the players flood the hinterland with inexpensive apparel and smartphones, driving aspirations and consumption.
India Three will be a new, rough landscape where language and affordability barriers will force radical innovation on the sector.
Today, we have about 70-million-odd regular e-commerce customers, and we need a 100 million more to be activated before firms can afford to take a breather—and that’s probably another $15-20 billion in investments, if not more. Online retailers will need enough fuel and resilience to power through all the three waves even as holding market share in each will suck away resources.
While it appears that it will be a battle of funding and execution—though over a longer period—it will become a battle of blueprints. India is an atypical market. It lacks the homogeneity of the US, and the growth rates of China. Everyone who assumed differently, has the scars to show for it. India needs its own blueprint; importing one from China or the US won’t work here. We’ll come to that in a moment.
A War of Capital
One of the keys to winning a war of attrition in e-commerce is cheap access to capital. Let’s see how Walmart and Amazon stack up.
Here are the numbers for the last five years of shareholder returns.
Market cap ($bln)
[Walmart’s share of online retail in the US is 1/10th of Amazon—approximately $20 billion.]
Walmart’s market capitalisation at $260 billion is about half its $500 billion revenue. Amazon, on the other hand, trades at roughly four times its $200 billion revenue. In a sense, every incremental dollar at Amazon is worth about eight times that for Walmart (there are many factors at play here: growth, scale, cash flow, the Cloud and Amazon’s other services).
The point is that while Walmart is valued for its business (its size, scale and profits), Amazon, whose stock defies gravity, is valued for the potential or optionality that’s built into the flywheel of e-commerce (the Cloud, Prime, Alexa and now Whole Foods).
You can read more about valuation and the ‘optionality’ that investors give companies like Amazon in my article, Battles in The Age of Engagement.
Walmart is valuing Flipkart at about 8% of its market cap, while it represents only about 1% of its revenue. If Amazon were to acquire Flipkart, the math would be 3% of the market cap for 4% of revenues. All else being equal, Walmart pays three times more in stock than Amazon would have.
Of course, Walmart has the free cash flow to fund this acquisition, but investors are watching these moves very carefully. Walmart will be under immense pressure to make this acquisition work.
Walmart has just upped the ante. Amazon too needs to win India, having given up China. In this very visible battle, their actions in India will spill over to their market values and the reverberations will be felt in how their stocks fare in the US.
If the Flipkart-Walmart performance slips, for Walmart it may become a very expensive distraction from the battle at home.
Walmart’s Flipkart Game Plan
The track record of most big ticket tech acquisitions is patchy. Especially in the consumer tech world—take Yahoo, Newscorp/Myspace, eBay/Skype or AOL/Time Warner. Of course, there are the ones that do sparklingly well, for example, Paypal and eBay.
Could Walmart have afforded to not make this play? Well, it’s a question of staying relevant.
Walmart's Flipkart acquisition comes close behind a spree of acquisitions in online retailing, which began two years ago with Jet.com. In August 2016, Walmart paid a princely sum of $3.3 billion for a 13-month-old, sub-$1 billion company that shipped just 25,000 packages a day. The intent was to acqui-hire the Jet.com team to galvanise Walmart into online retailing. Jet.com was billed as the largest e-commerce acquisition till then. Flipkart will now hold that record.
The purpose was to signal to stakeholders, both internal and external, that Walmart wasn’t willing to be written off, that it was ready to take the battle to Amazon. The Jet.com team was merged into Walmart and it took over the online retail channel for the behemoth.
For the first several quarters, this team delivered on its promise. Walmart’s online revenues grew at a scorching 60% per annum. But for the last few quarters, things haven’t been looking as rosy.
Growth has halved to about 25% as the company started feeling the impact of the costs and complexity of online business. The president of Jet.com has quit after barely a year. Traffic at Jet.com itself is falling and the latest news is that Marc Lore, the prized e-commerce veteran Walmart snagged as part of the $3 billion deal, just squashed rumours that he was leaving. Since Jet.com’s acquisition Walmart has made a series of investments—a smattering of much smaller direct-to-consumer brands like Shoes.com, Moosejaw, ModCloth and Bonobos. None of which will move the needle. Flipkart moves the needle—for Walmart’s global ambitions and for the Jet.com team that would be hungry to make a big move.
The jury seems to be out on how the Jet.com acquisition is working for Walmart. Could it turn out to be a cautionary tale for Walmart and set the tone for how it engages with Flipkart?
The India deal opens Walmart to two battlefronts, one in India and another on the home front. It’s a big gamble. The US business is under siege from Amazon, and it is opening up another front here.
A few years ago Flipkart would have been an unfamiliar animal to Walmart. But since Walmart bought into the online mindset, with it came the confidence to pay the whopping price of $19 billion. Now comes the challenge of integrating and navigating the ship in battle against arch rival Amazon—in a territory that is unfamiliar, in a market that’s complex, and in a country where Amazon has dug into the trenches.
The right thing to do would be to do as little as possible on a day-to-day basis in Flipkart. Make no changes and you’ll do no damage!
Tiger Global has things under control, the Indian team has settled in and has its ears to the ground. Keeping the same focus and energy when you have a board-run company will be key, and Walmart would be wise to keep Tiger as a stakeholder for the next few years to ensure much-needed continuity. After paying such a significant price and with such a visible asset, the Walmart team will be sorely tempted to bring its retailing strengths to bear, but those are learnings from another market that works on a different paradigm.
If anything, Walmart has a lot to learn from Flipkart rather than the other way round, and that’s the way the relationship should work.
The real challenge will be the fact that performance now will be visible—the burn will now be discussed on earnings calls. It’s difficult for businesses to take daring decisions under such high scrutiny. Amazon is probably the only exception, one that proves the rule. The markets are impatient and will demand stellar performance.
The next few years will determine whether Walmart will be able to work its way through the business model challenges it faces and morph itself into an omni-channel retailer with a sprawling network of offline stores, or if Amazon is indeed the infinite business that can eat anything, and live up to its potential.
Walmart vs Amazon: A Different DNA
Walmart competes with Amazon, but Amazon does not compete with Walmart.
Their DNA differs. They get up every morning to solve different problems. For Walmart the world is physical. The folks at Walmart move boxes and put up stuff on store shelves. They see inventory, shelf space and customer service kiosks.
For Amazon, the world is mathematical. It sees an algorithm that can move electronic barcodes into electronic shopping carts.
Amazon is a technology company that masquerades as a retailer; Walmart is a retailer trying to act like a technology player.
Walmart is product-first: how to fit a product into its retailing model—procure it at the lowest cost and survive on wafer thin margins, so that it can be the cheapest place for people to shop.
Amazon is customer-first: how can it convert anything into a digital avatar and serve it up to the customer at their home or wherever they desire. Or, can it simply just predict what they need and ship it already?
Before we delve into how the game will be played in India, it is important to look at the global landscape and see how retailing is morphing.
The Global Shift: Offline, Private Labels and Flywheels
Why the sudden love for Whole Foods? Why would Amazon, a company that swears by the digital future, by virtual reality, by new-age voice assistants and bots, suddenly make about turns and start investing in things made of concrete? Stores are things that can’t scale, are limited in size, come with overheads, blue collar workers, and a host of other complexities.
What happened to the idea that it could build an infinitely scalable business by being just online? Certainly, its potential trillion dollar valuation doesn't signal this. Why leave the sanctum of robot-run warehouses and cloud servers to keeping shops clean and point of sale terminals moving, and thousands of employees who have to be motivated to replenish stocks and smile at customers?
To answer this question, let us invert the lens. Offline and online are flawed definitions created by the industry. Not the consumers.
Consumers move seamlessly between their smartphones and the real world. They simply see their activity as one thing: they want to shop for what they need and want.
The digital manifestation of the analogue world has many advantages: instant ability to reach and deliver stimuli to millions of minds without physical presence. But it ignores the fact we consumers are essentially creatures of the senses—we want to touch, taste, hear, smell and see.
A purely online experience may work where I am using digital to book a ticket for Avengers: Infinity War, because I am using digital as a conduit to reach an analogue experience. But why would I leave out the sheer delight of test driving three cars before I choose one? That’s impossible to replicate digitally (yet!). So in that sense, digital retail suffers from a handicap. It only engages the brain and the eyes and has to compensate for the other senses.
Consumers want to be inspired and they then carry imprints of these experiences and form visceral relationships with brands. In their lives they sometimes see things that inspire them on their phones or in the stores. Some of their purchases are driven by price and convenience and others by aspiration and identity. Sometimes they like to deeply evaluate what they buy, and sometimes they just buy brands out of habit. It’s a continuum. They don’t stop to think very hard about offline and online.
They are simply analogue natives in a digital world, where they use the digital devices to amplify and personalise their analogue experiences.
If you look at it from this lens, you then see why there is a surfeit of discounts and deals online. It’s an attempt to compensate for this incomplete experience that you deliver to a customer.
This sub-optimal experience results in low loyalty, high customer acquisition cost, abysmally low conversion (if you start with 10,000 consumers, on average less than 100 will click on a Google or Facebook ad for a product, and only three will end up making a purchase!). Billions of dollars have been lost in the attempt to overcome this handicap.
The cost of inspiring and retaining customers solely in the digital format are astronomical. Many online companies have died in their attempt to bridge the chasm between a digital-only experience and the consumer’s primitive craving for a five-sense analogue experience.
Simply put, online is just too expensive for getting and retaining customers. It’s tough to build a brand on pixels alone.
Overcoming the Handicap
When you examine Amazon with this lens, you see a company that has realised this handicap early on, and is paranoid about it. It expends huge energy and effort in over-compensating for the debilitating nature of the digital-only experience.
This over-compensation has resulted in some ground-breaking innovations: the patented one-click order, well-curated reviews and Q&A, same day delivery are all designed to get a consumer to give primacy to convenience over everything else that would go into normal discovery, touch and try shopping experience. Amazon Prime has successfully lulled consumers into thinking that they are gaming Amazon by ordering even the silliest daily necessity and it costs you nothing to get it at your doorstep. For Amazon it’s a carefully designed strategy to ensure that you reach for your phone and not your car keys.
The execution effort required to ensure that the consumer values convenience and speed over all the other analogue factors is humongous. It bleeds the bottom line. It’s difficult to make money when consumers only reach out for you when they know exactly what they are looking for. It’s expensive to retain them, service them, deliver and earn returns. Eventually Amazon has had to resort to gaming them with dynamic pricing, and squeezing productivity from their employees (the tough work culture to create “Amabots” at Amazon has become notorious).
The margin, as I said earlier, lies not in selling what the consumer already wants to buy, but in selling them things they don’t need. Advantage Offline Retail: Once a consumer comes to a store, all these costs fall away, and every add-on dollar the consumer is inspired to spend adds to the bottom line. Without a store, you are fighting a battle with one hand tied behind your back.
Thus, Amazon is forced to innovate and create a flywheel of engagement around the consumer because there is just no room to make money as just an expensive conduit to deliver a product to the customer at home. Hence, the push to add Amazon Services, Prime, Prime Video, Private Labels and Offline experiences to the business model. Any way in which it can offset the costs of the imperfect we-deliver-everything-home-for-free business. In fact, it’s the profits from this flywheel that are pumped back into ensuring the online prices are kept lower and keep attracting new customers to Amazon.
Online firms have some natural advantages over offline: instant mass reach, personalisation, ability to segment markets and consumers, depth and width of services. Walmart is unlikely to succeed at selling cars or insurance or morphing into a bank but Amazon can.
I’ve discussed this war for engagement and creating the flywheel between the tech giants in an earlier article.
The Future of Shopping
Walmart wants you to shop. Amazon wants to change the definition of shopping.
Amazon hopes to offset the handicap by changing the nature of shopping itself—by removing the idea of mundane, every day shopping. It will use listening devices planted in your home to predict what you need and even arrange to deliver it right into your refrigerator (Amazon just acquired Ring, the marker of smart video doorbells which can give access to delivery right into your home).
The race for an intelligent home assistant is deeply intertwined with the ability to get people what they want when they call out for it. And in that race, Amazon is far ahead because it already has the goods sitting in its warehouse. Google and Apple, the other contenders, still have to stitch up supplies with other players like Walmart or Target, whereas Amazon manages the service end-to-end.
However, this zero-interface, machine-predicted lifestyle will work for a certain set of people and a certain set of categories. Eventually it will saturate as consumers crave for the shape and smell of a store. It’s only now that Walmart and Amazon in the US are coming head to head as they fight over the same consumers. At stake is the biggest component of the retail segment everywhere in the world—food and grocery.
Alibaba too has seen this coming and has been investing in offline retailers for the last two years. It has now taken it a step ahead and launched a ground-breaking integrated food and retail experience in Hema stores.
The Winning Troika in India: Offline, Private Labels and Prime
While these multi-billion-dollar deals indicate the strategic importance and potential of the Indian market, they don’t change the ground reality: India is rougher terrain. The average order values are low, pricing is bound by MRP, logistics costs and fraud-risks are high, customers have lots of time on their hands to search and find deals. So, what might the winning strategies be?
Private labels: Private labels can give up to three times the margins that a traded or marketplace product can. This fact changes the margin structure of the business. The real play for online-first retailers lies in this arbitrage—how they can use (hijack!) salient and popular brands for getting initial adoption and then slip in their own private labels.
Global brands are losing everyday as the share of e-commerce goes up. Large format retailers used private labels in stores too, but they could not control discovery to the extent e-commerce players do. They are being commoditised by being placed right next to a private label clone. And given the same few pixels to occupy.
Amazon Basics has shown that this can be strategy. Over 90% of the batteries sold on Amazon.com are private labels which are sold alongside Duracell. At last count Amazon has about 200 private labels, many of them carry no obvious link or lineage to Amazon.
Walmart has massive efficiencies of scale. It is years ahead of Amazon in sourcing and merchandising. Walmart has the private labels, the cheap products, the supply chains that Amazon does not. That could be the Achilles heel for Amazon in India, which is still learning its ropes in merchandising.
Prime: Amazon Prime has already stolen a march and captured the cream layer of the market. Much like in the US, the well-heeled India One customer is on Prime. The Prime customer spends more, and more often, on Amazon. This top layer of customers will provide the fuel for the companies to venture deeper into the market.
Prime is the single biggest weapon that Amazon has to make up for the handicap of a digital-only shopping experience. Drive convenience to such a degree that it overwhelms all other factors in the customer’s instinctive purchase path. Amazon’s flywheel include Advertising, Cloud, and Amazon’s advertising platform for merchants—and a tough work culture that keeps extraneous costs down to the bone.
Flipkart hasn’t been able to put together an effective counter to Prime here. What will be Flipkart’s flywheel? Will it cobble together many apparel brands? Or buy local services and classified players, to be able to package services with product, or will it find easy payments and integrated consumer financing options? It needs to answer this question, and answer it quick.
Offline: In a purely online world, Amazon has proven, again and again, that it can become the first port of call for a consumer. And once a consumer comes into its net, there is no battle left. Amazon Prime has proven to be a massive success in India, and I would argue that you’ll find it difficult to find a consumer who has opted for Amazon Prime and still gives Flipkart enough share of his or her wallet.
Thus, one weapon against Amazon could be to work hard on a seamless integration of offline retail and online. Walmart-Flipkart may have to jump through some regulatory hoops to do this, but it’ll be a structural advantage to build on.
Serving Indian customers food and groceries online would probably be one of the most difficult-to-run businesses. India has thousands of micro-markets. For example, the assortment of food and groceries at a kirana store in Mumbai’s Matunga area versus one in Bandra just about 7 km away can differ widely. Having a network of offline stores which can act as fulfilment centres will be paramount to craft a winning blueprint for attacking food and grocery retail. The rewards will be good to whoever is able to do that—the supply chains in India for food are broken and very inefficient, wastage drives the costs up and the lack of farm to fork integration deprives farmers of certainty of income.
Thus, for Walmart-Flipkart, the sooner they shift the battleground to offline, the better off they will be. The holy grail of groceries and food, which are sticky, could be the answer to Amazon Prime.
Of course, once Walmart moves the focus to offline either directly or indirectly, Amazon will be forced to take countermeasures, which could mean alliances with large Indian retailers, if not an acquisition.
Getting Closer to the Next 100 Million
Flipkart is already ahead here. It leads the way in engaging the customers in Tier II and Tier III cities and towns. Amazon in India (and even globally) has not been able to make a dent in the apparel business because its user-interface has been designed for functionality, and not to inspire consumers to browse and buy. Apparel needs a different approach to merchandising which the Flipkart- Myntra-Jabong combine is winning with. India One and Two consumers who want to fill their closets with cheap and cheerful choices have one destination. Flipkart needs to make this lead unassailable.
Both Amazon and Flipkart will have to act like media companies—make it easy to access content that inspires consumers to click and buy. The winner will have to think Indian, and create product catalogues that are language neutral and delivered via video so you are not constrained to a customer base that is comfortable reading.
Everyone Vs. Amazon: The Walmart-Flipkart combine will be able to cobble together partnerships with unlikely entities. The talk of Google taking a stake in Flipkart is because Google is feeling the threat from Amazon.
Why is Google threatened? It suddenly finds itself competing with Amazon to create a lifestyle for consumers. The idea that Google will be the only wrapper around consumers’ lives with Android, Maps, YouTube, Gmail and their other services is now challenged.
- Amazon has beaten it to the voicebot market with Alexa having three-to-one consumer market share advantage over Google Home.
- Amazon has fired another salvo at Google’s plan for a smart home by acquiring Ring which competes with Nest. If it is quick enough to integrate Ring with Alexa and Echo, it will steal a lion’s share of the smart home market. A market that Google always thought was its to own.
- Google is aggressively trying to win back product searches from Amazon and stay relevant in the future of e-commerce. Amazon has established itself as people’s default product-search engine. According to research firm Survata, some 49% of consumers’ first product search starts on Amazon, and for the other 36% of product searches that start on Google or another search engine, a goodly percentage are going to point to an Amazon listing first. With Amazon Prime crossing 100 million users, product search for most of these homes begins and ends on Amazon.
Even in China, JD.com, Tencent, and Walmart have joined forces against Alibaba, and we are seeing a repeat in India. The only way to beat Amazon’s tentacles around the consumer is to craft deep alliances. But integration between tech companies is not easy. Vital data that can personalise journeys is lost, and that’s where Amazon scores.
Very simply, Amazon is a threat to everyone. And that could open up many avenues for Walmart-Flipkart to find allies in this war. They can create integrated service offerings, create local market-by-market partnerships. They can potentially partner with Netflix, Hotstar and other content providers that deliver audio and video over the internet (what is called over-the-top or OTT content) and create a FlipkartPass vs. Amazon Prime Video. On payments, we may see closer alliance with Google’s Tez.
The battle will be unlike anywhere else in the world. It’ll be a uniquely Indian battle, and I wonder if any lessons from anywhere in the world will help the players. So, here’s me sticking my neck out to see how things could play out—not over the next one or two years, but over the next decade.
All battles are won before they are fought. I wager that it will not be just a battle of funding or of business models or of ingenuity and talent. It’ll be a battle of blueprints. The blueprint each of these companies writes for the next ten years will determine where they come out at the end of it. What happens today, or happened yesterday will give no clues on where things will end up.
The winner (or leader) will be the one who manages to shape choices for the Indian consumers using a careful mix of offline, online and content, capturing the customer early in their product consideration journey with content that can help them make choices.
One of the big disadvantages of online is that it cannot shape choices, it cannot inspire you to buy. It requires effort. However, in India it’s a bit easier to do that since customers are being exposed to new products and categories for the first time. They want to be inspired, and are happy to experiment with the shiny new things they see online.
What’s clear is the battle for supremacy in the Indian retail landscape will be brutal.
"Then it comes to be that the soothing light at the end of your tunnel
Is just a freight train coming your way"
- Metallica, No Leaf Clover