Can Quick Commerce model be considered as a startup?

Based on the title of my article, the first question that comes to the mind is, what is a startup?

In my multiple interactions with stakeholders in the startup ecosystem, I got varying answers, and the most common being any new business or an innovative business. My goal was to come out with a definition that will be universally applicable.

Startup is any young business which targets a large market, has a highly scalable business model and has an economic moat.

Let’s break them down:

1. Large market

Is the business targeting a considerable large market, usually $10 billion or more?

2. Highly scalable business model

2.1. Scalability?

Scalability refers to an organization's ability to grow without being hampered by its structure or available resources when faced with increased production.?

2.2. Costs

Does cost of serving every additional customer considerably come down as the business scales in its operations?

3. Economic moat

The term "economic moat," popularized by Warren Buffett, refers to a business's ability to maintain competitive advantages over its competitors in order to protect its long-term profits.

It’s not possible for startups to have economic moat right off the bat, but their business model should be such that they will be able create that economic moat in the future. For most companies in today’s age it will be network effect and that takes time to build.?

3.1 Network effect moats

Marketplace network effect moats

Marketplace network effect moats exist when a company derives a durable competitive advantage from bringing together customers and suppliers in some kind of marketplace.

Data network effect moats

Data network effect moats exist when a company can gain a competitive advantage by gathering user data and making that data more valuable.

Companies can use that data both to attract other users to the platform and to build better algorithms to provide a better product.

Platform network effects

Platform network effects are generally built on one product — for example, the iPhone, or Windows — that becomes core to a user’s life or work. New products that are released — such as the App Store, or Microsoft Office — both reinforce the core product’s initial value and layer more value on top of it.

3.2 Cost moats

Switching cost moats

Switching cost moats exist when a company sells a product its users need or trust too much to switch providers.

Sunk cost moats

Sunk cost moats operate by eliciting a significant one-time or repeating payment from a customer, the size of which is big enough to dissuade that customer from leaving for a competitor later.

Cost advantage moats

Cost advantage moats exist when companies build more efficient manufacturing or distribution and use that to offer lower prices than competitors.

3.3 Resource moats

Intellectual property moats

IP moats work because a company develops some kind of valuable intellectual property that its competition, structurally, cannot replicate and use.

Knowledge moats

Knowledge moats work by concentrating valuable expertise within a single organization.

Regulatory moats

Regulatory moats work by giving a company protection from competitors through legal channels, including regulations preventing new competitors or through a contract with a bigger, more durable company.

So that begs the question, can quick commerce model be considered as a startup.

1. Large Market

Quick commerce model is into retail market, so without doubt it’s a huge market. So in this model you definitely operate in a large market.

2. Scalability?

So is it a highly scalable business model? And this is where thinks get tricky.

Let’s dive in. As quick commerce model have dark stories, it’s more scalable than the traditional retail format of a Dmart or Reliance Retail etc., but still this model share many of the characteristics of a traditional retail format.

Fixed Cost

Quick commerce model use hub and spoke model to function. The hub and spoke model is a logistics strategy that involves a central warehouse or distribution center (the hub) that serves as a central point for storing and distributing goods to micro fulfilment centre or dark stores (the spokes).

And unlike?online grocery model, where warehouses are mostly located in the outskirts, land acquisition and rentals are cheaper. Cost of people is at least 25% more (in a dark store) compared to a warehouse, while rentals per square foot are at least four times more.

Any quick commerce model to expand the business, they need to add a lot of dark stores, and each dark store has limited radius of potential customers. This needs considerable investment on the building, equipments, inventory and staff for every additional new store.

Though, in this model, as you add more and more dark stores to a particular location, and as each dark store caters to more and more customers, the average cost will come down. Yet whatever scale this model achieves, the average fixed costs won’t come down drastically because of how the business model works.

Unit Economics/Variable Cost

For online grocery model that deliver orders on a slot basis, which can be same or next day, just not instant, has the ability to consolidate multiple orders and plan the most efficient route to deliver it. So as the orders increase, the per unit cost to deliver those orders will also decrease.

But since quick commerce model guarantee instant delivery, there’s no time to wait for consolidating orders. The shorter the promised delivery time, the lesser the time to wait for order consolidation. So for a quick commerce model, the per unit delivery cost will be remain more or less the same, unless there is increase in the delivery time. From my own experience, even for online food delivery model, during peak hours, where the preparation time for a dish can be 15-20 minutes, usually I see only 2 orders being clubbed together.

So the average variable cost will remain more or less the same.

Marginal Cost

The one thing that separates a highly scalable business with that which is not, is the?cost structure.?The closer the marginal cost is to zero, the more scalable the business is. This is one of the main reasons why startups command such a high valuation.?

It’s obvious that physical goods will be no where close to being as scalable as a digital good but still certain business models, like marketplace and P2P etc., allow startups to take an asset-light approach, thereby making their business more scalable (for eg. Airbnb). I just don’t see quick commerce as one.

3. Economic Moat

The grocery market is highly competitive and switching costs are essentially zero. Competitive advantages are difficult to gain, and successful firms often choose superior store locations, get better terms from suppliers, operate efficient supply chains and effectively manage their product offering and inventory. Intellectual property, regulatory protection, and the network effect are not often consequential among established industry participants

When startups entered the online grocery segment, predominantly there were two business models, marketplace and inventory-led. But the marketplace model in which wares from neighbourhood stores would be listed on an app and a delivery executive would deliver the order. However, this model met with operational challenges as neighbourhood stores rarely have a digital catalogue and don't always keep sufficient inventory. So eventually inventory-led model became the dominant model. Had it be been marketplace model, there would have been marketplace network effect.

And now to top it off, grocery companies in general have wafer-thin profit margins, with net margins being in low single digits. Now add to that the cost of instant delivers by operating several dark stores.

Also, the prices are on the higher side for quick commerce model. In a price sensitive country like India that might become a challenge. By waiting 4-12 hours for my orders, I was able to save a lot more on my orders.

The way forward?

I think achieving economies of scope more than economies of scale will be the key. These are?the cost savings achieved by providing a range of services together rather than?just one.

I don’t think quick commerce as a standalone service can excel in the competitive retail industry. Somewhere in the value chain, the infrastructure and resources have to be shared across multiple areas, it can be utilisation of the warehouses, the delivery personnel, omni-channel or using a single app to reduce customer acquisition (for eg. I tired Instamart, because I was already using Swiggy) etc.

Also, there’s a possibility that for the majority of the consumers, the use case of an quick commerce will be limited to just unplanned things, if that happens combining instant delivery and same/next day delivery service makes more sense but then the infrastructure has to be built in such a way as to provide both the services i.e. one needs dark stores with a focus on speed and the other, large warehouses with a focus on fill rate and savings.

And of course, AI and robots are getting used more and more in the warehouses of companies like Amazon and other large retailers, increasing the output of those warehouses.?Also, we need to wait and watch if cashierless stores/technology like Amazon Go, which can open 24/7, diminish the need for quick commerce.

WeWork: A cautionary tale?

One of the reasons for WeWork’s downfall, it was valued like a startup, ran like a startup but it was never a startup.

For example, in 2019, IWG was significantly larger than WeWork: it had a total of 3,000+ locations in 1,000 cities versus WeWork’s 650+ locations in 115 cities. IWG had a valuation of $3 billion, whereas WeWork was valued at $50 billion.

And Reid Hoffman has already written an article on the same in 2019, so I won’t repeat myself.

Conclusion

I’m not questioning the business model of quick commerce companies (though it’s yet to be proven) but instead my article questions if the quick commerce model deserve the kind of valuation it commands in the market.