Resetting the Competition

Every story has a beginning, middle and the end. This applies to the market spaces too. At times, the middle phase gets pulled forward due to events like demonetization for digital payments, like Covid-19 for digital transition. The early entrants who survive the beginning phase look to dominate and justify their massive investments during the middle phase. However, just about that time, a new player entered to reset the pie – this new entrant is Jio Platforms (Jio) + JioMart, for Flipkart and Amazon. Jio commoditized data, made it available at cheapest price point and garnered the scarcer asset i.e. user’s eyes & ears, their resulting data and now seeking larger share of their wallet. Jio with JioMart has maximum incentive to monetize these scarcer assets and build its digital ecosystem. Its current average revenue per user (ARPU) from telecom is $18-20 v/s ARPU of typical transacting online shoppers is $350-370*, a 15-20x opportunity for Jio and JioMart to capitalize on!

Facebook recently invested $5.7bn in Jio which also owns Jio Infocom. Jio is the digital ecosystem business and Jio Infocom is the telecom business, both owned by Reliance Industries (RIL). This investment, by Facebook, is approximately 10% of its cash balance (per CY20) and approximately 1% of its market cap (at the time the deal was announced). The analysts believe financially there is limited downside, generally for telecom assets in India, as ARPU’s are expected to increase given oligopolistic structure of competition (Jio Infocom, Vodafone and Airtel). In addition to capital investment, WhatsApp (owned by Facebook) has also entered into commercial partnership with a separate company of RIL, Reliance Retail (for its new retail commerce JioMart). The latter handles transactions which includes sourcing & merchandising, warehousing & delivery, distribution, return handling amongst others which Facebook / WhatsApp don’t do. Strategically, it’s optimistic to assume that a minority stake by a large strategic in another conglomerate will lead to disruptive products/services. In my view, this deal has a lot for Facebook / WhatsApp to extract for itself, for its growing commerce ambition, then what Jio seeks from the partnership. Although the range of benefit scenarios for Facebook / WhatsApp are many but it is unknown how much it could really capture for itself -

• Access small businesses via WhatsApp - SME’s & kirana stores (neighborhood small retailers) who transact and don’t necessarily do social media ads to grow revenues
• Entry into digital payments - for WhatsApp
• Cordial government relationship going forward
• Collaboration on voice & vernacular

How do you compete against a player, who has recovered its customer acquisition cost (CAC) and raised ~$16bn of new money? To put it in context, Walmart acquired Flipkart at ~$20bn valuation in 2018 with 54mn active transacting customers then and it continues to burn money overall. On the other hand, Jio has 388mn users with access to 400mn users from WhatsApp (there may be overlapping users though) and now arguably valued by analysts’ at ~$15bn (minus Jio Infocom business). The playbook for venture funded ecosystem apps starts with subsidizing the demand side, adding more use cases over time which eventually may earn them more than the CAC. This journey could take years to achieve. However, the playbook of Jio is starkly different compared to a typical venture funded ecosystem app. Hard asset first (telecom & offline retail) for Jio v/s asset light digital wrapper approach for ecosystem apps. The media has widely covered this deal and argues Jio as a consumer “ecosystem app” in the making. The ecosystem apps are a digital ecosystem built on top of offline hard assets, which in the digital age we consider as given. For example - food delivery needs install base of offline assets in restaurants & bikes, booking a ride needs installed base of cars/buses, making payments needs installed base of banks for settlement, booking flight tickets needs installed base of airlines and so on. You can see where I am getting to. The digital wrappers on top are fast growing layers leveraging underlying layers which are slow-moving hard assets, most times under-utilized.

Increasingly, many businesses are now valued by not the specific segment in which they operate but the ecosystem that they help create. The balance generally has shifted, for good or bad, away from supply side towards demand side. Jio, the digital ecosystem player, now accounts for ~50% of Reliance Industries market cap! There are global examples like Alibaba, Tencent, Amazon, Rakuten to name a few who have created massive consumer & equity value. Now, we have added one more prospect in Jio from India. 

For Start-ups & Venture funds – collaborate & ride on it

When Jio started in 2015, until then for 10 years Bharti had produced “zero” average excess returns over its cost of capital (assumed as 10%), for finance students it means destroying value. I bet an investor, looking at those historical return profiles, would have cautioned / warned RIL to not venture into telecom business. During this time, telecom was disrupted twice, first by apps and later by messaging. Still then, fueled by debt & cheap data, RIL has created ~$67bn of equity value (including Jio Infocom) in 4 years and now Jio accounts for 50% of RIL’s market cap. But importantly, it helped create multi-fold value for the digital ecosystem participants. Jio invested ~$30bn in capex to build Jio Infocom and catapult India into one of the fastest internet markets i.e. equivalent to purchase price of Flipkart + PhonePe or equivalent to 5 years of VC investments in one company. Between Flipkart and PayTM together they have raised ~$11bn, that is 1/3rd of Jio, which in the background of resetting competition does it mean they shall need more to claim stake in the market. Observing Jio and its transition, incumbents may learn to – “build the hard things & subsidize it to scale, make sure to enable an ecosystem on top which builds loyalty to eventually profit”.

Rise of digital ecosystems like Amazon, Alibaba among others has created positive spill-over effects for startups & venture funds. The digital ecosystem players don’t shy from aggressive acquisition / JV’s / strategic investments to protect erosion of their ecosystem value or increase its value manifold. For example, below paragraph I pulled from recent 10-k filing of Alibaba - "Although we expect our margins to be negatively affected by acquisitions of target companies with lower or negative margins, such as our acquisitions and consolidations of Youku, Lazada, Intime, Cainiao Network, Ele.me and Kaola, we do not expect our investment activities to have any significant negative impact on our liquidity or operations. We believe acquired businesses operating at a loss do not detract from our total value because they bring clear strategic value to us in the long run"

Further, in a study of 44 digital ecosystem businesses by BCG**, their analysis suggested that more external partners an ecosystem has, and from varied industries, the better that ecosystem shall fare. Amazon has 67 core partners, roughly double that of its peers in e-commerce – spanning logistics, finance, media among others.

In time, we will know a) what behavior a profitable new entrant like Jio will promote among competing players and b) how will Jio eventually get valued*** – whether as Telecom player or Ecosystem player? 

(Disclaimer - Views expressed are strictly personal)

*How India shops online – a Bain report

**What does successful digital ecosystem look like – a BCG study

***Market cap as on 10th July 2020