Valuations of Start-ups in India – Hype versus Reality

This is pretty much one of the top questions on the minds of anyone who has had the slightest interest in the start-up landscape in India.

The fact that sun-rise industries are overvalued is not surprising – overvaluation is the invisible hand that is gently encouraging much needed investments into these areas. It is also not surprising that in this process there would be some swings towards extremes that are corrected periodically.

This is an interesting debate on which there is no right or wrong answer but just different perspectives based on your world view and based on what you do for a living! Take a look at the two world views!

• Aswath Damodaran, who is arguably the most influential valuation expert in the world today, has written eloquently about the exaggerated valuations of companies like Uber, Facebook and Whatsapp. Obviously Venture Capitalists like Bill Gurley do not agree with his views and argue that (in the case of Uber) “In choosing to use the historical size of the taxi and limousine market, Damodaran is making an implicit assumption that the future will look quite like the past. In other words, the arrival of a product or service like Uber will have zero impact on the overall market size of the car-for-hire transportation market. There are multiple reasons why this is a flawed assumption”. 

• Damodaran’s retort is that, “If you are old enough to remember market fevers from past booms, you are probably inclined to dismiss the claims and the valuations as fantasy. I do believe, however, that there is a kernel of truth to the disruption argument though I think investors are being far too casual in accepting it at face value”. 

My own view is that every start-up (e-commerce or otherwise) should be built around a few central premises:

1. An idea that either addresses a fundamental customer pain point or an idea that enables a large number of people to lead their life in a fundamentally more convenient way (even if they themselves do not see a pain in the current way they lead their lives) 

1. Customers (or potential customers) should be willing to pay a price for the product or service that makes the provider of the service or product profitable 

1. The idea or business should be scalable 

1. The company should have a reasonably clear path to profitability that any rational investor can understand. The path to profitability should not rely upon outlandish assumptions about the way markets would be disrupted or on astronomical cash burns to create these markets.

There are businesses being built around these principles even in today’s start-up frenzy! I will use the example of Bigbasket. I know Bigbasket well because I work for it! Will Bigbasket make money? Is it different from a host of hyperlocal players emerging on the scene?

• It is worth asking how a so called e-grocer like Bigbasket is different (or similar) from (to) a large grocery chain like the Future group. The margins are pretty much in the same ballpark (upwards of 20%) and the supply chain is also pretty much the same. The only difference is that Bigbasket offers the convenience of home delivery and has no front end stores. If your purchase price of groceries is 20% lower than your selling price you have sufficient room to make money! Bigbasket is just addressing the commute problems of urban consumers and substituting the rental and electricity costs of stores with the cost of home delivery. The cost of delivering grocery and general merchandize at the customer doorstep is cheaper than running physical stores, and as the scale increases the cost per delivery drops even further because of increasing customer density. Warehousing costs are incurred by both – those that that have front end stores and those that only do home deliveries.
• On the other hand, e-grocers that are riding the hyperlocal wave typically are buying at MRP (or at best a 3%-5% discount from the MRP) and selling to customers at MRP. In addition, they are also incurring delivery costs. This margin will never make them profitable. Growing a customer base through discounts and hoping that it can be monetized in some unknown way in some unknown future is what most people are skeptical about – and this skepticism tends to rub off on the entire industry and questioning the economics and viability.

In conclusion, I would say that if you are running a start-up do not forget the fundamental objective of running any business – to run it profitably and make money. Do not waste your time on the industry valuation debate or fall for short-cuts that maximize valuations in the short term by sacrificing the fundamental tenets.