eCommerce and economies of scale

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Indian e-retail market has come a long since the inception of current leading player Flipkart in 2007. The Indian market has tremendous opportunity to grow due to fact that the current penetration of e-retail in overall retail is significantly low and penetration of internet in India (home to 17 per cent of the world’s population) is also significantly low. Rising penetration of internet, coupled with increasing use of smartphone, computers will attract the consumers to the online channel. However, price differentiation from traditional retail, offered in the form of discounts by e-retailers will remain the key driver of the growth.

Foreign players entering Indian market due to sizeable opportunity

Foreign e-Commerce companies like Amazon and eBay are gradually shifting their focus to emerging economies, with eBay Inc. and Amazon Inc. generating around 50 per cent of their revenue from non-US regions. Revenue of eBay Inc. have increased by around 297 times while for Amazon it increased by around 78 times indicating a clear change in strategy for these players. Further, Amazon Inc. entered Indian market in 2012 by the name Junglee.com which is a portal for price comparison. The portal provided the company sufficient details about buying pattern of Indian customers, demographics, etc. India which is home to around 17 per cent of the world's population remains a promising market for eCommerce players due to the fact that the current penetration level of internet/smartphone in India is very low but the same is increasing at a rapid pace. This leaves behind tremendous opportunity for players to succeed in the emerging economy.

Indian players tightening buckles as competition is expected to surge

Indian e-retailers have been offering several services like same say delivery, single day delivery, free shipping, express checkout, pick-up point, and cash-on-delivery. This is expected to trigger a price war in the Indian e-retail market. Players are also entering in exclusive sale deals. For example: Flipkart is the exclusive seller for the latest range of Xiaomi’s smart phones, while companies like Amazon and Snapdeal are exclusive seller for Karbonn and Spice manufactured Android One smartphones. The players in the space are also becoming innovative and are selling products like stamps (Snapdeal), automobile (Snapdeal has partnered with Mahindra to launch Scorpio on its platform), real estate (Snapdeal has tied up with Tata Value homes to offer booking of real estate), groceries (companies like Zopnow, Localbanya, Bigbasket, etc. are selling online groceries), jewellery (companies like Bluestone, Voylla are selling both artificial and real jewellery of gold, diamond, etc). This innovation will continue as the players jostle to capture a larger share of pie in the market.

However, these players will continue to generate volumes at the cost of margins. Indian customers have a typical mindest of touching and feeling any product before purchasing. Also bargaining and discounts are some of the traditional qualities of Indian customers. Thus, it is expected that the customers will continue to shop online only hen the discounts offered by the players is significantly high. 

It is thus evident that the consumers tend to shift to online channel for heavy discounts. This discounts, deals and availability of various coupons help the companies in the e-retail space generate volumes. However, companies compromise on profitability. E-Retailers undoubtedly save big buck on lease rentals vis-à-vis traditional retailers and also get better deals from manufacturer in lieu of volumes they generate but the investment in logistics and information technology is huge which leads them to diseconomies of scale.

Economies of scale without inorganic growth?
Economies of scale occur when a firm’s long run average cost per unit fall as its production increases. A firm efficiency affected by its size where large firms are often more cost efficient due to the fact that they clinch better deals from the manufacturers and have high bargaining power from both buyers and sellers thus achieving economies of scale.

Ways of firm expansion:

A business increases its scale of operations in two ways:

  1. Internal growth also known as organic growth where firm expand its normal business operations venture in to additional business segment to generate volume
  2. External growth also known as inorganic growth in which a firm grows by acquiring or merging with other firms

In e-Commerce market, the method of inorganic growth helps the parent company to diversify its product portfolio and also increase logistic capabilities. Further, the acquirer gets access to the customer base of the company acquired. Global e-Commerce players including Amazon.com and eBay have utilised their huge cash piles well to acquire numerous smaller companies over the past few years. These acquisitions have undoubtedly helped the biggies expand into varied geographies and also diversify their product portfolio. For example: Amazon Inc. has cash reserves (cash, cash equivalents and marketable securities) of $12.5 billion, and earned revenues of over $74 billion in 2013. Similarly, eBay reportedly has cash reserves of over $9 billion and recorded revenues of $16 billion in 2013. The table below shows how the increasing number of acquisitions helped Amazon increase its prof

Amazon Inc. revenue, profit and acquisitions

Acquisitions Acquisitions Amazon revenue Amazon profit (RHS)
Unit Nos. USD million USD million
2000   2,761  -863
2001   3,122  -412
2002   3,932 64
2003 1 5,263 271
2004 1 6,921 440
2005 3 8,490 432
2006 1 10,711 389
2007 2 14,835 655
2008 9 19,166 842
2009 4 24,509 1,129
2010 6 34,204 1,406
2011 4 48,077 862
2012 2 61,093 676
2013 3 74,452 745
Source: Company Annual Report (SEC Filings)

Thus, in Indian market too players need to relook at their strategy so as to compete with the foreign players. For a vast, demographically diversified country like India, where logistics is a prevailing issue, it is almost difficult for an e-Commerce company to build its own delivery network. Thus, the companies have to grow by mergers and acquisitions to gain access of geographies captured by other players. This will help the companies widen their portfolio thereby widening customer base. Acquisition and merging with the big Indian players will help the small companies and big players to maintain on-up volume as compared to global counterparts. This will also help in achieving huge volume, efficiency in terms of service and delivery and price competitiveness- the three pillars of survival in eCommerce battle.

References: 
  1. Company's Annual report for Amazon Inc. Ticker: AMZN www.sec.gov
  2. Company's Annual report for eBay Inc. Ticker: EBAY www.sec.gov
  3. Media articles on growth of Indian eCommerce market

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