"I want to have my own start-up," is the chant of every starry eyed student and every frustrated employee. The growth of multifarious companies in India like Flipkart, Snapdeal and OLA has made every B-school student dream of his own start-up to compete with multi-million dollar giants. The recent valuation of nine-year-old Flipkart at $15 billion makes it more valuable than the 50-year-old IOC (Indian Oil Corporation) Ltd, and several other companies, putting the online retailer in the top 20 firms vying for market capitalisation. Such hyped valuations of tech start-ups lead every aspiring entrepreneur to venture into the tech space over other domains like manufacturing, the service sector and so on.
But here is the million dollar question: Are these valuations justified? Right from Professors of Universities to CEOs of "Unicorn" start-ups to Angel Investors, everyone agrees that tech start-ups are overvalued. Traditionally, any newborn industry is overvalued and then comes into a consolidation phase. The IT industry, for instance, being comparatively nascent, is said to be valued much higher than any other industry. Take, for example, TCS (TATA Consultancy Services), the largest IT service provider and the most valued company in India. TCS is valued at around $80 billion, which is nearly five times its annual revenue, while it's making a profit of about $2 billion every year. The ratios are similar for other IT giants like Infosys, Wipro etc. These numbers may be justified for established IT companies for their prospective growth in coming years; however, it's a different ball game altogether for tech start-ups.
"[I]n the case of tech start-ups in India, the bubble is going to burst any time, because of the 'easy entry, easy exit' nature of this industry."
Flipkart, for example, made a revenue of almost $0.45 billion (Rs 2800 crores in FY 13-14), with a loss of 400 crores. On the other hand, four-year-old OLA is valued at $2.4 billion with a gross transaction value of $250-300 million. Flipkart has an ambitious target of GMV (Gross Merchandise Value) $10-12 billion by the end of financial year 2014-15 which is expected to push their valuation much higher.
Let us understand the concept of GMV to evaluate the companies better. Say, a USB drive worth Rs 500 is sold on Flipkart for Rs 400. Flipkart gets Rs 20 as commission. Here, the revenue of Flipkart is Rs 20, the transaction value is Rs 400 and GMV is Rs 500. Now, if Flipkart were any other industry, its revenue of Rs 20 would be considered for valuation. But, as it is a tech start up, the GMV is considered instead. This explains the over-valuations of tech start-ups. Is this an acceptable parameter? Definitely not! The fundamental objective of any enterprise -- of having a sustainable and profitable business model -- has been shattered by these so called disruptive innovations, just to gain market share at the expense of investors.
Flipkart is not the only fish in these troubled waters. The problem of not having a sound revenue model has started showing after-effects for several other companies. After the exit of Rahul Yadav, the controversial CEO of Housing.com, the media seems uninterested in the state of affairs at the site. According to the employees, the company is in a phase of restructuring and is planning to downsize by 30%. The company is also planning to shut down some of its non-revenue generating units in a year and will try to improve upon its productive verticals. Also worthy of mention is that many such start-ups are in a sorry state of affairs. According to a recent article published in Livemint about the operations of FoodPanda (an online aggregator of restaurants) in India, employees themselves have used loopholes in the company to fill their pockets.
"[T]he guileless investor's money is burning very fast -- faster than it may ever be recovered."
Grofers, an on-demand grocery delivery service, is rumoured to have raised $100mn in the last 10 months, thus increasing its valuation by 10 times. Freecharge, an online recharge portal, is valued at approximately Rs 2500 crore, primarily because of its 10 million customer base. There is a plethora of such examples in the tech space. Where are these investor-backed start-ups, which have no profits except on paper, headed?
To answer this question, let us briefly analyse the history of industry and business. An industrial revolution in manufacturing was at its peak in the 1800s, only to end up in consolidation in the early 1900s. An IT bubble started in the late 1980s, only to burst in the early 2000s. Historically, the rise and fall of every Industry has been a sine wave; a steady rise followed by an inevitably fall. It took innovations and sustainable business models that create value for stakeholders, to get these industries back on their feet. In our opinion, in the case of tech start-ups in India, the bubble is going to burst any time, because of the "easy entry, easy exit" nature of this industry. In the meantime, the guileless investor's money is burning very fast -- faster than it may ever be recovered.
Co-authored by Dilip Vedula. He can be contacted at: email@example.com