08/02/2016 8:27 AM IST | Updated 15/07/2016 8:26 AM IST

The Sky-High Valuations Of E-Commerce Companies -- And The Inevitable Crash

Illustrative representation showing rise in stock market
Fanatic Studio via Getty Images
Illustrative representation showing rise in stock market

Experts have pinned India as one of the fastest growing e-commerce markets. With the ever-increasing penetration of smartphones, the e-commerce world, according to a KPMG report, is set to touch $100 billion by 2020. Keeping this vision in mind many investment companies have parked billions at sky-high valuations. But the real question is, are these valuations justified? Let's take an example.

Flipkart is currently valued at $15 billion or ₹96,000 crore. This valuation comes on the back of investments and not cash flows, revenue or profits. In 2015, Flipkart's losses tripled to nearly ₹2,000 crore and revenue jumped five times to ₹10,000 crore. The losses were incurred mainly because of heavy discounts. Now, if a company sells products with heavy discounts it will surely get traction from customers and bring in revenues -- but when it comes to return of equity, the value goes in negative because of massive losses.

Many may argue that valuations are on the basis of cash flows. Here's what: in the case of any company, cash inflow is the money invested and cash outflow refers to the expenses paid. In the case of e-commerce companies, the definition of cash outflows is in terms of discounts, salaries and working capital. When cash outflow is higher than cash inflow, on what basis can a company be valued? Every valuation created by investment is defined by holistic analysis of returns, revenues and scope of operations over a period of time. But if the returns are negative, such sky high valuations cannot be justified.

Food-tech companies like Zomato, Swiggy, FoodPanda may have been the first to realise this. Apart from Zomato, no company in the segment is even near break-even. In fact, FoodPanda, unable to cope up with further losses, recently put its business for sale for $10-15 million. While lowering commissions and discounts may narrow losses, what incentive would customers have to order from them? Hence, business models of this kind cannot justify such valuations.

The only reason why a customer buys products from e-commerce companies is because of the huge discounts. The moment a company takes that away, your revenue, along with profits, is bound to fall. It follows that burning cash to attract customers will not fructify into sustainability. E-commerce companies need to realise the fact that their entire business model depends on discounts. Once the discount is lowered or dropped, customers will start looking elsewhere for a better deal.

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