“I believe that whatever doesn’t kill you, simply makes you…stranger,” so says the Joker in Christopher Nolan’s The Dark Knight. What he really means is not all change makes you stronger or better. Some changes leave a scar, or break us from the inside.

When looked at from the perspective of Internet companies, the Joker sounds ominous almost. The unicorns—start-ups with a valuation of $1 billion- plus—are forever flirting at the edge of a precipice, between becoming near-monopolies, or dying. There is no place in-between. You are either a great business or you are doomed.

The kind of things happening on the Indian Internet landscape are beginning to look strange, but if you dig deep, there’s a pattern.

Consider these for instance.

• Ctrip.com, China’s largest travel site, acquires a 26% stake in MakeMyTrip.com for $180 million. MakeMyTrip was already listed but had run out of ideas on how to break away from the pack of online travel companies (Yatra, Cleartrip and others).

• Snapdeal, a Delhi-based online marketplace, pays a mind-boggling $400 million to acquire FreeCharge, a Mumbai-based online facility that allows you to charge any mobile phone or data card in India.

• Alibaba, the Chinese e-commerce giant, invests $630 million in Paytm, an online payment wallet service. Paytm then proceeds to start selling goods and services to compete with Snapdeal, another Alibaba investment. Not just that, it has acquired a payments bank licence and now announced plans to invest in logistics.

• OYO Rooms, the budget hotel booking app backed by SoftBank, picked up its smaller rival Zo Rooms backed by Tiger Global before either had a chance to really compete. And consider the pace at which ZO Rooms vacated the market without a thought for its customers. What drove this case of nerves?

• Horizontal classifieds unicorns have jumped into real estate classifieds. This business demands specialist attention and capital because by its very nature the opportunity in real estate is worth multibillion dollars. How will they fund all these fronts?

• Sudden consolidation takes place in the vehicles classifieds markets. Firms are willing to pay cash instead of swapping stock—at this early stage, when the companies need to hold on to all the cash they can get. All of this is happening even as newer start-ups are getting funded.

• E-commerce firms have either divested or spun off their logistics arms. Think about it again. How many choices do you really need to send a packet from a warehouse in Bhiwandi in Mumbai to Jhumri Telaiya in Jharkhand? Just a few really. Why have the numbers suddenly burgeoned? And why does the logistics business sound like a great opportunity for India’s largest e-commerce firms?

• Then there is that darling, Flipkart. It is in the news for all the rejigs in its management team. Sachin Bansal stepped aside as CEO to make way for his co-founder Binny Bansal. Sachin has been moved to a new role as the executive chairman. Mukesh Bansal on the other hand is moving out to start his own venture. He came in as part of the top tier at Flipkart when it acquired Myntra—a firm Mukesh had founded—for $300 million.

Given all of these, it is incumbent we ask a few questions. What do you achieve by merging two companies, both of which have not yet figured how to be sustainable? Is the outcome a stronger entity or a weaker one? Have the pressures started to show on the Internet economy?

Moats made of
paper er…money

Imagine an Indian unicorn into transactions with 20-50 million consumers every month. Some buy frequently, others infrequently. To woo them anything between $100 million to $3 billion has been burnt. This to buy customer loyalty—through discounts, deals, cashbacks.

The money was pumped by investors indifferent to cash burn, outsized teams and eye-popping inefficiencies. No one bothered to dig into the state of a unicorn’s financials. They stayed squarely focused on the next round of funding and growth rates.

But over the last few weeks, the world has turned into a capital-starved one. Even if it were capital-flush, the unit economics reported by these entities make no sense. Money poured because A-teams were in place and they did a fantastic job of scaling up. Some competitors fell by the wayside because they couldn’t execute or because they couldn’t woo the right venture capitalists (VCs).

VCs overlooked management infirmities in these companies and their inability to retain senior leadership from the outside. Even early founding team members have left either due to fatigue or friction over the direction that the business ought to take. On the face of it, Ola seems to be the only exception to the problem.

Now there are just about two-four firms in each segment of the e-commerce market. Nobody else is likely to get funded. In theory, these unicorns ought to now be ready to reap the benefits of consolidation.

Morgan Stanley, for instance, estimates the Indian Internet market valued at $11 billion in 2013 will be worth $137 billion by 2020. Split that three or four ways and you are staring at some serious “decacorns” (unicorns with over $10 billion in valuation).

But a few problems exist that everybody seems to have overlooked.

• The unit economics are unlikely to improve soon. The battle will get even more bitter to woo the next 200 million Indians to the Internet bandwagon. With 4G around the corner, data prices will drop dramatically and populations the size of Canada and Australia will join our Internet economy. You can’t step off the gas. If you do, it’s a one-way ticket into oblivion.

• The moats—those wide ditches that surround castles and filled with water to defend against attacks—for Internet companies, are filled only with money. They’ve been created on risk appetites and not differentiators or unique business models. Moats ought to be wide and deep. But here, it’s made of paper—read money. They can’t be defended unless the moats are refuelled constantly. That explains how Amazon just took away market share so easily from Flipkart and Snapdeal.

Enter the holding
companies

The question facing Indian Internet companies is, how do they make the moat deeper? Only then do they have a convincing case to raise more money. A seemingly obvious solution is to think of these unicorns as giant water turbines churning the water, or dollars in this case, to keep adversaries out and suck customers in.

Indian unicorns know who their customers are, their homes, signatures, the size of their clothes, what they like, dislike—putty to be moulded. Can they think up more ways to churn value out of their customers, improve monetization, show investors sustainability and create holding companies that will own large chunks of the Indian Internet market by 2020?

To do that, a few things will have to happen.

1. Higher margin categories will have to be added to core offerings. Product e-commerce companies will need to add services and vice versa. It is entirely possible some tie-ups between the online and offline world fall in place. Flipkart and Snapdeal may buy vertical firms who are great at execution, but suffer from unsustainable customer acquisition costs. That is why Flipkart acquired Myntra. In much the same way, Jabong looks like a good target for Snapdeal. Categories like furniture, jewellery and upscale brands will be add-ons to their portfolio.

2. They will have to find ways to get more out of the consumers’ wallet. Can you cross-sell to them services like payments, media and local services? The moves we’ve seen at Flipkart and probably will at Snapdeal fit into this pattern as founders move into “holding company” roles. Think of them as scouts who need to find businesses that keep the giant turbines moving.

3. Next, think up ways to defray the cost of running these huge ships. That is why Flipkart and a few others have spun off their logistics arms. Some firms may even offer platform solutions to merchants for payments, micro-ERPs (enterprise resource planning) and SaaS (software as a service) solutions (much like Amazon did with Amazon Web Services and cloud solutions).

Taking a deep cut in operating costs is not a real option. You do that and curiously funding will get tougher. That is why unicorns will have to dig as deep as they can into the paper-moats they’ve built. We’ll witness seemingly unrelated diversifications. The early signs are already there. So don’t be surprised if you find yourself comparing car insurance policies on a Flipkart-owned platform tomorrow.

The holding company model seems to have worked. In China, such entities dominate the market. Between Baidu, Alibaba and Tencent—or BAT as they are called—they control most Internet transactions.

Running out of
unicorn fuel

Now that the plan seems clear, where is the money going to come from? Goldman Sachs estimates Indian e-commerce businesses (which have attracted $6 billion until now) will likely need another $20 billion before they become sustainable. That is going to be hard to find, especially in 2016.

In September last year, I had argued that large Indian e-tailers have reached a point of no return. Their capital efficiencies are low, unit economics look bleak, and they seemed to have generally ignored the fact that e-tailing is a business that at its best generates a few percentage points of operating margin.

While valuations look stratospheric in the press releases, privately they are tempered by structured instruments, special rights and liquidation preferences. These exist to protect the downside for investors even if the exit happens at one-third of what is reported. So while a down-round will make for noises in the media, it is an irrelevant event in the journey of these unicorns. That is if they survive the battle without consolidation or a sell-out. It hardly matters if Flipkart is valued at $10 billion or $15 billion today—if it creates a $50 billion behemoth holding company, with a one-third market share of Indian e-commerce transactions in 2020.

From the looks of it, the big guys are too large to fail, too fat to fit, and the road to sustainability is a long way off. Initial public offerings (IPOs) are dangerous. For e-commerce poster boys Flipkart and Snapdeal their valuations sound unsustainable. This was evident over the last couple of weeks as unicorns across the world got mauled. LinkedIn dropped 43% in a single session on the New York Stock Exchange. These are shocks our unicorns can do without—not when you still need shareholders to keep funding you.

But there is salvation a few thousand miles to the east. In China. Internet behemoths there are salivating at the prospect of practically doubling their addressable market if they add India to their footprint. Western markets are either too small or unassailable. India is free, democratic and ready to follow as the second largest Internet economy in China’s footsteps.

And with our Prime Minister’s Office whipping up frenzy about attracting overseas capital into start-ups, the Chinese have never felt so welcome any place else.

Let’s take Alibaba as a case in point (and Baidu and Tencent as well with a few tweaks).

What if Alibaba were to take a substantial stake in Flipkart and Paytm? Between e-commerce and payments, it would resemble the Taobao, Tmall and Alipay ecosystem they’ve built. The price? Anywhere between $10-15 billion. That’s just about 10% of Alibaba’s now-halved market cap (from its peak since IPO).

Winning more ground in China, on the other hand, will be an expensive battle for Alibaba. That money is better spent in India. Their shareholders will love it and it can keep their stock buzzing for the next five-seven years. For Jack Ma, the founder of Alibaba, this ought to be a no-brainer. In fact, given the ongoing meltdown in the Chinese economy, which will directly impact Alibaba, not investing in India could be hara-kiri.

Flipkart and Paytm can sing beautifully together. Refocus Paytm solely on running payments for the market (via wallets and payments bank). With the kind of monies Alibaba has, it can pretty much offer a commission-free payments infrastructure to small merchants and change the game, especially offline. Leave product e-commerce to the experts at Flipkart. The only call they need to take is whether they ought to pick up Snapdeal or Flipkart.

Then there’s the other Big Daddy—Amazon. From Amazon’s point of view, India is core. This is a large e-market. India has huge potential for media and cloud storage too. If Amazon gets its act right in India, its market capitalization can zoom. No one punished it for getting it wrong in China. But if it loses India, repercussions are bound to follow. And Jeff Bezos, Amazon’s founder and chief executive, doesn’t play to lose.

It isn’t difficult to imagine an Indian version of Amazon that bundles free delivery plus media, and subscription products to lock-in consumers here. In 20 years, India will be the most significant international e-commerce market outside China. And from Amazon’s perspective, to aspire for a 50% market share and back it with capital doesn’t sound outlandish.

No choice but to sell?

In the early stages of development, home-grown e-commerce companies did not focus on creating a well lubricated payments system. They did not find workarounds when the Reserve Bank of India came up with a regressive move—the two-factor authentication mechanism. They did not think up a credit system, a pay-once-a-month strategy, or wallets. They were happy pushing cash on delivery and expanding pincodes they served. They assumed the first who got to deliver to the boondocks will emerge the winner.

If Flipkart had built an ubiquitous payment system, its moat would have been defensible. It shouldn’t have given up on its fledgling payment effort PayZippy even while building the logistics arm out.

And finally, Flipkart’s capital inefficiency is legendary. Close to $3 billion spent on a business that will generate about $6 billion of gross merchandise volume in 2015. This is a term used in online retailing to indicate the total sales dollar value for merchandise sold through a marketplace over a period of time. It will perhaps need another $2-3 billion to hit sustainability. It has few choices.

It is now facing heat on execution and internal friction. If it doesn’t become the holding company, it stands the risk of becoming a part of one.

What holding companies can look like

In China, the BAT trio is loosely clustered around its core strengths: Baidu for search, Alibaba for e-commerce and payments, and Tencent around social media and messaging. Each of them has created ecosystems that try and serve most of the needs of a Chinese consumer. For example, the Tencent family covers shopping, banking, entertainment, travel, real estate, gaming, healthcare, jobs and food-tech—all driven by its social network offerings. The three compete to create a one-window “super app”, but between them have a stranglehold on the Chinese Internet market.

Sure, prospective Indian holding companies will have a weaker grip on Indian consumers than their Chinese counterparts because Western firms like Google and Facebook control search and social media in India.

But once the Chinese start playing, the Westerners won’t be interested in staying at the periphery of the ecosystem. Imagine Google or Facebook investing in Flipkart. Suddenly the game changes once more. Does WhatsApp (a Facebook-owned company) have it in it to become the Tencent of India? Or will it leave that opportunity wide open for a similar app called WeChat—the Chinese equivalent of WhatsApp and built by Tencent? Social media capabilities apart, WeChat supports a host of transaction capabilities like payment and money transfer that allows users to transfer funds and make electronic bill payments. You can even make a passport application on WeChat. Incidentally, WeChat competes with Alipay as well.

As I write this, Baidu is talking to Zomato—a restaurant search and discovery service founded in 2008 which operates out of 28 countries including India. Look hard at Zomato and you’ll realize it’s close to Baidu’s core—curated search around food and communities.

Zomato too is trying to be a holding company for food-tech. It has tried to stretch its boundaries by offering reviews, ordering mechanisms, a POS (point of sale, or retail management) system and an ad platform for restaurants. It even tried its hands at becoming an Apple Pay for restaurants.

What changes for
everyone else?

Every dollar has a best-used-before date. From a VC’s perspective, it is typically five-seven years—a bit longer if you are an established one with a record of exits. But money from strategic investors is usually permanent capital.

Suddenly Indian VCs are now at a table where the entity sitting across them has near infinite capital and near infinite time horizon, and isn’t looking for an exit.

For VCs betting on large consumer Internet start-ups in India, the path is clear. They necessarily will become sellers to these holding companies.

They will run start-ups with an eye to make them attractive “for” the strategic, versus battle “against” a strategic. They will be acutely aware about how long they can play the game.

It may not be apparent today. But from Series C and D funding onwards, the funding rationale will change dramatically. These are the investors who come and fuel market share dominance in start-ups. These are the real “unicorn-shepherds”. They will know to look at the “strategic” fit of a business idea versus its intrinsic potential. They are in the business to make money, not to win noble battles. They also realize that once they give a foothold to a strategic investor, chances of exit elsewhere narrow. The ripples of these changes will eventually impact how Series A and seed investors evaluate their investments too.

Clearly, Indian start-ups will be built for sale. We saw what happened with MakeMyTrip. Ctrip will always be a buyer of MakeMyTrip stock with a willing cheque book. It leaves VCs in other online travel companies in the lurch. How does one start competing with a firm that has permanent capital? In fact, the next big move for Ctrip could be to buy OYO Rooms as well. That will create a holding company that’s got the air travel market and the hotel rooms to bundle and bid everyone else out. How do VCs with five-seven year horizons then compete?

We are seeing it in the pullback of funding from the much hyped-up Grofers and PepperTap. VCs don’t have a strategic buyer in sight and have gone cold. They seemed to have poured in over Rs.800 crore just to discover that there is no product-market fit. Aren’t investors at Series C and D meant to do this due diligence?

Anyways, Round One has gone to the kirana-wallah, who is willing to bundle-in delivery, credit and loyalty for the consumer. Given the unit economics and density issues, a new model where whoever co-opts the neighbourhood merchants and brings them onto the marketplace via chat and payments could be a winner. That’s a direction a firm like ShopClues may head into to differentiate itself. Else, it will be difficult to survive as a low-value, low-aspiration e-commerce marketplace, especially since the bigger guys will step down to take that market out.

VCs and founders are finding that it takes no skill in throwing money at a problem. The real skill lies in collecting money for the solution you’ve created. It’s there that you get into the metaphorical chakravyuha. In ancient Indian military parlance, it is the arrangement of soldiers in the form of a wheel. Getting in and out of it requires great skill.

Abhimanyu, the son of that great warrior Arjuna, knew how to penetrate one. He learnt of it when he was in his mother Subhadra’s womb as his father was telling her all about it. But while Arjuna was trying to tell her how to get out of it, she fell asleep. So in the epic battle of the Mahabharata, Abhimanyu managed to penetrate the chakravyuha, but didn’t know how to get out of it.

Much like Abhimanyu, Indian unicorns have gotten into thechakravyuha. They haven’t figured how to get out of it.

They need the cash. But 2016 is the new 2008—a funding and confidence crisis looms. By the looks of it, these businesses will have to be rolled up into one of the holding companies, or be left to die.

Read an unabridged version on www.foundingfuel.com

Haresh Chawla was founding chief executive of Network18. He joined the firm in 1999 when it had revenue of Rs.15 crore. When he moved out in 2012, he had built it into a Rs.3,000 crore media conglomerate. He is now partner at India Value Fund, and mentors several start-ups. He writes regularly onfoundingfuel.com

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