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3 Oct

Ashneer's Razor

Last week, I wrote about how we saw traditional retail businesses shift to online marketplaces, the rise of D2C brands with the advent of digital marketing, and how many D2C businesses today are again exploring sales through retail stores as a part of an omnichannel hybrid model.

An illustrated summary of the essay:

Many reasons are stated by founders of businesses like Lenskart, Bombay Shaving Company, Wakefit, Mamaearth for why they're making inroads into retail.A summary of those reasons:

  1. Retail stores allow customers to test products before buying them
  2. Exclusive retail stores allow the brand to create a unique sales and buying experience for the consumers
  3. Retail stores allow brands to display their wide assortment of product categories to consumers who might only know the brand for a certain product category
  4. Retail stores are an example of costly signalling that allows D2C brands to cement trust with their target consumers; a retail store in a premium locality builds trust much better than a landing page online
  5. Retail stores also act as delivery hubs that enable same-day delivery for neighboring locations
  6. Retail stores allow D2C brands to drive brand visibility and spread legs offline as online marketing approaches a saturation point for them

But besides all these reasons, there is one big reason around profit margins and unit economics that Ashneer Grover (Founder – BharatPe, ex-CFO – Grofers) sheds first-hand insight on in this podcast.

Ashneer's stance: D2C businesses have to go to retail to turn profitable.

To understand this, we have to first understand why fintech businesses are so good at scaling, in contrast to D2C businesses that have so far only been able to achieve profitability by transitioning to retail.

Why are fintech businesses so good?

Ashneer’s answer:

Cost of Delivery.

Due to UPI and other tech innovation in the country, the marginal cost of delivering the service tends towards zero, at scale. Compare it to a traditional hyperlocal or e-commerce delivery business where the business has to shell out a fixed cost of delivery every time a product is ordered.

According to Ashneer, success in D2C business models is all about ticket size.

D2C comes with fixed costs of delivery: every customer still has to be delivered the product individually. Hence, if the ticket size, i.e., the average order value per order is low, it’s hard for a delivery business to make a profit because there is no way around the fixed delivery cost, even at scale.

As a result, only D2C businesses selling high ticket size products that are easy to deliver can earn profits. Examples of such D2C businesses are cosmetics, jewellery, and expensive tech. The product size is small, which means it costs less to deliver and the margins are high, which means delivery costs can be easily absorbed by these high profit margins.

Cost of Delivery for fintech businesses is zero.

If you see fintech businesses, this isn’t a problem because the delivery is automated with tech protocols like UPI. No matter the amount of money being transferred, the cost of delivery remains the same. Also, as transaction volume increases, tech infrastructure can be scaled up relatively easily to accommodate a larger volume of transactions.

In Ashneer’s own words:

Jahaan pe bhi cost of delivery zero hai, woh digital hai aur mereko banda nahi bhejna, woh mast business hai, shaahi business hai.”

Ashneer's Razor: Cost of Delivery decides profitability at scale.

Costs that a business has to bear for every delivery stay constant even when number of deliveries go up. They can limit the earning potential of the business and are susceptible to external events.

Hence, a lot of D2C businesses today find it more lucrative to venture into retail shops and reduce delivery costs to zero, while improving the brand experience.

And for any D2C business that wants to scale to the next level, elevating brand experience becomes doubly important to maintain differentiation. According to a recent white paper released by retail consultancy Technopak (source: Moneycontrol), there are about 600 D2C brands in the country, of which only 5% have more than ₹100 crore in revenue. About 2% have ₹20-90 crore in annual revenue, while 75% have an annual turnover of less than ₹20 crore. So, as you see, most D2C businesses in the country don't end up being that successful.

Online marketplaces cannot deliver on a lot of intangibles that brands can leverage in the offline space to create a memorable experience. But more on this in a future essay.

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