E-commerce - the internet scale utopia

Way too many people - not just naive observers but people who follow the markets, who are in start-up scene have pretty basic notions about internet business especially in business models where hard money to take home is expected to be made only in future - post growth. Particularly true to E-commerce scene and some media circulations. 

Questions like how come they are having this crazy evaluation? How and why are they burning so much cash? Is this a bubble? They don't even break-even and the biggest of all are they even profitable to command all this?

Frankly I am not aware of their current financials of any of the e-commerce business except Amazon's and there is no incentive for me to be a rumour-monger. But i believe the general thought of looking at this is misleading- people mistake profitability in income statements for cash-flow statement – hence this post. 

I guess with “profitability” one is looking to evaluate their prospects.

The question should rather be in the long term will their investment pan-out or having gained critical mass what their yearly cashflow could be?

They may be cashflow negative (losing money) on yearly or quarterly basis Now but they still might be ‘profitable’ even while losing money. That is because according to basic principles of Accounting - you match revenue and cost in the period in which they occur. Discounting, amortization is put in for and obviously it all comes down to assumptions about future and only after taking all that into consideration one could come up with profitability.

Unless of course one is simply asking what their operating margin i.e. cashflow status or margin on sales is?

Cashflow at the bottom of income statement = Revenue - Cost of goods - Operating cost

Margin on sale = Selling price - Cost of goods 

• If the goods are stocked by the e-commerce venture then
  margin on sale is generally 80-100%, varying with type of goods (expiry date,
  type of partnership etc).
  After taking into account Operating cost (IT + Management + Office + Inventory management - efficiency being key here) this would lead to Negative cashflow or +50% depending on scale.
• In the other case, if the goods are not stocked by the e-commerce company then Margin on sale could be simply 20-50%. Again depending on scale one would get cashflow status.

Two businesses having similar Cashflow or Net profit or Revenue could be in a very different boat - so by just asking like Maruti Ad - 'Kitna deti hai' - How much mileage does this luxury yacht give? won't provide any valuable info. People still go bonkers when they hear Amazon's present net profit (after a decade of leadership) vs evaluation.

What have we not taken into account above -

1. Cost of acquisition (discounted to current fiscal)
2. Marketing and sales effort (discounted to current fiscal) - how much money are they investing today to fuel tomorrow’s growth and profits.
3. Their business model and operating model (which could vary for time to time) - Are they an intermediary or do they stock goods, how do they stock if any, are they offering nonviable discounts in short-term, partnerships with retailers etc
4. Future prospects of growth

So I would try to answer a larger issue here - about profitability (mistaken as money to take home now) rather than cashflow(actual money to take home now).

For a business one has to decide if they want positive cashflow or growth or bit of both? One's goal towards profitability should be driven by what they want to achieve - an exit? Small but profitable venture? Leverage and then scale with proper funding?

• Having positive cash-flow helps in difficult times - going by the trends it hasn't been particularly difficult times for e-commerce in India.
• It also gives you leverage with your evaluation while raising funds or at exit.

The present status of e-commerce demands ambition – rather than small but beautiful cocoon.
But when one is trying to scale by acquiring new customers there is always a lag with which the investments in business bear fruit - for that we need investment. And from the looks of things these ventures want internet scale and for that they have relatively easy access to capital.

As far as the VCs are concerned they too seem to want to go big - so the investments. Also revenue of a decent e-commerce site is always high - disregard to cashflow and that helps in raising subsequent rounds and exits for present investors. May be the fear of recovering invested cash also helps in raising more money.


So to summarize one should be more concerned with following metrics and how one stacks on these with respect to competition rather than present cashflow status or are they making money now (generally mistaken as profitability)-

1. Revenue growth and Revenue-to-operating profit growth.
2. Monthly traffic growth, viral coefficient etc.
3. Conversion percentage
4. Beakeven time for Customer acquisition

There would always be less generic metrics for specific business models.
Hopefully people would stop saying they are not even profitable (they mean not cashflow positive) and still burning so much cash - crazy!