Amazon

Why Indian E-commerce Is A Ponzi Scheme

flipkartIt is that time of the year when the business media is publishing the financial results of Indian ecommerce companies for the financial year 2014-2015(i.e. the period between April 1, 2014 and March 31, 2015). The numbers are being taken from the filings that the ecommerce companies have made with the Registrar of Companies(RoC).

And the results make for a very interesting reading. As can be seen from the accompanying table compiled from various media reports, the losses of the major ecommerce companies have gone up multiple times during the course of the year.

It needs to be stated here upfront that it is difficult to estimate the exact numbers of the ecommerce companies given that they have complex holding structures as regulations in India currently do not allow foreign direct investment in online retail, but allow it in case of an online marketplace.

chart

The combined losses of the five companies in the table stood at Rs 5524 crore in 2014-2015. In 2013-2014, the losses had stood at Rs 1338.1 crore. This is a jump of a whopping 313%. How does their combined revenue number look? In this case a direct comparison cannot be made given that the revenue numbers of Snapdeal for 2014-2015 are not available.

As a recent news-report in the Mint newspaper points out: “Snapdeal reported a loss of Rs.1,328.01 crore for the same year, compared with Rs.264.6 crore in the previous year, RoC documents show. It didn’t disclose revenue numbers.”

Hence, we will have to adjust for Snapdeal numbers before we compare revenue earned by the companies with their accumulated losses. The revenue for 2014-2015 for four companies other than Snapdeal stood at Rs 11,827 crore. The revenue for 2013-2014 for these four companies had stood at Rs 3,445.8 crore. This is a jump of 243% over the course of one year.

In the normal scheme of things a jump of 243% in revenue in one year would have been deemed to be fantastic, but the losses of these companies have gone up at a much faster rate. In 2013-2014, the losses of the four companies other than Snapdeal stood at Rs 1073.5 crore. In 2014-2015, the losses had jumped by a whopping 291% to Rs 4,196 crore.

Hence, a 243% jump in revenues has been accompanied by a 291% jump in losses. This analysis is skewed to some extent given the huge size of Flipkart in the sample. If we had known Snapdeal revenue numbers for 2014-2015, the results would have been more robust.

Nevertheless, even the small companies in the sample, show the same trend as the broad trend is. Take the case of Paytm. In 2013-2014, the company made a profit of Rs 5 crore on a revenue of Rs 210 crore. In 2014-2015, the revenue jumped to Rs 336 crore and the losses jumped to Rs 372 crore. Shopclues also showed a similar trend. The revenue of the company went up by 155% between 2013-2014 and 2014-2015, whereas the losses went up by 163%.

What sort of a business model is this—where the losses of a company go up at a faster rate than its revenue? The answer lies in the fact that the Indian ecommerce companies have adopted a discount model in order to lure customers. This means selling products at a loss in order to build a customer base.

This strategy of acquiring customers has been directly copy-pasted from what many American ecommerce companies did during the dotcom boom towards the turn of the century.  As Gary Smith writes in Standard Deviations—Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics: “A dotcom company proved it was a player not by making money, but by spending money, preferably other people’s money…One rationale was to be the first-mover by getting big fast…The idea was that once people believe that your web site is the place to go to buy something, sell something, or learn something, you have a monopoly that can crush competition and reap profits.”

The major Indian ecommerce companies seem to be following a similar strategy of trying to build a monopoly by offering products on substantial discounts. The trouble with this strategy is that it needs a lot of money. Up until now, the Indian ecommerce companies have managed to survive because international hedge funds and private equity investors have made a beeline for investing in them.

With returns from financial securities all over the world drying up over the last few years, Indian ecommerce companies have offered an iota of hope. The trouble is that every reasonably big Indian ecommerce company with access to funding seems to be following the same strategy of offering discounts and wanting to build a monopoly. And once they are there, they hope to cash in.

Having said that, the current structure of the Indian ecommerce companies is akin to a Ponzi scheme. A Ponzi scheme is essentially a financial fraud in which investment is solicited by offering very high returns. The investment of the first lot of investors is redeemed by using the money brought in by the second lot.

The investment of the second lot of investors is redeemed by using the money brought in by the third lot and so on.

The scheme continues up until the money being brought in by the new investors is greater than the money being redeemed to the old investors. The moment the money that needs to be redeemed becomes greater than the fresh money coming in, the scheme collapses.

How does this apply in case of Indian ecommerce companies? Up until now the companies have managed to survive because of investors bringing in fresh money into the scheme at regular intervals. It is worth mentioning here that every time investors bring in more money, they bring it in at a higher valuation.

This essentially means that the price at which shares of the company are sold to the investors are higher than they were the last time around. This increases the market capitalization of the company.

This increase in market capitalization comes about because the company has managed to increase its revenue. But as we have seen earlier in this column, this increase in revenue typically comes at the losses increasing at a much faster rate. I wonder why all these fancy investors do not take something as basic as this into account?

Having said that, as long as this money keeps coming in and is greater than the losses being accumulated by the ecommerce firms, these firms will keep running.

The moment this changes, the firms will start to shut-down. The structure of the Indian ecommerce companies is that of a classic Ponzi scheme. In fact, a news-report in The Economic Times suggests that FabFurnish, a furniture retailer, is likely to shutdown given that its German investor does not want to burn any more money to finance its losses.

The trouble is that everyone wants to be build a monopoly. But everyone cannot be a monopoly. As Smith writes in the context of the American dotcom bubble: “The problem is that, even if it is possible to monopolize something, there were thousands of dotcom companies and there isn’t room for thousands of monopolies. Of the thousands of companies trying to get big fast, very few can ever be monopolies.” While the word thousands does not really apply in the Indian case, the overall logic still remains the same i.e. everyone cannot be a monopoly.

This means that many of today’s fledging ecommerce companies will shutdown in the years to come as investors pull the plug. In fact, the companies with the deepest pockets are likely to survive. Meanwhile, dear reader, enjoy the discounts until they last.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on SwarajyaMag on January 28, 2016

Of prisoner’s dilemma and the discounting wars of Indian e-commerce

Big-Billion-Day-Sale
This week the ecommerce companies operating in India are at war.

Snapdeal had its electronic Monday sale on October 12, 2015.

Fllipkart has The Big Billion Days Sale between October 13 and October 17, 2015. This sale is limited to its smartphone app.

Amazon has the Great Indian Festival Sale during the same period. Amazon’s sale isn’t limited to its app, like Flipkart’s. Nevertheless, the company is offering higher discounts on the app.

Over the next few days you will see reports in the business press with senior executives of these companies saying that they have managed to sell this much and sell that much.

The trouble is everyone will talk about revenue numbers. No one will tell you that they are losing money on each product they sell and the more they sell the more money they will lose.

In fact, the business press is already talking about the positive impact of these sales. As Rahul Taneja of Snapdeal told the Mint newspaper: “We are well on track to reach $100 million sales on our Electronics Monday Sale.”

Nevertheless, things are not as simplistic as they are being out to be. The Indian ecommerce scene should be viewed from the lens of the prisoner’s dilemma.

The dilemma was first put forward by Polish mathematician Melvin Dresher while he was working at the Rand Corporation in the United States in 1950. It was given its name by Canadian Mathematician Albert Tucker.

And this is how the dilemma goes. There are two people who are suspected of a major crime. They are apprehended during the course of carrying out a minor offense and put in jail.

As John Allen Paulos writes in A Mathematician Plays the Stock Market: “They’re then interrogated separately, and each is given the choice of confessing to the major crime and thereby implicating his partner or remaining silent. If they both remain silent they’ll get one year in prison. If one confesses and the other doesn’t, the one who confesses will be rewarded by being set free, while the other one will get a five-year term. If they both confess, they can expect to spend three years in prison.”

The best solution here is for both individuals to remain quiet and get a prison sentence of one year. But the individuals are being interrogated separately and hence, one doesn’t know how the other will react. So what happens?

As Paulos writes: “Given…human psychology, the most likely outcome is for both to confess; the best outcome for the pair as a pair is for both to remain silent; the best outcome for each prisoner as an individual is to confess and have one’s partner remain silent.”

So even though the best outcome is for both to remain silent and spend one year in prison, the most possible outcome is that both of them will confess in the hope that they will get away free. In the process they land up in jail for three years.

Now how is this linked to what we started with i.e. the discount wars of Indian ecommerce? As Paulos writes: “The charm of the dilemma has nothing to do with any interest that one might have in prisoner’s rights…Rather, it provides the logical skeleton for many situations we face in everyday life. Whether we’re negotiators in business, spouses in a marriage, or nations in dispute…If both (all) parties pursue their own interests exclusively and do not cooperate, the outcome is worse for both (all) of them; yet in any given situation, any given party is better off not cooperating.”

Economist Dani Rodrik explains the situation of prisoner’s dilemma in the context of advertising carried out by competing companies in his new book Economics Rules—Why Economics Works, When It Fails and How to Tell the Difference.

As he writes: “Assume that two competing firms must decide whether to have a big advertising budget. Advertising would allow one firm to steal some of the other’s customers. But when they both advertise, the effects of customer demand cancel out. The firms end up having spent money needlessly.”

What is happening here? As Rodrik writes: “When the firms make their choices independently and they care only about their own profits, each one has an incentive to advertise, regardless of what the other firm does: When the other firm does not advertise, you can steal customers from it if you do advertise; when the other firm does advertise, you have to advertise to prevent loss of customers. So the two firms end up in bad equilibrium in which both have to waste resources.”

Now replace the word advertise in the above paragraph with the sales that are currently on and the situation is very similar. Let’s say Flipkart (or Amazon or Snapdeal, it doesn’t really matter) announces a big sale over five days to acquire new customers as well as sell more to existing ones. It makes tremendous sense for Flipkart to do that as long as it is the only company doing it.

If Amazon and Snapdeal (and other similar ecommerce websites and aps) decide to ignore the Flipkart sale, they will lose out on their customers. So they need to announce their sales as well to prevent Flipkart from stealing their customers and retain their customers.

The moment they do this, Flipkart loses out on the advantage it would have had if it was the only sale in town. The vice versa is also true.

Now Amazon and Snapdeal also have a sale on just to ensure that they don’t lose out on their customers. A classic prisoner’s dilemma.

Also, each company now has to offer greater discounts on their products, to make it look like a sale. This means accumulating more losses than they currently are. The Indian ecommerce players don’t mind doing this given that they are currently looking to drive up their revenue.

The higher the revenue number they are able to generate, the higher the valuation they get. And this helps them raise more money from investors. This, in turn, helps them keep running the show given that their current operations are loss-making.

Akhilesh Tilotia of Kotak Institutional Equities in a report titled .com 2.0 – Value versus Valuation makes a very interesting point. As he writes: “It will be instructive to note that the proportion of people who have purchasing power in India is limited to the top 10% or so of the population.” So the number of people that Indian ecommerce companies can tap is limited and is nowhere near as is typically made out to be.

And this has important repercussions. As Tilotia writes: “It is important to consider whether India’s e-commerce GMVs[Gross Merchandise Values] and volumes are going to come from (1) a larger number of users doing more transactions or (2) a smaller base of consumers (say the top-end 100 million or so users) driving all the volume. If it is going to be the latter, customer engagement and retention will be more important than customer acquisition.”

If customer retention is more important than customer acquisition then any one company launching a sale will lead to others having to join in, in order to retain their customers, even though they may not want to do the same. The prisoner’s dilemma is at work.

As John Allen Paulos writes in Beyond Numeracy: “The parties involved will be generally better off as a pair if each resists the temptation to double-cross the other and instead cooperates…If both parties pursue their own interests exclusively, the outcome is worse for both of them than if they cooperate.”

But that’s not going to happen because that is what competition is all about. And it does work at some places.

The column originally appeared on The Daily Reckoning on October 14, 2015

Does Janet Yellen know Bahl and Bansal of Indian ecommerce?

yellen_janet_040512_8x10
On August 31, 2015, The Economic Times, the largest read business newspaper in the country carried an interview with Kunal Bahl, the chief executive officer of Snapdeal. In this interview Bahl claimed that: “The one thing I am very , very clear about right now is that I think we’re going to be No. 1 (in terms of sales) by March 2016….I think we’re going to beat Flipkart by then.”

Two days later on September 2, 2015 (i.e. yesterday), Mukesh Bansal, the head of commerce at Flipkart, responded in the same paper by saying: “Flipkart will sell goods worth $10 billion (Rs 65,000 crore) during fiscal 2016, and “nobody will be even half of that”…There is not a shred of doubt based on all the market numbers we have today.”

When was the last time you saw a CEO or a CXO of a brick and mortar company talk like this? Where does this confidence of Bahl and Bansal come from?
There is a basic advantage that ecommerce companies have, which the brick and mortar crowd does not. Consumers can buy many things through a single transaction. I can buy a geyser, a book case and several books, all at the same time and pay for it all at once sitting at home (or in office for that matter). I don’t have to visit different shops to buy these things.

As economist Alvin E. Roth writes in Who Gets What and Why—The Hidden World of Matchmaking and Market Design: “It looks to me like a single transaction, even though I may have bought each item from a different seller that subscribes to Amazon’s marketplace services.” Now replace the word Amazon with Flipkart or Snapdeal and the logic remains the same.

Plus, there is something called “thickness” at work here as well. As Roth writes: “The thickness of the Amazon marketplace—the ready availability of so many buyers and sellers—is self-reinforcing. More sellers will be attracted by all those potential buyers, and more buyers will come to this market place because of ever-expanding variety of sellers.”

And as I said earlier, what works in case of Amazon in the United States, also works in case of Flipkart and Snapdeal. But there is also something else that needs to be pointed out here.

Typically, the tendency is to look at India as one big market given the huge population of more than 120 crore people. But the more important question is –how many people are digitally proficient to be able to carry out ecommerce transactions on computers as well as smart phones.

And this is where things get interesting. Analyst Akhilesh Tilotia of Kotak Institutional Equities in a recent research report titled How many internet literates in India?  points out some very interesting data based on the 71st round of the National Sample Survey Organization (NSSO).

As Tilotia writes: “We note that 48.9% of the youth in urban India in the age range of 14-29 can operate a computer; this proportion falls to 18.3% in rural India. We also note that digital literacy among women trails men’s by 10 percentage-points. Even more interesting, only a quarter of those in urban Indian in the age range of 30-45 years can operate a computer, this percentage is 4% in rural India.”

It needs to be pointed out that in the NSSO survey on which this data is based, “any of the devices such as desktops, laptops, notebooks, netbooks, palmtops, smartphones, etc. were considered as computers.”

In fact, digital proficiency is significantly lower than digital literacy. As Tilotia writes: “Only around one in seven Indians can do any meaningful activity with their computers/smartphones. Urban India is better off with between a fourth and a third of its populace having dexterity to work on their digital devices; less than one in 12 rural Indians have such skills. It is quite possible to be communicative on social media without having email-writing skills or Googling skills.”

This is not the kind of data which the Indian e-commerce companies would want to take a look at.

The NSSO survey on which these numbers are based was carried out between January and June 2014. While things would have definitely improved on the digital proficiency front since then, the improvement couldn’t have been very significant.

So, given this low level of digital proficiency among Indians there has to be a limit to the size of the ecommerce market in India. But individuals who run these companies clearly don’t think that way. As Bansal of Flipkart told The Economic Times: “Flipkart is aiming to sell goods worth $100 billion in 5-7 years.”

The way things are currently going, the kind of valuations the ecommerce companies seem are getting, leads one to conclude that the investors who invest in these companies believe that Indian ecommerce companies will continue to grow at a rapid rate in the time to come.

There are regular news-reports on the front pages of business newspapers of millions of dollars of investment going into Indian ecommerce companies. But none of these news-reports ever seems to talk about the profitability of these companies.

As I have written in the past, almost all the Indian ecommerce companies are losing money big time. Most of these companies have been able to attract buyers by offering discounts on products that they sell. The only thing that has kept them going in spite of making massive losses, is the endless rounds funding that keep coming in, from venture capital and private equity firms, as well as hedge funds. And with every round of funding, the valuation of these firms also goes up.

All this money coming into Indian ecommerce is essentially because of extremely low interest rates that prevail through much of the Western world. In the aftermath of the financial crisis that started in September 2008, the Western central banks started to print money and drove interest rates to very low levels, in the hope of initiating an economic recovery. Leading the way was Ben Bernanke, the Chairman of the Federal Reserve of the United States, the American central bank. He was succeeded by Janet Yellen in 2014.

The private equity and the venture capital firms have borrowed and invested this money into Indian ecommerce companies. And it is this “easy money” from the West that has kept the loss making Indian e-commerce companies selling things on discounts, going.

The question is till when will this money keep coming in? Until very recently most economists were of the opinion that the Federal Reserve would raise interest rates from September 2015 on. Now with the massive fall in stock markets all over the world that seems unlikely.

Nevertheless, the Indian ecommerce companies are totally dependent on this “easy money” borrowed at very low interest rates. And it is this money that has kept them going. And it is this money that will keep them going. In fact, I am even tempted to ask, does Janet Yellen know Bahl and Bansal of Indian ecommerce?

The column appeared originally in The Daily Reckoning on Sep 3, 2015

Games companies play: Why you pay more while he pays less for the same product


Vivek Kaul
Indian Railways can even spring up positive surprises, now and then.
Recently while travelling from Delhi to Mumbai I was pleasantly surprised to have been upgraded from third AC to second AC. And this of course meant traveling more comfortably.
On entering the coupe in the second AC bogie I found an elderly lady already sitting there who somehow figured out that I had been upgraded.
“How can they upgrade you? You haven’t paid as much as I have!” she said.
And she was right about it.  I was travelling second AC while having paid for a third AC fare.
Nevertheless, this sort of “price-discrimination” has now become a quintessential part of our lives. Airlines are an obvious example. You could have paid many times more than the guy sitting next to you because you booked the ticket two hours before takeoff and he had it all planned out three months back.  Yours might be a business trip wherein you need to be a particular place on a particular day at a particular point of time. The person sitting next to you might be simply travelling for pleasure and could have thus planned it all in advance.
When books are first launched they are typically launched in the hardback form. A few months later a cheaper paperback is launched. The hardback is targeted at an avid book reader who just can’t wait to have his hands on the book, and so is ready to pay more.  When the bestselling Shantaram first came out in India it retailed for around Rs 1200 in hardback form. Prices finally fell to around Rs 400 for the paperback, which was 66% lower.
But these as I said a little earlier are the obvious examples. Companies have also started using the discriminatory pricing strategy when it comes to electronic products. This has started to happen primarily because being spotted with the latest cell phone (be it an Apple iPhone 5 or a Samsung Galaxy G3) or a tablet (the Apple iPad) gives so much meaning to the lives of people these days. Till a decade back a man’s worth was decided by what he wore. Now it’s decided by the brand of cell-phone that he carries.
What was once a luxury became a comfort and is now almost a necessity for a large number of individuals. When such products are first launched they are targeted at the “geeks” or early adopters who find a lot of meaning in their lives by being the first ones to use the latest i-Pad/i-Phone and hence are willing to pay more for it.
Companies tend to exploit this human need by charging more for freshly launched electronic products. Of course, once companies have skimmed higher prices off these early adopters, they cut prices so that you, I and everybody else, can start buying the product.
In the apparel industry, fresh stocks go for higher rates towards the beginning of a season, whereas as the season ends the same set of clothes is sold at a discount.
The logic behind price discrimination is to divide consumers into various categories and get them to pay what they are willing to pay. As Seth Godin points out in All Marketers are Liars “Ralph Lauren generates a huge portion of its sales from seconds… There are so many of these stores that many of the items aren’t seconds at all.”
So those who are price sensitive buy the “so-called” seconds, those who are not buy the “so-called” originals. Companies try and cash in on this price sensitivity of consumers through price discrimination. Anyone living in Mumbai can go to Parel and buy all kinds of things from the so called seconds shops that swarm the area and get a good discount doing so.
As Jagmohan Raju a professor at Wharton Business School says in an article published by Knowledge@Wharton “Companies…charge people different prices depending on the buyer’s desire or ability to pay…They reap wide profit margins from those willing to pay a premium price. In addition, they benefit from high volume, even at a lower per unit price, by building a wider customer base for the product later.”
But this logic doesn’t always work. Consumers may not mind discounts for senior citizens or lower prices for early morning cinema shows, but they can be touchy about discriminatory pricing.
In the late 1990s Coca Cola developed a vending machine which charged the consumer a higher price on warm days. As Eduardo Porter writes in The Price of Everything “When Coke chief executive Doug Ivester revealed the project in an interview…a storm of protest erupted.” Coca Cola had to ultimately drop the idea.
In September 2000, it was revealed that www.Amazon.com was charging different prices for the same DVDs to different customers. The company denied segregating customers on the basis of their ability to pay, something they could easily figure out from their shopping histories.
The early adopters of Appne iPhone were an unhappy lot when in 2007, the company decided to cut prices of the 8GB model from $599 to $399 within two months of launching it. The company had to placate this lot of customers by offering them a $100 store credit.
However, there are no easy ways of ensuring that your customers do not feel cheated. One way is to differentiate the offering in some way. “Companies have to sell products that are at least slightly different from each other,” writes Tim Harford in The Undercover Economist. ”So they offer products in different quantities (a large cappuccino instead of a small one, or an offer of three for the price of two) or with different features (with whipped cream or white chocolate),” he adds.  The products are marginally different, but it gives the company a reliable excuse to charge “significantly” higher prices. The next time you go to a coffee shop try this little experiment by just try saying no to everything extra that the barista tries to offer you and see by what proportion your bill comes down.
Book publishers tend to launch a book in a hardback form.  The cost of production of a hardback is slightly higher, but the price difference between a hardback and a paperback is significantly different (as we saw in the case of Shantaram earlier).  The hardback is just a way of telling the early buyer that the book firm is offering him something more.
Frequent flyer programmes work in a similar way where the frequent flyer may get a cheaper rate because he is a frequent flyer and thus other flyers do not feel cheated.
Companies practice price discrimination in the hope of raising their average price per unit of sale. This of course works if the core business model of the industry is strong.  But even price discrimination cannot rescue a flawed business model.
A great example is the newspaper/magazine industry worldwide. It started putting news and analysis free online while expecting those buying the newspaper/magazine in their physical form to pay a price for it.  Of course consumers will take what is free and shun what they have to pay for, especially if it’s the same product. No wonder, worldwide the industry is in trouble. While it was easy to put news/analysis free online and get the so called “eyeballs”, nobody bothered to figure out how would they go about earning money doing the same?
The other example of an industry which has been disaster despite all the price discrimination is the airline industry. As Porter points out “For all their efforts at price management, competition has pushed airfares down by about half since 1978, to about 4.16 cents per passenger mile, before taxes…In terms of operating profits, the industry as a whole spent half the decade from 2000 to 2009 in the red.”
At times companies end up in trouble because of price discrimination practiced by someone else. A spate of websites which sell books at a discount of as high as 40% have been launched in India over the last few years and this has led to bookstores getting into serious trouble. People now use bookstores to browse and check out what are the latest titles to have come out and then go home and order the books online at a discount.
Price discrimination is a new game in town and impacts consumers and companies in both good and bad ways. Hence it’s important, at least, for consumers to be aware when and where are they being price discriminated.  Or else, they are likely to react like the old lady who travelled with me from Delhi to Mumbai.
The article originally appeared on www.firstpost.com on November 22,2012.
(Vivek Kaul is a writer. He can be reached at [email protected])

Why you shouldn’t write off the Tata Nano just yet


Vivek Kaul

A little over three years after it was first introduced Tata Nano is being widely touted as a flop. The car which was supposed to cause traffic jams all over India is not selling as much as it was expected to.
Between January and July this year 55,398 units of the car have been sold. This is 13.3% more than the number of units that were sold during the same period last year. So even though the numbers are looking better this year they are nowhere near the installed capacity that the Nano plant in Sanand in Gujarat has, as an earlier piece pointed out. (You can read the complete piece here).
Numbers of reasons are being pointed out for the Nano flop show. Let me discuss a few here. In the book The Little Black Book of Innovation Scott D Anthony, who is an innovation consultant, points out a conversation he had with a colleague in late 2009. ““Here’s a provocative perspective,” my colleague said in late 2009… “I think the Tata Nano is going to be a disappointment.”… So why was my colleague being so skeptical? “Look at it from a customer’s perspective,” he said. These people could already afford to pay twenty-five-hundred dollars (or around Rs 1 lakh as the Nano was expected to be priced initially) for a perfectly good used car. Instead they consciously chose the scooter.”
Ratan Tata had the idea to build a car like Nano when he saw a family of four struggling on a two-wheeler on a rainy night in Mumbai. But despite the safety hazards people still preferred a two wheeler to a Nano. “Why would consumers choose a scooter? It wasn’t that these people didn’t care about their family. Rather, they didn’t have the space to park a car, or they found scooters that fit into tiny gaps on India’ chaotic streets a much more convenient form of transformation,” writes Anthony.
Another major reason being pointed out for Nano’s failure is it’s positioning. As Rahul Shankar points out in a blog post titled “Why did the Tata Nano fail as a disruptive innovation?” “The Nano was essentially branded as the world’s cheapest car…The truth is that no one wants to own a car that is thought off as cheap. Very few people treat a car as just a machine that takes them from point A to point B. This is basically what the Nano has been reduced to. People want to brag about how awesome their car is and how it kicks their neighbor/friends car’s butt….The advertisements that I have seen for the Nano have unfortunately come off as bland and catering again to the theme of affordability.” (You can read the complete post here)
These are valid points that have been raised. Even Ratan Tata has admitted to mistakes having been made. “We never really got our act together…I don’t think we were adequately ready with an advertising campaign, a dealer network,” Tata remarked earlier this year.
But these reasons notwithstanding, it’s too early to write off the Nano. Nano is what innovation experts call a disruptive innovation. This term was coined by Harvard Business School professor Clayton Christensen. “A disruptive innovation is an innovation that transforms an existing market or creates a new one by introducing simplicity, convenience, accessibility and affordability,” is how Christensen defined disruptive innovation when I had interviewed him a few years back for the Daily News and Analysis (DNA).
An important thing with disruptive innovations is that they tend to work out over a period of time. As Christensen said “It is initially formed in a narrow foothold market that appears unattractive or inconsequential to industry incumbents.”
A great example is the Apple personal computer which took around a decade to establish itself. As Christensen put it “A great example is the Apple personal computer. The incumbent companies of the time were those like Digital Equipment Corporation (DEC) that made minicomputers, which were big machines that sold for lots of money and could handle very complex tasks. When the personal computer burst on the scene, it sold for significantly less money than the minicomputer did…the PC wasn’t as good as the minicomputer for the market as it existed at that time. Apple made a wise decision and first sold the personal computer as a toy for children. Over time Apple and the other PC companies improved the PC so it could handle more complicated tasks. And ultimately the PC has transformed the market by allowing many people to benefit from its simplicity, affordability, and convenience relative to the minicomputer.”
Given this any disruption does not come as an immediate shift. “Disruption rarely arrives as an abrupt shift in reality,” write Clayton Christensen, Michael B Horn and Curtis W Johnson in Disrupting Class —How Disruptive Innovation Will Change the Way the World Learns.
This is something that Nirmalya Kumar, a professor at the London Business School (LBS) agrees with. “What I know about is radical versus incremental innovation. The more radical the innovation is the longer the time customers take to adopt it. People think of Nesspresso as being as a great radical innovation, but what they don’t know is that for 20 years it did not sell a whole lot and then the sales went up in a spike,” Nirmalya Kumar had told me in an interview I did for the Economic Times. Nespresso is a cappuccino maker sold by Nestle.
Amazon, which started off as a bookseller is another great example of a disruptive innovation which took time to get settled in. Another great example from the field of cinema is the movie Sholay. The film was massacred by critics when it released on August 15,1975. As Anupama Chopra writes in Sholay: The Making of a Classic “Taking off on the title of the film, K.L.Almadi writing in the India Today called it a ‘dead ember’… Filmfare’s Bikram Singh wrote: ‘The major trouble with the film is the unsuccessful transplantation it attempts – grafting a western on the Indian milieu.”
The Indian audience had never seen anything like this before. And it thus took time to sink in. The film went onto become the biggest box office hit of all time.
What these examples tell us is that it is too early to write off the Nano, despite the fact that the initial planks on which it was sold are largely not true anymore. “A cheap car that’s not really cheap. A safe car whose safety has been questioned. A poor people’s car that poor people aren’t buying. That sounds like a failure, certainly. But really it’s not. It’s par for the course for almost every breakthrough innovation,” writes Matthew J. Eyring the president of Innosight, a strategy innovation consulting and investment firm, on the HBR blog network. (you can read the complete piece here). “In fact, I can think of only one example of a CEO who pre-announced an innovation that was going to change the world and actually delivered it. That’s Steve Jobs of course,” he adds.
Critics point out that a lot of assumptions that Nano’s initial strategy was built on are not turning out to be true. The two wheeler riders aren’t upgrading to the Nano as they were. It’s no longer as cheap as it was initially promised to be. And people are buying it more of as a second car rather than their main mode of transport. But this is again in line with the way breakthrough or disruptive innovations operate.
As Eyring puts it “There’s nothing unusual about a company having to adjust the price, the production process, the marketing, or even the market of a breakthrough offering. The Nano’s price changes, the new maintenance contract Tata is rolling out to assure buyers of quality, the test drives it’s introducing, the new smaller showrooms, and the new commercials — all widely discussed in the press — should not really be news.”
All these things are also happening with the Nano because Tata Motors went in for a full fledged launch of the car rather than a small one. As Nirmalya Kumar put it “When the product development is radical you always do a small launch. They did a huge launch for Nano. They should have done a smaller launch. With radical innovation you need to keep tinkering and figuring out what is it exactly that the customer wants. This is because with radical innovation pre market testing is not really relevant because the consumers are not good at telling you whether they will buy a radical new product because they have no conceptualisation.”
This is something that Godrej & Boyce did with the ChotuKool refrigeratior. “Long before most people had heard of the low-power fridge ChotuKool, Godrej & Boyce spent quite some time investigating people’s refrigeration needs, designing and redesigning the product, and redoing its distribution strategy, carefully, slowly, and quietly,” writes Eyring.
It would have helped if Tata Motors had followed a similar strategy with Nano. As Eyring points out “It might not have been easy, but had Tata piloted the Nano quietly, on a small scale, perhaps through a limited production run in a small city like Durgapur in West Bengal or Ranchi in Jharkand, its engineering, pricing, financing, and marketing might have been adjusted far from the limelight to suit the needs of an optimal target customer… the Nano might have made its debut to the wider world with less hype and greater effect. It might not have been a 1 lakh car or even an alternative to motorscooters. But when it first appeared in the mainstream, it would have been right product for the right price in the right market.”
So now the Nano has entered the tinkering phase. And as this goes along Tata Motors will figure out what works and what does not. And this may be totally different from the assumptions the company started out with.
What still doesn’t change is its low price, despite the fact that it never sold for Rs 1 lakh as it was initially expected to. As Nirmalya Kumar put it “That’s the real startling novelty of the product because there is no car available anywhere in the world for $5000.”
The article originally appeared on www.firstpost.com on August 24,2012. http://www.firstpost.com/business/why-you-shouldnt-write-off-the-tata-nano-just-yet-429044.html
(Vivek Kaul is a writer and can be reached at [email protected])