Grokking India: High fixed cost per transaction

27 August, 2012

This blog post is really worthy only of a tweet since the core lesson is simple and either you grok it or you don’t; either you believe it or you don’t. There really is little middle ground.

I have previously written about hidden costs of starting up a business in India, I’ve written about accounting for cost of collections in calculating LTV and I have written about the unique challenges in building a distribution network in India. The common theme, the underlying economic fact of India, is as follows:

Every transaction has a high fixed cost

OK, that’s all I have to say. Thank you for reading.

Juuuust kidding! This idea is very important to understand and in the context of VC funded companies has a non-trivial impact on capital efficiency, scalability and therefore returns. Let me re-hash a few examples I have given previously to explain this further:

1) As you go from B2B to B2B2C (FMCG) to B2C, the revenue per transaction keeps decreasing, but after a point the fixed costs per transaction (cost of collections, returns, customer service, defaults, high friction courier etc) do not go down. Therefore unit profitability and/or scalability on B2C continues to be a challenge. B2B2C (FMCG companies) are big and hugely profitable and it is no surprise that their collections and deliveries are to consolidators of volume and therefore they are able to profitably pay for the fixed cost per transaction.

2) VC investments in internet businesses have to be thought about like it is ’94 in the US. The early stage bets are big even to just prove out the concept because like in ’94 in the US, companies have to first build their operating eco-system in order to even validate their ideas. Borrowing the present-day methodology in Silicon Valley of doing $250K experiments in more cases than not will not tell you anything in India. In other words there is a high fixed investment amount for early stage transactions.

3) Lack of trust: Consumers trusting businesses, citizens trusting laws and law enforcement, businesses trusting each other – due to systemic issues India is characterized by low trust and that almost always requires face-to-face contact and physical access to close all kinds of transactions. Even business transactions require much higher level of diligence due to worries of being cheated. This is again HIGH fixed cost for many different kinds of transactions.

And the list goes on. Analyzing the sources of the fixed costs can tell you what needs to be done to reduce the fixed costs. And there you find all the usual suspects, for example:

1) Electronic payment systems need to be in place (to completely “variablaize” cost of collections)

  • which in turn require consumer trust
  • which in turn require reliable credit agencies
  • which in turn require trustworthy laws and law enforcement
  • OR you can build a telecom company that does electronic payments. A telecom company has the consumer’s trust and obviates the need for an EXTERNAL credit agency or good law enforcement around payments (Put it another way: the fixed cost of building a national level electronic payment network is building a telecom company!).

2) Better infrastructure: good roads (reduced fixed costs of transportation), good power systems (reduce fixed cost of operations), etc

3)Trustworthy law enforcement so that there is implicit trust in legal contracts

These fixed costs are worth reducing as they have non-trivial implications, including:

1) Unleashing innovation as cost and risks of experimentation goes down; with high fixed costs experimentation becomes tougher

2) Improving investor returns as the bets can be staged better

3) Decreaing time to scale for ideas that show potential because lower fixed costs imply a “lower friction” operating environment

For all these reasons, India is, and will remain in the foreseeable future, an economy dominated by operational complexity not strategic complexity. The big question in India is HOW to get products and services to consumers not WHAT. In other words India is not demand constrained but supply constrained and keeping an eye on the fixed costs in the system can help navigate the complexities of doing business while staying true to needs of profitability, scalability and investor returns.

(Dhiraj Kacker is CEO & Co-founder of Canvera.com, an online Digital Photography company based out of Bangalore. This post has been reproduced from Dhiraj’s blog with his permission”.)


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Grokking India: High fixed cost per transaction

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