| Log in

Why inventory-led e-commerce companies in India will not be profitable… EVER

03 September, 2012

While more than $350 million have been invested in Indian e-commerce over the past three years, a majority of the capital has gone into only one kind of e-commerce business model, i.e., inventory-led e-commerce models. The inventory led e-commerce models have almost the same economic characteristics as the traditional brick-and-mortar model when it comes to inventory risk exposure, warehousing, and sourcing. Even at an approximately $65 billion in gross merchandise value (excluding Kindle, AWS and digital downloads) in 2011, Amazon did not produce more than 0.25 per cent in operating margin from Amazon.com. The entire Indian e-commerce (excluding online travel) is around $550 million and is, at least, 8-10 years away from the scale, where inventory-led model may even turn profitable.

Let’s understand the basic economics of retail business

In retail industry, the blended gross margins are at around 30 per cent – low gross margins for categories such as mobile or electronics; moderate gross margins for categories such as home appliances and health & beauty; and high gross margins for clothing, shoes, accessories, watches, jewellery, etc. In all, retail is a 30 per cent gross margin business. After this gross margin, a retailer has to recover money for marketing, IT, operations (warehousing, sourcing, retail ops, etc.), lease/rental and G&A. If a retailer is highly efficient, in net-net he can achieve 7 per cent operating margin. For a 7 per cent operating margin, a retailer has to show that his inventory turnover is 10x or 12x and has no unsold inventory. The operating margins will be in negative territory if the retailer has more than 6 per cent unsold inventory.

So in general, retail earns 30 per cent in gross margin and spends 12 per cent on marketing, 6 per cent on lease/rental, 1 per cent on technology, 3 per cent on operations and 1 per cent on G&A to make 7 per cent operating margin. And if there is a high level of unsold inventory, the 7 per cent operating margin can be operating loss (assuming a minimum of 7 per cent unsold inventory).

Let’s define what makes an e-commerce company an inventory-led business model

Almost all e-commerce companies operating in India are theoretically based on an inventory-led business model. While there is no hard and fast or stringent definition, let me highlight four distinct things that set apart what is an inventory led e-commerce model versus not an inventory-led e-commerce model, for example, a marketplace model. First of all, the value proposition to a customer for the inventory-led e-commerce models is that whatever a customer is buying from them, they have those items in their inventory stock. Second, there is only one seller for each product sold by these companies and that would be these companies themselves. Third, these companies are merchants of record for the products sold by them. And finally, these companies issue invoices to the customers in their names. On the other hand, all the four distinctions are not applicable on a marketplace model.

After setting the stage with these two aspects, let me now highlight the five reasons why inventory-led e-commerce companies will not be profitable… ever!

1) Existing practices by inventory-led Indian e-commerce players are not sustainable. Most of the Indian e-commerce players have inventory-led models. However, these companies try to reduce their inventory exposure by restoring to something called SOR or sales on return basis. The sales-on-return basis is a working capital management technique or negotiation style that assumes that the e-commerce company is buying an item from a supplier and in case the product is not sold within a stipulated time, the supplier will take the item back. Another practice that is in vogue is to create a back-to-back arrangement, i.e., get a customer order and then procure the item and ship it to the buyer. These practices are fine when you are doing 5-3,000 unit shipment per day but beyond that, it is not sustainable. Most of the inventory-led models promise customers that anything you see on my site is in my warehouse and that may not be true. More importantly, SOR and back-to-back are clever working capital management but not a choice of business model. 

2) Inventory risk means 12-15 per cent gross margin is down the drain. Because sales on return and back-to-back are not sustainable practices, majority of the inventory-led e-commerce models are either buying in advance more and more products they sell or will soon have to start holding inventory. And it does not matter how large or sophisticated a retailer or an e-commerce company is – every year, he is left with 12-15 per cent unsold inventory. That means, even if you are making sizable gross profits, Opex and unsold inventory will push you down into losses as seen with the majority of the e-commerce companies. Now, if you add the cost of storing items, i.e., running monolithic warehouses with inventory and store managers, insurance cost, security cost, etc., this can take another 3-5 per cent toll in terms of costs.

3) Marketing spend is very reckless. This is less to do with the inventory-led model but one common characteristic among most Indian e-commerce companies is that they have very high cost of customer acquisition. But if you are an inventory-led model, the pressure of selling it sooner and faster is higher and that means more aggressive marketing techniques. Most aggressive are the marketing practices, the higher cost of customer acquisition that you incur. Indian e-commerce companies who are sitting on sizable inventory, on an average are spending 25 per cent of their gross revenues on marketing, if not 35 per cent, in 50 per cent of the cases. With this level of marketing spend, profitability is almost next to impossible. 

4) Own delivery network has no economics at any scale. Many of the e-commerce companies are offering their own branded delivery. These companies have been investing heavily in creating their own delivery networks for a country like India, which has poor infrastructure and high diversity. Creating your own delivery network is not only a monolithic task but also economics is highly unattractive. In my view, own delivery network means a minimum of Rs 150 per package in delivery cost. If you are selling deodorants, books or other lower-price items, how can you ever make money with your own delivery network?

5) Free shipping. Majority of Indian e-commerce companies are offering free shipping and taking a toll of around 6 per cent of their gross revenues for funding free shipping. In the US and Western Europe, free shipping for an online shopper is a privilege, not a right.

Below, I present how the unit economics for the inventory-led e-commerce model looks like with four scenarios. But in all scenarios, I am assuming Rs 1,000 as average selling price (ASP). With lower ASP, the unit economics will actually start to look more unfavourable.

The bottom line is that inventory-led e-commerce business models are highly unlikely to achieve profitability and extremely large scale, unless there is access to a cheque book with never-ending leaves. For a 30 per cent gross margin business, they are spending 45-50 per cent on operating expenses and that is not changing anytime soon. The inventory-led business model will keep on relying heavily on capital and even 20x or 30x scale from the current level may not deliver the path to profitability and huge appetite for capital.

(Sandeep Aggarwal is the founder and CEO of “ShopClues.com”. He is counted amongst leading Internet experts globally, and has regularly appeared on CNBC, Fox, ABC News and regularly quoted by Wall Street Journal, Fortune, Forbes and other prominent media outlets.)

To become a guest contributor with VCCircle, write to shrija@vccircle.com.

View Comments
Is E-Commerce Party Over In India?

Is E-Commerce Party Over In India?

Sandeep Aggarwal 6 years ago
While the general euphoria about the Internet sector, especially for e-commerce,...
Don't Let The E-commerce Bust Fool You!

Don't Let The E-commerce Bust Fool You!

Alok Mittal 6 years ago
It seems that the past 6-9 months have played out a full boom-and-bust cycle as...
Choose marketplace only if you know what you are getting into

Choose marketplace only if you know what you are getting into

Sandeep Aggarwal 5 years ago
Twenty months ago, when I landed in this country, I found it very difficult and...
Gaurav . 6 years ago

Can the author substantiate his calculation of 150/unit for delivery under own network.. sounds counter intuitive

Tarun Gulati . 6 years ago

This article is too narrow in its definition of e-commerce companies..completely ignores the segment where people are manufacturing their own stuff and selling online..furniture, handicrafts, interior decor items where there should be much higher margins. I feel there is no space for large online businesses promoted on a mass scale with large profits yet… but i personally feel there is enough play for small online businesses with smart advertising/promotion and encouraging profits and ROI early on… i think too many people including the author (I just took a look at his own website didnt find anything other than the same mix of deals on mobile phone, laptops, hardware tht you find on almost all other websites these days) seem to be still caught up in the ‘being everything for everyone tangle’…

Phoenix . 6 years ago

Good article. Not only have you mentioned the inventory issue very well but some people are really asking for it- they wish to set up their own logistics. Marketing spend is still another matter. VCs heavily focussed in this area are play a betting game. This IS a game for them. All all these funds compete for a small market not only diminishing returns but infact creating losses for all. I bet LPs with “good memories” are watching (dreams of super returns).

Ram Prasad . 6 years ago

Sandeep -you have used real facts, lucid thought,and reasonable data to make a valid point about e-com. What you fail to address is that most VCs don’t value facts, thought, and data….much less innovation. Like lemmings, most investors follow the herd….time for another baby products e-com site to pop up…..

Pramod . 6 years ago

Hi Sandeep, One clarification please. Are you saying all retail is unprofitable? Brick and Mortar is also inventory led and has the same costs? What choices does a traditional retailer have- none other than the inventory led model. So, he can never be profitable. Is that a right conclusion?

Lakshmi Potluri . 6 years ago

My view on reason for non-profitability in ecomm is not the inventory model, but poor business practices such as deep discounting to entice customers, offering freebies to keep the online customer’s incentivized to buy online.

Marketing spends are reckless in ecom not necessarily driven by inventory models -they are driven by the pressure to meet unrealistic topline growth.

For ex, there are several brick & mortar stores that run on an inventory & SOR mode l and are profitable on a per transaction basis despite the rentals in the commercials. An ecomm should technically do better due to the advantage of savings generated from shop space/interiors, fulltime personable staff etc.,

Dharmender Singh . 6 years ago

It has become the order of the day to criticize the e tailing for some or other issues. People have been predicting future of e tailing in India. Why single out e tailing. It seems to have become a favorite punching bag for pessimists. Someone has suggested above that brick and mortar retailers should start own e tailing to cater to a larger segment. While that may be applicable for large retailers, for smaller retailers to manage both brick and mortar and e tailing could be a daunting task. In my opinion e tailers are better equipped to start the brick and mortar model with better inventory management capabilities. Private Labels, Franchise and Distribution could lower the risk wrt to unsold inventories. As the AIM is to RETAIL, whether its E tailing or brick and mortar …none is perfect, they can co exist and complement. In a diverse country like ours no single strategy is perfect, one needs to keep experimenting, learning from past ,,,,,Strategies need to be altered during the course of a projects life cycle. With sound efforts and consistent improvement e tailing is going to stay and live. Its not just a fad that will vanish with changing times.

Zarine Ninan.. retail enthusiast & employed by the industry . 6 years ago

This discussion cannot be complete without considering the customer.

From an online customer perspective, there is no greater satisfaction that receiving a shipment of an order placed online, within 3-4 days. When she receives the text on her cell phone, that the shipment has been dispatched within 2-3 hours of placing an order,her sense of joy is unmatched. Everything said and done,this level of efficiency can be achieved only with inventory led e-commerce websites. Great website efficiency (i.e: the customer does not have to call the customer support to tract an order)implies a customer who will return.

I believe that there are loyal online shoppers. I am one. If by ensuring smooth navigation through a website, fast check out, efficient delivery (I am willing to pay a nominal price) and a quality product, I will shop again and again. Only then will the high spends on customer acquisition be justified. In fact as a happy customer, I will even refer your website to many of my friends and get them to convert from being an offline shopper to an online one. And get those extra coupons for recommending a friend.

Yes! I do like a great deal, I do look out for it. But I can get it delivered promptly only if a website owns that stock right? Else I wait for 2 months until the website has generated enough orders to get that good discount from the brand. As a customer I don’t have patience to wait. If I have bought something, I want it now!

I also agree that owning your own delivery channel is a waste of time for any website. Why shift from your core competence? Let the hard core courier guys take care of that. The more the pin codes that the website can deliver to, the better. Why compromise?

I also think that e-commerce sites must start charging for delivery. Why spoil the customer? She will pay if she sees value. I am sure she will shell out that nominal fee. But websites are too scared! What if the customer goes else where?

Yeah..She may go else where, but she will be back, provided you keep her engrossed in your product. Pamper her with your efficiency and she will not be disloyal.

So my key pointers for this debate are:

1. Its great to own the stock, or at least ensure that your vendor holds stock for you.

2. Plan your merchandise mix, so that high margin products have a greater share of the mix. We will take some time before for economies of scale will allow us to retail low margin products profitably.

3. Spend money on creating a robust system. It should not crash because your marketing campaign actually worked and too many customers logged on.

4. Keep website, clean, interesting, with easy navigation.

5. Yes we are Indians.. we like a good deal. Keep a sustainable mix of merchandise which will offer a great unbeatable price. An 80-20 principle should work.. 20% of your merchandise should be offering a good deal.

5. Delivery within 2-3 days, maximum 5 days to interiors of the country.

6. Charge for delivery… yes you are worth it!

7. Ensure that what you promised to the customer is what you deliver i.e. quality of product and service.

E-commerce may be just be a baby in our country, but this baby is growing fast and moreover is getting very attractive and more and more people will want to play with it!

vedradijaus . 6 years ago

I like every post in this blog. Really a nice work has done.

Alok . 6 years ago

Interesting analysis… confirms to the analysis put up by Mckinsey in 2001 for US based …. etailers believe me they are all dead now… but by the same logic you (your market place biz model) will be dead too (sooner or later)… if your customers can’t make … you can’t be sustainable…. unless you reach a scale of e-bay where having a few thousand loosing clients(vendors)… doesn’t make a dent to the credibility of the business model and business goes as usual …. has India reached the scale or will it anytime soon… given the fragmentation of the country… I think e-tailing can only be a trash bag… where you can sell unwanted branded inventory (the last 5-6%) crap of crap…. to the brand blinded customers… and recover a few pennies in the process… market place model may just do that… but beyond that… start thinking something else dude… :-s

Varun . 6 years ago

well guys, Sandeep invested only 250k of his own money in shopclues.com as per article posted on VCC. All I can say he must be low paid analyst on wall street thus he’s bashing all other e-commerce business in India.

read this :

4) Own delivery network has no economics at any scale. Many of the e-commerce companies are offering their own branded delivery. These companies have been investing heavily in creating their own delivery networks for a country like India, which has poor infrastructure and high diversity. Creating your own delivery network is not only a monolithic task but also economics is highly unattractive. In my view, own delivery network means a minimum of Rs 150 per package in delivery cost. If you are selling deodorants, books or other lower-price items, how can you ever make money with your own delivery network?

dude..how about you go back to USA ? who asked you to come back and start new venture ? Hardcore Indian from heart but you gotta bash Indian values as well eh ?

Jay . 6 years ago

Typical Wall street analyst….PUMP AND DUMP….you gotta pump your brand and bash rest all 🙂

Mr Wallstreet, you just lost yourself probably 1 million clients

Abhishek . 6 years ago

Add to this the fact that heavy discounts is the key marketing input driving customers to these websites, which is not sustainable in the long run. Quality of service has already started to deteriorate as companies like Flipkart started facing profit pressure. I ordered a backpack from Flipkart sometime back and it took them 7 days to deliver the same. I would rather go to a nearby shopping mall than wait for 7 days in the future.

Sam . 6 years ago

Hi Sandeep, for the most part a very good article. Never mind the personal attacks from some of the readers.

I seek 1 clarification from you. You clubbed the “back to back” model in the “inventory led business models” bucket. You mention that “..beyond 3000 unit shipments a day this model is not sustainable..” can you please elaborate with facts and figures like you have done with your other points?

Appreciate hearing from you….


Gurvinder . 6 years ago

The article does point a lot of issues with the ecomm. But the fact that it is hard for them to be profitable is wrong.

If you keep following the traditional ways of doing business, you cannot survive or grow in todays world. This is a fact which remains true for all the industries.

I can still see a lot of growth in ecomm and retail biz, provided you keep innovating and analyzing the industry trends.

tejash . 6 years ago

Hi Sandeep, nice article. good analysis and explanation. even i think that apart from high inventory, reckless marketing expenses one more thing is discounts and freebies to attract customers.

i suggest you should have also thrown light on what are other ecommerce model , non inventory based which can be profitable.




Sagar Deshpande . 6 years ago

Your calculations to some extent are correct; and the scenarios you have explained are realistic. However, your have not considered who the owner of the inventory-led-eCommerce website is. If the owner is the manufacturer itself, your calculations and conclusions are pessimistic. The manufacturer who is selling his goods online in such model does much better business then you have mentioned. Many of our clients who are also manufacturers are already earning monitory and non-monitory benifits and their business is in green. By the way, I appreciate your deep study and research.

prathik . 6 years ago

I completly agree to the fact that inventory led e-commerce companies will not be profitable,as there are more risks than responsibilities. Unlike mydeals247.com which does not have inventory system instead it connects buyers & sellers real time. And gets the lowest price for a product within an hour for the customer.

Why inventory-led e-commerce companies in India will not be profitable… EVER

Powered by WordPress.com VIP