Should consumer internet companies aim for sustainable profitability or opt for market domination with less regard for profitability?
An interesting debate is taking place among stakeholders and enthusiasts in the Indian startup ecosystem. It pertains to whether consumer internet companies should aim for sustainable profitability or gun for complete market domination with less regard for profitability.
Going on for quite some time now, the debate has intensified in recent times. This is due to a slowdown in the pace of funding, indicating that only the profitable and cash-generating companies can survive. More and more entrepreneurs and angel investors are talking about the dhandha mindset. Essentially, the dhandha mindset is the Indian version of doing traditional business which focuses on prudent decision-making and a keen eye on the bottom-line. Profitability is the main goal of doing business, they argue, and anyone else saying anything to the contrary is committing sacrilege.
There has also been this belief among a few that investors have been employing the time-tested principle of the greater fool theory. The claim suggests that entrepreneurs and their investors are not focusing on building sustainable businesses but rather trying to create sky-high valuations by over-selling startups. The eventual aim of doing so is to offload the stakes to unsuspecting subsequent greater fools with deep pockets. Whatever the merit of the argument (or the lack of it), such a claim has set the cat among the pigeons by sparking intense discussions among startup folks with ardent supporters on both sides.
On the other side of the debate, there are people arguing that traditional businesses and disruptive digital businesses are not comparable – that it’s essentially apples and oranges. I have to admit that I belong to this side of the table. Consumer internet is inherently a ‘winner takes all’ ecosystem with a huge propensity for creating total monopolies.
Consider the case of Google. It absolutely dominates the search engine segment across the globe (except China, for obvious reasons) while Gmail virtually owns the personal email market. The same is the case with Facebook as there is hardly any competition to it among social networks. Even a behemoth like Google could not dethrone Facebook from its perch. It did make an attempt through Google+, but that struggled to make a mark and failed to. Facebook enjoyed the immense benefit of network effects as people only wanted to visit that social network where all their friends and family were already active. Same is the case with Linkedin for professional networks and Twitter for informational networks.
The network effects create such a virtual cycle that it becomes extremely difficult for even the second-place entity to catch up with the leader. Orkut and Myspace now feel like a part of distant memory for the vast majority of people. Given this context, it becomes much more important to focus on ruthless market domination rather than nitpick about profitability and margins. If the market is large enough, venture capital investors are ready to throw money by the bucketloads as they are always on the lookout for the next Google, Facebook, Whatsapp or Instagram. If the venture capital investors are smart enough to bet on the winner, they can earn parabolic returns which can make up for any amount of duds in their portfolio. They are not really looking for steady-state businesses that hooray at every increasing percentage point in profit margins.
Another prime example of a company which has managed complete market domination across the globe (again, except in China, of course) is Amazon. The company is probably one of the pioneers in disregarding profitability. Jeff Bezos intuitively understood that investors would keep backing him and his company if he kept delivering to one geography after another for them. And the result of the strategy is for everyone to see. Many times, normal rules of business do not apply to consumer internet companies as the market leaders keep defying gravity by ruthlessly dominating their respective markets. Amazon’s competitors do survive but only by building its model across a specific niche or through game-changing innovation. eBay, Zappos and Walmart (online) are examples of such instances.
Domestically too, we are observing the impact of the ‘winner takes all’ effect. Naukri has managed to take a huge lead in the job portals market and now enjoys close to 60 per cent profit margins in its recruitment business while making losses initially. Zomato has emerged as the dominant leader in restaurant search. BookMyShow has taken a lead over its competitors in the movie-ticketing business while MakeMyTrip is doing the same with travel bookings. The e-commerce market is still undecided with Flipkart, Amazon and Paytm vying for the top spot. Snapdeal may have missed a trick by pivoting to a scaled-down version and focusing on “profitability”. It is now losing out to the top three. Flipkart may have frittered away its early-mover advantage by not pressing home its advantage. It left the door open for Amazon, which is now giving Flipkart a run for its money.
The flip side of the ‘winner takes all’ effect argument is that there are exceptions to every rule. This concept does not necessarily apply to every segment in consumer internet. There are many spaces where much lower levels of consolidation exist. Sometimes, the market is not large enough to attract a large supply of venture capital money. For example, Housing.com entered the real estate portal segment with much hoopla and fanfare as well as promise of wholesale disruption. This did not take place as envisioned as the real estate market started going through a deep slump. Suddenly, all the money that Housing.com was spending on its advertising blitz started seeming exorbitant. Investor interest waned, and Rahul Yadav, the former chief executive officer of Housing.com, did not help matters with his frequent run-ins with the investors.
Incidentally, Yadav symbolises everything that is wrong as well as right with the Indian startup ecosystem. He is young, brash and aggressive, but instead of becoming a potential Virat Kohli of startups, he became more like Vinod Kambli, as someone who could not utilise his full potential. Yet, for a brief period of time, he became a household name among startup enthusiasts in India. Even to this day, many young entrepreneurs look up to him as a role model and for good reason. He typified the spirit of building a world-class company with technology as its bedrock and huge scale as the modus operandi. Even though he may not have succeeded in his attempt, he is a flag-bearer of the domination mindset.
The argument being made here is to make a distinction between ideas which work for regular businesses and ideas which work in a disruptive environment, where technology is the mainstay and internet is the medium. The motive is not to deride people who follow the dhandha approach. Dhirubhai Ambani is the prime example of the dhandha attitude. Traditional businesses have to work on sustainability and profits as they do not have the luxury of deep-pocketed investors who are ready to pick up the tab. But in the case of highly scalable internet arenas, a focus on market domination is essential, and many times, it comes at the cost of profitability.