Are Online Retailers Really more Valuable than Offline Ones?; Just Wait Till Mr.Biyani says “Chalo Online”

Valuable, is an interesting word. What is really the value of a business, who determines it, what are the guiding principles?

In past decade India has seen, valuations were a function of how much money people are willing to give – or risk – or bet – on a really small business based on its potential of future sell-ability. But these valuations are largely high risk bets. The proof is frequent underwritings of ventures by the money people, which were ‘valued’ very high at some point in time and became a big buzz, eventually were valued a big ‘0’.

However in case of offline business, whatever their valuation is, seldom you see it going drastically down to zero.

An interesting look at the data below from a recent report by Economic Times:

Asset ~500 Cr
Revenue ~6000 Cr
Valuation ~ 30000 Cr?

Future Retail
Asset ~11000 Cr
Revenue ~11000 Cr
Valuation 2775 Cr?

Assuming in a situation, VC backed company’s life support system – the eternal investment – is removed for a while, what really would this high value giant be valued? The Money People may argue that it shall still be valued a lot and there may be “takers” of it at reasonable valuation, which makes the point stronger, that the ability of the money people to play big bets is really what we have started calling valuations?

So the question is, if really offline retail is less valuable than online?

Why people perceive offline as less ‘valuable’

Inventory (-)ve

As per ET Report, “The physical retail model is weighed down by inventory and high rental costs,” says Roy of Edelweiss. “There is no inventory or rental costs in an online model, and it therefore tends to fetch higher valuations. PE valuations are based on profitability growth three to four years down the line.”

Let’s take the example of Flipkart, for a long time it was a heavy inventory led model, however was always valued high. Today Flipkart is a marketplace, in possibility due to FDI restrictions. Given a choice, based on the volumes of Flipkart, they would be better off holding inventory in their warehouse, and ensure faster, reliable fulfilment and better margins on goods.

Flipkart, if they hold inventory would likely keep it in their warehouse, and is as good as blocked until an online order comes along.

Offline Retailers, keep the inventory in stores, closer to consumer. Hence can deliver faster than online players. Their inventory is also open to purchase hence poses a lesser dead inventory risk than online players.

Further they enjoy higher margins because of their inventory models.

Scalability (-)ve

As online retailers scale up, their profitability improves. But for brick-and-mortar players, every expansion is a hit on profitability,” says Bijou Kurien former chief executive of the lifestyle division of Reliance Retail.

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Online Retailers scale much faster, well definitely. But in what? Customer Acquisitions, traffic? does this fast scale really translate into long term value like margins? consumer loyalty? Brand ?

Flipkart operated on Gross margin negative for a long time, with scale the gross margins shall turn into a grosser losses, and only the losses would scale up. The company shall become a bigger machine to eat more money? Yet was valued high? Why?

The money people believe that over time with economy of scale the profitability shall surface. The money people say, Amazon did it the same way! Why can’t Flipkart?

Will the investors finally start to evaluate Amazon’s stock price according to normal metrics or will they continue to award the company a stock price with no relationship to business fundamentals?

Forbes did an article around the same agenda earlier this year Is Amazon’s Stock Bubble Bursting? Below are some excerpts from the same.

The story behind Amazon’s stratospheric stock has always been the company’s future and the top line growth in customers and gross revenue. People trusted CEO Jeff Bezos’ strategy of capturing eyeballs and turning them into buying customers in the belief that down the road he would make money off of them. Bezos has also stated that the company’s goal is to make customers happy. Perhaps investors thought that would translate into profits down the road, but most years it has not.

Currently, Amazon’s profit margin is running around one-half of one percent. That is vanishingly small. Wal-Mart is a low margin business, with margins that have been shrinking for years as it expands into the famously low-margin grocery business; yet Wal-Mart still earned a 3.36 percent profit margin over the past year.

As per scalability of offline business, yes, to reach to wider consumer base they need to invest in physical stores, heavy investment, etc. The physicality of offline retail makes is heavy investment led scale model. As the valuation is an indication of potential to become much bigger in much smaller time, offline retail loses on this front due to low scalability

But why do we forget that soon they all would be online and would be much better off servicing consumer across all channels, seamlessly? And then what? Would they be valued as per below equation?

Valuation of VC funded online retailers + Valuation of Offline Store + Much Higher potential to scale, grow + Valuation of existing brand equity + Contribution of better last mile fulfilment reach = 20 times of Online retailer?

One of the strong reasons that we believe offline business are valued less is because they are led by entrepreneurs who believe in creating wealth and not selling the business. Hence since The Money People can not ‘Trade’ the ‘business’ they do not see ‘value’ in them.

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We believe to agree that Mr. Biyani is not someone who is after a quick 5 year exit game and make lots of money by being in the business of business. Guess he is in the business of Retail.

Why we believe that the retail businesses must be valued much higher even today

Retail is a unique opportunity for India today. While many pure play online players activated the opportunity and brought consumers online, they have sort of played an act of warming up the pitch for more seasoned team to play.

With online being an exciting building space, most of the large retail firms are gearing up for their online enablement. If they play their cards right and transform their retail into an omni channel experience for consumers, that’s where the world of shopping is going to be eventually. With their present strengths, they stand much strong potential to lead the race over pure play online players

Pure Play Online Retailers
Strengths Strengths
Higher margins Early Mover Advantage
Control on Price Availability of Investment
Strong Supply Chain Readiness for Online Retailing
Deeper knowledge of Products
Deeper knowledge of Consumers
Established, Trusted Brand
Much Higher Volumes
Control on Product Availability
Established Private Labels
High Cash Flows
High Asset Base
Weakness Weakness
Physicality of Scale Margins
Organisation Culture & Mindset Knowledge of Products, Sellers
Legacy Inertia, Slow Adoption Knowledge of Consumer
Small Volumes
‘Under-construction Brand’
‘Under-construction’ supply chain
‘Under-construction’ Private Labels
Smaller Cash Flows
Very Small Asset Base
Threats Threats 
Growth of Pure Play Players Mr. Biyani saying one fine day ‘Chalo Online’
Consumer Shift to Online
Opportunity Opportunity
Omni Channel Retail Getting Acquired by an Offline Retailer
Getting Acquired by Amazon
Getting Acquired by Rakuten, Alibaba

“The obituary of physical retail is being written,” says Sanjeev Aggarwal, senior managing director of venture capital fund Helion Venture Partners. “They are fighting a losing battle.”

Well we agree with the first statement, but ‘they’ – the physical retailers – shall certainly fight a losing battle if they do not go online or: Mr. Biyani does not take up a mass address to entire retail community and say “Chalo Online”

Disclaimer: The views expressed in the author are of the author’s own and do not reflect the opinions of the publisher.

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