The Indian internet and e-commerce sector has emerged to be one of the fastest growing sectors of the country, even in the pandemic-hit economy. The Indian start-up ecosystem witnessed 43 companies turn unicorns in 2021; more than 30 odd unicorns that were created till date up to 2020.
However, history suggests that most of these unicorns find it difficult to survive and only a few thrive. The ones that do survive have some key common characteristics. Below we try to highlight the key common characteristics. Below we try to highlight the key among these.
Key characteristics of a successful new-age tech company:
In our opinion, a successful modern tech company can transform industries, achieve expansion of scale, and make enormous profits, all without requiring significant capital investments. It typically has most, if not all of the following features:
1) Low capital cost – Google, Airbnb, Facebook, LinkedIn, Uber etc. share one common feature: They have scalable virtual models that can be magnified exponentially without any significant addition to their assets. This is unlike a company like
NSE 1.63 % or D-Mart that would require land, factories, distribution centres or warehouses to expand.
2) Data – New-age tech companies collect, store, organize and analyse years of user data as it enables them to run targeted ads and personalize the customer experience. The key difference between a customer walking into a Walmart supercentre and Amazon’s online store is that Amazon instantly reorganizes the whole store in a way that’s tailor made for that customer.
3) Network effects – For most new-age tech companies, the bigger the network, the more valuable the company. While almost all platform businesses boast network effect, the quality of network effect varies across different businesses.
4) Economies of scale – Google, Microsoft and Facebook can scale up their revenues with minimal variable costs. It costs relatively little to make another copy of Windows 10 or service another Google or Facebook customer. Facebook’s gross margins, for instance, run as high as 80–85%.
In the Indian context, among the listed companies we believe one of the companies, which has the potential to thrive over the next decade, is Zomato.
Zomato – A disruptor in food business, albeit offering a win-win solution
Zomato offered a solution by being the bridge between the needs of the consumer and offering scalability/distribution to manufacturers (restaurants).
As we all understand, the gross margins (ex-RM cost) are very high (around 65%-75%) in the food business, but the fixed overhead cost for the restaurant owners also remains heavy. Therefore, for every incremental revenue if the restaurant has to share a certain percentage (15%-25%) with the distribution partner like Zomato, it is still a very high margin / contribution on marginal costing. And from consumers’ perspective access to variety, ease of ordering and delivery are great value propositions for a minimal cost compared to the time & logistics cost and hassle that the consumer will encounter.
When analysing a company, we like to focus on 3 key areas – scalability, inherent profitability and management quality
Zomato, in our opinion, checks all the above three boxes. Below we discuss them in detail.
1. Scalability
Food consumption, at US$607 billion in 2020 constitutes around a quarter of India’s GDP. However, most of this is driven by home-cooked food. Restaurant food (or food services) currently contributes only approximately 8-9% (US$56bn) to the total food consumption market. This is substantially low when compared to the United States and China.
The food service market in India is benefiting from a cultural shift towards eating food out of home, primarily hastened by lack of time, convenience and improvement in quality (mainly taste and temperature of food in India).
The Indian online food services market has rapidly expanded, growing 7x (c.50% CAGR) over the last five years to US$3.6bn, but still only captures 6% of the overall US$56bn pie that Indians spent on eating out in FY20.
We see continued momentum in the online food delivery market, where growth will be driven by tailwinds like increasing smartphone penetration, demographic profile, rising income level, expanding share of youth, expansion in middle class, urbanisation, expansion in nuclear families, expansion in working women, etc. Some of the headwinds in the past decade like poor infra, unorganised supply chain, food regulation, and irregular supply have been arrested, aiding growth.
Thus, we expect the online food service market to be the fastest-growing segment in the overall food service sector in India and based on industry estimates expect the market size to be around US$11bn by 2026 implying a 21% CAGR.
India’s food delivery sector has already witnessed considerable consolidation over the past two years as several competitors such as UberEats, Foodpanda, Tinyowl and Scootsy have either been acquired or they have shut their businesses. Swiggy remains a well-funded competitor. We reckon that these two will deploy cash to scale-up the food delivery business by focusing on market expansion and not reckless discounting. They will also use this cash to explore adjacencies.
We thus reckon that Zomato is well-poised to grow at a strong pace over the next decade led by attractive market opportunity and potential cross-sell and up-sell opportunity by adding other value-added services like grocery delivery into the portfolio.
2) Inherent Profitability
Zomato has been burning cash ever since its existence. However, we believe all these investments towards marketing and promotions were required to accelerate adoption of food delivery and category creation. Based on the cohort analysis (Exhibit 2) provided by the company in their DRHP we anticipate a sharp reduction in promotional and marketing spends as the customer stickiness improves.
As the market consolidates, focus for both Swiggy and Zomato is now shifting to improving unit economics through promotion rationalisation, introduction of delivery fees, operating leverage and logistics cost optimisation. As can be seen in Exhibit 3 below, Zomato has seen a significant improvement in its unit economics.
FY22 contribution margins at 1.7% is significantly lower than 5.2% delivered in previous year as Zomato has ramped up its investment in Tier II, III, IV cities leading to compression in contribution margins. Zomato is now present in 1000+ towns and cities in India and out of these, top 300 cities contributed 99% of the gross order value and of these top 300 cities only 120 cities were contribution positive.
In Exhibit 4, the company spoke on profitability and how top 2 cities have consistently seen contribution margins in excess of 5% for the last 7 quarters, giving us the confidence on the strength in the unit economics of the company’s business model.
We believe economies of scale, knowledge about suppliers, increase in bargaining power and usage of EVs will help Zomato reduce delivery and other variable costs leading to an improvement in contribution margins (from current 1% levels) leading to company turning EBITDA and PAT positive leading to significant free cash flow generation and high returns on invested capital, given the asset light business model similar to any other platform company
3) Management Quality
Zomato started out as a restaurant review platform in FY2011 and expanded to food delivery in India in FY2015. It further launched the table reservation concept in FY2016 and Zomato Pro in FY2017. Acquisition of Carthero Technologies in FY2018 was done to add hyperlocal delivery capabilities. HyperPure was launched in FY2019. Finally, Uber Eats India business was acquired in FY2020.
Zomato is one of the very few start-ups from India who have managed to successfully pivot their business and thrive in a super competitive environment to eventually become the first new-age start-up to come out with an IPO in India. This speaks volumes about the quality of the management and their execution capabilities.
Zomato’s team is led by Deepinder Goyal, founder (also Managing Director and Chief Executive Officer), who holds an integrated master’s degree of technology in mathematics and computing from the Indian Institute of Technology, Delhi. Prior to founding Zomato, he worked with Bain and Company.
Long before Zomato became a billion-dollar public company, it was spotted by lone investor and founder of
NSE 0.83 %, Sanjeev Bikhchandani, who today sits on the board as a non-executive director. Bikhchandani has been instrumental in Zomato’s success, backing and supporting the founders through good and bad times.
Recently, Deepinder Goyal announced that he will be donating all his employee stock option plan (ESOP) proceeds worth Rs 700 crore to Zomato Future Foundation. The Zomato Future Foundation will be covering education of up to two children of all Zomato delivery partners who have been on Zomato’s fleet for more than five years. Initiatives like these give us confidence on management integrity and the type of culture that flows through into the company from the top.
In conclusion, we believe Zomato (having all the characteristics of a new-age tech company) led by a good management with strong execution capabilities, aiming to transform the eating habits of the large Indian consumer base has a huge runaway for a high and profitable growth in the years to come.
Sachin Shah
Fund Manager, Emkay Investment Managers Ltd.
Sachin is a seasoned fund manager with over two decades of experience in the Indian equity markets. By virtue of his extensive research, Sachin realised early-on the need for a framework in which companies with evasively tricky standing needed to be filtered out very objectively, leading to the development of E-Qual Risk, EIML’s proprietary module which helps us to evaluate and compare listed companies on various aspects of governance. Sachin shares his knowledge and insights through various media interactions across print and digital platforms.
