Nov 19, 2022

Business fundamentals sidelined by the startup ecosystem

We are regularly updating our knowledge on various aspects of our business, its facts, and figures. Since we are professionals and working in business environments so there we have to be equipped with the current affairs of our ecosystem. 

💥I am working in a Kirana startup ecosystem and also heading a startup in B2B grocery retail so there my daily routine is to keep myself updated with the latest developments and maintain the information flows. Like me, there are many professionals who are closely following the stream. Things are related to startups, investors, and the ecosystem. No doubt things were moving in the retail ecosystems since 2014 onwards in the right direction and a big buzz is there in terms of investment and turning startups into unicorns. Startup definition in layman's language, Startups are those who do execution with speed, and how fast they were able to achieve the status of a unicorn or smart valuation was the basis of success. Huge money was pumped by the VC funds, angel investors, family offices, and HNIs which helped more than 75 startups turn unicorns in the last three years time. I am fully convinced of the things that were brought in by the innovators. But, We are bound to certain fundamentals and basic Laws, so the same is applied to businesses where things are very much driven by few fundamentals. The fundamental law of business is to earn profit from business activities through whatsoever practices. Let's jump to the preamble of this article " Ignorance of Fundamentals by the Startups and how they sidelined it" 

👉Startups and investors both started working on some easy conversion approach which led towards meanless directions somewhere. I am going to let you understand the fundamental approach in layman's style. This will surely match with the ongoing practice of the ecosystem stakeholders. A few things remain constant which we called by fundamentals so the same is applicable to Startups and investors both.

Inside of Investors and how they forget to apply fundamentals of investment: 

Investing is simply the process of acquiring assets that you hope will grow in value. Investments can include owning a home, owning a business, owning real estate, or having money in savings accounts and CDs at a bank or credit union. Investors in the startup ecosystem have some different theses. Investors do have many theses to work on but again they are concluding their decision that out of 10 investments they will succeed to get a handsome exit in 2 or 3. This means 7 or 8 investments will go in vain and will be a failed decision. Here somehow they are breaching the fundamentals of investing and driving them in the direction of such thoughts. Here my question is why out of 10 investments, 2 are getting successful and some many cases even this is also not. And if such things are there then what is the use of evaluating the startup, asking for an Investment Deck, and carrying strict Due diligence? 💥and

If the startup business model is so convincing, disruptive, and scalable then how things go negative in near future? 

This shows that the fundamentals were not analyzed before shortlisting the startup and evaluating them or what about the business model of the startup they believe it will run and will do best in near future. Why am I stressing about this? Every business has certain set rules which have to be followed religiously, these rules are the basic principles of that business stream. I am not talking about completely IT-driven business models or ideas that can operate certain businesses on the cloud with nothing physically running on it. 

But, again if there is the physical movement of goods and services in the business model like it is in grocery eB2B retail then one cannot ignore the fact. An investor needs to differentiate those things while finalizing startups for further-stage investment proposals. If any real business is growing on the ground then it will take time to reach a level i.e. to reach a scale or become profitable. There are no shortcuts to making them successful overnight or say in two, three, or five years. awesome? How can a VC expect 100X returns or 20X, or 10X? Just think about the cost of that money investing in a startup for a given period of time and calculate the return. The shortcuts are good if they help to save time and money but business fundamental works on certain laws.

The calculation of interest over market risk and its return is the soul of investment. A 5x return is logical if the primary work is done thoroughly by the investors before investing in a startup. If you being an investor don't believe in the idea or you are thinking that 80% of the investment will be completely devastated and you will make your money from the rest of the investment in Multi X returns then don't invest.

Investment is not gambling and investors should not be gamblers  

My above thoughts would give a contrary impression of the present scenario. But, let us not forget that the current landscape of investment in the startup ecosystem is mount formation. Currently, the law of 👀FOMO is operating in the ecosystem and no one wants to be left out of the race. This show of changing caps is in the stream. Early-stage investors want to hand over the hat to the big one and this goes on till the startup either succeeds or fails. One needs to think deeply. The same is going with startups. 

Fundamental of business that startups are not following. 

Startups too have some shortcomings or failures on the ground of applying basic fundamentals in their business model. There are startups that are really working on some problems at large and through their innovative ideas, something good has been built. We can talk about #Zarodha #Groww #cardekho #Shopify #Swiggy #Zomato. They definitely brought disruption in their area of exploration. In a true sense bringing disruption in the segment is a kind of outcome by the Startups. If we analyze deeply the inside story of successful startups, we will find that they are totally IT-driven businesses and without their stack or involvement business processes can't take place. I would categorize them as Startups working on the cloud. However, in the case of Swiggy, Zomato, Dunzo, etc and other delivery startups will have profitability challenges but they are creating adoption and consumers take them as granted. Again fundamental of these businesses has to be taken care of.  

Business fundamentals are logical and have the compulsion to fit them in the business stream before ideation, implementation, and execution. 

If your startup is involved in the physical movement of goods whether it belongs to grocery retail or other retail formats, you have to inbuild them on your own to tune with some set of market conditions that are prevailing in the market and no one can bypass them. The cost of changing existing conditions is very high. Let's understand this equation through a real-time example.  Startup ABC is working in grocery retail. They got the idea of building an online marketplace for grocery retail, Built a high-stack IT solution for the stack holder. It is a seller marketplace model. The model is called eB2B online marketplace, onboarded thousands of Kirana Retailers on their IT platform, and started reaching them through Mobile App. This is a kind of Direct to Retail Model. Why they thought of bringing this kind of change into the ecosystem as a new idea and how it helped them to raise money? Definitely, Startup ABC found some gaps in the market, Problem was large so they started working on a solution. Filling up the gap and finding solutions. In their pitch, the startup is working to empower Retailers by way of providing them with one umbrella solution as a Supply Chain Aggregator. DTR model removed the middle distribution channel resulting increase in margin. This is how a new idea takes place and the same is with other eB2B startups or even B2C or D2C or Agri startups. In these kinds of startups, there is the physical movement of goods involved at each stage.

Now, what happened wrong to this business model? I don't want to mention the name of startups working in this segment. You know them, but the question, again and again, is why they are not making profit despite raising huge money, even burning the entire amount, and also scaling to other territories like crazy. They tried to convince investors that their business model is scalable and profitable. 

Here is the answer, they failed to incorporate the fundamental of such businesses that they tried to disrupt through the innovative business model and intervention of costly IT tools. What are those fundamentals: 

  1. Lack of Business Mindset
  2. Half of knowledge is dangerous 
  3. Trying to change the traditional miniature practices of market 
  4. Managers are driving the low-margin business in high profile style
  5. Burning money on adoption.
  6. IT-driven business is for unfriendly IT users like Retailers seldom use.
  7. Founders are highly paid without bringing profit to the organization  

A lack of a Business mindset is the first fundamental requirement for a business. The founders should have a business-mindedness or else they will become puppets in the hands of the investors or their KMPs. Mere finding a problem in a certain area and working on it through KMPs will lead to a possible failure. A business mindset founder protects the business by predicting near-future trends based on his inherent capabilities. This helps them to align their business strategies on time. In the current startup ecosystem, founders are not of that mindset or I would say most of the founders are technocrats. They firmly believe that an IT-driven business model will scale and will be the valuation driver. The business cannot be projected the way IT can run it. It has to go through the market conditions and accordingly needs to be coordinated with the business owners.

Half knowledge is dangerous: Skill-driven founders are willing to disrupt retail based on some logical business verticals, but for physical business, they must have a deep understanding of market conditions and business terms in the first place. The skill set is more likely to be the first choice of professional investors as they have the ability to grow a loss-making business and increase valuation and even turn it into a unicorn. Half the knowledge of market practices by the founders is dangerous and ultimately the ground-level work does not synch with the projected one, resulting failed venture. 

 Trying to change traditional business practices: Let's talk about grocery business or FMCG business in India. Both streams are being carried by a series of middlemen. The margin spread is there to feed all of them in their stage of execution but that is too much narrow. In the FMCG business- Brands distribute their products to retailers through CFA, SS, distributors, and then retailers. Retailers further sell to final consumers. In the staples stream, this is done through local mandis, traders, and wholesalers/ Semi Wholesalers.

What is the harm in it if one is trying to bring solutions for the retailers and provide them with one umbrella solution? This question will come to the readers. But, a major point here is that the basic principles of traditional practices were violated. Generating margins is a big deal in grocery retail but an existing traditional channel of distribution is making money from this low-margin spread by keeping its shows on a low profile. “Remember – the cost of running a business through managers is always a costly affair but running it through existing owners is always cost savvy and effective”. Distributors, SS & retailers are owners of their businesses. They are working in a very low profile and master of earning profit from its thin margin basket.

Another main reason for not making a profit is: Squeezed margin - Brands are not giving preference to such startups as they do not want to disturb their existing channels, however on the same way, they do not want to lose the opportunities that these startups are bringing, however here they are not sacrificing on the margin side. In some cases, they did so but again had to roll back their decisions amid strong opposition from existing channel partners as channel conflicts broke out.

I am giving stress on this point because this is one of the major aspects and practices where startups are hammering. As an eB2B startup, you have asset-heavy operations in terms of heavy opex, cost of setting up systems, and processes. based on analyzing the financials of existing eB2B players. How they will earn from a thin layer of margin is again subjective but if someone is there who is bringing operation excellence and capabilities will definitely earn profit and make their startup a real business.  

Managers are driving the low-margin business in a high-profile style:  The managers are managing the show of the low-margin business of various startups as they are not working with the existing middle distribution channel where the owners are working. Getting work done through managers is always expensive, whether the traditional distributors are working at a low cost and earning profit and matching ROI. Setting up systems and processes always attracts a good number of cost components. Metro Cash & Carry, Walmart, and other heavy Capex and Opex run models are examples.

Burning money on adoption. India is not a country where we think of bringing change in all spheres as we are living in different walks of life where there are different demographic changes in our religious thoughts, food habits, tastes, customs, and even in society. The business model of a startup is based on certain principles of optimization. It refers to the process of changing the product in which it is made, to meet the needs of customers in a market other than that in which it is made. This means changing products to bring about customization in the long run and that brand has to spend heavily for free sampling or up to a level where demand can start spontaneously. But, India is a country of diversity, and spending to bring about adoption is a costly affair. No one can change the behavior of Indian consumers. A startup always failed to meet the hyperlocal requirements or they are not able to align with the diverse requirements.

IT-driven business is for unfriendly IT users like Retailers seldom use. Startups are getting funded based on their IT stack as VCs are investing in startups where IT is the product and the main driver of the business. But, one-third of India's population is still struggling to meet their daily needs. As per the current data, only 43.5% of mobile users are using smartphones. 40% of grocery retailers are using basic phones or they are using basic features of smartphones. This means that people are still unfriendly towards smartphones. Startups are trying to bring use cases where their end consumers can start using their smartphones to order goods. This adoption happens when we talk about B2C marketplace but it is not the case in B2B. What if you are working on a solution that the end user is not using. According to a market survey, only 30 out of 100 retailers are using B2B startup App to order merchandise, with the rest relying on the foot-on-street manpower of those startups.

Founders are highly paid without bringing profit to the organization:  The fundamental crunch is once again seen in this, & and the founding team and KMPs take home a large amount in terms of salaries. The basic rule of business is that promoters should take cash from the business for their personal use only when the business is making a profit or can take a minimum amount to run their family's daily bread and butter but in most cases, startup founders are using to build their personal wealth. Most of them are enjoying a hefty amount of salary, accommodation etc. This is a layman's argument about how a loss-making startup is letting its money go out of its cash flow. Startups are struggling to get funds but founders are investing in other startups as angel investors. Startups like Paytm, where investors' money evaporated within a year of their IPO launch, but individual founders are running their own personal wealth funds and investing in startups. 

There are many other points to elaborate but a question always will be raised by professionals why is the ecosystem not following the basic fundamentals of business? Investors and startups need to think about the basic rules and fundamentals. Disruption is not what comes with success rather it disturbs the existing ecosystem at large if certain basic principles of business are not followed. And the cost of disorganizing the existing system is huge which eventually leaves ashes of burning money behind with a tag of failure.

Ignorance of fundamentals is tantamount to ignorance of the law which will not bail you out on the basis of ignorance of the law. The same logic applies in the business where the ultimate objective is to make a profit. And making a profit from the business is always an art and some fundamental principles have to be followed.

We are operating in the Food & FMCG grocery retail ecosystem in India. As an emerging organization, we carry the business fundamentals and startup mindset of innovation in our business model. Our focus is on building a technology-enabled platform for brands, distributors, wholesalers, and retailers. Taking the grocery retail ecosystem with us at every step for their empowerment so that we can contribute to building a $ 5 trillion ecosystem in the coming years.

A Layman write-up is written by Balwant Singh Rana, the Kirana Retail professional

written on: 18.11.2022, Jaipur, Rajasthan (India)

 

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