Why investment in Retail & e-commerce is Risky?

There are certain characteristics that are common across all fundamentally good business, one such characteristic is “pricing power”.

Pricing power is an economic term referring to the effect that a change in a firm's product price has on the quantity demanded of that product. Pricing power ties in with the "Price Elasticity of Demand."

Try to think of a brand that you would continue to buy even if the its price is increased substantially? Usually, companies are not in a position to increase the prices of its products at will, they fear loss of market share to rivals.? So, they have to price a product such that the volumes are not sacrificed.

But what if your product is unique? What if you are the only seller? What if people depend on your product in their everyday live? THINK APPLE. Humongous pricing power is the reason behind Apple being the world's most valuable company, because the company has such a strong brand recall around it that it knows that people will not stop buying even if it increases the price by 10%.

Retailing is the definition of “No Pricing Power”.

Be it Big bazaar, Walmart or Flipkart, these stores mostly sell the same stuff. The can of coke that you buy from Big Bazaar is identical to the one available at Walmart, people will not be willing to pay more to buy coke from Big Bazaar. Therefore, there is hardly any brand loyalty towards these stores, we simply buy from the store which is offering the product at the cheapest price.

If you manufacture a product, say shoes, you have the freedom to put a price tag on the product (to some extent). You decide the money you would make on a pair and you also decide the margins for the retailer and the distributor. So the manufacturers or service providers at least have some kind of pricing power. But retailers are bound by the MRP decided by the brand owner. So, a retailer cannot increase the price of the products it sells, even if its own operating costs are increasing. All it can do is reduce the discounts and offers. Whereas other companies have the option to transfer the rise in costs to the consumers.

Their problems are unlimited

So, to sum up, these retail businesses -

• Cannot even decide the price at which they want to sell the goods,
• Offer no product differentiation,
• Require huge amount of working capital,
• Maintain large inventory and
• Face Unending competition from every other departmental store.

Large scale organized retailers like Walmart and Big Bazaar try to gain pricing power by introducing "private labels". These are brands owned not by a manufacturer or producer but by a retailer or supplier who gets its goods made by a contract manufacturer under its own label. All those "Tasty treat products in big bazaar" or "Symbol & "Amazon Basics" products on Amazon are examples of private labels. Since these brands are owned by the retailers, they are free to price their products according to their needs.

But then it’s not easy to market these products.

Firstly, these products are exclusive to a particular retailer, so it’s difficult to create brand awareness & recall.

Secondly, they usually fail to match the quality of their branded rivals, because you cannot expect a fizzy drink under the 'Tasty Treat' brand, to match the quality & taste of Coke, which has a centuries of expertise and a winning recipe behind it. Therefore these private labels brands are often rejected by the customers owing to lacking of brand recall & quality.

Why Flipkart is a bad business?

The situation for online retailers is not very different, we simply buy from the website that offers the product at the cheapest price, we are hardly loyal to Flipkart, amazon or Snapdeal. Therefore, it becomes difficult for these companies to operate profitably. As soon as they think of earning profits by reducing discounts, the buyers switch to a different website. An e-commerce player is only competitive till it has the funding to discount the products. So, while it’s easy to increase revenue, it’s almost impossible to earn profits by reducing discounts.

It's like riding a tiger, not knowing how to get off without being eaten.

The Amazon Difference

Amazon is one of the very few eCommerce firms which have achieved profitability while maximizing revenues as well.

The reasons for Amazon's success are Exclusive products & services like -

• Kindle,
• Amazon Prime Video and
• Cloud Services.

It's through these original products & services that Amazon was able to earn profitability. So, it wouldn't be wrong to conclude that it is a successful products & services company rather than an e-commerce one. Of course, these offerings have also helped its eCommerce business, but it was largely dependent on the network effect & switching cost benefits arising out of these innovations. 

Also, it took 20 years for Amazon to become profitable. It took 20 long years, even when the strategy, execution and timing was absolutely impeccable! it would have taken an eternity for it to earn profits if the execution would have been slightly wrong.

It's clear that Retail is a difficult business to master, the balance sheet of Big Bazaar, Flipkart, Snapdeal etc. testifies it. It requires a genius manager like Jeff Bezos to turn profitable!

Here is what Warren Buffett has to say on this -

“Buy a Business that even an idiot can run, because sooner or later, an idiot will run it”.

It’s safe to conclude that retailing is certainly not an easy business to manage. Before you invest, Ask yourself - Does the business has Pricing Power?