The e-commerce landscape in Bangladesh is quickly evolving as more than three million people placed an e-commerce or f-commerce order in the last twelve months. With the rise of smartphone and internet penetration in the country, it is safe to assume that a healthy portion of the vibrant retail market in Bangladesh will be won by the e-commerce companies within the next five to seven years. As a result, it is incredibly important for all stakeholders to understand the ecosystem that makes e-commerce possible.
When a customer places an order to be delivered to her home, a complex set of operations start. Essentially, there are two types of e-commerce business model. The first is the Market-place Model where e-commerce platform doesn't take inventory risk and essentially works like a digital shopping mall. One small business can list its products on the e-commerce page and the e-commerce company gives logistics services (like deliveries and customer care). The second one is the E-tailer Model where the company sells its products via the internet. The company takes the inventory risk. It is important to note that few pure market-place models are operating in Bangladesh. Most of the biggest e-commerce players in Bangladesh have their warehouse where they keep their high-frequency SKUs and take the inventory risk.
Once an e-commerce figures out what type of operating model it is subscribing to, these are the essential parts that the e-commerce company needs to figure out:
Any e-commerce starts with what type of products it is selling. In choosing the products, the e-commerce can provide three types of values to the customer; in price (by giving the lowest price in the market as e-commerce typically has better margins than brick-and-mortar stores), in variety (a customer can inspect thousands of shirts with some easy search and filter options) and in convenience (the products are delivered at home). In a country like Bangladesh where the e-commerce ecosystem is still developing, most of the sales come from branded products with a discount. Without anyone's surprise, phones and phone accessories are the highest selling SKU for most of the e-commerce operating in Bangladesh. When a customer decides to buy a Samsung phone, it hardly matters which retailer is selling the phone. Whether he buys it from the local Samsung store or an e-commerce, the customer is getting the same phone. If a customer can save BDT 1,000 on a BDT 20,000 phone from buying from a particular website, she will opt for that option. The second type of product is off-branded products. The main reason for buying off-branded products from an e-commerce website is the variety the consumer gets. Choosing a shirt from hundreds of options by visiting retail clothing stores can be exhausting. One can easily choose his favourite shirt from an e-commerce with different filters (business-casual, different colours, brands, stripe-plain, etc.). The third type of product is private label brands where e-commerce launches its products. While a few e-commerce companies are trying this option, market size is still very small.
Once the product mix has been finalised, the next step is to acquire customers. An important metric is monthly visits (how many hits on one e-commerce website or app, its breakdown from various sources and the month-on-month growth) and conversion rate (how many people are ordering). The conversion rate ranges from 2.5 to 3.5 per cent in Bangladesh. Even in highly successful e-commerce companies, the conversion rate is rarely more than 10 per cent. Then, any e-commerce company needs to look at the customer acquisition cost. A portion of the customer acquisition cost is the discounts and cashback he gets on various products. In Bangladesh, cashback and discounts are still the main forms of customer acquisition cost. This is great news for the consumers as their phones and motorcycles are subsidized by Jack Ma. However, the price war is not great for e-commerce businesses. The best example is the price war between Lazada and Shopee in the ASEAN market, which resulted in a cash crunch for both of the companies. Understanding consumer behaviour is the key to minimizing the customer acquisition cost. The best example in Bangladesh is the mobile money platform bKash, which has reduced its customer acquisition cost to less than BDT 100 per customer. As a whole, the e-commerce industry in Bangladesh is adding incredible value to the rise of digital marketing companies.
Once an e-commerce has the product portfolio and the orders are coming in, the company needs to figure out how to deliver those products to the customer. Innovative ways of warehouse and inventory maintenance can help the company but the logistics cost is the biggest issue for the e-commerce businesses in Bangladesh. Particularly, unit economics is yet to make sense for small basket sizes. For example, let's imagine, the average basket size for grocery e-commerce is BDT 300.0. If the company uses third-party vendors, the delivery charge per order should be around BDT 50, erasing all of the gross margins. The company can maintain a delivery fleet of vans, motorcycles (most of the e-commerce company in Bangladesh uses TVS XL 100, that bike has some obvious advantages). In that case, however, the company needs to find out the perfect balance between the peak and off-peak order time. The delivery fleet will remain underutilized for five-days a week and then the company gets 3,000 orders on a Friday afternoon and the promise of "2-hour delivery" falls apart. The unit economics for larger basket size is a bit more forgiving but no e-commerce company is yet to figure out how to minimize the delivery cost with a scalable model.
Then comes the issue of payment. This part has been figured out in the Bangladesh e-commerce ecosystem, thanks to the popularity of bKash. However, dependence on bKash has its consequences.
The final equation of the e-commerce ecosystem is consumer financing. In the e-commerce ecosystem in Bangladesh, this is the blue-ocean territory. E-commerce companies and financial institutions in Bangladesh can work together and unlock incredible value for both the banked and unbanked population. Consumer financing is a key part of the buying experience. Given the low penetration of credit cards in Bangladesh, various companies have figured out different mechanisms to provide that financing for the consumers. Singer sells electronic products at instalments, and Nitol, Ifad, and other commercial vehicle manufacturers sell trucks at instalments but the to duplicate the same business model is almost impossible for any e-commerce. If an e-commerce company decides to take the loans on its books, the company's accounts receivable will balloon up and the cash conversion cycle will be a mess. With the high cash needs for an e-commerce business, it is difficult for the company to pursue such a strategy.
The tech is the underlying factor that optimises an e-commerce companies operations. With great tech, the company can find the correct product portfolio, reduce customer acquisition costs and increase customer lifetime value, reduce logistics cost and optimize payment systems. Tech is the thing that differentiates an e-commerce company from a traditional retail company.
The e-commerce companies in Bangladesh are facing some obvious problems that can be eradicated with correct initiatives.
Remember that we mentioned the e-commerce ecosystem has figured out the payment component of the model, thanks to bKash. Well, that comes at a cost. The average merchant fee for mobile financial transaction is 1.5 per cent. E-commerce companies have contracts with online payment gateways like SSL Commerz and Portwallet, and the charges are usually 2.5 to 3.0 per cent. Given the extremely thin margins of any trading business, a large portion of the gross margin is eroded by the high payment processing fees. For example, let's say, the gross margin for a mobile phone is 6.0 per cent. If the customer uses an MFS/digital payment provider for payment, 25 per cent of the gross margin (1.5 per cent of 6.0 per cent) will go to that payment provider. The margin erosion is even more severe if the customer uses a credit card to pay for the phone because 40 per cent to 50 per cent of the gross margin will go to the online payment gateway. The situation gets even worse in case of cancelled orders. Let's say, one e-commerce company sold 100 phones prepaid by bKash and 20 of those orders got cancelled. Using a 6 per cent margin, the company's gross profit will be 4.8 per cent but the payment processing fee will be 1.5 per cent. Therefore, the company will generate 3.3 per cent in the gross margin after payment processing fees. In this example, the payment processing fee eroded more than 30 per cent of the gross profit.
The second problem is the issue of stock-out that creates a bad customer experience. Most of the vendors doing business with the e-commerce companies in Bangladesh are small and medium-sized vendors and most of them do not maintain a live inventory. As we can see from the previous example, cancelled orders and high payment processing fees erode the gross margin of e-commerce in Bangladesh. An e-commerce company operating as a market-place model has virtually no control over the inventory it shows on its website. Stock-out is the number one reason for order cancellation in Bangladesh. Vendors rarely mention any stock-outs before the order is placed. The e-commerce website/app then show the product as stock-out on its website or app. The e-commerce company can update the product status for a few high-frequency SKUs using person-to-person communication with the vendor but the process becomes increasingly difficult as the company adds more SKUs and vendors to its ecosystem.
Here's a controversial one that the economies of scale theory might not work in e-commerce. What is the primary financial goal of any e-commerce business? The answer is to break-even after customer acquisition cost and logistics expenses. Now, the next question is at what revenue do you achieve that (if you want to deep dive, what is the average number of orders per day and what is your basket size when you break-even)? This is the question that the e-commerce companies in Bangladesh are yet to figure out. Do you break-even at 3,000 orders per day, 10,000 orders per day or 50,000 orders per day? No one knows that. This can be best illustrated in the biggest company in the world (and what e-commerce companies in Bangladesh aspire to be) Amazon. This is Amazon's operating model from 2006 to 2017 (see Chart).
As a company, Amazon increased its revenue from USD 10.7 billion to USD 177.8 billion in only ten years. However, take a look at the net shipping cost (shipping revenue - shipping cost) as a percentage of total revenue. Net shipping cost as a percentage of total revenue increased from 2.96 per cent in 2006 to 5.6 per cent in 2017. More orders did not result in the lower shipping cost for Amazon. In case the e-commerce companies in Bangladesh think that more orders will reduce their logistics cost, just taking a look at Amazon's operating history will bring them back to reality. (A note of caution: this is an extremely naïve analysis of Amazon's numbers which requires much more nuance. Amazon's revenue includes subscription fees from Prime members and AWS. But I will argue that the same logic holds here. Amazon's revenue would not have grown so rapidly with lower net shipment costs. Imagine a Bangladeshi e-commerce company that charges BDT 20 as delivery revenue per order vs other e-commerce company that has free delivery. Given all the other factors are equal, the company with a free delivery charge will see its revenue grow faster than the other one).
Analyzing the venture capital movement in the world can be a fascinating journey. There is always a particular era that favours a particular industry in the VC investment. The type of capital needed for e-commerce is not aligned with the investors' needs now. E-commerce is cash heavy business and typically takes a number of years to break even. Few Bangladeshi investors can stomach that type of risk appetite and heavy cash burn. Therefore, most e-commerce companies in Bangladesh need to look for foreign capital. E-commerce was the favoured sector for VCs in the 2011 to 2015 period. Flipkart, Lazada and Shopee got billions in funding during this period. Then the whimsical VCs moved to the ride-sharing sector. Ola, DiDi and Grab raised good investments in this period. Now, the general VC sentiment is in two sectors; startups that work for financial inclusion and the super-apps. Convincing a VC to invest in traditional e-commerce, without an interesting twist in the business model, in Bangladesh in 2019 can be extremely difficult.
Well, the last issue must be in the conspiracy theory territory but not one without any merit. The question we need to ask is who is the biggest competitor of the e-commerce companies in Bangladesh. The answer is no other e-commerce but traditional retail stores. As the Walmart story goes, when Walmart goes to a US town, all the traditional mom and pop stores had to shut down. The same goes for e-commerce companies in Bangladesh. When someone buys a shirt from an e-commerce site, a clothing retailer is losing its business. Now, the e-commerce business in Bangladesh is too small to make a dent in the retail business. But as e-commerce in Bangladesh grows, there will surely be some pushback from this community. While the collective power of these retail business owners in Bangladesh can't be measured, they will surely oppose the growth of e-commerce. This opposition can come as the e-commerce business grows. Another important stakeholder is the regulators. E-commerce is still a relatively small sector but regulators are already taking notice. The latest 5.0 per cent VAT on the e-commerce business commission is an example of this phenomenon. As the e-commerce business in Bangladesh grows, new regulations will surely be implemented and that is the challenge e-commerce needs to get ready for.
S M Samiuzzaman is the Head of Financial Analysis at Deligram Technology Limited.
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