Family enterprise startups

Recently, Ambiga Dhiraj, co-founder of MuSigma, was appointed CEO of the company, replacing her other co-founder (and husband) Dhiraj Rajaram. There was a lot of chatter about the “first woman CEO of Indian unicorn”.

I didn’t see it that way. The way, I saw it, MuSigma was like a family enterprise, and so it was no big deal that one of the woman founders had become CEO. A couple of tweets went out:

People didn’t take my tweets too kindly. One guy quickly pointed out that she had had a pivotal role in building the company, and so she was more like Hillary Clinton than like Rabri Devi.

Another guy (a MuSigma employee) said that she’s gotten there on merit and not on account of her relationship.

While it might be the case that she got there on her own merit (I don’t know her at all, so can’t comment), the fact that she’s become CEO of a company she founded with her husband means that people will judge her on her relationships rather than purely on merit.

I wonder if this is a good reason to not start a company with a close relative.

On another note, I’d think twice (or maybe three times) before working for a company whose top management is closely related to each other – it will create a kind of glass ceiling and also a highly correlated top management meaning others will find it that much harder to create impact.

Counter staffing and service levels

I’m writing this from the international section of the Bangalore International Airport, as I wait to board my flight to Barcelona. It was a plan I’d made in October 2014 to “hibernate” for a few months in Barcelona during my wife’s last term of classes there, and this is the execution of the same plan.

There was a fairly long line at the passport control counters this morning, and it took me perhaps twenty minutes to cross it. When I joined the line, there were about 10 passport officers to say goodbye to Indian passport, so the line moved fairly quickly.

Presently, officers started getting up one by one, and going to one side to drink tea. I initially thought it was a tea break, but the officers drinking tea soon disappeared, leaving just four counters in operation, implying that the line moved much slowly thereafter. Some people were pissed off, but I soon got out.

It is not an uncommon occurrence to suddenly see a section of “servers” being closed. For example, you might go to the supermarket on a weekday afternoon to expect quick checkouts, but you might notice that only a fraction of the checkout counters are operational, leading to lines as long as on a weekend evening.

From the system of servers’ point of view, this is quite rational. While some customers might expect some kind of a moral obligation from the system of servers to keep all servers operational, the system of servers has no obligation to do so. All they have an obligation towards is in maintaining a certain service level.

So coming back to passport control at the Bangalore airport, maybe they have a service level of “an average of 30 minutes of waiting time for passengers”, and knowing that the number of international flights in late morning is lower than early morning, they know that the new demand can be met with a smaller number of servers.

The problem here is with the way that this gets implemented, which might piss off people – when half the servers summarily disappear, and waiting period suddenly goes up, people are bound to get pissed off. A superior strategy would be to do it in phases – giving a reasonable gap between each server going off. That smoothens the supply and waiting time, and people are far less likely to notice.

As the old Mirinda Lime advertisement went (#youremember), zor ka jhatka dheere se lage.

Grofers scaling down

Readers of this blog might be aware that I’m not a big fan of hyperlocal grocery delivery firm Grofers’s business model. The problem is that there are no costs saved to make Grofers its margin – apart from the retail inventory expense incurred at the retailer (from whom Grofers procures), there is also the last mile delivery expense that is incurred which doesn’t leave much profits.

The reason for Grofers scaling back from nine cities in India, however, is not related to this. It is more to do with market size and scale.

Given the uncertainties in terms of demand and service times, a business such as Grofers makes sense only when there is a minimum critical mass in terms of demand. Serving a locality with only one delivery person doesn’t make sense, for example, since uncertainty in demand will mean that either that delivery person is underworked or service levels cannot be guaranteed.

If the average demand in an area can support more delivery persons, though, this can smoothen out the uncertainty (that aggregation smoothens uncertainty is one of the fundamental principles of operations) and higher service levels can be guaranteed without building in too much slack.

While the cities that Grofers has pulled back from are not small (Mysore/Vizag/Coimbatore etc) it is unlikely that any of them would have had the size and density of demand in order to support a scale of operations which would make sense for Grofers. There are several reasons for this.

Firstly, Grofers only captures the incremental demand for grocery delivery, and with most small retailers already offering grocery delivery, the value Grofers adds is to deliver from large retailers. While I don’t have data to support this, my hypothesis is that large retailers have a smaller share in small cities thus cutting Grofers’s natural market.

Next, the transaction cost of travelling to the store is lesser in smaller cities, given shorter travel times (on account of both size and traffic), further cutting demand for on-demand delivery. Thirdly, while smartphones are widespread across the country, my hypothesis (again don’t have data to support this) is that usage is lower in smaller cities (compared to larger cities). Fourthly, smaller cities are likely to be less dense than larger cities (data on this should be available but NED to compile it now) meaning delivery personnel have to cover larger areas.

Some thinking can lead to more such reasons, but the basic point is that not only are these cities small, but demand for on-demand hyperlocal grocery delivery is also much lower (on a per capita basis) than in larger cities for several reasons.

These two factors have together meant that the scale (and density) of demand that is necessary for Grofers to be viable as a business was simply not there in these cities. So it’s a logical move for them to pull out.

This doesn’t answer, however, the question of why Grofers entered these cities in the first place, since the above factors should’ve been apparent before the entry. My hypothesis here is that some fast-growing startups measure their growth in terms of the number of cities they’re in. I’ll elaborate on that on another day.

Two kinds of Customer Acquisition Cost

A few days back, there was a story in Mint (Disclosure: I write regularly for them, and get paid for it) about Urban Ladder’s increasing losses. This was primarily on the back of increased marketing expenses, the report said.

Losses at Urban Ladder Home Décor Solutions Pvt. Ltd grew eight times to Rs.58.51 crore in the year ended 31 March from Rs.7.62 crore in the year-ago period, according to data available with the Registrar of Companies. Revenue rose 60% to Rs.19.21 crore from Rs.11.88 crore.

Advertising and marketing spending accounted for more than half of its expenses of Rs.77.72 crore. The online retailer spent Rs.40.24 crore on marketing, a whopping 11-time increase from Rs.3.57 crore a year ago. Employee costs surged to Rs.16.58 crore from Rs.4.69 crore.

With the startup madness starting to be tempered, with some companies (such as SpoonJoy) shutting down, others scaling back operations (TinyOwl, FoodPanda) and some others firing lots of employees (Helpchat, LocalOye), one of the big concerns in the startup ecosystem is “cash burn”, with a large part of the burn in most companies being accounted for by the cost of “acquiring” customers – you need to let your potential customers know that you exist, and get them to try you out in the hope that they become your regular customers.

All this is in the hope that once you “acquire” a customer, he will become a regular customer and so you defend your spend to acquire him (“customer acquisition cost”) based on the total profits you can make from him over a long period of time (“Life time value”). It’s not uncommon nowadays to see “CAC” and “LTV” being mentioned liberally in LinkedIn posts.

The problem with a lot of startups is that they continue to give “inaugural discounts” well after inauguration in order to achieve higher growth and customer base, only to see these customers disappear when the discounts disappear (US-based HomeJoy is a good example for this). In fact, I had written recently on the “optimal extent” to which a company should discount its products (the level at which the company can be profitable in “steady state”).

The thing with Urban Ladder is that while they are currently spending a lot of money to acquire customers (and a lot of it is through hoardings, known to be among the least effective ways to advertise),  they are not going the discount way. In other words, while they may have the odd seasonal discount the customers they acquire through their marketing activities still have to pay full price for the goods they purchase.

What this means is that customers once acquired have a higher chance of sticking on as long as they like their product – which is likely if Urban Ladder is doing a good job of designing products and marketing them to the right kind of customers. Even if Urban Ladder is going to cut down its customer acquisition spending at some point in time, that will only have an effect on the new customers being acquired, and existing customers will remain in the system.

Contrast this with a customer acquisition strategy built around discounting, where once the acquisition spend falls, existing customers are also affected and become more likely to exit the system.

So while it is fashionable to talk about “customer acquisition cost”, how this cost is incurred is important in determining how long the customers will stay. Spending on “third parties” (!= customers) to acquire customers is more sustainable than spending on customers. It is important to take this into consideration while determining if a company’s acquisition spending makes sense.

 

Flight food and choice

The topic of outrage for the day on Twitter seems to be Air India’s decision to serve only vegetarian food on flights that last less than 90 minutes. Predictably, given the current government’s policies and track record so far, people are decrying this as some sort of a “brahminical conspiracy”. This was even quoted as  a reason to privatise Air India (while I don’t agree with this reason, I fully agree that there are several other reasons to privatise Air India).

While outragers will outrage (and they might have a pathological need to outrage), this decision of Air India actually has sound basis. I had touched upon this in an earlier  blog post about why I get irritated with Indigo’s in-flight service.

The problem is that the more the choice you give customers, the slower the overall service will be. While this may not affect people seated in rows where service begins, it can be an immense cause of frustration for passengers who are seated in rows that will be served last.

In longer duration flights, this matters less since people who are served last will have sufficient amount of time to finish their meals before the trays have to be cleared in time for the flight to land. On shorter flights, however, the time available for meal service is so short that it is possible that trays might have to be cleared barely after a section of the passengers have started eating.

Eliminating choice significantly speeds up the meal delivery process (refer to my post on Indigo’s food for more on this), and ensures that people who have been served last have sufficient time to finish their meals before trays have to be cleared. While it may not take much time for the steward to ask the customer her choice, considering the total cycle time (along with passengers asking details of the menu, etc.) and the number of passengers to be served, cutting choice is a sound decision indeed.

As for the vegetarian option, when there is no choice offered, it is natural to go with the option that satisfies the maximum number of people. Considering that Indians don’t eat much meat (while only a small proportion of Indians are vegetarian, overall meat consumption is very low), it is a rather obvious choice that only vegetarian food will be served.

This is a commendable decision by Air India and I hope they stick to it. I hope other airlines will also learn from this and cut choice in their inflight menus (Indigo, I’m looking at you) so that passengers can be served with the minimum uncertainty and minimum fuss.

Tailpiece The above linked NDTV Profit piece has a bizarre comment from an expert. Quoting:

However, according to travel industry expert Rajji Rai, the state-owned airline should have first carried out a passenger survey, which is an industry practice, before affecting any change in the menu.

“Airlines world over carry out customer surveys before taking such decisions. Unfortunately, Air India is very poor in such practices. This decision to discontinue non-vegetarian food on these non-metro flights is just one-sided,” he said.

Surveys are overrated in my opinion, and there is no reason Air India should have conducted a survey before making this decision – for they have access to significant amounts of actual customer preferences over a large number of schedules. The value of a survey in this case is at best marginal

Uber’s anchoring problem

The Karnataka transport department has come out with a proposal to regulate cab aggregators such as Uber and Ola. The proposal is hare-brained on most  counts, such as limiting drivers’ working hours, limiting the number of aggregators a driver can attach himself to and having a “digital meter”. The most bizarre regulation, however, states that the regulator will decide the fares and that dynamic pricing will not be permitted.

While these regulations have been proposed “in the interest of the customer” it is unlikely to fly as it will not bring much joy to the customers – apart from increasing the number of auto rickshaws and taxis in the city through the back door. I’m confident the aggregators will find a way to flout these regulations until a time they become more sensible.

Dynamic pricing is an integral aspect of the value that cab aggregators such as Uber or Ola add. By adjusting prices in a dynamic fashion, these aggregators push information to drivers and passengers regarding demand and supply. Passengers can use the surge price, for example, to know what the demand-supply pattern is (I’ve used Uber surge as a proxy to determine what is a fair price to pay for an auto rickshaw, for example).

Drivers get information on the surge pricing pattern, and are encouraged to move to areas of high demand, which will help clear markets more efficiently. Thus, surge pricing is not only a method to match demand and supply, but is also an important measure of information to a cab aggregator’s operations. Doing away with dynamic pricing will thus stem this flow of information, thus reducing the value that these aggregators can add. Hopefully the transport department will see greater sense and permit dynamic pricing (Disclosure: One of my lines of business is in helping companies implement dynamic pricing, so I have a vested interest here. I haven’t advised any cab aggregators though).

That said, Uber has a massive anchoring problem, because dynamic pricing works only in one way. Anchoring is a concept from behavioural economics where people’s expectations of something are defined by something similar they have seen (there is an excellent NED Talk on this topic (by Prithwiraj Mukherjee of IIMB) which I hope to upload in its entirety soon). There are certain associations that are wired in our heads thanks to past information, and these associations bias our view of the world.

A paper by economists at NorthEastern University on Uber’s surge pricing showed that demand for rides is highly elastic to price (a small increase in price leads to a large drop in demand), while the supply of rides (on behalf of drivers) is less elastic, which makes determination of the surge price hard. Based on anecdotal information (friends, family and self), elasticity of demand for Uber in India is likely to be much higher.

Uber’s anchoring problem stems from the fact that the “base prices” (prices when there is no surge) is anchored in people’s minds. Uber’s big break in India happened in late 2014 when they increased their discounts to a level where travelling by Uber became comparable in terms of cost to travelling by auto rickshaw (the then prevalent anchor for local for-hire public transport).

Over the last year, Uber’s base price (which is cheaper than an auto rickshaw fare for rides of a certain length) have become the new anchor in the minds of people, especially Uber regulars. Thus, whenever there is a demand-supply mismatch and there is a surge, comparison to the anchor price means that demand is likely to drop even if the new price is by itself fairly competitive (compared to other options at that point in time).

The way Uber has implemented its dynamic pricing is that it has set the “base price” at one end of the distribution, and moves price in only one direction (upwards). While there are several good reasons for doing this, the problem is that the resultant anchoring can lead to much higher elasticity than desired. Also, Uber’s pricing model (more on this in a book on Liquidity that I’m writing) relies upon a certain minimum proportion of rides taking place at a surge (the “base price” is to ensure minimum utilisation during off-peak hours), and anchoring-driven elasticity can’t do this model too much good.

A possible solution to this would be to keep the base fare marginally higher, and adjust prices both ways – this will mean that during off-peak hours a discount might be offered to maintain liquidity. The problem with this might be that the new higher base fare might be anchored in people’s minds, leading to diminished demand in off-peak hours (when a discount is offered). Another problem might be that drivers might be highly elastic to drop in fares killing the discounted market. Still, it is an idea worth exploring – in my opinion there’s a sweet spot in terms of the maximum possible discount (maybe as low as 10%, but I think it’s strictly greater than zero)  where the elasticities of drivers and passengers are balanced out, maximising overall revenues for the firm.

We are in for interesting days, as long as stupid regulation doesn’t get in the way, that is.

Cash on delivery

One of the big problems in the Indian e-commerce industry is that a lot of business happens through the “Cash on delivery” model, where the customer pays for the goods upon receiving it rather than at the time of ordering. According to sources, nearly three fourth of e-commerce in India is paid for using this model.

The problem with Cash On Delivery (COD) is that it leads to higher product returns and non-deliveries, since the recipient is not pre-committed to accepting it. While e-commerce vendors might try methods such as blacklisting customers in order to cut their losses, there is no clear solution in sight. COD is also a massive source of fraud, especially given that currently e-commerce platforms are more likely to subsidise rather than take a cut of transactions on their platforms.

One of the reasons given for the development of the COD model is the low credit card penetration in India (compared to other markets), and Indians’ unease with transmitting money online. Research (which I can’t be bothered to find and link to right now) shows that the Indian e-commerce industry actually took off once CoD was introduced.

Given that India is developing some new and innovative payment systems (the Immediate Payment System (IMPS) is one. There is a Unified Payments Interface (UPI) which is even better which is coming up), it will be interesting to see how the e-commerce industry in India shapes up from a payment standpoint.

There are two factors that drive CoD – one is the ease of payment transaction – you just hand over the cash to the courier when the goods are delivered. This is not seamless, of course, since it could involve problems involving change, and handling of large amounts of hard currency which makes it unsafe.

The other factor is trust – Indians don’t seem to trust vendors enough to pay for their goods before they receive them. While not prepaying gives the option to change mind at a later date, this can lead to significant friction in the system resulting in costs that are likely to get added to the customer (this doesn’t happen right now since platforms are still in heavy subsidy mode).

By paying for goods on delivery, the customer hedges against fraud by the vendor, and the transaction is smoother from the customer’s perspective.

While the industry claims that CoD is primarily due to lack of credit card penetration, my hypothesis is that it is more due to the trust factor. So far there has been no method (apart from possibly surveys which are internal to e-commerce platforms and which will never get disclosed) to understand which of the two it is.

With the development of new and innovative payment platforms, and the ability for a large number of people in India to transact online (willingness is another matter), this hypothesis can be tested. Once people have access to mobile apps that let them make instant and secure inter-bank payments (we are already on our way there), the low credit card penetration is unlikely to be a constraint against pre-payment for goods. If my hypothesis is true, the proportion of CoD will not fall despite the growth of these new payment methods.

There are flies in the ointment of course – platforms, driven by losses, are investing in moving customers away from CoD, so the data might not be very clear. Also, over time, people may develop more trust in e-commerce companies and start pre-paying, which will not tell us anything about their confidence levels right now.

We are in for interesting times!

PS: Like telecommunications (where most of India skipped the landline) and retail (where India skipped the “walmart step”), the payments industry in India is also likely to “leapfrog”, with a large part of the country set to bypass credit cards altogether.