Barriers to entry in cab aggregation

The news that Reliance might be getting into the cab aggregation game got me thinking about the barriers to entry in this business. Considering that it is fundamentally an unregulated industry, or rather an industry where players actively flout regulations, the regulatory barrier is not there.

Consequently, anyone who is able and willing to make the investment and set up the infrastructure will be able to enter the industry. The more important barrier to entry, however, is scale.

Recently I was talking to an Uber driver who had recently switched from TaxiForSure. The latter, he said had lost “liquidity” over the last couple of months (after the Ola takeover), with customers and drivers deserting the service successively in a vicious cycle. Given that cab aggregation is a two-sided market, with prominent cross-sided network effects (number of customers depends on number of cabs and vice versa), it is not possible to do business if you are small, and it takes scale.

For this reason, for a new player to enter the cab aggregation business, it takes significant investments. The cost of acquisition for drivers and passengers is still quite high, and this has to be borne by the new player. Given that a significant number of drivers have to be initially attracted, it takes deep pockets to be able to come in.

Industry players were probably banking on the fact that with the industry already seeing consolidation (when Ola bought TaxiForSure), Venture Capitalists might stop funding newer businesses in this segment, and for that reason Uber and Ola might have a free rein. Ola had even stopped subsidising passengers in the meantime, reasoning (correctly for the time) that with their only competition being Uber they might charge market rates.

From this perspective it is significant that the new player who is entering is an industrial powerhouse with both deep pockets and with a reputation of getting their way around in terms of regulation. The first ensures that they can make the requisite investment (without resorting to VC money) and the second gives the hope that the industry might get around the regulatory troubles it’s been facing so far.

I once again go back to this excellent blog post by Deepak Shenoy on the cab aggregation industry. He had mentioned that what Uber and Ola are doing is to lay down the groundwork for a new sector and more efficient urban transport services. That they may not survive but the ecosystem they create will continue to thrive and add value to urban transport. Reliance’s entry into this sector is a step in making this sector more sustainable.

Will I switch once they launch? Depends upon the quality of service. Currently I’m loyal to Uber primarily because of that factor, but if their service drops and Reliance can offer better service I will have no hesitation in switching.

The ET article linked above talks about drivers cribbing about falling incentives by Uber and Ola. It will be interesting to see how the market plays out once the market stabilises and incentives hit long-run market rates (at which aggregators need to make a profit). A number of drivers have invested in cabs now looking at the short-term profits at hand, but these will surely drop with incentives as the industry stabilises.

Reliance’s entry into cab aggregation is also ominous to other “new” sectors that have shown a semblance of settling down after exuberant VC activity – in the hope that VCs will stop funding that sector and hence competition won’t grow. After the entry into cab aggregation, I won’t be surprised if Reliance Retail were to move into online retail and do a good job of it. The likes of Flipkart beware.

FDI in retail

I’m trying to figure why that is turning out to be a big deal. Given that we have over 5 years of history of “organized retail” in India, and that it hasn’t performed particularly well on a lot of factors, I don’t know how permitting FDI in multi-brand retail is going to make a difference.

In my personal experience, the performance of “modern retail” over the last 5 years has been underwhelming at best. I can’t recall a single time when I’ve gone to one of these chain stores (Big Bazaar/ Reliance Fresh / More) and come back without getting annoyed with the checkout staff. While the variety available at these stores is massive, which is why I go there at times, the stores are all staffed with a bunch of imbeciles. Yes, all of them. They have made an attempt to overcome the unskilled staff by means of “software systems” and that has only added to the problem, rather than helping solve it.

On countless occasions, staff at modern retail outlets have refused to sell me something that I wanted to buy because “the item code wasn’t found in the system”. The other day the customer in front of me wanted to cancel an item midway through checkout, and the checkout staff had to call the store manager to reverse the transaction. I don’t know why the systems have been designed so badly. The fundamental problem with most of these “modern retail” outlets is that the staff there have no real incentive to actually sell you stuff, and the impression one gets is that the only thing staff strive to do is to avoid mistakes. Perhaps their incentives are structured thus. I know of a case from some 4-5 years back, when a family-owned opened across the road from a More outlet and in the course of a year, the latter had shut down.

Given this lacklustre performance of modern retail, I don’t know how much of a difference permitting FDI in the sector will achieve. Yes, it is argued that if Walmart invests directly the “know-how” it has accumulated over the years will be introduced to India. However, there is no reason to believe that this “know-how” has not already been implemented. Major players in organized retail such as Reliance and the Aditya Birla Group (More) have demonstrated in other sectors of their willingness to acquire know-how from across the globe, and implement it better than their global counterparts. Then, most major management consultants in India have established retail practices, which is another route for “knowledge import”. It is also not an issue of capital – Indian investors in various sectors have time and again shown that they are willing to invest in companies with strong business practices.

The problem with modern retail lies not with either know-how or investment. The problem is one of implementation, and I don’t see how bringing in Walmart (who have little idea of Indian markets) can make a difference there. FDI in retail is not going to solve this problem.

The real problem lies in bottlenecks higher up the food supply chain. Various states are yet to repeal the archaic APMC Act which gives certain people monopoly over food trade in certain areas. There are various restrictions on movement of goods across states (though this should be lesser of a problem once the GST (Goods and Service Tax) Regime comes into play). Time and again, the government acts arbitrarily in changing the rules concerning movement, import, export and “support price” of commodities, and this creates uncertainty in the market and scares away investors.

It is reforms higher up the supply chain that are crucial in order to make the food supply chain more efficient and reduce wastage. The government would do well to put the topic of retail FDI on the backburner (especially since it’s controversial) and instead focus on enabling the rest of the supply chain to become more efficient.

Government finances versus public interest

In an op-ed in Business Standard (I think) yesterday, Praveen Chakravarti (he’s with Anand Rathi now, used to be with UIDAI when I met him at the Takshashila Conclave last year) argues that fixed price allocation of telecom spectrum wasn’t such a bad thing since it kept prices for customers low and reasonable. As part of his argument, he mentions that due to the auction of 3G spectrum and licenses, prices of 3G services have been really high, way over the reach of the common man. Similarly, after the auction of the 4th telecom license in 2001, mobile telephony prices remained high, and came down only after the backdoor entry of Reliance and Tata Teleservices a couple of years later.

One of the points that the CAG mentioned in his report on Air India a few days back was about the granting of “sixth freedom” rights to international carriers flying from India. For example, twice this year I flew west (once to the US, once to Europe) from Bangalore, stopping over at Dubai. For both trips, Emirates sold me a single ticket (i.e. I purchased a Bangalore-New York ticket, not separate tickets for Bangalore-Dubai and Dubai-New York). The granting of this sixth freedom to carriers such as Emirates, points out the CAG, has resulted in substantial loss to Air India since no one flies Air India for international flights anymore. I didn’t believe it when I read it but one of the recommendations for the CAG was to cancel sixth freedom licenses to carriers such as Emirates. Another report around the same time recommended that “interior markets” (Bangalore, Hyderabad, Ahmedabad, etc.) be made Air India monopolies in order to protect its finances.

Now, there is a fine balance that needs to be achieved between government revenues through grant of licenses, and the economic impact on the general public because of the grant of such licenses. For example, the government (through Air India) may have lost significant amounts of money thanks to the grant of sixth freedom licenses to carriers such as Emirates. That has been counterbalanced with lower fares and easier flying options for travelers from hitherto less connected sources like Bangalore or Hyderabad. The government may have lost significant revenue by granting backdoor entry to Reliance and Tata Teleservices, but that was compensated by sudden drop in charges for mobile telephony, and the subsequent growth of the sector.

Given Air India’s history and performance, the government could have never invested enough to make Bangalore and Hyderabad as well connected with the rest of the world as, say, Bombay or Delhi. In that sense, granting of sixth freedom rights to Emirates was a cheap way for the government to provide international connectivity to these cities. Similarly, it would have been hard for the government to invest in MTNL or BSNL in order to take mobile telephony to the masses. Backdoor entry to two operators was a “cheaper option” to achieve this objective.

So what was the problem with what Raja did, you ask. The problem there was the creation of a playing field that was not level. He blatantly favoured certain players against others, and made hefty kickbacks from the process. That is the real tragedy of a non-auction process – in that there is “consumer surplus” left over with some of the companies after they’ve paid the fixed price for the resource, and some of this consumer surplus can be channeled in the form of kickbacks to government officials. I don’t know the parallel for this in the aviation space so I’m not able to comment on that.

Reliance Retail?

So on Sunday morning when I went to Reliance Fresh down the road I saw this guy who runs a vegetable store nearby frantically running between shelves, stocking up huge quantities of fresh vegetables. If this were a government store, and if this were license-permit raj, we could have said that this guy was hoarding vegetables.

While this explained why you seldom get fresh stuff at Reliance Fresh later in the day, it made me wonder if Reliance Retail is actually a retail operation. Given the amount of vegetables that this retailer was buying it seemed like it was more profitable for him to walk down the road and source the stuff from Reliance Fresh, rather than traveling a few kilometres down the nearby KR Road to source from the city market.

So thinking about it, this is probably reliance fresh’s strategy. Apart from selling to retail customers, they also make money out of supplying to nearby retailers, who take advantage of the lower prices at Reliance Fresh in order to make a margin for themselves and avoid the long trudge to the wholesale market.

I’m sure Reliance Fresh doesn’t particularly have a problem with the deal, except that they might lose out on customers who know about the poor quality of vegetables one gets there in the evening and so decide to not shop there for other groceries also. Customers know when to get good stuff so they don’t mind. The retailers obviously don’t have a problem.

Neat, ain’t it?