Tag: urban ladder

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.

 

Uber’s surge pricing, Urban Ladder’s Diwali sales and clearing marketplace transactions

I recently bought a bed from Urban Ladder. Since I bought it during their Diwali sale, I got a 20% discount on it. It was supposed to be delivered in three weeks, but it took four. For the trouble caused by the delayed delivery, they gave me an additional 5% discount. As a lay customer, I would have been delighted. As someone with ideas on liquidity and two-sided markets, I’m still delighted by the customer service but intrigued as to why they had to offer the sale at all.
Before we proceed, a word on two-sided markets. By definition, all markets are two-sided, for there is a set of buyers and a set of sellers. The difference between a “traditional market” and a “two sided market” or “platform” as we understand it is that in the former case, the owner and designer of the market is also a participant. Rather the designer of the market is the only participant on the sell side. In a “platform” scenario, the designer of the market is not a participant. The designer makes money by enabling and facilitating transactions. For the rest of this post, however, we will return to the popular definitions and imply “two sided markets” to refer to markets where the market designer is not a participant.
In a two-sided market (by popular definition), the owner of the market usually makes money on a transaction basis. She either takes a fixed sum of money per transaction or more usually a proportion of the value transacted. For example, when you trade stocks, both buyer and seller pay small fees to the exchange (this is in addition to the fees paid to their respective brokers). When you ride an Uber, the marketplace (Uber) takes 20% of the ride proceeds (not currently the case in India, though). Thus, it is in the interest of the designer of the market to maximise the volume/value (usually the latter) of transactions on the market.
Now, two-sided markets have a virtuous cycle/positive feedback built in. The more the buyers you have, the more the sellers want to sell on your “exchange”. And the more the sellers you have, the more the buyers who want to buy. Thus, as a market designer, your job is to “seed” the exchange, to an extent that this virtuous cycle takes off, and then you can essentially relax as the market builds itself and more transactions are transacted.
This necessitates that in the initial stages of building the market, the marketplace will have to make some investments such that buyers and sellers find it profitable to transact. For example, you might choose to take the hit on most of the transaction costs that buyers and sellers face. For example, consider the cab companies in India such as Uber and Ola, which are subsidising both drivers and customers in the hope of building up their respective marketplaces. Once these marketplaces are built and the virtuous cycle kicks in, the platforms can then start making profits.
Building a marketplace is in a sense like climbing two ladders simultaneously, with one foot on each. You have to make constant efforts to beef up both demand and supply, for if at any point in time one goes too far ahead of the other, the market gets unbalanced and you will either have dissatisfied participants (because they could not find a counterparty) or you have to take a hit to ensure that the market gets cleared (to continue the metaphor you either strain your loins or you fall off the ladders 🙂 ). From this perspective, the recent Diwali sale on Urban Ladder doesn’t make too much sense.
I’m getting into anecdata territory here, but as a customer my main pain point regarding Urban Ladder has been their availability. Every time I’ve wanted to buy something it’s either been out of stock or the delivery cycle has been too long – never has the price been a problem to me. My understanding of their market, thus, has been that demand has been far outstripping supply, and at their current market clearing prices (notice that urban ladder sets the prices at which customers buy on the platform), quantity demanded far exceeds quantity supplied. The normal economic response to this would either be to jack up prices – to a level where the market clears, or to aggressively woo suppliers, such that the market clears at current prices. Instead, Urban Ladder made the problem worse by subsidising customers, which further pushed up the gap between quantities demanded and supplied.
Figure 1 illustrates this problem. In the face of the discount (effectively a subsidy) by Urban Ladder, the demand curve shifted right. There was already a gap between demand and supply at the undiscounted price (which was lower than the market clearing price), and the introduction of the discount only made this gap worse. (the Y axis of this graph refers to the price received by the seller).
In the face of the discount, demand moves downward along the curve, and the demand-supply gap increases as shown in the figure.
urbanladder2
During Diwali, Urban Ladder offered a 20% discount. It is unlikely that this discount would have been passed on to their suppliers, which means that the marketplace took a temporary hit in margins in order to grow their market. While it would have grown the market in terms of increasing orders from the buy side, it is unlikely that the market itself would have grown – since the problem with Urban Ladder is supply and not demand.
In the traditional inventory-led model, sales promotions and customer incentivisation are common techniques in order to grow sales – the incentives not only lead you to increase your sales, but also result in a clearing out on your inventory to make room (and working capital) for fresh stocks. In a marketplace model, however, where the bottleneck is clearly on the supply side, it is not clear how a sale results in growth. It seems like Urban Ladder got carried away by the traditional model of growing topline in an inventory-led model.
So does that mean that Urban Ladder’s Diwali sale was wrong? Not really, for they could have done it better. The way to do it would have been to first approach suppliers and lock in an increase in supply. This would have necessitated some subsidies on the supply side – like for example guaranteeing a certain amount of orders during the sale month. Supplies thus guaranteed, Urban Ladder could have then brought on a sale on the demand side to an extent that
1. it would be within their promotional budget and
2. the market would have been cleared.
In fact, it is not even necessary that the discount would have to be entirely monetary – for Urban Ladder could have structured the discount as “10% off sale price and 1 week delivery” or something.
The important thing to consider, thus, is that in a market place model, both demand and supply side are elastic – something that is not the case in an inventory led model where once you have the inventory the supply is largely inelastic. Thus, when demand exceeds supply, one way to clear the market is to actually raise the incentives for the supply side (rather than reducing incentives for the demand side). And this is something that Uber gets right with its surge pricing.
When there is a surge in demand on Uber, prices are jacked up, and more importantly, the jacked up prices are passed on to the drivers. Thus, the jacked up prices help clear the market from two sides – culling demand and increasing supply – for higher prices for a ride would mean that drivers who would otherwise be loathe to venture out into heavy traffic or rain (conditions when surge usually kicks in) would have more incentive to come in and help clear the market!
A market place such as Uber or Urban Ladder is basically a mechanism of matching supply to demand, and the key is in getting the pricing right. Constantly “listening” to both demand and supply helps you do that, and as Uber’s constantly updating surge prices show, adjustments are required. Of course such frequent adjustments are not prudent from the perspective of a company like Urban Ladder. But it is important for them to get at least the direction in the price movement right.
Errata
The original version of this piece indicated the change in price as effecting a shift in the demand curve itself. As those of you know Econ 101 better than I do know, this is simply wrong and the price change results in a movement along the curve. Thanks to Shruti Rajagopalan for pointing this out.