CIRCUIT BREAKER. Monsters versus midgets

As Alibaba has found eager takers for its $24 billion Initial Public Offer (IPO) in the US, this has added a few more bubbles to the frothy valuations of e-commerce companies in India. If China’s largest online retailer can be valued at over $160 billion, hopeful investors are asking, isn’t India’s very own Alibaba-in-waiting — Flipkart — dirt-cheap at $7 billion? And shouldn’t smaller e-tailers such as Snapdeal be worth a few billions more?

The answer today is a clear ‘No’. Indian e-commerce players, and the market itself, have miles to traverse before they can pit themselves against the Chinese giant.

As of now, comparing Indian e-commerce platforms to Alibaba is like comparing a beetle to a T-Rex. Just consider the numbers.

If social media companies derive their market mojo from the number of active users, e-commerce companies derive theirs from Gross Merchandise Volume (GMV). GMV is a fancy term for the total value of goods and services that change hands on the platform.

Now, Alibaba which owns China’s largest online bazaars such as TaoBao and Tmall, reported a GMV of $296 billion in the year to June 2014. In comparison, Flipkart celebrated an annual GMV of $1 billion in March 2014 (it hopes this will rise to $3 billion in three years).

Simply put, Alibaba is nearly 300 times bigger than Flipkart. Thus, Alibaba is seeking a market value of half its GMV, while Flipkart, going by the recent round of funding, is already valued at 7 times its GMV.

This is not Flipkart’s fault. It’s a function of the tiny e-commerce marketplace in India.

While China’s e-commerce market is pegged at over $500 billion, India’s currently stands at a minuscule $10 billion. What is more, ticketing and travel sites take up the lion’s share of this market while retailing of books, fashion apparel, electronic goods and other wares online is worth just $2.3 billion.

Yes, this sliver of the market is growing fast. But it will have to expand at least a hundredfold before it gets anywhere near China’s. A key reason for the Indian online market’s small size is the country’s poor internet penetration. According to World Bank, while 45 per cent of the Chinese have access to the internet, only 15 per cent of Indians do.

What is more, though India has an estimated 243 million internet users (according to the Internet and Mobile Association of India), thanks to abysmal speed, poor quality connections and concerns about online security, less than a tenth of these users actually buy or sell anything online.

This compares to China’s 300 million online shoppers.

Growth in the domestic e-commerce market is directly dependent on how fast internet connections are added and also on whether these offer a good enough experience for more shoppers to brave online buying.

Profitability is yet another reason why Indian e-commerce companies cannot hold a candle to the Chinese leviathan. While leading online retailers in India are mostly loss-making, Alibaba is hugely and visibly profitable.

For the year ended March 2014, the Chinese e-tailer reported $8.45 billion in revenues and $3.75 billion in profits, earning a mouth-watering profit margin of 44 per cent. This kind of profitability, mixed with the heady growth possibilities of e-commerce, makes for a potent mocktail for global investors.

After all, profits are a rarity in the global internet space, with social media companies only now figuring out how to monetise their user numbers. At its IPO price, each Alibaba share is priced at about 35 times its annual earnings. Financial metrics, combined with the size of the Chinese online market, are the reasons why global investors have pronounced the IPO a steal.

Computing a similar price-earnings multiple for Flipkart would be impossible; its numbers are not in the public domain and it is still reported to be making losses.

With the market itself in a fledgling state, Indian e-tailers are still in the process of figuring out a business model that can turn a profit from booming sales.

Today, the country’s online shoppers are spoilt for choice with shopping sites offering deep discounts, liberal 30-day exchange policies and cash-on-delivery deals.

Online retailers such as Flipkart have sworn by the managed marketplace model, where they don’t just offer a platform for the buyer and seller to meet, but also create the warehousing infrastructure and supply chain to deliver the goods on time to the buyer.

While all this is great for consumers and for market expansion, it isn’t great for the retailers whose bottomlines are liberally bespattered with red. Bruising competition in the sector, which has drawn in global players such as Amazon and eBay, may not allow home-grown players to ease up on the discounts or advertising splurge anytime soon; preventing them from breaking even for some time to come.

In contrast, with its near-monopoly in the Chinese market (some attribute this to friends in high places), Alibaba has got its business model all figured out. TaoBao, its eBay-like arm which allows consumers to buy and sell goods to each other, holds a staggering 80 per cent share of its market.

This kind of dominance automatically rakes in large advertising revenues. TMall, the online retail arm, holds a 51 per cent market share. It allows businesses to set up mini-malls on its site and charges them a fixed commission on all sales.

The sheer number of buyers and sellers who have already signed up on these sites creates a formidable entry barrier to keep out new rivals. Assured revenue streams have in fact helped Alibaba stick to a pure marketplace model, where it spends nothing on logistics or storage, but rakes in the moolah every time a buyer or seller logs on.

In fact, the only point of vulnerability for Alibaba (and it isn’t a small one), is its rather questionable governance practices, made worse by its convoluted structure.

Investors who buy shares in the firm’s IPO will essentially not get to directly own shares in Alibaba’s thriving retail business. Instead they will be buying into a Cayman Island-based holding company which holds ‘interests’ in Alibaba’s diverse businesses.

But then this chink in Alibaba’s armour is cold comfort to investors stacking it up against Indian e-tailers. The regulatory framework for the Indian e-commerce sector is just beginning to evolve.

The ban on Foreign Direct Investments (FDI) in retail has already forced players to house their shareholding and accept funding via Singapore-based arms.

This is yet another risk that e-commerce enthusiasts have to factor in before betting big on the emergence of a desi Alibaba.

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