Ever since Flipkart emerged the poster boy of explosive entrepreneurial growth in India, the drumbeat of Indian unicorns has been growing louder. According to one account, of a total of 494 unicorns globally, India has the third largest number at 21, after China’s 206 and the US’ 203.

This was probably before Quikr discovered some issues with its accounting. The popular narrative has lately turned a little worrying as not so assuring news has been arriving about some of these unicorns, not just Quikr alone. As someone who had been trained in the old school of financial value I decided to do a quick and dirty, back of the envelope analysis of the financial performance of a dozen randomly chosen hypergrowth companies. Not all of them have attained unicornhood yet. The 12 start-ups in various stages of evolution or maturity included Delhivery, Dunzo, Gaana, Meesho, Mobikwik, PayTM Mall, PhonePe, Sharechat, Traxcn, Unacademy, Vedantu and Zoomcar.

Consumer-facing business

What is common to the enterprises is that they are all consumer facing businesses, or, in contemporary language, B2C (business to consumer) enterprises that sell their services entirely, or at least predominantly, to retail consumers directly, as opposed to institutional or corporate businesses.

Most of them are also platform enterprises. Contemporary business wisdom recognises that the economics of platform businesses, which have multiple clients at the same time, are different from that of the traditional vertical enterprise that would source inputs from suppliers, process them into goods or services and earn revenue by selling them to customers.

The investment theses behind these enterprises appear to be that they will achieve economies of scale by deploying technology in their operations and would, therefore, deliver extraordinary returns on investment. Further, once they achieve pole position in a market or product category it would be nearly impossible to dislodge them because of the winner take all nature of these markets. Network effects will ensure that their growth is unstoppable and gravity-defying. The financial analysis compared the growth in revenue, growth in expenses and the increase in losses between the two years, using published data relating to these 12 enterprises, between 2017-18 and 2018-19. The data was based on email broadcasts from Entrackr, an electronic publisher of start-up related news.

The combined sales of these enterprises increased from around ₹2,240 crore in 2017-18 to ₹3,316 crore during 2018-19. The combined losses of 11 of these enterprises for which data was available, increased from ₹2,891 crore to ₹4,286 crore. These amount to growth in revenue of 376 per cent and increase in losses of 368 per cent.

The percentage increase in the losses incurred by seven out of 11 was less than the percentage growth in revenue, while in three of the 11 cases the story was the opposite. Together these enterprises had consumed around ₹19,800 crore of capital since they started operations.

The income for many of these enterprises included sizeable levels of financial returns that they had earned on the capital they had mobilised from investors. If income from non-core activities were to be ignored, the operational losses would have been higher.

Invested as fresh equity, in producers of less glamorous old world goods and services, this capital would have been expected to produce at least a 12 per cent post tax return on investment, amounting to profit before tax of around ₹4,000 crore, corresponding to sales of ₹55,000 crore or more, assuming a generous margin of 7 per cent on sales.

To provide a reference point from the less glamorous world of fast moving consumer goods, the combined Indian revenues of the highly valued Colgate Palmolive, Procter & Gamble Home and Healthcare, Dabur, Marico Industries, Godrej Consumer Products, Britannia Industries and Glaxo Smithkline Beecham for 2018-19 were ₹41,600 crore approximately while that of the FMCG behemoth Hindustan Unilever was ₹39,000 crore. It is also worth pointing out that most of the companies mentioned sell premium consumer products. Their products are rarely deeply discounted unlike the offerings of many of the hypergrowth start-ups.

Admittedly, these comparisons are not entirely analogous. They are meant to provide a sense of the scale of revenue that could justify an investment of the order that was made in these dozen start-ups and the distance they would need to cover approximately from where they are to justify these investments.

Effects of globalisation

This pattern in the financials assumes importance when viewed together with the not so encouraging news that has been appearing in the press about governance of some of these firms or the state of their employee relations. There have been accounts in the press for example about OYO’s reduction in staff headcount. These reductions were said to be a result of the developments in WeWork, in what is perhaps an interesting instance of the effects of globalisation of capital flows. OYO has also been in the press, also for the troubled relations it seems to have with some of its key partners, namely, the hotels.

Another unicorn, Zomato, appears to have had similar woes with its restaurant partners even as it was beset with many members of its senior management team leaving in quick succession. Their principal competitor Swiggy had similar problems, although it seems to have been more pragmatic in mending fences quickly.

Governance issues

These developments raise even more basic questions. Are the governance issues and the other signs of trouble the result of the pressure on growth? Where are these pressures coming from? Are these self-inflicted by entrepreneurs who are in a hurry to join the dollar billionaire club? Are these the result of investors who have sub-10 year clocks ticking away because of their fund sizes? Are these signs of basic flaws in the investment theses? Or, are these great products or services that were badly needed in the economy just poorly executed?

The story of home-grown e-commerce firms such as Flipkart, Myntra, BigBasket and Grofers would suggest that they had to go through numerous changes in their operating model as they dealt with the challenges of achieving growth. Yet, their promises of extraordinary returns on invested capital remain unrealised, notwithstanding the various “network effects” that they claim. The returns realised by some of the early-stage investors in these enterprises, which some may offer as a counterfactual to this concern about return on investment, appear to be at best an unexplained financial phenomenon if one does not want to subscribe to the greater fool theory.

Whatever the explanations, one thing appears to be clear. Except for the sharp-nosed early investors who exited from these investments and realised their returns, the pathway to profitability and return on investment for these high profile start-ups appear unclear. It is perhaps a good idea for all of usto hold our excitement on their spectacular growth in sales, before we start looking up to such hypergrowth firms as the aspirational model for all start-ups.

The author teaches at IIM-B. Views are personal.