Flipkart-Amazon battle: Where is the money going?

A huge amount of capital is pouring into Indian e-commerce. With Flipkart raising $1 billion in funding, the biggest funding round any online company has ever raised in India, and Amazon announcing $2 billion worth of investment in India, there are many things that are clear beyond doubt.

One, investors in Flipkart have faith in its execution capabilities and its ability to grab and retain market share. Two, there are no doubts about the online market in India growing at a fast pace. Three, there is clearly an all-out war between the two leaders of online retail in India. So, it's needless to say that all other players are far behind in the race.

The big question is: How are they going to utilise the money?

A good place for this money would be funding operating losses. Another big area is bolstering the technology infrastructure, which will include building a great recommendations engine based on Big Data analytics, backend infrastructure, vendor on boarding, and expanding the logistics and warehousing infrastructure to deliver in more cities in lesser time. Another area is brand building because they would want to be seen more on digital marketing platforms and mainstream media like television.

Also, a big area would be acquisitions - both in vertical areas where they do not have a presence or in horizontal areas like boosting their payments platform. Given that almost 50 per cent of all e-commerce is happening on mobile phones, Flipkart and Amazon will also compete for space on mobile applications on customers' phone. Providing a seamless mobile experience is going to be one area to use funds.

They have the funds for growth but whether that will lead to economies of scale will depend on customer stickiness. Apart from adding new customers, whether or not an existing customer is coming back on the website again and again will be the deciding factor in achieving economies of scale. This is especially important because the cost of customer acquisition continues to be high. Digital marketing is becoming more mainstream but also costlier at the same time. Multiple companies are bidding for the same key words.

Big money, however, carries with it big risks. Companies may tend to invest too much in brand building and marketing, discounting etc. The biggest one by far is scaling up too rapidly, more than what they could handle.

"Customer satisfaction is the biggest casualty when companies turn on the growth engine too hard," says Sanjeev Aggarwal, Managing Director at venture firm Helion Venture Partners.

Besides, the investment is in equity not debt. "It is risk capital and it is the investor's risk if the market growth doesn't come through," says Aggarwal. Most investments in e-commerce companies are happening on the basis of predictions about how the market would grow in the medium to long term.

The e-commerce market has been doubling for the last two years at least. As per a report by consulting firm Technopak, it was $2.3 billion at the end of March 2014. The market was less than half the size at $1 billion a year before.

Technopak predicts the growth trajectory to continue based on what is being observed on consumer behavior, technology penetration which includes both number of devices growing as well as Internet connectivity on phones. Also, the firm studies the growth of brick-and-mortar retail, online retail's biggest competitor, and benchmarks the growth of other e-commerce companies around the world to understand the dynamics in India.

There could be hiccups like foreign direct investment in the sector not being allowed or telecom companies delaying their infrastructure investments, leading to a slowdown in market growth.

"The speed at which a new sector evolves depends on the growth at which the ecosystem evolves... India is a unique market. One would need to keep revisiting its assumptions and revise estimates," says Pragya Singh, Associate Vice President-Retail at Technopak.