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Ventures & Valuations. The Economics of Profit in Loss?

Trying to understand the magic of valuation, ventures, and the economics of investments in losses for profits in the future. Is it a bubble that will burst eventually?

The terms like “Disruptive idea”, “Startups”, “Valuation” and “Funding (Seed A, B, C...)” have been floating all around for more than a decade. Aggregating platforms (digital) seem to dominate the business world. Thousands of crores rupees are floating, infused, and getting invested in such aggregating businesses where such businesses have either not even met the break-even point or are meeting losses.




A few days back I came across a news article that a 7-year-old online pharma company (private limited) has taken over 15 years old pathology lab chain (listed company) at a whopping amount of some six thousand crores rupees. Being from a medical background, this transaction (deal/proposition) attracted me to further study it. While exploring using my limited means, I revealed some information that astonished me completely:


1. The market size of the retail pharma industry in India is of the magnitude of some 4000 crores rupees. Out of this, the small retail medical stores on the streets dominate about 50%. From the remaining pool, there are medical stores located inside or near small, medium, and large hospitals.


2. The medical stores in the hospital premises and the vicinity are difficult to penetrate by any online pharma company. They already have a consistent flow of clients.


3. There are existing brick and mortar chains of the retail pharma brands which are difficult to penetrate by these online pharma companies.


4. With the above facts/information in mind we can calculate that the target market size of all the online retail pharma companies is of the magnitude of not over two thousand crore rupees. For that kind of market, there are multiple players (including the existing brick and mortar brand chains).


5. One usual term used by these companies is “Loyal Clients”. This seems to be a misappropriate term in reality. How can any company consider “Client as loyal”? Why should “Client be loyal”? In the era where “Client is God”, how can anybody think and expect the client to be loyal. It should ideally be another way round. The companies have to be “loyal to their clients”.


6. To buy the hypothetical loyalty of their clients, the online companies then need to offer “cash backs” and “discounts” to their clients. This cashback and discounts eat upon their net revenue. They then claim that it is their “client acquisition cost”. The real problem is that this client acquisition cost keeps escalating as soon as the existing brick and mortar retailer offers a better discount on some medicines or some other online company offers one percent extra discount or fifty rupees extra cashback. The struggle of retaining the client by offering cash backs and unrealistic discounts finally ends in vain.


7. When I am saying “unrealistic discounts”, then I mean it. In a distribution chain, the retailer usually gets a margin between 5% to 25% on the products. Now, these online companies are tying up with the retailers and offering higher discounts. This extra discount definitely will not be offered by the retailer. The online pharma company bears this extra cost. Above that, there is the cost of courier or delivery. Where is the profit then? Oh! They are building a brand value. The question remains unanswered, where is the profit? Oh! It’s coming from advertisements. Ok! Then why keep pharma? Why not search engines? In all this, I forgot to mention the enormous cost involved in advertising for the brand.


8. With the restriction on selling certain medications online, and cost capping by the government. The online pharma companies can’t venture into these segments which are completely driven by the brick-and-mortar pharma retailers.


9. One big challenge is the use of an app. The medicines have to be selected by the client (as per the prescription) and then the prescription to be uploaded and then payment to be made using any payment channel. This looks easier said than done by many patients. India still lives dominantly in the rural sector and there are challenges in using the app (Internet connectivity, language, understanding of medicine’s names, doctor’s handwriting, similarity between names of two different drugs, and many more challenges).


10. If a customer can avoid all these hassles at a neighboring medical store, why anybody would take the pain of selecting the products, uploading the prescription, and paying online (with the possibility of paying an extra convenience fee)?


11. “Doctor’s handwriting” is an enormous challenge for people while ordering medicines online. Electronic Medical Records and Prescriptions are still a distant dream (specifically in rural India). It may take a few years to apply strict EMR throughout the nation. Till then, this challenge will continue.


12. Availability of a particular brand of medicine (as prescribed by the doctor) with the tied-up medical store is also variable. In that situation, the online pharma company people try to influence the patient to go for another brand. This raises ethical and competency issues.


13. One of the online pharmacies claims that they have a tie-up with over Eighty Thousand retailers and have covered over 90% of the pin codes of the country. With this information in mind, we can assume that there is an availability of lacs of pharma retailers covering most of the pin codes in India. We know that these pharma stores/retailers share an excellent relationship with the neighboring clients and most of them offer home delivery, discounts, and credits to their clients. A big question arises here is then why would these clients switch to any online pharmacy? The cashback and discounts incentives can be the reasons but they can’t sustain for long. These clients will ultimately come back to their previous medical store. Let’s not underestimate the need for “Timely delivery” and also the cases of emergency.


14. Data privacy undoubtedly is the biggest challenge. We are already witnessing this issue with almost all digital platforms. Despite various claims, there are no strict guidelines for data privacy and confidentiality. The customer’s data has become a sellable commodity.


15. A very important factor in all this analysis is that the supply of the products is not unlimited. The raw material supply of most of such products comes from a non-friendly neighbor. In that situation, the supply chain gets affected by across-the-border relationships and situations. That brings one big dent to the revenue.


16. In the pharmaceutical industry, too much demand ethically should not increase the cost proportionally. If some medicines are is too much in demand (because of certain situations) then government plays or should play a role to control the cost to avoid the situation of converting disaster into an opportunity for the business houses.


17. Finally, the laws related to the distribution of medicines are highly strict and keep amending keeping the safety of the patients (people) in mind. Any tweak in the law can go for or against online pharma companies. That may bring out the possibility of lobbying by these online pharma companies. The lobbying may lead to corruption.


18. With all the above calculations, the profitability of online pharma is questionable. The cost of mass marketing, tie-up with multiple medical stores, maintaining the delivery chain, and above all the volatility of the clients makes it more difficult for these online pharma companies to turn profitable.


With all the above points in consideration, the questions that remain unanswered are:

1. Why are investors putting funds into these projects? Is it only the projection of future sales? Are these sales realistic? Will there be any profits? If there are no profits, then how do the investors get their money back? Again, one more valuation exercise and selling the part of the project to another investor? The bubble will keep growing. Will, it burst someday? If yes, then where the invested money came from and where did it go? Were the investors not interested in seeing the profits from the business? Or it’s a business of developing a product for valuation and then one more valuation and then more valuation? Where is the real growth? It’s confusing.


2. An online private limited company booking loss (before tax) of a hundred crore buys a brick and mortar diagnostic company (listed) with a net annual turnover of about 450 crores. How realistic is this deal? The deal is worth about six thousand crores. That again raises questions. With a net annual turnover of 450 crores, the profits of this company would be between 40-50 crores (presumptive figure). Then there are many players (of equal and more strength) in the market (of diagnostics). The overall market size is about 6000-7000 crores (shared by all the small, mid, large players). With these facts, the quantum of investment of six thousand crores raises many queries. In the same context, it makes me think; it takes an investment of 200-300 crores to build one medical college. With this amount used in the transaction discussed above, nearly 20 medical colleges (with every college having diagnostic labs and imaging centers) could be up.


Finally, I can say that this business of valuation looks magical. There are many players in this market (Promoter, Analyst, Pitcher, liasoner, Funder, etc.). The pitch deck is more valuable than the product. There are pitch deck templates available to woo the funders/investors. They derive various formulae to calculate the valuation (based on future projections) on which the investors invest in the particular startup. There surely would be some accounts, art, science, data, and logic behind these transactions, but the magnitude of these transactions in such businesses is questionable.


I have taken only one example here. A lot of deals like this are happening around. Funds seem to flow in with unrealistic magnitude and with no realistic and logical expectations of profits from these businesses. I hope this is not one more bubble to burst in the future.


My intention of writing this article is not to raise suspicion but to bring forward a query coming into the minds of common people. The funds and investments are flowing in the online aggregator’s sector (food, pharma, health, hospitality, entertainment, travel, luxury, etc.) But the actual issues seem to be untouched and devoid of funding. I am again repeating my question and pardon me for being repetitive: Why and how this funds movement is happening? Is there anything that the eyes of common people cannot see? Only time will tell.


Regards,

Dr. Deepak Chaturvedi M.D. Medicine


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